Good day, everyone, and welcome to the Paycom Software third quarter 2017 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note that today's event is being recorded. I would now like to turn the conference over to Mr. Craig Boelte, Chief Financial Officer. Please go ahead, sir.
Thank you, and good afternoon. Before we get started, I would like to note that certain statements made during this conference call that are not historical facts, including those regarding our future plans, objectives, and expected performance, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements represent our outlook only as of the date of this conference call. While we believe any forward-looking statements we have made are reasonable, actual results could differ materially because the statements are based on our current expectations and are subject to risks and uncertainties. These risks and uncertainties are discussed in our filings with the Securities and Exchange Commission, including our annual report on Form 10-K for the year ended December 31st, 2016. You should refer to and consider these factors when relying on such forward-looking information.
Any forward-looking statement speaks only as of the date on which it is made. We do not undertake and expressly disclaim any obligation to update or alter our forward-looking statements, whether as a result of new information, future events, or otherwise, except as required by applicable law. Also, during the course of today's call, we will refer to certain non-GAAP financial measures. A reconciliation schedule showing GAAP versus non-GAAP results is included in the press release that we issued after the close of the market today, which is available on our website at investors.paycom.com. I will now turn the call over to Chad Richison, Paycom's President and Chief Executive Officer.
Thanks, Craig, and thank you to everyone joining our call to review our third quarter 2017 results. As with prior calls, I'll start with a brief review of our results and then provide some comments on the payroll and human capital management or HCM market and recent developments. Craig will speak to our financials and guidance. Then we'll open up the line for Q&A. Our third quarter results were solid, with revenue coming in at $101.3 million, representing growth of 31% over the comparable prior year period. Our commitment to client success continues to fuel our progress at Paycom. This drive, combined with our powerful single database solution, allows us to attract new clients as our reputation for providing the best option for business continues to grow.
Our success was recognized in September when we placed second on the Fortune magazine's 100 Fastest-Growing Companies list of publicly traded companies for 2017. Each company's rank on the list was determined based on three areas of performance over a three-year period. Average revenue growth, average increase in earnings per share, and total stock return. We believe this recognition underscores the fact that Paycom is one of a very small number of public companies that is achieving not just the rule of 40, but the rule of 60 when you look at the combination of our revenue growth and adjusted EBITDA margin. We are very proud of this achievement. Our profitable business model continues to allow us to return value to our shareholders.
We recently completed our second $50 million stock repurchase plan. Today I'm pleased to announce that our board has reloaded and increased our plan to allow us to repurchase an additional $75 million of common stock. We are able to achieve these results by remaining focused on providing the best possible user experience. With this goal in mind, we continued to enhance our value proposition in October by creating our own content and releasing 10 learning courses to clients who have our learning management system or LMS module. These courses were designed and built internally at Paycom, and the feedback we have received from clients regarding our proprietary content has been tremendous. These courses are built into our LMS module, enabling employers to educate their managers and employees quickly, easily, and consistently on topics like workplace violence, preventing discrimination and harassment, workplace ethics, hiring practices, lawful separations, and more.
We look forward to delivering even more content to our LMS clients and believe offering these courses will help drive further adoption of this module. Additionally, with Paycom's November release, our Mileage Tracker capability will now be available in our native mobile app. This significant upgrade to our expense management module allows our clients' employees to easily calculate mileage reimbursement for work-related activities that then automatically populate Paycom's expense management module. Employers can now track mileage more accurately, which will help them eliminate profit leaks within their organization. For instance, without this functionality, an employee might travel 22.1 miles but actually fill out an expense report reflecting 25 miles. With Mileage Tracker, specific miles are tracked accurately. On a trip for one current employee where 2.9 miles were rounded up, the company will now save over $1.50 on that one trip for just that one employee.
This is based on the federal reimbursement rate of $0.535 per mile. As this is extrapolated out to include all reimbursable travel mileage for employees, the savings can be into the tens, if not hundreds of thousands of dollars for any one company. On the marketing side, I'm pleased to highlight that toward the end of the third quarter, we launched our first national television advertising campaign with an accompanying digital strategy. The ad supports our overall value proposition of using one system with a very simple tagline, "Paycom does more." We have been monitoring several indicators of brand awareness growth to evaluate the success of this campaign and are pleased with the early returns we are seeing. You can view the ad at our website, paycom.com. I want to make a brief mention of hurricanes Harvey and Irma.
We have a significant presence in the affected areas, with two offices in Florida and five in Texas. We evacuated both our Florida offices and even asked our personnel to evacuate the state during the storm. Our offices in Texas experienced disruption as well, with two complete evacuations in Houston and Austin. We had all of our offices back up and running as quickly as possible, and I want to thank people on the ground in those areas, as well as our teams in Oklahoma City, for making sure the impact was as minimal as possible, both for our employees and for our clients. As of today, all of the Paycom sales offices are fully operational. A final point to be understood is that while we experienced some disruption to our prospecting and conversion efforts in the affected areas, at no time were any clients' payrolls impacted by these events.
This wasn't our first hurricane experience. That was evident in our preparations before and service during these events. Before I turn the call over to Craig for an update on our financials and our guidance, I'd like to take a moment to thank William Kerber, our longtime CIO, for his many years of service and invaluable contributions to helping Paycom grow into the success it is today. I have known William for many years, and we continue our friendship even as this chapter of working together is closed. Regarding our software development and IT efforts, we have a very solid team with a deep bench in place that will continue to ensure that we remain on the cutting edge of HCM and are able to provide the best solution to our clients and prospective clients. I'll let Craig comment on our financial performance for the quarter. Craig?
Thanks, Chad. Before I review our third quarter results and also our outlook for the fourth quarter and full year 2017, I would like to remind everyone that my comments related to certain financial measures will be on a non-GAAP basis. We use adjusted EBITDA and non-GAAP net income as supplemental measures to review and assess our performance and for planning purposes. Adjusted EBITDA is a non-GAAP financial measure that excludes non-cash stock-based compensation expense. Non-GAAP net income is a non-GAAP financial measure that also reflects adjustment for non-cash stock-based compensation expense, which is further adjusted for the effect of income taxes. Reconciliations of the GAAP to non-GAAP measures discussed today are included in the earnings press release issued earlier this afternoon. As Chad mentioned, we had good results in the third quarter with total revenues of $101.3 million, representing year-over-year growth of 31% from the comparable prior year period.
Our revenue growth continues to be primarily driven by new business wins. We are pleased with our continued performance over the comparable growth we saw in 2016. Within total revenues, recurring revenue was $99.5 million for the third quarter of 2017, representing 98% of total revenues for the quarter and growing 31% from the comparable prior year period. Total adjusted gross profit for the third quarter was $85 million, representing an adjusted gross margin of 84%. For the full year 2017, we anticipate that our adjusted gross margin will be within a range of 83%-84%. Total adjusted administrative expenses were $59.3 million for the quarter as compared to $49.1 million in the third quarter of 2016. Adjusted sales and marketing expense for the third quarter of 2017 was $33.5 million. Adjusted R&D expense was $7.4 million in the third quarter of 2017, or 7.3% of total revenues.
Although we capitalized a higher percentage of our total R&D costs this quarter, we anticipate that going forward, our capitalized R&D costs will be in line with our historical capitalization rate of approximately 29%-32%, though we may see fluctuations from quarter to quarter. Total adjusted R&D costs, including the capitalized portion, were $10.8 million in the third quarter of 2017, compared to $7.6 million in the prior year period. Adjusted EBITDA was $30.7 million or 30.3% of total revenues in the third quarter of 2017, compared to $18.2 million or 23.5% of total revenues in the third quarter of 2016. Our GAAP net income for the third quarter was $14.1 million, or $0.24 per diluted share based on approximately 59 million shares, versus $6.2 million, or $0.10 per diluted share based on approximately 59 million shares a year ago.
Our effective income tax rate for the third quarter year-to-date 2017 was 8.3%. Non-GAAP net income for the third quarter of 2017 was $17 million, or $0.29 per diluted share, based on approximately 59 million shares versus $9 million or $0.15 per diluted share a year ago. We expect stock-based comp to be approximately $7 million in the fourth quarter of 2017. In the third quarter, we repurchased a total of approximately $17.3 million of stock under our $50 million stock repurchase plan. As Chad mentioned, we are pleased to announce our $75 million repurchase plan and look forward to continuing to return cash to our stockholders opportunistically via open market purchases. For modeling purposes, we anticipate fully diluted shares outstanding will be approximately 59 million in the fourth quarter. Turning to the balance sheet.
We ended the quarter with cash and cash equivalents of $66.6 million and total debt of $34.4 million. As a reminder, this debt represents a financing of construction at our corporate headquarters. Construction of our fourth building continues to go well and according to schedule. Cash from operations was $37.1 million for the third quarter, reflecting our strong revenue performance and the profitability of our business model. The average daily balance of funds held on behalf of clients was approximately $740 million in the third quarter of 2017. Now let me turn to guidance for the fourth quarter and full year for fiscal 2017. For the fourth quarter of 2017, we expect total revenues in the range of $111.5 million-$113.5 million, representing a growth rate over the comparable prior year period of approximately 28% at the midpoint of the range.
We expect adjusted EBITDA for the fourth quarter in the range of $26 million-$28 million, representing an adjusted EBITDA margin of approximately 24% at the midpoint of the range. For fiscal 2017, we are increasing our revenue guidance to a range of $430.5 million-$432.5 million, or approximately 31% year-over-year growth at the midpoint of the range. We are increasing our full year 2017 adjusted EBITDA guidance to a range of $131 million-$133 million, representing an adjusted EBITDA margin of approximately 31% at the midpoint of the range. With that, we will open the line for questions. Operator?
Thank you. We will now begin the question and answer session. To ask a question, you may press star, then one on your touch tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then two. At this time, we will pause for a moment to assemble our roster. Our first questioner today will be Raimo Lenschow with Barclays. Please go ahead.
Thanks for taking my question and congrats on a great quarter. Just quick questions from me. Chad, on the impact on the hurricane, I know it kind of will disrupt some of the sales cycles. Could that impact some of the revenue as well that you're seeing in Q3, Q4? Or is it just really a week or two on the sales cycles that you're missing?
Yeah, it depends on the office. We had some offices that were inaccessible for a longer period of time. Other offices weren't necessarily as inaccessible. We just had to get people back into the areas where there wasn't a lot of gasoline and different things. Then you even had other places where potentially, not potentially, but you actually had prospective clients that were in other areas where they weren't specifically in the path of the hurricane, but they had assets in those areas. The people we sell to and the people we work with on conversion are the same people that work on asset protection when you talk about employees and what have you. So, there was some minor disruption, I would say. This is nothing that, from a Paycom perspective, I believe it's just a period in time that it's impacted us.
Again, specifically as it relates to certain prospecting efforts and some conversions as well. I can't say that we had deals that were set to start and they're not going to start. Many of them are coming in already. It's just situational, depending upon the client and their own situation of impact in those areas.
Okay, thanks. Craig, for you, on the big beat on EBITDA this quarter, a lot of that came from sales and marketing. Is there anything you can help us, look, as a devil's advocate, I would say the new ARR sales was weak, and hence there was lower commission payment, but maybe I'm kind of right or wrong there. Can you just help us understand what kind of drove that upside there? Thank you.
This is Chad. We definitely did have some deals that pushed in out of that quarter that were ready to start, and they pushed out of that quarter. You had the Houston piece and then the Florida. There's some of that there. There's also, if you think back, last year, we opened up 6 offices, not only that, we opened them all up in the beginning of the year. We talked about how it takes 14 months for reps to become executive reps and productive, and it takes 24 months for an office to become mature. Last year, we had 6 offices with twice or more, because again, as you're heading into the third quarter, you would have had additional reps hired in those offices. We were carrying more reps last year that weren't selling as much because they're newer.
This year, we opened up 3 offices, we didn't open them up at the first of the year. We actually opened them up later. They actually have less non-productive reps. You have a little bit of that.
You have a little bit of some of the hurricane. The other thing is, our sales and marketing just doesn't include sales commissions and sales salaries. You also have marketing in there. We gained some efficiencies also in that area.
Yeah. Okay, perfect. Thank you.
Thank you.
The next question will be Michael Nemerov with Credit Suisse. Please go ahead.
Hey, thanks for taking my questions. I want to piggyback on the hurricane issue. First of all, I hope all of your employees are safe. Chad, can you maybe quantify the impact on revenues and the bookings in Q3 and maybe if there is an impact in Q4, if we could quantify that? Are you still seeing any lasting impact on new bookings in the affected areas?
Yeah. I'll take your last question first. I am sure there are still some prospects and clients that are dealing with the effects of the hurricane. There would be some of that. Now, is that a meaningful impact on us? As I sit here today, I would not think so. That's for prospecting efforts as we sit here today. Now, when you're talking about the week or week and a half leading up to some of these, and the time during, and then getting people back into office. When we evacuate an office, we evacuate the office. It's not just people. There's data, there's paper, there's files. There's a lot to that. You've got to get everybody back in those locations, and a hurricane is something that you do rather quickly.
The other answer to your question is, the specific analysis of that, I think for myself, I feel like those deals are good and they're going to start, and we're seeing them start, and many of them have. I do see this as more of an impact from a certain point. Obviously, if you had a prospecting impact, that can last a little bit longer for you into the subsequent month. I believe that we've weathered this well. I don't feel like this is going to have any impact on 2018 at all. I think as time goes on throughout this quarter, it's going to have less and less of an impact as we move forward.
That's helpful, Chad. Asked another way, do you think that your Q4 guidance on revenue was impacted by the hurricane?
Well, like I said, if deals are scheduled to start in September, or scheduled to start even in mid-August, or even the beginning of August, and you push those past first quarter, that's going to impact first quarter because you could have potentially received 100% of the revenue billing in fourth quarter, and you might only receive two-thirds of the expectation there. Those thoughts of ours are baked in to our Q4 guidance right now.
Yeah, I think Chad said first quarter. I think he meant the first month.
Yeah, I said first quarter. I meant first month.
The first month of the fourth quarter. That's right.
Right. Just one for Craig, if I may, just piggybacking on Raimo's question. Your prior long-term target operating model has adjusted EBITDA at 30%-33%, your guide this year already implies at the lower end of this range. How should we view the margin profile in the medium to long term going forward? Thanks. That's it.
We increased our adjusted EBITDA long-term model to the 30%-33%, I think, middle of last year, and we're already starting to hit that moving forward. I think the one thing that will have some impact on that moving forward is going to be 606. We're still evaluating 606, and we don't foresee a big impact on the revenue side, but we do foresee an impact on the adjusted EBITDA side on that. We're really focused on being a high-growth company. Not including 606, the adjusted EBITDA is not something we're necessarily super focused on. We're focused on the growth, and we're going to spend accordingly and hope to have some margin expansion along the way.
That's great. Thanks, guys, for taking my questions.
Thank you.
The next question will be John DiFucci with Jefferies. Please go ahead.
Thank you. I think you hit the natural disaster stuff pretty well. I guess one of the things that we noticed in our model here, Chad and Craig, is you've shown significant sales and marketing leverage, not only this year, but last year, too. You mentioned the national TV ad campaign. I guess, should we start to see that not show as much leverage going forward, or should we continue to see some of that?
Yeah, leverage on the sales marketing side. Our advertising campaign was at the very end. I don't even know how much of it was even in third quarter.
The third quarter.
I'd have to look at that. We launched it toward the very end of third quarter, I think if you look at us quarter to quarter, it ebbs and flows, it depends on how many non-productive reps we're carrying. It depends on whether or not a newer rep sold a deal in which they get half the commission of an executive rep. There's many factors that can go into any quarter, and that's just on the commission and salary side for salespeople. We had promoted more regional managers last year than we did this year. There's other factors that factor into that. You have the marketing expense. People have made mention that we weren't at HR Tech this year. Well, if you go to HR Tech, that's pretty expensive.
It costs us, I think, $80,000 just to ship and set up our booth, much less everything else. We've gained expenses in the sales and marketing in other areas. Is that going to continue? There's going to be months where it's not specifically that way, depending upon when deals start and what somebody's commission rates are on that. Craig, I don't know if you had anything to add.
No, I would agree with that. On the marketing side, there's certain events that we attend one year and then maybe not the next. We're probably not going to see, in terms of HR Tech and those type of things, those aren't going to increase at the same level as our revenue rates. You would, from quarter-to-quarter, see some ups and downs in those.
Okay. Thank you.
Thank you.
Our next question will be Mark Murphy with JPMorgan. Please go ahead.
Yes, thank you very much, and I'll add my congrats on the results. Chad, so I wanted to ask you, did anything in the Ackman slide deck regarding ADP stand out to you? Anything in there that you think further illustrates the industry backdrop, and just whether you think their assessment of the landscape and the technology in there is accurate or not?
I don't really think it's fair for me to comment on that situation. I do think that there's a lot of information out there. I think a lot of the information that was pulled was information that was already out there and well-known, and so we don't really have a dog in that hunt, so I'll let ADP and Ackman comment on that.
Over the summer, you conducted a survey of HR professionals, and I think you published some of those results. It touched on self-service trends, like single login and data entry and so on and so forth. What do you think we should take away from the findings? Was there anything in there that surprised you?
I think what surprises me, I don't know that it surprised me, but it was very confirming, that is that people are still using, businesses are still using HCM an old way. There's new technology available. There's new devices available. A perfect example of that's our Mileage Tracker. I mentioned it. It's in our app. You push start, it tracks. It'll even tell you the best way to get to a location. It tracks the specific drive you take. Again, that's reported right back into the system, and it becomes part of the expense management. If you're a rep or someone that travels and you don't receive direct reimbursement for the company, but it's something that you track for tax purposes, it does that as well.
That's something that wouldn't have been available in the past, today it is, that's something that employees have access to, we expect that to drive adoption and usage of our, not just employee self-service, but specifically that expense management module, the same goes for LMS training. I think that, for me, is what I notice most about it. It's confirming that there's still a huge opportunity to shift the way businesses use HCM products and specifically their employees.
Okay. The next one I wanted to touch on is the course content. I think you mentioned you launched 10 courses. Can you just help us understand at a high level, why did you decide to begin developing content, and how material do you think that revenue stream could become for Paycom?
Well, this first group, this first piece of content is included within our LMS module, if there's a client using LMS today, they just received 10 courses of value in their content, which we do believe is going to increase usage and drive additional adoption of that. Training's not something new. People have been training people since the stone tablets, training's not anything that's new. Again, that's another area where maybe people in the enterprise level have started training people this way, now it's making its way to the mid-market, there's also a piece where you have to train people on how to train and go through that process. We created the distribution module of LMS that allows us to update LMS courses.
It's not just the courses that they're taking, it's also we measure retention of the information, the training that they went through. For us, I do believe Learning management is a very important thing for any organization. We're a very large user of our own system, and I think we're thousands of courses in our own system that we use internally here at Paycom to manage our own business. I see that as being a future catalyst for LMS, for sure, and a potential revenue driver. It will be, in the future, a revenue driver as we release more courses.
Thank you.
Thank you.
The next question will be Brad Reback with Stifel. Please go ahead.
Great. Thanks a lot. [Abhey Lamba], as you think about the expansion here on learning, beyond that, what type of growth do you think you can see in per employee, per month pricing a couple of years from now on a percent basis?
That's hard. It's all about the value. Just because we come up with something, it doesn't necessarily mean that it drives value for the client. For us, it's about the value and the ROI that we're driving for the client. To the extent somebody's paying us $1, they need to have an ROI of $2 plus. That's really the way we approach pricing of the products that we put out. We do have monthly releases here at Paycom, so we're always updating the system. 99% of that, we're not charging for. It's enhancements to our current system, and sometimes we do. That's just hard to forecast from here when we're talking a couple of years out.
Great. Thanks very much.
Thank you.
The next question or two will be David Hynes with Canaccord. Please go ahead.
Hey. Thanks, guys. Congrats on the Fortune award. That's a great company to be included with. I wanted to build on Mark's question on the LMS. Now that you guys have invested in the content, do you feel like you're going to put a more concerted effort to go back into the base with that product, or is this really about improving attach on new deals?
Well, for instance, the 10 content courses we created, we created a library launch, and 100% of every one of our LMS clients today now has those 10 courses in their LMS platform. That's already there today. Yes, it will allow us to go back into clients and talk about how they use those courses and gain value. We had to have a focus group as we went through and created these products. We were very deliberate with this as we moved Stacey into that role of our Chief Learning Officer earlier this year, to really go through that. We just think that that's going to impact not just client training, but also how they learn on our system and increase usage over time as well.
Yeah, sure. It sounds like a little bit of both. I wanted to ask about stock-based comp, as it pertains, I guess, to quality of earnings. I think you guys came in double where you had guided us. It's the second quarter in a row where it's ticked up. Just curious if there's any change in philosophy there, if there's anything one-time in nature that we should be aware of. How are you thinking about that line as we build our models forward?
Yeah, in terms of stock-based comp, what we saw in this quarter was we have certain market shares out there, and two of those hit the triggers on those. We had some of that as well as in the second quarter. All of those have hit their triggers now, moving forward, there'll be some more of those issued next year. We don't really guide on stock comp. We did give some information that we expect fourth quarter to be in that $7 million range.
Got it. Last, I'll sneak one in if I can. I suspect I know the answer. Chad, care to give any thoughts about 2018 high-level framework for thinking about growth versus profits and the trade-off there?
Yeah. Well, in a perfect world, there's not as much trade-off on that. You can somewhat capture both, and I think we've kind of proven that as we've continued to grow.
Sure.
As far as 2018, there's so much that we're doing right now, and we're going to know so much more as we kind of turn the corner on that. As with years in the past, we'll update that with our fourth quarter announcement.
You got it. Sounds good. Thanks, guys.
Thank you, Dave.
The next question will come from Mark Marcon with Baird. Please go ahead.
Good afternoon. Thanks for taking my question, and congratulations. I was wondering if you could just come back to some of the earlier questions. If we take a look at this Florida and Texas, what % of your revenue base is that, and how different are the commission runs or the new sales that they're seeing in those offices relative to areas that would be completely unaffected, whether it's out in the Northeast or West Coast, et cetera?
Well, I think we have 36 mature offices. We have 45, and we have nine still in the maturing phase. We have 36 mature offices. This impacted four of those. Business doesn't all come in I guess it doesn't all flow. You can have a good month, and the next month it's not as well, and I'm talking about for any one office.
Sure.
They can maximize one month, and then the next month they're doing more prospecting or what have you. That's really hard to say. These are successful offices for us. They have been mature offices. A couple of them finished consistently up in the top. One of them specifically is always up at the top in that area. Like I said before, I think it's hard to quantify specifically all the areas of either missed opportunity or deals that might still be in conversion as well. We've had a plan for all of them. We feel really good about what's going on. Many of them are already converted, it's just hard to quantify it specifically.
Okay. Chad, how would you characterize
I guess what I'd say, Mark. Oh, go ahead, sorry. Go ahead.
No, no. You go ahead.
Well, I was just going to say, it's not nothing. There is an impact there. Again, we're dealing with our own employee base, too. We had our own employees that experienced loss during this as well. So, there's kind of a time for everything. Right now, we've called the time to get back out there and be prospecting and get those businesses set up, and I'm really happy with the people of how they handled it. I feel really good. Like I said before, any disruption we would have expected to happen to us in Q4 is provided within that guidance that we've given, and we do not expect this to have any impact on our 2018.
Great. Then just a follow-up. You obviously have a ton of different feelers out there in terms of the real economy. It seems like economic activity is picking up. How would you characterize, in areas that are completely unaffected, just the level of buyer enthusiasm, the pipeline, et cetera? How would you characterize that?
Yeah, I would say it's been business as usual. I can't point to anything that's changed there. It's been good. We're a business that, in a down market, we look to drive efficiencies for our clients, and therefore, we're a good fit for them. That doesn't really change when things are going well. So, for us, we have to be strong regardless of what's happening. Again, we still represent such a small portion of our overall opportunity. There's still plenty out there.
Great. The new offices that have just opened, how are those progressing?
They're progressing according to plan. As a reminder, it does take 24 months for a new office to become mature. They are progressing.
Great. Thank you.
Thank you.
Our next questioner will be Corey Greendale with First Analysis. Please go ahead.
Hey, good afternoon. Congratulations on the quarter. Also returning to a topic from earlier when talking about maybe the reasons for the beat, you mentioned two things, like the hurricanes could've affected commissions, but I'm not sure I got a full sense of Beating EBITDA is not unusual, but it's a larger beat than usual. Can you just talk a little bit more about what drove the outperformance relative to your expectation?
I think if you look at the overall beat, it came in two areas. I think we probably talked about the sales and marketing. In R&D, one of the things I pointed out was we capitalized at a little higher rate this quarter than what we had been seeing. That probably drove 80 basis points in the R&D, from where it would've been had we capitalized at a more normal rate. We expect that to come back to more normal rates for fourth quarter. In our G&A, we saw some efficiencies there, as well as in the gross margin. I think on the gross margin, it was more of a head count. We didn't hire quite as many people as what we had expected for the quarter, but we're continuing to staff up and looking good going into fourth quarter on that.
You've been investing more in R&D, whether it's expensed or capitalized. Are you happy with this if you look at this run rate as a % of revenue, or do you expect that to still increase over time?
Well, what we're happy about is the output that's coming out of R&D. To the extent we need to spend more as a % of revenue to get the specific output we're looking for, we're going to do that. I think I've said it before. We're at where we're at as a % of R&D. We've continued to spend, we've continued to increase that. I don't see us rivaling our competitors in that area of R&D spend. I believe that we're doing a great job on the output side, and that has to do with our process and the way we work.
Great. Then just one last quick one, and I'm taking this from the answer to another question, maybe I'm taking this too much out of context, in answer to another question, I think maybe Craig said, the focus is on growth over margin. As you think about that, where are the places where you could spend more to kind of increase growth? Would you think about accelerating new office openings, or an ad in the TV spend, or how should we think about those opportunities?
Yeah. The best way to increase growth for us is productivity. Then obviously, in order to best leverage your productivity gains that you have within the sales force, you definitely want to continue to open up offices because that becomes your future productivity model. I would see us focusing on both of those.
Great. Thank you.
Thank you.
The next questioner will be Ross MacMillan with RBC. Please go ahead.
Thanks so much for taking my questions. Chad, you did a great job in highlighting the number of offices impacted and maybe the backdrop of the productive offices. I was just curious, is it right to think of this impact in terms of time being in the last two months of Q3 and maybe the first month of Q4 in terms of the selling motion and then the go live, so it's like a three-month period weighted towards Q3? Is that a fair reflection of the situation from the hurricanes?
Yeah. Definitely. I don't want to talk about any one client that might still be out there suffering that we can't necessarily do a lot about based on their situation, that might be waiting longer. Yeah, I wouldn't expect this to have much longer of a run than that. That's not to say we wouldn't have a few outliers with that, but I feel really good. We measure pushes every week, so I know when a deal pushes. During this time, we had weeks of $900,000 in annualized pushes, which is just unheard of at our company. The question is, okay, when are those coming back? Well, some of them are already coming back, and we didn't lose them again. There were other points of focus for them as it relates to their own assets in those areas.
We did have pushes, but again, I just want to stress this, any disruption we felt like there would be in fourth quarter is already baked into our guidance, and we do not feel like this would have any impact for 2018.
That's very clear. That 900's probably come down, but it's not quite at a normalized level yet?
That was just for one week.
That's just for one week.
That's an annualized number. That's an annualized revenue number, but that's $900,000 annually.
I understand. This one for Craig. You mentioned 606, and I'm just thinking this through. I don't believe you capitalize commissions, and you generally recognize them within the first month of a deal start. Is the way to think about this is that your EBIT could get a benefit, but then there's going to be a tail of amortization, so it might be short term beneficial for EBITDA? Am I not thinking about that the right way? Is there some other pushes and pulls on EBITDA under 606?
I think you're kind of thinking about that right, but we're recognizing that over the life of the client, which is 10 years. As we've grown throughout the years, those type of expenses, and it's not just commissions, it's also some salaries related to that. Those have continued to grow, so the amortization on that on some of those earlier years is pretty small. We should see a benefit under 606 in the-
Yeah
as it relates to EBITDA.
Yeah. That's helpful. Just on, Chad, I know you don't talk about office openings, but just on the productivity commentary, I just wondered, is there a trigger point when you look at the productivity across the productive offices and you say, "Okay, now is the time to move forward with the new opening"? Or maybe just any commentary about where you are on that productivity curve, and when you get to a threshold where you'd want to start to maybe press on more openings. That would be helpful.
Yeah. It's important for us to be opening up offices throughout 2018. I think that we took a more staggered approach this year to develop those salespeople who are ready to be in management. They know who they are, and we've been working with that group, many of them, for the better part of seven or eight months. As we turn the corner on the beginning of the year, we'll be assessing that and making those decisions. 2018, we will be opening up offices.
Great. Thanks again, and congratulations.
Thank you.
The next question will be Brent Bracelin with KeyBanc. Please go ahead.
Thanks for taking the question. Chad, I'll actually follow up on that last question. This is just from a high-level perspective, as you think about new offices, the mature offices, I think 80% of the offices are mature now. You have another six that looking like they'll turn that 24-month maturity in Q1 of next year. Assuming no additional offices, that puts you at north of 90% of the offices that are kind of mature. How do you think about that balance, mature versus new? What's the right kind of balance as you think about that mature versus new equation?
Yeah. I would like to sit here and say that it's very scientific, but I'll just be flat out straight is, if we have the people ready to do it, we're doing it. We did find that there were some areas we could get better at that, development of people who are ready and identifying the right people. That's something that we very much improved on and have become stronger at. This is a people development. The market's right. There's plenty of opportunity out there for us. We are gaining the productivity gains. If I was waiting for that, it's something that I would've said, "Okay, well, let's do more." This is really about people being ready to be able to backfill relocating managers.
Got it. As you think about the target cities opportunity out there, is there still some low-hanging fruit and opportunities you'd like to pursue sooner rather than later, and it's the people that is kind of slowing things down a little bit? Walk us through the opportunity for new city expansion.
When it comes to any specific territory that we've identified for opening, I'm somewhat agnostic on which one.
Okay.
To some extent, that depends on the relocating manager. I think I've said it before. We wouldn't necessarily take an Oklahoma City manager and relocate them to Manhattan. You want to make sure you have a cultural fit with the people that you are putting in an area, and our Manhattan people are doing quite well. You have to look at that as well across the board.
Our next question will be Siti Panigrahi with Wells Fargo Securities. Please go ahead.
Yeah, I think a lot of the questions that I was going to ask have been answered, but could you kind of just talk about if you've seen any changes in the competitive landscape, specifically from ADP or any other competitors?
It's been somewhat business as usual for us. I can't say it's harder to get business, for sure, but it's been business as usual for us. I think I've said it before, we're very focused on our own value proposition and what we do, and we've really stayed in our own lane on that. Yeah, I can't speak to any, and I'd say that I don't know of any new entrants that have made an impact. For us, it's been the usual suspects.
Our next questioner today will be Abhey Lamba with Mizuho Securities. Please go ahead.
Thank you. Chad, you talked about the leverage from sales and marketing that we saw. Can you just break it down to how much of it was personnel versus commissions versus scale back in some marketing spend?
We haven't done that in the past, and we wouldn't do that on this call.
Our next questioner today will be Ryan MacDonald with Dougherty & Company. Please go ahead.
Hey, guys. I guess just expanding on maybe what you talked about with the new national brand campaign, to the extent that maybe you're starting to see results and benefits from that, can you talk about how you're thinking about brand awareness and maybe how that might factor in your potential office expansions? Are you looking at the data and trying to see certain regions or areas where you might not have much brand equity in that space to try and look at that as a new greenfield opportunity? Perhaps in areas where you think you have some really great brand awareness and that you want to even double down on that type of region?
Yeah. Well, first I would say that the ads are pretty new, I wouldn't say they've had an impact on our Well, they wouldn't be having an impact on our numbers right now. Driving brand awareness also, or maybe those deals we pitched two years ago that didn't go, you definitely want to be in front of them. Also, if you watch our ads, we're not necessarily just advertising to prospects. We have a client base as well, and there's best case usage for how someone uses our product. I'll make this last point. I didn't know the iPhone did merge calls until I saw a commercial on it, and I'd used it for a couple of years. I think it's important for people to use our products the correct way as well.
Got it. I guess just one quick follow-up. When you talk about learning management, I think it's an area where we've seen that's been penetrated sort of on the enterprise side of the business. As you start looking at your target customer base and expanding there, can you talk about what kind of penetration you've already seen maybe in that market for learning management? Is it something that you're finding is new to your existing customer base?
We sell a single system, so we do not break out adoption for any one module. Like I said, everyone in the mid-market does training. There is not a client that does not do training and learning. They just might be doing it using a different type of model, which could even be manually in many cases. So, we are not just bringing the tool, we are not just bringing the content, we are also bringing the process through which someone can set up training specific to their business. Then, they already have the tool to be able to get it out to all of their employees, be able to actually assess comprehension of the information that was presented and trained on.
Ladies and gentlemen, this will conclude the question and answer session. I would now like to turn the conference back over to Chad Richison for any closing remarks.
I want to thank everyone for joining us on the call today. We appreciate your time and interest. We look forward to meeting with investors at the Credit Suisse TMT Conference on November 28th in Scottsdale. The Wells Fargo Tech Summit in Park City on December 5th, and the Barclays Global TMT Conference in San Francisco on December 6th. Thank you, operator, you may disconnect.
Thank you. The conference has now concluded. Thank you all for attending today's presentation. You may now disconnect.