Paylocity Holding Corporation (PCTY) Q2 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Paylocity Holding Corporation Second Quarter 2016 Fiscal Year Results. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this conference call may be recorded. I would now like to turn the conference over to Peter McGrail, CFO. You may begin.

Good afternoon and welcome to Paylocity's earnings results call for the second quarter of fiscal 2016, which ended on December 31, 2015. I am Peter McGrail, CFO; and joining me on the call today is Steve Beauchamp, CEO of Paylocity. Today, we will be discussing the results announced in our press release, issued after the market close. A webcast replay of this call will be available for the next 45 days on our website under the Investor Relations tab. Before beginning, we must caution you that today's remarks in this discussion including statements made during the question-and-answer session contain forward-looking statements. These statements are subject to numerous important factors, risks and uncertainties which could cause actual results to differ from the results implied by these or other forward-looking statements. Also, these statements are based solely on the present information and are subject to risks and uncertainties that can cause actual results to differ materially from those projected in the forward-looking statements. For additional information, please refer to our filings with the Securities and Exchange Commission for the risk factors contained therein and other disclosures. We do not undertake any duty to update any forward-looking statements. Also, during the course of today's call, we will refer to certain non-GAAP financial measures. We believe that non-GAAP measures are more representative of how we internally measure the business. And there is a reconciliation schedule detailing these results currently available on our press release, which is located on our website at paylocity.com, under the Investor Relations tab and filed with the Securities and Exchange Commission. The non-revenue financial measures we will discuss today are non-GAAP unless we state the measures as GAAP. With that, let me turn the call over to Steve.

Thank you, Peter, and thanks to all of you for joining us on our second quarter earnings call. Our second quarter was our strongest quarter as a public company with record revenue growth accompanied by strong margin expansion, meaningful leverage in G&A cost, and positive non-GAAP net income. Total revenue was up 61% year-over-year, as we experienced significant demand for our ACA Enhanced solution from current clients. We also had strong performance from both sales and implementation based on strong demand in the market as evidenced by the 52% increase in implementation revenue. Adjusted total gross margin increased to 60% for the quarter, up from 52% the same period last fiscal year. The improvement in adjusted gross margin expansion was largely driven by strong revenue performance on higher-margin ACA product along with the benefits from the purchase of our last reseller in May of 2015. Non-GAAP net income was positive for the second consecutive quarter at $4.1 million and $0.08 per share. We are increasing our fiscal 2016 guidance to forecast non-GAAP net income of between $9.5 million and $10.5 million or $0.18 to $0.19 per share for fiscal 2016. The combination of delivering a differentiated platform with high-touch client service, including our approach to ACA compliance has allowed us to continue posting 92% revenue retention. During the quarter, we were once again ranked on Deloitte's list of 500 fastest growing technology companies in North America. The fall selling season is a very important time of year as many medium size businesses evaluate their payroll and HCM platform, targeting a change in January. The primary reason clients continue to select Paylocity is the strength of our unified human capital management platform that delivers an intuitive user experience for every employee in the company. We continue to have success in the broker channel as referrals from 401(k) advisors, health insurance brokers, and third-party administrators represented more than 30% of our new business revenue in the quarter. Overall demand environment for a unified payroll and HCM solution remains very strong. Affordable Care Act compliance is an important topic with brokers and prospects; therefore let me provide some additional detail on the impact to new business sales in the quarter. ACA did drive some clients to advance their implementation timeline and we had a number of clients start in October and November versus January such that all of their ACA data for 2015 could be managed in a single platform. We found that mid-market clients were still relatively unfamiliar with the new legislation; therefore, they did not spend much time evaluating competitive ACA offerings. We do, however, believe the investments we have made in our Enhanced ACA module will provide a differentiated experience to our current clients and will become a more important part of the decision criteria throughout calendar year 2016 once businesses have completed ACA filing for the first time. As you are aware, current clients with 50 or more full-time employees are required to file 1095s for calendar year 2015. In response to this new legislation, most payroll competitors developed an ACA product for both their clients and prospects. Our approach was to develop a product that provided all clients impacted by ACA, the tools necessary to comply with this legislation. The ACA Enhanced offering represents a reoccurring revenue stream and is built on a per-employee per-month basis and is a full ACA compliance module with an interactive dashboard for ongoing management of ACA events and ability to preview individual 1095s anytime throughout the year. We designed our Enhanced ACA solution to automate as much of the set up as possible, easing the burden for current clients by creating business logic using their payroll data instead of requiring them to subscribe to our benefit enrollment and time and labor solutions. We trained and leveraged our service teams to interact with current clients driving high attach rates. The majority of clients with 50 or more employees signed up for our ACA Enhanced product offerings during the quarter. The recent announcement, delaying ACA deadlines for distribution of the 1095s to March 30 and then subsequent filing to the IRS by June 30, simply provides our operation teams more time to proactively work with clients to make sure we have the required company and employee data to accurately produce and file the forms on their behalf. We now anticipate producing 1095s for all our clients in February and early March. This is a very busy quarter for all of our operations employees who are focused on delivering a seamless yearend experience to our clients. Our cross functional year-end committee coordinates with all of our internal operation teams to ensure we can answer the various year-end payroll questions, complete annual bonus and adjustment payrolls and file year-end tax forms to various federal, state and local agencies. The collaborative efforts across our organization has allowed us to produce more than 2 million W-2s and deliver them to our client even earlier than last year. The addition of ACA also had significant complexity, increasing the number of client touch points. The proactive approach we have taken with our clients puts us in a position to prepare more than 1 million 1095s. I am very proud of the effort and collaboration from all employees during this very busy time of year as we continue to focus on delivering innovative technology backed by high-touch service. We increased our investment in research and development by 51% versus the same period a year ago as we make frequent improvements to our platform based on feedback from our clients. As mentioned earlier, the primary reason clients switch to Paylocity is the efficiency gained by rolling out our HCM platform to every employee in the company. Clients leverage our platform by rolling out additional capabilities to managers and employees, therefore reducing the administrative burden on the HR and payroll internal staff. Employees use both our portal and mobile app for a variety of common tasks. Examples include viewing a new redesigned visual representation of their pay, requesting time off, punching in and out, providing peer-to-peer recognition, reading company news and contents published by the HR administrator just to name a few common functions. The intuitive nature of the self-service platform continued to an important in valuation criteria as it saves clients a significant amount of time and allows them to efficiently engage with their employees. We continue to see our clients increasingly take advantage of these capabilities with more than 30% of all active employees on our platform signing into our software every month. The addition of newer mobile app features such as push notification for time-off approval and mobile timesheet approval has increased manager utilization rates with 70% of active manager roles logging into our platform at least once per month. I would like to wrap up my prepared remarks by thanking our more than 1,500 dedicated employees for delivering a strong second quarter and creating positive momentum as we move into the second half of our fiscal year. I would now like to pass the call to Peter to provide more details on our financial results.

Thanks, Steve. Let me walk through the results in more detail. Total revenue for the quarter was $55.2 million, which represents a 60.8% increase from the year-ago quarter. Our total recurring revenue of $52.3 million was up 61.3% from the year-ago quarter and represented 95% of our total revenue. As Steve mentioned, this tremendous growth was attributable to the wide acceptance by our clients of our ACA Enhanced solution as well as the performance of our sales team. The second quarter also benefited from a favorable calendar, as we experienced very high levels of payroll activity related to yearend bonuses and adjustment runs. Recurring fees were up 61.4% in the quarter and interest revenue increased 57.7% year-over-year, primarily as a result of our client growth and balance increases. Implementation services and other revenue was $2.8 million for the quarter, up 51.9% from the year-ago quarter. Within our implementation services and other revenue category, payroll start-up revenue was particularly strong. As Steve noted in his remarks, we did have a number of clients start in October and November versus January, so that their 2015 ACA data could be managed in a single platform. We are also pleased to report that our annual revenue retention rate, which is always calculated on a trailing 12-month basis, remained above 92% as it has for several years. As we've noted in the past, we believe this is best-in-class for our segment. The combination of high recurring revenue percentages and high retention rates, provide significant visibility into our future operating results. Adjusted gross profit in the quarter was $33.3 million, representing margin of 60.3%, as compared to $17.8 million or 51.9% in the year-ago quarter, an 840 basis point improvement. ACA Enhanced, a higher margin to product, was a key driver to this increase along with improvements related to our second reseller acquisition, strong performance by our sales team and other natural cost leverage. We view our adjusted recurring revenue gross margins as the best indicator of our overall long-term margin opportunity as we generate these margins on greater than 95% of our revenues. Our adjusted gross profit on recurring revenues was $38.1 million or 72.8% in the second quarter, up from $21.6 million or 66.7% in the year-ago quarter, a 610 basis point improvement. Again, this improvement was a combination of the wide adoption of our ACA Enhanced product along with improvements attributable to our second reseller acquisition and other natural cost leverage. Given the large-scale adoption of our ACA Enhanced product and the tremendous performance of our sales team, we began adding significant additional operational resources at the tail end of the second quarter and plan to continue this trend over the next few quarters. Amongst other benefits, this will allow us to provide ongoing ACA related support to our clients as well as maintain the highest overall service levels. We continue to invest in research and development. In addition to significant new modules such as ACA, we are equally committed to refreshing and modernizing our platform to maintain and extend our technological advantage. In order to understand our overall investment in research and development, it is important to combine both what we expense and what we capitalize. On a combined non-GAAP basis, total research and development investments were $7.7 million or 14% of revenue in the second quarter, up 51% increase from the year-ago quarter. On a non-GAAP basis, sales and marketing expense was $13.1 million or 23.8% of revenue in the quarter, compared to $8.5 million or 24.7% in the same period last year. We are especially pleased that we were able to achieve significant penetration of our ACA Enhanced product without a significant increase in sales costs. On a non-GAAP basis, general and administrative costs were $8.8 million or 15.9% of revenue in the quarter, compared to $6.6 million or 19.1% of revenue in the year-ago quarter, a 320 basis point improvement. We continue to leverage our G&A costs following our IPO in March of 2014. Our adjusted EBITDA was $7.2 million for the quarter versus a loss of $0.2 million for the year-ago quarter. For the first six months of our fiscal year, we've generated $10.5 million of adjusted EBITDA versus $0.1 million for the same period last year and $8.2 million for all of last fiscal year. Non-GAAP net income was $4.1 million or $0.8 per share for the quarter versus a loss of $2.3 million or negative $0.05 per share in the year-ago quarter. For the first six months of our fiscal year, we've generated $4.9 million of non-GAAP net income versus a loss of $3.7 million for the same period last year and non-GAAP net income of approximately $0.4 million for all of last fiscal year. Briefly covering our GAAP results; for the quarter gross profit was $31.1 million, operating loss was $1.3 million and net loss was $1.2 million. In regard to the balance sheet, we ended the quarter with cash and cash equivalents of $79 million. Cash flows generated by operating activities were $7.8 million in the quarter versus $1 million in the year-ago quarter. This increase was the direct result of our increased on non-GAAP net income in the quarter. For the first six months of our fiscal year, we've generated $10.8 million of operating cash flows versus point $0.8 million for the same period last year and $11.1 million for all of last fiscal year. Finally, I'd like to provide our financial guidance for the third quarter and updated guidance for the full year of fiscal 2016. In the third quarter, total revenue is expected to be in the range of $66.5 million to $67.5 million, which represents 41% to 43% growth over the third quarter of last year. Adjusted EBITDA is expected to be in the range of $10.5 million to $11.5 million. Non-GAAP net income is expected to be in the range of $7 million to $8 million or $0.13 per share to $0.15 per share based on approximately $54 million diluted weighted average common shares outstanding. For the fiscal year, total revenue is expected to be in the range of $223 million to $225 million, an increase of $12 million at the midpoint from our previous guidance and representing 46% to 47% growth over last year. Adjusted EBITDA is expected to be in the range of $22 million to $23 million. Non-GAAP net income is expected to be in the range of $9.5 million to $10.5 million or $0.18 to $0.19 per share based on approximately $54 million diluted weighted average common shares outstanding. In summary, we are very pleased with our performance during the quarter highlighted by wide adoption of our ACA Enhanced product and excellent sales execution. We experienced the greatest quarterly revenue growth on a percentage in dollar basis in our history along with tremendous gross margin expansion and substantial G&A expense leverage. As a result, we are meaningfully raising guidance for the full fiscal year. One final note, Steve will be attending the JMP Technology Conference in San Francisco on February 29, and I will be attending the Northland Growth Conference on March 9 in New York. Operator, we are now ready to begin the Q&A session.

Thank you. [Operator Instructions] And our first question comes from Justin Furby of William Blair. Your line is now open.

Hi, guys. Thanks and congrats on another stunning quarter. Steve, I wanted to ask about the growth rate. Historically if you look at the - it's comprised sort of mid-20% unit growth and then ARPU drives the rest of it, and I'm wondering if you look under the coverage this quarter, it feels like maybe unit growth steps up. I'm just curious how much it steps up. Is it meaningfully higher than what you typically see, and if it is, I'm just curious how if that becomes difficult to manage to keep the retention where it is and it sounds like you're making lot of operational hires, but any sort of commentary there would be helpful, and the I've got a couple of follow-ups.

Sure. So first, I would just point out the fact that this is really the fourth year in a row, we've had 40% plus growth, clearly a 60% quarter is an acceleration from that. We've had pretty solid demand environment overall for a number of years; that consistently happened throughout this quarter. We had a little bit more new starts in the quarter that we felt changed. Clients actually said to us, I wanted to start in January, but could you get me on the platform in October or November. So that had an impact and certainly impacted the growth rate for the quarter. In addition to that, the majority of our customers purchasing ACA, mostly at the start of the quarter frankly, had a big impact to the quarter and then lastly this quarter always had some calendar impacts. Peter mentioned that in his prepared remarks, bonus runs adjustments that was much higher than last quarter. So I think you can see we've had a pretty consistent increase in - a gradual increase in kind of our core business, and then we had these other circumstances that led it to a higher revenue quarter.

Got it. And then if you look out over the next sort of three years to five years, obviously it seems unreasonable to keep these kind of growth rates up, but is there anything preventing you from sort of same 30%, 35% plus type range in - just any general commentary over the next sort of medium term will be super helpful, and I've got one more. Thanks.

Sure. So I think if you look back at our history, we've been 20% to 25% unit growth rate over the last several years, and then the ARPU growth has really driven the rest of the balance of the growth, and you combine that with your solid sales execution over top of that. I think we look at the future with that exact same formula, it might not be exactly 20% to 25% unit growth rate, but that mix between unit growth and ARPU growth. We've obviously continued to add to our product portfolio, it's $250 per employee per year, somebody bought everything. We've got internal targets to move that up over time to $300. So we feel confident that mix between ARPU and unit growth is really going to be key to our future growth.

Got it. And then one more, I was sitting in a seminar earlier this week by a competitor of yours, and they talked about some of the coming - changes in the overtime rules, and they were positioning something as big as ACA. And just curious if you think these coming changes are another big opportunity or sort of how you view them? Thanks.

Yes. So I think any time there is legislative changes that creates a little bit more complexity and increases the need to have kind of an intuitive software experience in terms of managing these changes, is a good thing for the industry as a whole. The changes that we're talking about in terms of overtime rules certainly fall into that category. But I wouldn't necessarily compare from a revenue opportunity to ACA.

Got it. Thank you very much, and congrats guys.

Thank you.

Thank you. And our next question comes from Terry Tillman of Raymond James. Your line is now open.

Hi, this is Brian Peterson in for Terry; congrats on the quarter guys. I just want to hit on the ACA dynamic a little bit. Curious if that was a factor at all in some of the bake offs versus the competition in actually securing new deals or was that - a lot of that success simply selling into the customer base?

Yes. So, ACA, the success in the revenue component of ACA was really driven from selling back into the customer base. In fact, spending time with our sales force, it was very difficult for them to even demonstrate differentiation around the ACA solution since customers had nothing to compare to and all of our competitors were offering an ACA solution. So, I would say to you beyond having some customers start a little it earlier, we didn't really see ACA have any impact, in terms of wining new business.

Customers who would have otherwise started in January, decided to start a little early, so they can take advantage of our ACA solution.

Got it. Understood. And just maybe a higher level question, Steve: as obviously when you came out with the IPO, it was a $200 million per employee per year, now we're at $250 million, targeting $300 million. Just curious what kind of products you see in the roadmap that are going to get you that extra $50? Thanks.

Sure. So, we always talk about our products in five categories. Payroll being core, and everybody obviously require and payroll being core part of our value proposition. But we do feel that there is opportunities to add either additional modules or capabilities such that we can increase that product opportunity in time and labor and benefits. We've done some recent adds in talent management and having a good traction with that. And so we feel pretty - as well as core HR. And so, those would be all four categories, we feel like we've got an opportunity to significantly increase the total product opportunity.

Thank you. And our next question comes from Scott Burg of Needham & Company. Your line is now open.

Hi Steve and Peter, congrats on an outstanding quarter. A couple of quick ones for me; Peter, would it be difficult to qualify or quantify the impact of pulling ahead those implementations for the customers that wanted to get live early. My guess is it probably didn't have a meaningful impact to the quarter, but just trying to think about it there is a different way to maybe understand what that impact was.

So, I don't know that we can put exact percentage on it, but we certainly had great sales execution for seven months. We did see. It was enough for us to notice, right? There was enough for us to notice that we will point that clients were asking to [indiscernible] to normally start in January that we're going to - wanted to start in October and November so they could take advantage of our ACA solution. So, it certainly did have an impact. The exact quantity is difficult to say, but it's definitely had an impact on the quarter.

Sure. I guess the better way to ask is the outperformance in the quarter was really driven more by the additional customer adds versus just a few customers wanting to ramp early.

I think going back to kind of our historical run rate in terms of our growth rate, you can see we've been at roughly 40% net accelerated last quarter. So we've continued to build momentum in the core business. And then if you take the fact that we had some people start a little bit earlier, you take the fact that we had a huge adoption rate within our ACA module and then you take the fact that we had some additional year-end activity that kind of gets you from where we've been gradually accelerating historically to the 61% quarter.

That gets you from our recent history to what happened this quarter.

Got it. And then given the continued strength in the end market, as you look at your direct sales force here in the back half of your fiscal year, do you think you accelerate any hiring there. Whether it's on a significant or nominal basis to help capture an end market that clearly still has a lot of demand opportunity in the near-term for you?

Yes, I think overall, we still think of kind of consistent execution over time is kind of our core focus, and obviously there are some circumstances that we were able to accelerate revenue this quarter. But if you look back at the reason I mentioned that, you look back at our history, we've been growing sales reps in the 30% range historically. We have not made any decisions in terms of what the number of sales reps look like for next year, but we certainly wouldn't go materially outside of that range in terms of trying to accelerate, no.

Got it. And then I guess the last question for me; I'd be remiss if I didn't ask an ACA questions since everyone else has. Do you think in the quarter you drove any incremental deal close or drove customers to maybe go out and seek a new payroll core HR solution, maybe for someone that wasn't in the market or thought about being in the market?

Well, here's what I would say to you: we continue to get more than 50% of our business from ADP and Paychex and they both have ACA solutions and we're making that widely known to their customer base as well as any of the local and regional. So, pretty much everybody that we are in competition within the fall, had an ACA solution, and customers had actually never been through it before, so couldn't really even do a comparison between our ACA solution versus another. So, in many cases we wouldn't actually even have to demonstrate ACA. We would just bring them on the strength of our platform and they want to make sure that we had that kind of as a checkbox. We do think though that the investments that we've made in ACA and some of the automation that we've built into our dashboards, will help differentiate our platform in 2016 once customers have actually already been through a filing.

Yes. And to add a little more color to that, if our customers were like the other customers in the midmarket, from summer to fall, our customers were still very uncertain as to what ACA was and whether they were going to have to comply a lot. So that would tell you that they probably weren't out looking for solutions, because they were uncertain as to what they needed to do, what their obligation was.

Great. That's all I have. I'll jump back in the queue. Thanks for taking my questions.

Thanks, Scott.

Thank you. And our next question comes from Jeff Houston of Northland Securities. Your line is now open.

Hey guys, thanks for taking my questions. I guess looking at the partner referral network, it's the second sequential quarter of that being roughly 30% of new business, just curious about how you - if you expect that momentum to continue there and is your guidance for the rest of the year assume that 30% stays in place or maybe it dips back to 25% or - just some color there and how it's tracking and what you're really doing to fuel it?

Yes, so we were obviously very pleased with the overall sales execution within the quarter as a whole. And being able to continue and maintain 30% plus in terms of referrals from brokers was certainly part of that execution. Our view is that the brokers are going through a significant kind of multiyear change in their business model, where technology is becoming a much more important part of the equation for them, and therefore technology partnership is going to be important to them. And we think that that's really the big driver for us. We continue to have great conversations in that channel. So I would be thrilled if we can maintain 30% plus, but we don't necessarily task our sales force with a specific percentage from brokers, it's really based off of an overall quota. So we haven't really anticipated any changes going forward in terms of how we set our quotas.

Got it, great. And then, ACA was clearly a big winner in the quarter. What other modules had some pretty good momentum behind them in the last three months was a time benefits recruiting performance management?

Yes.

[indiscernible]

Sure. I think what we're seeing is kind of, what I would call, more of a steady increase across the board, it's very uncommon now for us to sell payroll without the core HR application, pretty much everybody is looking at us as not only being the payroll system, but using that employee of record to expand and us being their core human resource system. That's happened more and more commonly. Time and labor continues to be a strong product for us and kind of gradually improve. And then on-boarding has been fantastic performance management, maybe a little bit more gradual than on-boarding, and then benefits is definitely increasing. It's relatively small for the smallest category for us overall, but it has had a really nice growth rate. So, we've kind of seen gradual improvement in terms of product penetration across all the categories.

That's helpful. Thank you.

Thank you. And our next question comes from Corey Greendale of First Analysis. Your line is now open.

Hey, good afternoon and congratulations on a great quarter. You've done a really good job explaining kind of the ACA impact and the pieces that added up the accelerated growth. So, associated with that, can you just talk a little bit about implementation, many strains on your implementation staff with people accelerating into October and - any initial customer feedback on how the implementations have been going?

Sure. So one of the things, we're very focused on, I think, we'd be consistent in telling you that implementation really is the driver of capacity versus really our sales execution. And so, it was a very busy quarter for us from an implementation perspective and then you add on the fact that you've got customers who have told us they would normally go in January, and then come to us and ask to start earlier. We try to accommodate as many of those customers as possible. And so we certainly stretched our implementation capacity this quarter. It's one of the reasons that we're really hiring both in implementation as well in service to make sure that we can maintain the quality level that our customers have come to expect. We've delivered 92% plus retention for years, and so we feel like we stretched ourselves a little bit but we're on top of the hiring and we shouldn't impact - we shouldn't have an impact to overall customer satisfaction.

Okay, that's great. And on that point about hiring any - can you possibly quantify that a little better just give us some sense of the cost impact of the additional hiring you're going to be doing?

Well, I think if you look at our forecast from an adjusted EBITDA and a non-GAAP net income, you can see that we certainly have incorporated some additional expenses into that forecast to be able to react to this great quarter from a sales perspective and an ACA Enhanced product penetration, so we've got that built into the forecast, probably the easiest thing for you to look at.

Okay. And just one more quick one for me: with everything going on in the market, any change or any new commentary on some of the newer different business model kinds of competitors in the market like those that are giving away the software for free?

Sure. So, there are some other business models. We generally see those maybe at the low end of our target market segment in terms of size. The broker community is well aware of those, because they typically are giving away the software and trying to collect the insurance commissions. I would say, it does have the brokers more interested in partnerships, and we think that's one of the factors in terms of driving us to a 30% broker referral rate. But we haven't - we don't see them very often form a head-to-head perspective, because it's typically at the low end of our market.

Great. Thank you.

Thank you. And our next question comes from Nandan Amladi of Deutsche Bank. Your line is now open.

Thank you for taking my question. So Steve, this is a kind of a big picture question: how sensitive is your buy plan and your new customer signups to just the broader employment data versus switchovers form the traditional service bureaus?

Yes. I would tell you that most of the customers as I mentioned in my prepared remarks, they're really coming to us to create efficiencies within their organization. They potentially rolling out new capabilities and modules. And remember this is maybe an average - I think last year it was about a $13,000 purchase. So, this isn't a high dollar purchase, and it's one that's really being driven from efficiency. So our prior experience obviously being a much smaller company in less than deal economic perspective, it didn't really feel it from a new business perspective. Where we do feel it obviously and we had historically where interest rates were dropping at that time, and then our customers would have a few less people on the platform. Those are really the two areas of impact. But we don't think necessarily that from a new business perspective, it changes our value proposition.

Great. And a quick financial follow-up for Peter: as we look ahead, what would be the main areas of leverage in your model, you touched on G&A and gross margins in your script.

So I think we've been pretty consistent over time that we had - obviously had tremendous gross margin advancement in the quarter, 800 overall, 600 recurring and then tremendous leverage, 320 basis points or so in G&A. But we've been pretty - it was a great quarter, ACA propelled this quarter was terrific, but we have consistently said over time that we'd like to grind out 80 basis points to 100 basis points in margin on annual basis, and 80 basis point and 100 basis point improvement in G&A on an annual basis. Maybe not linear, but that's our goal, we stick to it, we believe we can plug along and do that. Obviously we've had tremendously more than that since we've been public, but we still believe that that over the long-term is what we should be shooting for what we should - what we should - what our goal is.

Thank you. That's all for me.

Thank you. And our next question comes from Mark Marcon of Robert W. Baird. Your line is now open.

Good afternoon and congratulations, Steve and Peter. With regards to the ACA how - what percentage of the clients ended up signing up in October or November? And then wondering if you can break it down between Enhanced versus Essentials?

Yes. So our Enhanced offering, which is the per-employee per-month offering was really dominant share of all the signups. We had very few customers not even worth - the number is not worth mentioning on Essentials frankly. So we were very pleased that they saw the value in the ongoing management of ACA, not just this past quarter, but throughout calendar year 2016. And the way we rolled it out is we essentially got the revenue for the entire quarter for those customers. And in terms of the numbers, we have 50% of our customers over 50 employees, the majority of the customers signed up for ACA Enhanced and we got that revenue for the entire quarter.

Great. And then with regards to the pipeline, what - based on the sales calls that you're going out on and that your team is going out on, what are they seeing in terms of like the percentage of companies that are out there in your target market that have already implemented an ACA solution at this point in time. So we're here in February; how many are still like in catch up mode do you think?

Yes. So I think if you look at - and obviously I know you follow all the companies in the industry, you see some various penetration rates, but many of them are north of 50% in terms of other company penetration rates, that's obviously we had those type of results as well. So we think in the mid market that companies are generally turning to their payroll provider for an ACA solution. We do, at time, see companies maybe using a third party or their broker, but I would say that's fewer and far between. As we're competing right now, we're generally taking someone from our competitor and they are generally subscribing to that ACA solution.

Great. And then how does your pipeline look? In terms of the sales pipeline, RFPs that are active, how is that momentum that you've had in the business and the great success that you've had, how is that translating to forward momentum in terms of the sales pipeline?

Yes. So, we kind of manage our pipeline. You don't see a lot of RFPs and the average customer is a little more than 100 employees. It's pretty activity driven, it's activity in the broker channel, it's activity with first presentations and follow-up presentations and closing business. This is a time of year right now, where our sales team is kind of actively engaging and filling that pipeline backup every-year-after year end, because the customers that wanted to start in January, we've got them on onboard and now customers are starting to look at, hey, maybe I should have switched in January and you see some activity in February and March. And then the next big kind of start month for our business is April. And because of how quickly our cycles move, it's a little early for us to have a sense on April, but we certainly came in with good momentum. The first seven months of the year has been very strong for us from a sales perspective, and we are - it's still a bit difficult for us to give you a sense of the balance of the year at this point.

Okay, great. And then lastly, as it relates to the client size and the ARPU, what are you seeing in terms of the differences now? I mean you mentioned the 13,000 average was 100 before; how is it looking in terms of average size? And is it staying at 13,000 or with the Enhanced, is it going up as we go through the balance of the year?

So, let's just take a step back. We've been executing really a land and expand strategy, really focused on the land part and trying to get as many new customers as possible on, and we've been selling those customers more product every year. ACA Enhanced is really the first time that we've executed an expand strategy back to the client base, and obviously we were very successful with the penetration rate associated with that. We still will continue to focus on land versus expand. We've always viewed expand as frankly an easier solution to be able to solve. So, I would tell you on a go-forward basis, we're still going to focus on land. We may do a little bit of expand on a go-forward basis, but that will not be our primary factor. Your points of valid one, this penetration rate into the client base will have an impact in terms of that average revenue per customer, but we'll also continue to sell new customers more products. So the combination of those two things, which is really going to have an impact on that ARPU year-over-year.

And does the size of the average client, is that changing at all?

So what I would tell you is the size of the average customer over the last couple of years has ticked up just likely every year, and we believe that it's been a positive employment environment over the last couple of years, so our customers are naturally adding employees; that's probably been the bigger driver. Sales has been selling roughly the same average size. There might be a slight uptick, but we're only going up a few employees a year on our averages, so it's certainly not a material driver.

Great. Thank you very much.

Thank you. And our next question comes from Patrick Walravens of JMP Securities. Your line is now open. Patrick, your line is now open.

Great, thank you. Sorry about that. Can you talk about whether you've seen any shifts in the competitive environment at all and also investors worry about this - about what a recession might do to payroll vendors. Just walk us through how that would play out that would be great. Thank you.

So the first part of the question is kind of the competitive environment. I think we're seeing really the same people in all of our deals. I do think that the ACA approach towards satisfying those needs has been a little different by competitor. So we've seen some competitors really try to drive an adoption of benefits in time and labor to be able to drive their ACA products. We've really kind of created a standalone Enhanced offering that doesn't necessarily require that. And so, that's something that does get differentiated in the competitive process. But we're certainly seeing the same people we haven't seen really changes in terms of close ratios or our activity levels at all. And then the second question, Pat?

Recession.

The second was just, how do we think about - yes, in a downturn what happens?

Yes. So, I think we've been through this in our history obviously at a much smaller size. Typically it's - our customers may have less people on their platform. Remember, we're not necessarily selling a high cost product into the customer, and the reason they're buying is really for the efficiencies gained. So in a recession environment, we haven't necessarily seen deal flow really change dramatically. It's just that our customers might have a few less people on their platform. The prior recession we had interest rate drops as well. Obviously, interest rates are quite low today, so that would - that might be different.

And payroll is a must-have product. So they need it, they won't drop it. It's at a, as Steve said, at a reasonable price. So, we don't see a lot of movement that way.

Great. Thank you.

Thank you. And our next question comes from Scott Shiao of Bank of America. Your line is now open.

Hi, thanks for taking my question. So you mentioned that after the ACA module, you'll shift back to more landing than expanding. Does that mean that the new sales head count goes to landing and the same head count is still expanding or does that mean that's being reallocated all back into landing new customers?

Yes, that's a good question. So, one of the things that we did in terms of satisfying our customer is we really drove a lot of the ACA activity through an education process that was driven by their account managers and our customer service organization, and really try to get focused on having our sales team continue to drive new business sales. And so, that was a strategic approach that we took. Because of that, we added very few people in terms of sales focused on selling back to the customers; only maybe to some of our largest customers. So there isn't a big shift required. We have a very, very small team who's focused on expanding. We would keep a very small team focused on that and the sales force has not lost any momentum in terms of going after new labels in the market.

Okay. Got it. And then a quick follow up: has the mix of the customer wins changed significantly in this quarter versus the past? Is it still roughly the 50% wins from Paychex and ADP?

Yes, that's correct. We have not seen a big shift in mix. As we've noted in prior calls, we've seen a slight uptick in in-house category. It's not a big percentage for us, but it has continued to have a slight uptick. And we think that those customers aren't less likely to have an ACA solution, but it's not a material part of our new sales.

Okay. Got it. Thanks.

Thank you. And I'm showing no further questions at this time. I'd like to turn the conference back over to Mr. Beauchamp for closing remarks.

I'd like to thank all of you for taking the time to join us on our second quarter fiscal earnings call. Thank you everybody, and have a great day.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Have a great day, everyone.