Paylocity Holding Corp (PCTY) 2017 Q2 法說會逐字稿

Good day, ladies and gentlemen, and thank you for your patience. You've joined Paylocity's earnings results call for the second quarter of FY17.

(Operator Instructions)

As a reminder, this conference may be recorded. I would now turn the call over to your host, CFO of Paylocity, Mr. Peter McGrail. Sir, you may begin.

Thank you. Good afternoon, and welcome to Paylocity's earnings results call for the second quarter of FY17, which ended on December 31, 2016. 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 closed. 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 the these or other forward-looking statements. Also, these statements are based solely on the present information, and are subject to risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements.

For additional information, please refer to our files 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 non-certain non-GAAP 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 in 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.

And non-revenue financial measures we will discuss today are non-GAAP, unless we state the measure as GAAP. Please note that we are unable to reconcile any forward-looking non-GAAP financial measure to their directly comparable GAAP financial measure, because the information which is needed to complete a reconciliation is unavailable at this time without unreasonable effort. 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 FY17 earnings call. The second fiscal quarter exceeded our guidance in terms of revenue, adjusted EBITDA and non-GAAP net income. Total revenue grew by 24.4% to $68.7 million, with recurring revenue growing 26.2% versus the same period last fiscal year.

Adjusted EBITDA for the second quarter was $9.9 million, exceeding the midpoint of our guidance by $4.4 million. We generated $17.8 million in adjusted EBITDA for the first six months of the year, up 70% from $10.5 million for the same period last fiscal year.

We had a number of announcements during the quarter that I would like to take a moment to highlight. We were very pleased to be recognized as number 14 on Glassdoor's Annual Employer of Choice Awards, in the large-employer category. This is a second time we've been recognized as an employer of choice in Glassdoor's annual rankings, and the first time in the large-employer category.

Paylocity was recognized as one of the 2016 Best and Brightest Companies to Work For in the Nation by the National Association for Business Resources. We were once again ranked on the list of 500 Fastest Growing Technology Companies in North America. This is the fourth year in a row that we've been included on the fast 500 list.

Lastly, during the quarter, we announced the addition of Ellen Carnahan to our Board of Directors. Ellen has experience serving on several private and public company boards, and has had a very successful career investing in technology companies.

The second fiscal quarter is a busy time of year for our sales organization. Many medium-size businesses target January as a convenient time to change their payroll and HCM platform. Last fiscal year's fall selling season was particularly active in our broker channel, as broker referrals climbed above 30%, peaking in the high-30%s.

As you may recall, on our last earnings call, we highlighted the fact that broker referrals were trending back towards our historical range. This trend continued in the second quarter, with broker referrals finishing slightly under 30%, consistent with our experience prior to ACA, where we routinely reported more than 25% of our new business revenue from brokers.

The channel continues to be in an attractive opportunity, with new technology and increased demand for modern HCM applications creating pressure for brokers to differentiate and grow the business. Brokers remain an important part of our go-to-market strategy, as our combination of industry-leading HCM platforms and extensive data integration capabilities provide a strong value proposition.

In addition, as we've mentioned in prior calls, we also saw an increase in demand from our in-house channel last fiscal year as a result of ACA. Similar to the broker channel, new business from this channel has also returned to more historic levels.

Not only is this a busy quarter for our sales, but for all of our operation's employees who are focused on delivering a seamless year-end experience to our clients. We entered this year-end fully staffed, with higher-average tenure in our service organization, as we started hiring earlier last calendar year.

The addition of our Boise office las year has provided capacity to grow the organization ahead of increased year-end volume, and improved our coverage for West Coast clients. One year later, we now have 100 employees in Boise across a number of departments.

At the same time, we have worked hard to make sure we are ready to answer all 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. Clients leveraged our new year-end dashboard, designed to quickly service potential W-2 issues, easily correct employee data, and then generate real-time W-2s previews well-before the January deadline.

The collaborative effort across our organization allowed us to produce all our client W-2s and 1095s, while meeting the IRS accelerated employer filing deadline of January 31. I am very proud of the effort and collaboration from our employees during this very busy time of year, as we continue to focus on delivering innovative technology, backed by high-touch service for our clients.

We increased our total investment in research and development by 26.3% over the second fiscal quarter of last year, when you consider what we expensed and capitalized. We continue to invest in research and development in an effort to differentiate our platform and develop new modules for our clients.

We launched our recruiting module this fall, making it available to new sales starting in January. We have been pleased with the initial momentum, as we were able to sign up 150 clients to our new recruiting product in January. The early client feedback highlights the ease-of-use of the module and the benefit of being able to easily manage all internal and external recruiting needs in a single HCM platform.

We also announced today the general availability of our new expense management product. Our organically developed expense management solution automates the collection of business expenses, providing mobile receipt-capture capabilities for employees, and then automates the expense report creation and approval process based on the company-predefined rules. We then leverage the fact that we provide payroll by automatically reimbursing the employee on their regular paycheck.

The addition of expense management to our portfolio increases our total per-employee per-year opportunity from $270 to $285 when a client buys all modules available in our product portfolio. This is up significantly from $200 per employee per year at the time of our IPO less than three years ago.

At this point, 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. As we've noted in our last few calls, the wide adoption of our ACA Enhanced product, which began in earnest during this quarter last year, has created challenging comparisons for us through the remainder of this fiscal year.

With that in mind, total revenue for the quarter was $68.7 million, which represents a 24.4% increase from the year-ago quarter. As a reminder, we grew 61% in the second quarter of last fiscal year.

Total revenue for the first six months of FY17 was $133.7 million, a 33.3% increase from the same period last year. Our total recurring revenue of $66.1 million was up 26.2% from the year-ago quarter, and represented 96% of our total revenue. Total recurring revenue for the first six months of 2017 was $128.7 million, a 35.2% increase from the same period last year. Recurring fees were up 26.3% in the quarter, and 35.3% for the first six months of the fiscal year. And interest revenue increased 18.9% in the quarter, and 26.7% for the first six months of the fiscal year, primarily as a result of our client growth and balance increases.

In line with expectations we set in our last call, implementation services and other revenue of $2.6 million was down 9.2% from the year-ago quarter. As noted previously, a number of clients pulled forward their stock into October and November from January, to take advantage of our ACA offering last year. As a reminder, implementation services and other revenue grew 51% in the year-ago quarter.

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%. Adjusted gross profit in the quarter was $41.2 million, representing a margin of 60%, as compared to $33.3 million or 60.3% in the year-ago quarter. Adjusted gross profit for the first six months of FY17 was $80.5 million or 60.2%, as compared to $59.8 million or 59.6% for the first six months of FY16, a 60-basis point improvement.

Our adjusted gross profit on recurring revenues was $47.9 million or 72.5% in the second quarter, as compared to $38.1 million or 72.8% in the year-ago quarter. Adjusted gross profit on recurring revenues was $93.7 million or 72.8% for the first six months of FY17, as compared to $69.2 million or 72.6% for the first six months of 2016, a 20-basis point improvement.

We continue to invest in research and development. In addition to significant new modules, such as recruiting and expense management, we are equally committed to refreshing and modernizing our platform. 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 $9.7 million or 14.2% of revenue in the second quarter. On a dollar basis, our year-over-year investment in total research and development increased by 26.3% in the second fiscal quarter, and 30.7% for the first six months of FY17, versus the same periods of FY16.

On a non-GAAP basis, sales and marketing expense was $16 million or 23.4% of revenue in the quarter, as compared to $13.1 million or 23.8% in the same period last year. Non-GAAP sales and marketing expense was $32.5 million or 24.3% for the first six months of FY17, as compared to $24.6 million or 24.6% for the first six months of FY16.

On a non-GAAP basis, general and administrative expense was $11.4 million or 16.7% of revenue in the quarter, as compared to $8.8 million or 15.9% of revenue in the year-ago quarter. Non-GAAP general and administrative expense was $22.2 million or 16.6% for the first six months of FY17, as compared to $17.2 million or 17.2% for the first six months of FY16, a 60-basis point improvement.

Our adjusted EBITDA was $9.9 million or 14.4% of revenue for the second quarter, versus $7.2 million or 13.1% for the year-ago quarter. For the first six months of our fiscal year, we generated $17.8 million of adjusted EBITDA or 13.3% of revenue, versus $10.5 million or 10.5% of revenue for the same period last year, a 280-basis point improvement.

Non-GAAP net income was $5.4 million or $0.10 per share for the quarter, versus $4.1 million or $0.08 per share in the year-ago quarter. For the first six months of our fiscal year, we generated $9.4 million of non-GAAP net income, versus $4.9 million for the same period last year.

Briefly covering our GAAP results, for the quarter, gross profit was $38.3 million, operating loss was negative $1.6 million, and net loss was negative $1.7 million.

In regard to the balance sheet, we ended the quarter with cash and cash equivalents of $82.3 million. Cash flows generated by operating activities were $13.5 million in the quarter, versus $7.8 million in the year-ago quarter.

For the first six months of our fiscal year, we've generated $15.4 million of operating cash flows, versus $10.8 million for the same period last year. This increase was the direct result of our increased non-GAAP net income.

Finally, I'd like to provide our financial guidance for the third quarter and for the full FY17. Two items of note. First, as everyone is aware, President Trump signed an executive action allowing government agencies to review ways to reduce the fiscal and regulatory burden on individuals and others with respect to rules associated with the Affordable Care Act. This order confirms that ACA continues to be the law, but that it is the intent of the Administration to seek to repeal and replace it.

At this point, we do not have clarity on timing of a repeal, nor do we have any details on a replacement plan. As a result, our guidance for the remainder of fiscal year includes ACA revenue, as we are committed to keeping our clients in compliance with current and future legislative changes. We anticipate that ACA revenue will represent 7% to 8% of our total revenue for FY17. Second, our guidance reflects the impact of demand from our broker and in-house channels returning to more historical levels.

With all this as a backdrop, total revenue in the third quarter is expected to be in the range of $87.5 million to $88.5 million, which represents 23.9% to 25.4% growth over the third quarter of last year. Adjusted EBITDA is expected to be in the range of $17 million to $18 million.

Non-GAAP net income is expected be in the range of $12 million to $13 million, or $0.22 to $0.24 per share, based on approximately 54 million diluted, weighted average common shares outstanding. Total revenue for the fiscal year is still expected to be in the range of $296 million to $298 million, or approximately 28% to 29% greater than the prior year.

Adjusted EBITDA is expected be in the range of $42 million to $43 million, an increase of $4 million from previous guidance. At the midpoint, our adjusted EBITDA represents 14.3% of revenue for the year, a 200-basis point increase from our FY16 results. We continue to be confident in our ability to scale as our business grows.

Non-GAAP net income is expected be in the range of $22.5 million to $23.5 million, an increase of $2 million from previous guidance, or $0.41 to $0.43 per share, based on approximately 55 million diluted, weighted average common shares outstanding.

In summary, we are pleased with our performance in a challenging comparative environment. One final note: Steve and I will be attending the JMP Technology Conference in San Francisco on February 27, and the Pac Crest Conference, also in San Francisco, on March 1.

Operator, we are now ready to begin the Q&A session.

Thank you, sir.

(Operator Instructions)

Justin Furby, William Blair.

Thanks, and congrats on a nice quarter, and thanks for the smart guidance for the back-half of the year.

Steve, I wanted to ask, first, in terms of how the quarter progressed. If you go back to your conference call in early November, a few days later, we elect Trump. And I'm just wondering if you saw any change in terms of business environment or sales cycles as you moved through the quarter and entered January?

And then I had a quick follow-up. Thanks.

Sure. I think we saw continued activity from our first fiscal quarter in terms of broker referral percentages trending back towards those historical levels. The Company we wouldn't have anticipated at the start of the fiscal year, in terms of getting there this quickly. Not surprising that we get back to those historical ranges, it just happened a little faster. So that continued through the second quarter.

And then as we looked at the data over the first six months, we also saw that the amount of business we get from in-house, which has never been that material to us, but did get up to the high-teens in terms of the percentage of new business. Kind of a return back into the mid- to lower-teens, where we have been historically. So those would be the two trends that we saw continue in the second quarter.

Got it. And then any change, though, in terms of sales cycles or people putting deals off? I think ADP this week scared some folks in talking about -- did you guys see that at all in the margin in the last couple of months?

I think it's hard for us to tell exactly whether customers have a level of inertia around the election cycle. We certainly saw less activity, both in terms of mostly brokers, but a little bit in the in-house. Don't know whether that was affected by the election or not. So really difficult for us to give you an assessment of that.

Okay, that's fair. And then just quickly on the core business. If you set aside ACA in the product -- and I'm just thinking about the core and the medium-term growth in that business. Just based on what you see today, Steve, do you think it's a 25%-plus-type business?

And when you think out to FY18, as you get to easier comps -- again, net of ACA, excluding that business, when you think out to FY18, do you think the core could actually accelerate just as comps ease and you continue to add products like the recruiting and expense management? Thanks.

Certainly this year has been a little bit more of a challenging comp versus last year. Last year was very much an anomaly, with the activity around ACA. So not only did we get the sale back into the client base last year, but we also got a different type of cycle and cadence in terms of new business.

And what I mean by that is, we got a lot more business in the first half of last year, the first six months of the year. A typical year, we get more business in second-half of the year.

So the point is, there's a lot of puts and takes to try to be able to reconcile this year versus last year. And so it's difficult for us to give you any type of long-term guidance at this point in time. Still a very transactional business. We feel good about the project initiatives that we've got, the sales initiatives that we've got, and the retention that we have going forward. But I'd be a little hesitant to comment with any type of metrics looking into FY18.

Okay, that's fair. Thank you.

Scott Berg, Needham.

Hi, Steve and Peter. Congrats on the good quarter. I have two questions from me.

First of all, Steve, can you comment on your direct salesforce and efforts with them, or even through the broker channel, upselling all the new modules that you have been able to bring out over the last year? I know you've talked about it over the last 12 months, that you've been selling back into the install base really for the first time, changing a little bit of your mode from new customer acquisition to upsells. And trying to understand what capacity is for that over the next 12 to 18 months?

Sure. I think we're still focused on the land part of the land-and-expand strategy. Albeit, as you mentioned, last year ACA provided us an opportunity to start expanding products back into the client base, first starting with ACA, and then additional modules that we either had available then, or we have since launched, like expense and recruiting.

I think we are still early in that effort, and we certainly see the expand opportunity is a very good one going forward. However, it is something that we would see gradually happen over time.

We got good feedback on our recruitment module. Most of those recruiting customers I mentioned were new customers, but we did have some current customers as well, adopt our recruiting module. So we are seeing some success, but I would still think about this mostly as focused on land, a gradual expansion strategy over time.

Great. And then my follow-up, quickly, Peter, on the earnings possibility in the quarter. You had a pretty significant [lead], $0.06, $0.07 there. Can you talk about expenses in the quarter? Did any shift into the second half, or were your overall expenses in line with expectations? Just trying to reconcile why it was such a [date] of performance?

Yes, I guess we would say on a macro level that it is our intention not only to grow, but also to manage our expenses and to grow either. And I think that carried through to this quarter. And I think you actually saw it carry through to our guide year-end, where we set up the midpoint of the range we'd increase 200 basis points.

We are committed to EBITDA expansion as much as we are committed to growing. It's a big part of who we are and how we think we ought to run the business.

To point out to that, is, if you go back a couple years ago, we are at about 5% adjusted EBITDA, and we are guiding now to over 14% adjusted EBITDA, two years later. So it's hard to get really specific around the quarter, because we have some things that certainly move around. But when you look at the year, we feel really good about the leverage we are driving in the model.

Great. That's all I have. Thanks for taking my questions.

Nandan Amladi, Deutsche Bank.

Hi, good afternoon, thanks for taking my questions. Peter, in the quarter, what actually drove the earnings outperformance? And as we look ahead into the March quarter, which is seasonally your strongest quarter with all the electronic filings and so on, in terms of margin, how much room do you think you're leaving yourself? Because the guidance is fairly conservative, I think.

Well, in the quarter, I think we got something out of everything. That is sort of how we play the game, and how we think about it. We look at our business that way, and we try to drive, through our people and through our production, we try to drive leverage everywhere we can.

Looking out, I don't know that electronic filing makes that -- I think the mantra that we had in the second quarter is the mantra we will carry to other quarters. We try to do that every quarter. So I don't know if electronic filing and auto-electronic filing is a specific element that drives leverage. I don't think so.

So you should think about the way we guided. I mean, we absolutely try to drive EBITDA. And the way we guided to the year-end is, we are looking for 200-basis point improvement. And that is who we are, and it fits our culture.

Thank you.

Brad Reback, Stifel.

Great, thanks a lot. Steve, as it relates to ADP ending of life as a mid-market product middle of this calendar year, have you seen any acceleration in those types of sales cycles? And if not, do you think there might be?

Yes, I think that ADP has certainly been on a journey to refresh their technology, and that's been happening over a long number of years. And they are certainly in a migration path in the mid-market. As we look at the data, we see ADP the same amount, we've got the same type of win rates we've had historically versus them and we don't necessarily see that just come from one segment.

So we get them on the upper end of small business, we see them in mid-market, we see the newer version of Workforce Now, we see the older versions of Workforce Now. So I don't necessarily have any data that would point to the fact that we have much more success versus the one-product category, versus the other, at this point

Great. Thanks very much.

Mark Marcon, Baird.

Good afternoon, and thanks for taking my question. With regards to the new client wins that you ended up having during the quarter, and the way the pipeline is shaping up here in the fiscal third quarter, are you seeing any sort of marked difference between smaller companies relative to larger companies, just in terms of ability to move ahead, or where it seems a little bit more fruitful?

If you think about the target market that we are in, which is really 20 to 1,000, and our average customer being in that 120-employee range, it grows a little bit each year, but not by a lot. We stay focused on that target market segment. I'm not sure within that target market we see a lot of behavior change.

Certainly the larger the customer, maybe a little bit longer is the sales cycle, and then obviously maybe a little longer the implementation process. But that actually happens relatively quickly.

And so I wouldn't say that we see any type of behavior changes this past quarter in our target market. Where we are seeing different behavior is at the upper end versus the lower end of the market.

It's just a faster on the low end, as usual, and it takes just a little bit longer. But when you look at in aggregate, it still is pretty transactional and goes pretty quick.

Great. And then with regards to the recruiting module, 150 clients. Any characterization there in terms of the ones that came on? Whether they were smaller, larger, how broadly applicable does it seem at this point relative to your overall installed client base?

Yes, I would say that the clients that are hiring a little bit more are certainly what we are seeing in terms of maybe that initial adoption. And so if I'm a 50-employee account and I maybe have higher turnover or I'm hiring 20, 30, 40 employees, it's still attractive. And then on the upper end, if I'm closer to our 1,000-employee target market, and again, I'm doing a lot of hiring, I think that's where we see a little bit more demand for recruiting.

But at the same time, one of the value propositions that we offer is, you can also handle the internal recruiting needs. So if I've got a job, and then I've got somebody to get promoted, I need to fill that, and I want to communicate that internally and manage the application process internally, I can do that.

So there is certainly value, even if I am not necessarily a fast-growing or hiring a lot of people. So I think we've seen it across a wide variety of industries and various sizes for at least the first 150 that have signed up.

For that first 150, are you replacing first-gen solutions, first-gen ATS, or do some of them not have anything at all?

I would say, I don't have the exact data on the 150, but we have looked at that as we've entered the market, in terms of how our existing clients behave. And we do have a lot of customers that are still operating some sort of manual-type process. There are times we might replace an alternative system, but if I were to hazard a guess, you would see a significant number of those customers being somewhat manual at this point in time.

Great, thank you.

Pat Walravens, JMP Securities.

Great, thank you. I guess my first question, Steve, would be, as we look at the deceleration in the business, is it just because of ACA and the tough comp, or is there something else that's going on too?

Well, I think as you look at the business, broker channel being a key driver last year, spiking up, creating some additional activity and volume. We certainly got more customers from in-house last year.

So as we look at the data over the first six months of the year, that's a pretty significant drop in brokers -- we talk about high-30%s back into the high-20%s, where we've been historically, and then in-house dropping down a little bit as well. That seems to be the biggest driver in terms of the lower growth rate versus last year, obviously last year being a very tough comp. But that's what we would highlight.

Okay. And then if I could just follow up a little bit on that, because I get the question all the time. Has your segment of the market gotten any more competitive?

I would tell you that we still see the biggest players in the market the most, as you would imagine -- so the traditional service provider, the ADP and Paychex and so on, are the players that we see. We still see local and regional players kind of next. They vary by geography.

And then certainly some of the newer players, like a Paycom, obviously we would see at times. We're both growing, so that grows over time. But we're still at the traditional service providers that we see the most.

Okay, thank you.

Ross MacMillan, RBC Capital Markets.

Thank you, and congrats from me as well, on being able to maintain the year. Steve, one for you and one for Peter.

Steve, ADP made some comments suggesting that since the election, they've signed new customers that would be under the employer mandate, i.e., 50 employees up. But they maybe hadn't seen the same rate of attach of the enhanced reporting, and obviously subsequently, filing services. In other words, there seemed to be some companies saying we'll mandate it if we don't have it this year, with the view that ACA goes away. Are you seeing anything similar, or are you still finding that most of your new signings that would fall under the employer mandate are taking the enhanced reporting, et cetera?

I think if you go back to the market segment that we focus on, most of our customers' primary objective is just focusing on running their business. And even when ACA was first being passed, we had to do a lot of education to those users. And at that point, they became focused on compliance.

I actually had calls with our service organization throughout January to see what types of question we were getting. And by far and away the biggest questions we were getting from customers is: how do I get compliant this year, and how do I get my 1095 done? We are not necessarily seeing a lot of questions about what's happening in the future. I think they will react when that happens.

And then on the new client, you would see a similar behavior. They need to issue the 1095s, we have a great ACA product that we offer them, and so we are seeing pretty good attach rates still. Because it is the law, and they have to be able to achieve these, and they don't want to do it manually.

That's helpful. And Peter, if we do get to the point where we got a full repeal, if you will, and the ACA reporting and filing revenue went away, is there any way you could characterize the EBITDA margin on that business? Is it at Company average, below or above Company average? Any way to think about that?

Well, certainly we have said that HCM products carry more recurring margin to us than regular payroll. So this ACA would be one of those products.

But I think in terms of ACA, as you can see, we are bringing on a lot of new products at the same time. So if we saw that coming, we would certainly try to be into our clients and attempting to sell them other products.

They've got the budget set aside for ACA, and the opportunity probably would exist for us to displace some of that. Of course, ACA was a legal mandate on the product -- not legal mandate, but you would see us actively trying to replace that revenue and margin as we move forward -- if replace, repeal, repair, or whatever it is, takes place.

Very helpful. Thanks so much.

Terry Tillman, Raymond James.

Hey, good afternoon, guys. Can you all hear me okay?

We can, Terry.

Well, I'm excited to say I have some ACA- and competition-free questions for you. Just two of them actually -- or two and a half.

So the first question, Steve, just relates to, last quarter, you talked about just as you evolved your direct sales resources, you obviously historically have had a lot of success with folks that know payroll. You were going to expand your horizons to bring in some [people] who maybe were more enterprise class sales reps to fill modernizing HCM-type initiatives.

Maybe you could give us an update on how that initiative is going? And an update also on the size of your salesforce, and where you are in terms of a report card on the growth in your salesforce?

Sure. So let's just start with the last one first. So from a side perspective, we are really -- after we get through year-end here, we get into February, March, is where we typically start doing most of our hiring in terms of the salesforce. So I think we are starting that process in earnest, and hard on recruiting for next year. Obviously we have not set our target number yet for next year.

And then if you think about the strategy that we talked about last year, which was just expanding the hiring pool by still hiring business-to-business experienced folks, but maybe not with the same industry experience. I think the reason that I wanted to call that out on the last call is, that may affect a little bit of how our sales and marketing expense -- the cadence of that throughout the year for hiring some subset of our total hires a little bit earlier in the year. I don't think it's a big shift for us. It's really more of a tweak to the strategy, and it will take us really through next fiscal year to see how those folks do.

Okay. And I guess, Peter, in terms of -- you've had a couple quarters where you have exceeded estimates for the current quarter, so that's good to see you maintain the guidance again for the year. Is there anything to say about either conservatism for full-year bookings, or is this reflective of -- maybe the flow of business is not so front-end-loaded like we saw last year because of ACA? Thank you.

I would think I would just repeat some of the things that Steve has said about the business. Broker and in-house have returned to more historical levels, faster than we have originally anticipated. And certainly we built that into how we think about the business through year-end. And frankly, we're happy that we are able to affirm guidance this quarter at the year-end, given those circumstances.

Okay, thank you.

Jim Macdonald, First Analysis.

Good quarter, guys. Following up on Terry's question, any update on the competition for salespeople out there in the market?

We are a little early still in the hiring process, at this point in time. As you probably know already, we have a lot of recruiting resources internally. We handle most of that ourselves. We're actively talking to people in the market, certainly a lot of good conversations at this point in time, but won't really start getting our first hires on the ground here until we wrap up year-end at the end of February. And then we expect to have hiring classes all the way through to the start of our next fiscal year. So good early conversations going on right now, but just too early to give you a sense of where we are, in terms of our hiring goals.

And then I had two quick ones. Any impact of the slightly higher interest rates? Should we start seeing something there? And also, how many 1095s did you put out in January versus -- was it up from last year?

No question, 1095s were up from last year. I think we've historically said -- last year, we talked about more than 1 million 1095s, and that we would imagine that, that would grow in line with client growth. And that's the right expectations to have in terms of looking at the number of 1095s we delivered. Certainly more than last year, and over that 1 million number again.

Yes, so certainly on interest rates, certainly the trend is going in the right direction. We, of course, like others, would benefit from rising interest rates. To give you a sense of how much -- what our average balances look like in the second quarter, around approximately $800 million on average. So a good number. And if interest rates continue to go up, certainly it will have a more meaningful impact to our numbers as we go forward.

Any -- just quickly -- 0.2%? What kind of number makes sense to you?

I think you can do the math pretty simply in your mind. Those are the impacts. The thing you have to think about is, as interest rates go up, banks don't react overnight and say: oh, I'm going to give you that 25 basis points. There's some process they go through that, eventually they raise rates. This will be somewhat gradual, will take some time.

And it also has a -- the impact of banks on where they think rates are ultimately going to go will impact how quickly they raise rates as well. So it is definitely going the right direction. We will be a beneficiary of it. We just need to keep all our ears to the road to see how quickly and when they do increase.

Okay, great, thanks.

Jeff Van Rhee, Craig-Hallum.

Great, thank you. Couple from me, guys. First, on the brokers, just to clarify, I think you said it would sell faster than expected. Do you believe it will stay in the high-20s? And then also, I think pushing some initiatives -- I think a broker portal and a few other things -- to try to make that a little sticker. Just a little update on both of those?

Sure. We've had good reception in the broker market to some of the enhancements that we've made to the broker portal. We will continue to invest in the broker portal as we move forward. And we've also worked with brokers to collect some other ideas that we have in flight now.

So we are pretty excited about some of the things we can do with the broker portal concept. Really allows them to be able to engage with us, and then therefore, get access to valuable data from their clients. So we will continue to do that.

I think we've always said, if you go to prior to ACA, I think we've always said being about 25% is great. We would be very happy if we could maintain that as we continue to grow and scale the business. That certainly is our goal.

At this point in time, as we return back to the pre-ACA levels, we see very similar type of behavior in the market that we saw before. So no reason to think that we can't do it. But I obviously -- we need to execute in that channel, and it does get a little bit more challenging as you grow. So that is certainly our goal.

Okay, that's great. And then just last for me. In terms of the new wins, just the initial tax rate of modules now versus, say, a comparable period a year ago. If you could call out anything that's changed there? And then also in that same frame of mind, the module up-sell, cross-sells -- anything notable this quarter that exceeded or missed expectations?

You know, I get that question a lot. It's really been a fairly gradual process for us. I think I said this in the past: at this point, you're really selling payroll and HR on almost every single deal. It's very odd to sell payroll only. It happens, but not very frequently.

Time and labor, we continue to see gradual increases in that category. We also see increases in benefits, some nights increases in the talent category, so that might be increasing slightly faster than the other two. Also a little less mature, so makes sense. And the newer products are early at this point in time, but good feedback, really happy with the early results.

Even expense management, as I talked about, launching today, we have customers on that today. We always get beta customers on the product to get their feedback before we launch it. We have active users using that now.

So we really feel good about the product strategy that we have been able to execute, to go from $200 per employee per year less than three years ago now, to $285. We are on track to get to that $300 per employee per year, which was our goal at the time of the IPO.

Okay, fair enough, thanks. I'm all set.

Trevor Upton, Pacific Crest Securities.

Hey, thanks much for taking my questions. Most of them have been answered, but maybe a couple modeling ones. Peter, we talked about the increased margins for the first half of the year, but in the core, I think our recurring gross margins were down a bit, and G&A was up a bit. Is there anything to -- any puts and takes or anything to take away from that?

Yes, the quarter has caused us an anomaly, because we were comparing against a 61% quarter. Which, if you have a quarter like that on the sales side, all your marks are going to benefit from that, there's no doubt about it.

So when you compare it, it can look like things had gone backwards. But that's why we looked out at over a six-month period, and they had gone forward. And that's when we looked to the end of the year, where we are anticipating 200 basis points of EBITDA improvement.

Right. That's helpful. And the pull-forward, the implementations last year, how should we think about implementation growth sequentially this coming quarter?

If you think about implementation revenue, it's really implementation revenue and other. And I think we have called out on a number of quarters that, that other category doesn't grow exactly at the same rate. We've also called out some of our HCM products that we are getting higher penetration on, don't necessarily carry the same percentage of implementation revenue.

We also mentioned that it was going to be negative in the quarter because of the tough compare. So no surprises there from an implementation revenue perspective. We would see that grow kind of in line with sales, but not directly -- you can't necessarily just look at that to understand sales.

Okay, so probably back to a more kind of traditional sequential growth, but tempered a little bit because HCM has a lower implementation, and other is not growing. Is that fair?

And the other pieces can fluctuate in the quarter. And generally the other pieces, I think Steve mentioned, actually have trended down, like people buying hardware clocks. Used to be much bigger than it is today, because people go to electronic versions of things, and much more automated.

Okay, that's helpful. That's all I have, thank you.

John Byun, UBS.

Thank you. I wanted to ask about the Web Expense product. Is there a way to think about potential tax rate versus, let's say, recruiting? Is it something that could have much broader appeal? And then also in terms of relative pricing of Web Expense specifically?

Yes, here is the way we think about our product expansion strategy. We work with our customers to see what they need that we don't have.

We typically won't embark on a build process unless we think, over a period of time, we can get in that 10% to 20% penetration rate. That doesn't happen initially, it certainly doesn't happen the first year. But our philosophy is, if we build it, we believe we can drive 10% to 20% penetration rate over a number of years and then beyond that, long term, obviously.

So we certainly feel like recruiting has that opportunity. We also feel that expense has that opportunity. Now expense isn't necessarily always used by every single employee in the company, because not every employee necessarily is an expense filer. But most employers have this problem -- they have some subset of employees that need to file expenses.

So we think that it' got a broad kind of appeal, but it will probably run like many of our products -- takes us a while to get into the 10% to 20% range, and then we'll make efforts to be able to push it beyond. But we think of those as similar opportunities.

Okay, thank you.

Kash Rangan, Bank of America.

Hey, Steve. I'm a little disappointed you didn't talk about your 99% CEO approval rating on Glassdoor, the highest in software that we track.

I appreciate that, Kash. We did mention the award we won on Glassdoor, though, and we are certainly proud of all the feedback we get from our employees.

Yes, we tracked the CEO rating for the past three years. You've come out on top, 99%. I don't know how you do it, but maybe over a beer one day you will tell me.

My serious question is, if you look at what looks to be about 10 percentage points to 13 percentage points of the delta in growth rate, excluding ACA, is it fair to say that almost all that is from the broker channel contribution? Or was there also some slowness in hiring direct sales people? How should we think about how much of that is due to just hiring versus external channel constraints?

Sure. We were certainly fully staffed on our goal of hires going into this fiscal year, so I don't think that was necessarily a factor. I would point to two real factors.

One is, there is some tough compares over last year because we sold ACA back to our client base, and that all happened in the second quarter of last year. So we get three quarters of the year that are going to be tough compares. That naturally has an impact on the delta in the growth rate.

And then secondly, certainly seeing brokers' activity decline. You are talking almost 10 percentage points, roughly, in decline in broker activity. That would be the biggest driver. A little bit of in-house decline factors in there. But we were certainly fully staffed going into the year, and that wasn't necessarily a factor.

And your productivity, you're happy. How's sales proactively trending?

What I would say is, I think sales productivity was certainly impacted by the number of broker referrals. We anticipated that broker referrals would gradually make their way back to the historical range. We didn't anticipate that would happen in the first six months of the year. It has happened in the first six months of the year. And so if you look at sales productivity, they would then be impacted by that decline.

Got it. But it's good to see that your aspirational plan is to continue to sustain what looks to be about 25%-type top-end growth. It's fair to assume that, in the medium term, you're shooting for that aspirational number once you get past this ACA and broker channel bump to your growth rate. Is that fair?

Well, I would say it this way -- we are still focused on getting to our long-term model that we had talked about at the time of IPO. So we view ourselves as a goal of continuing to maintain 20%-plus growth. We're going to be obviously forecasting in the high-20%s this year, and at the same time, we want to get ourselves to 20% EBITDA. And we're making good progress this year. So we are still focusing on being a growth Company, and at the same time, expanding that bottom line.

Wonderful, congratulations.

Thanks, Kash.

Mark Marcon, Baird.

I'm just curious, in terms of the guidance for revenue for the second half of this year, is the assumption that implementation and other would actually increase year over year, or how should we think about that?

We called out, there's a client in the second quarter. And obviously didn't call out there's a client the rest of the year. So you have made the right assumption.

Yes, we would definitely assume that, for the year, we would get growth in implementation, service in another.

Great, thank you.

Thank you. At this time, I would like to turn the call back over to management for any closing remarks. Gentlemen?

Yes, I would like to take a brief moment to thank all of our employees again for the effort. This is a very busy quarter, as I mentioned in my prepared remarks, and we've had a very successful year-end, managing all of our clients' needs with W-2s and 1095s. So thank you very much. Appreciate it.

And go, Patriots.

Thank you, ladies and gentlemen. That does conclude your program. Thank you for your participation, and have a wonderful day. You may disconnect your lines at this time.