Paylocity Holding's (PCTY) CEO Steve Beauchamp on Q4 2014 Results - Earnings Call Transcript

Aug.14.14 | About: Paylocity Holding (PCTY)

Paylocity Holding Corp (NASDAQ:PCTY)

Q4 2014 Results Earnings Conference Call

August 14, 2014, 05:00 PM ET

Executives

Peter McGrail - CFO

Steve Beauchamp - President and CEO

Analysts

Justin Furby - William Blair & Company

Terry Tillman - Raymond James

Nandan Amladi - Deutsche Bank

Peter Lowry - JMP Group

Michael Turn - Needham & Company

Operator

Good day ladies and gentlemen, and welcome to the Paylocity Holding Corporation, Fourth Quarter and 2014 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 follow at that time. (Operator Instructions) As a reminder, this call has been recorded.

I would now like to introduce your host for today's conference Peter McGrail, Chief Financial Officer.

Peter McGrail

Good afternoon, and welcome to Paylocity's earnings results call for the fourth quarter of 2014 which ended on June 30, 2014. I am Peter McGrail, CFO, and joining me on the call today is Steve Beauchamp, Chief Executive Officer 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 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. There is reconciliation schedule detailing these results currently available in our press release, which is located on our website at www.paylocity.com under the Investor Relations tab and filed with the Securities and Exchange Commission.

With that, let me turn the call over to Steve.

Steve Beauchamp

Thank you, Peter. And thanks to all of you for joining us today. Peter will review our financial results and 2015 guidance in detail, but let me share a few of the highlights from fourth quarter and fiscal year 2014.

We finished the year with strong performance across all of our key metrics. As demand for our cloud-based unified payroll and human capital management solutions continues to grow.

Total revenue was up 41% for both the quarter and the fiscal year. Recurring fees grew even faster at 42% for the quarter and 41% for the year. We completed the acquisition of one of our resellers in May, which yielded a lift in Q4 gross margin.

Adjusted recurring gross margin was 67% for the quarter and 66% for the year. Recurring revenue was 95% of total revenue in the quarter and 94% for the year. Revenue retention continues to exceed 92% which is best-in-class for company targeting mid-size firms.

Our client count at year end was 8500 up 24% year-over-year. We have achieved 25% compounded annual growth in client count over the last four years.

Adjusted EBITDA was just slightly negative for the quarter as we ramped up our spending on sales and marketing and research and development, as well as the addition of certain public company expenses. Adjusted EBITDA however was $5.4 million for the fiscal year.

A highlight of the year was our March IPO which strengthened our balance sheet raising net proceeds of over $82 million. The increase in our resources provides us with the ability to execute against our strategic growth initiatives and fully capitalize on our market opportunity.

Let me take a moment to review our strategic opportunity. We deliver cloud-based payroll and human capital management software tailored specifically to the needs of medium sized companies. We define med-sized companies as those with 20 to 1000 employees. We believe we are in the early stages of a major market shift from traditional payroll service providers to a cloud-based SaaS model, which leverages the payroll system to enable more comprehensive human capital management capabilities.

There were 565,000 firms that fit the definition of mid-size in the U.S. in 2010 and we still have less than 2% penetration into that target market. The 40% plus growth we delivered in fiscal 2014 was fueled by a combination of strong execution, industry leading products, and a very healthy demand environment for next generation human capital management solutions.

We remain very much in the land phase of our land and expand strategy with more than 44% of our revenue coming from new customers for fiscal year 2014, consistent with fiscal year 2013. We ended the year with 8500 customers up 24% from the 6850 we had at the end of fiscal year 2013.

We also increased our average revenue per client this past fiscal year by 13% to nearly $12,000 primarily by selling more modules to new clients. While we're quick to respond to client needs, we have not yet developed a targeted strategy to sell back into the client base and we want our implementation resources squarely focused on delivering the highest quality experience for our new clients.

As we know, we calculate average revenue per client based on total recurring revenue for the fiscal year divided by the ending annual client base.

We intend to continue to invest to take advantage of the momentum we’re seeing in the market and we’ve increased our spend in both sales and marketing and research and development. We have invested in a number of new marketing initiatives to expand our brand such as first-time attendance at the national trade shows for both the American payroll association and the society of human resource management.

We have also expanded our upcoming client conference to two full days on October 16th, and October 17th. We have historically drawn the large majority of our attendees from the Chicago land area. But based on feedback from our clients, we have enhanced the conference agenda in an effort to attract additional clients from different geographies.

From a marketing perspective we are also making incremental investments in the broker channel with webinars, newsletters, golf sponsorship and broker events targeting this important channel that once again yielded greater than 25% of our new business revenue in fiscal 2014.

This past fiscal year we received referrals from more than 1,000 individual brokers across the country up from over 700 in fiscal year 2013. This unique referral network of 401k advisors, insurance brokers, third party administrators and HR consultants provide our sales force highly qualified leads that are at the highest close ratio across any of our channels.

A key reason for our success in this channel is our ability to automate data integration by connecting the client's payroll information to product providers in the 401k and insurance industries.

Our direct sales force is a highly effective group of very experienced software sales representatives, with extensive payroll and human capital domain expertise.

As we enter the fiscal year, we have set our targeted number of quota carrying reps at 126, up from 95 in fiscal 2014. This represents a 33% increase from the prior year, very consistent with the increase we made from fiscal 2013 to 2014. Where we grew quota carriers by 34%.

I am pleased to report that we are fully staffed and had all of our new team members attend our annual sales kickoff meeting in late July. I spent the week with our sales team here in Chicago, where they shared best practices, rolled out new training and celebrated the best year in our sales history.

Our sales team is highly energized and definitely very excited about opportunity, this fiscal year and beyond. I would now like to spend a few moments discussing our products strategy.

We invested 14.7% in R&D for the quarter and 12.6% for the fiscal year when you combined R&D expense and capitalized software. Our modern cloud architecture enables us to add features and modules quickly and seamlessly as we release new versions of our software every quarter.

We continue to ramp our investment in R&D as we remain focused on delivering new products and features to the market in a timely fashion, further cementing our product leadership position.

We have recently launched a new onboarding module that allows clients to automate the process of hiring employees. This module is available for an additional monthly fee and allows new hires to follow a customized step-by-step hiring process to complete new hire forms on their phone, tablet or desktop.

This product was introduced at the National Society of Human Resource Management show in June, an early feedback from clients indicate they really appreciate the ease of use of our new adaptive design and the flexibility to automate what has traditionally been a very manual process for our clients.

We have also recently launched Web Benefits at our annual sales kickoff, and expect to have our first client completing their annual enrollment this fall. Web Benefits is a proprietary benefits enrollment solution, specifically built for the small and mid-sized organizations that wish to move away from manual enrollment process to an automated online experience.

This solution provides an alternative to Paylocity's enterprise benefit solution powered by Bswift which generally targets clients with more than 300 employees.

In summary, we are very pleased with the fourth quarter and full year results. Before I pass the call over to Peter, to review the financial details and targets for 2015, I would like to give particular thanks to our employees for their commitment to Paylocity. I could not be prouder to have been recently recognized as one of Chicago's 101 best and brightest companies to work for based on feedback from our employees in the Chicago end area.

With that, let me turn it over to Peter.

Peter McGrail

Thanks, Steve. Let me walk through the results and provide a bit of color, as well as review some of the key aspects of our financial model.

Revenue. Total revenue for the quarter was $28.6 million, which represents a robust 41% increase from the same period in the prior year. Total revenue for the year was $108.7 million, and as with the quarter was up 41% in the prior year.

As you may recall, our revenues have two major components, recurring and non-recurring. Our recurring revenue has historically represented about 94% of our overall revenues, and is separated into two categories.

First, we have recurring fees attributable to our cloud-based payroll and HCM software solutions. Second, we earn interest income on funds held for clients. We collect funds for employee payroll payments and related taxes in advance of remittance to employees and the taxing authorities.

Given the current interest rate environment, we do not derive a material amount of recurring revenue from this source, 1% to 2% of overall revenue. But we obviously would benefit from an increase in interest rates.

For the fourth quarter, our total recurring revenue of $27.1 million was up 41% from the prior year and represented 95% of our total revenue in the quarter. Recurring fees were up 42%, while interest income actually declined 7%, with declining rates offsetting balance increases.

For the year, our total recurring revenue of $101.9 million was up over 40% and represented 94% of our total revenue for the year. Our non-recurring revenues are comprised of implementation services and other and primarily consist of implementation fees charged to new clients for professional services provided to implement and configure our payroll and HCM solutions.

We charge fee services when our implementations are complete and do not defer revenue. These fees typically represent 5% to 6% of our overall revenues on an annual basis.

Implementation services and other revenue was $1.5 million for the fourth quarter and $6.7 million for the year, up 48% and 49% respectively from a year ago. Our agreements with the clients do not have a specified term and are generally cancelable by the client on 60 days notice or less.

Even without fixed term agreements, our annual revenue retention rate, which is always calculated on a trailing 12 month basis, has been consistently greater than 92% for several years and remains for this year. As we've noted in the past, we believe this is best-in-class in our segment. This combination of high recurring revenue percentages, and high retention rates, provide significant visibility into our future operating results.

Gross margins. Like our revenues, we separate our cost of revenues into two different categories; recurring revenue and implementation services and other. These two numbers are combined to form our overall costs and then to produce our overall gross profit margins.

We refine our gross margins further by providing adjusted numbers. We adjust for three items. First, we exclude stock-based compensation. Second, we exclude the one-time cash bonus payout for long term employees and recognition of their past service which was generously contributed by our founder Steve Sarowitz in the fourth quarter of 2014.

And third, we exclude amortization expense associated with capitalized research and development costs.

Our reconciliation of GAAP to non-GAAP adjusted gross margin is provided in the press release we issued after the close today. We believe these adjusted numbers provide the best and most reliable comparison to other software's or service companies.

Adjusted gross profit in the fourth quarter was $15 million representing a gross margin of 52%, as compared to $10.1 million or 50% in the fourth quarter of 2013. This improvement was primarily the result of the acquisition of one of our two resellers in May, which Steve highlighted in his comments.

Adjusted gross profit for the full fiscal year was $57 million, representing a gross margin of 53% as compared to $40.7 million or 53% for the prior year.

We view our adjusted recurring revenue gross margins as the best barometer for our overall long-term margin opportunity as we generate these margins on the vast majority of our revenues. Our adjusted gross profit on recurring revenues was $18 million or 67% in the fourth quarter, up in $12.3 million or 64% in the year prior.

Again, this improvement was primarily the result of the acquisition of one of our two resellers.

Adjusted gross profit on recurring revenues was $67.5 million or 66% for the fiscal year 2014, up from $47 million or 65% in the prior year.

As we've discussed in the past, our adjusted gross margins on non-recurring revenue specifically on implementation services are negative. We view the negative margins on our implementation services as a great short term investment, they only last three to six weeks, which then become a long term, high margin annuity.

In regards to implementations, we charge what we believe our market rates and we'll continue this practice as we continue to gain market share.

Operating expenses. Given that we are less than 2% penetrated into this tremendous market opportunity, we are as Steve noted, incrementally increasing our investments in two key areas. First, we are focusing investment in research and development to maintain and extend our technological leadership.

Second, we are engaging in sales and marketing activities that have the potential for long term impacts, including taking a higher profile industry events and cultivating our relationships with our unique broker referral channel, both of which we did in the fourth quarter.

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, research and development investments were $4.2 million or 14.7% of revenue in the fourth quarter, and $13.7 million or 12.6% of revenue for the full year.

On a non-GAAP basis, sales and marketing expense increased to $8.2 million or 28.7% of revenue in the fourth quarter and $27.3 million or 25.2% of revenue for the full year.

On a non-GAAP basis, general and administrative costs were $5.7 million or 19.9% of revenue in the fourth quarter including some one-time public cost and $19.2 million or 70.7% of revenue for the full year.

Income loss. Our adjusted EBITDA, which is adjusted for stock-based compensation or one-time founder funded bonus payout in the amortization of intangibles related to our reseller acquisition, was negative $0.3 million for the quarter versus $0.7 million for the year ago quarter. Our adjusted EBITDA for the year was $5.4 million versus $6.3 million for the year prior.

For the quarter non-GAAP net loss was negative $2.4 million which included $0.5 million of income tax expense resulting from a one-time non-cash charge to establish a valuation allowance against deferred tax assets.

Excluding tax impacts, non-GAAP net loss outperformed guidance by $1.1 million. Non-GAAP net loss per share including the non-cash tax expense was negative $0.05 for the three months ended June 30, 2014 based on $49.6 million diluted weighted average common shares outstanding. The tax deferential negatively impacted non-GAAP net loss per share by negative $0.03.

For the year non-GAAP net loss was negative $1.1 million which included $0.3 million of income tax expense, resulting from a one-time non-cash charge to establish valuation loans allowance against deferred tax assets. Excluding tax impacts, non-GAAP net loss outperformed guidance by $1.2 million.

On a pro forma basis, assuming conversion of all outstanding preferred shares as of July 1, 2013, non-GAAP net loss per share was negative $0.02 for fiscal year 2014, based on $45.4 million diluted weighted average common shares outstanding. The tax differential negatively impacted non-GAAP net loss per share by negative $0.01.

Briefly covering our GAAP results. For the quarter gross profit was $13.5 million, operating loss was negative $6.3 million and net loss was negative $6.7 million. And on a full year basis, gross profit was $53.6 million, operating loss was negative $7 million and net loss was negative $7.1 million.

Cash. Like others in our industry, we do collect funds from our clients in advance of making payments to employees and taxing authorities. Or cash flows from investing and financing activities are influenced by the timing and amount of funds held for clients which vary significantly from quarter-to-quarter. Funds held for clients are restricted solely for the repayment of client fund obligations.

In regard to the balance sheet. We ended the year with cash and cash equivalents of $78.8 million. From a cash flow perspective, we generated $7.2 million in cash from operating activities in the year ended June 30, 2014, and spent $6.7 million on property plant and equipment.

Finally, I’d like to provide our financial guidance for the first quarter and full year of fiscal 2015. For the first quarter of 2015, total revenue is expected to be in the range of $29 million to $30 million. Adjusted EBITDA is expected to be a loss in the range of negative $2.5 million to negative $1.5 million. Non-GAAP net loss is expected to be in the range of negative $5 million to negative $4 million or negative $0.10 to negative $0.08 per share based on $49.6 million basic weighted average common shares outstanding.

As a result of the tax valuation allowance, this guidance assumes no income tax expense or benefit. For the full fiscal year 2015, keep in mind that W-2 and other year end tax filings make our third fiscal quarter significantly higher in revenue, adjusted EBITDA, and non-GAAP net income than our other quarters.

For the full year. Total revenue is expected to be in the range of $139 million to $143 million. Adjusted EBITDA is expected to be in the range $1 million to $3 million. Non-GAAP net loss is expected to be in the range of negative $8 million to negative $6 million or negative $0.16 to negative $0.12 per share based on $49.6 million basic weighted average common shares outstanding.

As the result of the tax valuation allowance, this guidance assumes no income tax expense or benefit.

In summary, we are very pleased with our operational performance during the fourth quarter and full 2014 fiscal year.

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from the line of Justin Furby with William Blair & Company. Your line is open.

Justin Furby - William Blair & Company

Great, thanks guys and congrats. Steve, maybe to start, can you maybe give us essence for, in Q4 the average pricing that you saw on new deals just sort of what that look like in terms of, per employee per month, and maybe what that look like a year ago? And as you look out over the next three to five years, where do you think that’s heading over the medium term?

Steve Beauchamp

Well, first I would point you to the fact that over the last several years, you see we've had a fairly consistent growth rate and then fairly consistent unit growth rate over that time period. And so the balance of that is really coming from new customers buying more of our modules.

We saw the average revenue per customer increase by over 13% this past fiscal year. And I wouldn’t give you any color that that was different in the fourth quarter versus the rest of the year. It was really gradually throughout the year we see ourselves, getting a little bit more attached rates to those new customers and then selling them more.

So, nothing happened in the fourth quarter to create those dynamics. That was something that happened over the entire fiscal year.

Justin Furby - William Blair & Company

Okay. And if you think about the guidance, revenue guidance for fiscal 2015, are you assuming sort of similar dynamic or you have 20%, 25% unit growth and the balance is price or is there something different that may, maybe thinking about I guess.

Steve Beauchamp

Well we tax our sales force with bringing new business revenue in. That is the way our sales quarter works. And so from my perspective, the market somewhat dictates whether it is going to be more unit growth or more average revenue per customer combined with obviously our products that we have available to them.

So, I'm not that worried if it's a little bit different. I think in order to magnitude that makes sense. It wouldn't surprise me if it's a little bit different and its really just going to be a reaction to the marketplace.

The customers want more from it. There are sales force focusing on that or we’re going to end up with little more, little less unit growth.

But I think in order to magnitude that kind of what would we expect, but don’t be surprise if there is some differences around that.

Justin Furby - William Blair & Company

Okay. And the new products, the onboarding, the benefits. What's the – as it relates to fiscal 2015, is there much impact to whatsoever in the model or how do you expect that to play out?

Steve Beauchamp

Yeah. So, first let's talk about onboarding. We are very excited about the onboarding offering. We released that at the SHRM show which I said in my opening remarks. And we are seeing really great early feedback and it really automates a fairly manual process of bringing on new hires, getting them involved, working them to the company.

So we’re seeing good early traction with that module. That is an additional per employee per month. We have just started actively selling that. That was trained at our annual sales kickoff. So we should start to see a little bit of revenue leak into fiscal 2015 but I don’t see that being a big contributor simply because as customers come on, we only get the part of the annual revenue for that year.

So it's certainly helpful to us this fiscal year. I think Web Benefit is probably another fiscal year away to being at all material. We’ll have our first clients doing online enrollment this fall. We don’t have current clients on that as of yet. We are selling that into the marketplace for customers that are in a really target market, so think of 100 to 200 employees.

And we anticipate that some of those customers will come online. We’ll continue to add every quarter to that product. Get that better throughout the year and we think that’s going to be a great revenue contributor to the falling fiscal year.

Justin Furby - William Blair & Company

Okay. And then in terms of the earnings guidance for this fiscal year, I just kind of love to hear your thoughts on how you're approaching that? As a year from now as you end up outperforming revenue expectations, is it likely that you also outperform on earnings or you'd like to reinvest those incremental dollars back into other areas?

Steve Beauchamp

So, I think we highlighted on a couple of areas where we have made some incremental investments already and those would certainly be the area that we would evaluate if we have over performance.

So, we look at research and development, we’ve got a very broad roadmap from a product development perspective that we think we can execute against. If we do get over performance, we certainly would look at the opportunities continue to add to that team. We've got great performance from them.

And then secondly, we’re in the very early innings of our very large market opportunity. And so, from a sales and marketing perspective, we always look for opportunities where we can get our return on those.

I would characterize both those things as incremental opportunities and not, big differences in terms of our history. But to answer your question, we would evaluate if we have over performance, whether we have those opportunities to invest this ultimately, we'll really try to capitalize on a huge opportunity in front of us, and that's really the way that we think about it.

Justin Furby - William Blair & Company

Okay, great. And then last one if I may, on the gross margins Peter, for fiscal 2015, any reason why, since you get a full year of that resell or buyouts in the numbers. Any reason why they wouldn't pick up another 100, 200 basis points in fiscal 2015 on recurring side?

Peter McGrail

Yeah, there's no reason why they would not. That blip you saw on the fourth quarter, will carry into the new year.

Justin Furby - William Blair & Company

Okay, great. Thanks guys.

Peter McGrail

Thank you.

Operator

Our next question comes from the line of Terry Tillman with Raymond James. Your line is open.

Terry Tillman - Raymond James

Hey gentlemen, good afternoon. Thanks for taking my questions. And I would also add congrats. Maybe Steve, start with you in terms of the benefit side. It's highly dynamic right now in terms of ACA requirements, healthcare reform et cetera. I know this benefit solution is still brand new and you don't have customers up on it yet.

But I am curious about your referral network. Is this a potential calling card or an incremental calling card for them to call on the CFOs or key level executives of these mid-sized firms that could help accelerate from your regeneration or introducing these benefit solution. Does that actually create channel conflict because, maybe they’re selling those kind of solution?

Steve Beauchamp

Okay. Let me take a step back and talk about some of the things going on in the benefit space, and one of the things you didn't mention, but I would like to start with that is certainly, some of the legislative changes around healthcare reform. And I think we talked about this on the last call. We introduced a module in our application that really allows clients to forecast to healthcare reform impact, and we’re going to continue to add to that module.

That has been very well received in the broker community, and has increased a partnership opportunity. We think that our benefit offering is going to another step in that direction. So, we don’t see brokers typically offering these type of technology solutions, and frankly these technology solutions are not readily available in our core target market segments.

So, think of 20 to a thousand being our core segment, 20 to 200 or 300 employees, very hard to find an automated benefit enrollment solution, certainly available beyond that, and that's where we obviously partnering with Bswift.

So, we think that the combination of really investing in healthcare reform tools for our clients and for the brokers combined with this benefit solution is really going to solidify our channel strategy.

Terry Tillman - Raymond James

Okay, great. And I guess, Steve, I have in my notes here, you had made a remark about where you ended FY '14 in terms of volunteering sales reps, 95? Did you actually say you’re already at your target of 126 or that's where you’re striving for as the year progresses, so would it be fun and loaded, just more comments on where we are in the 126 goal?

Steve Beauchamp

So, I did say we are at our target hiring of 126. We had 126 the quota carriers at our sales kickoff in late July. So, we are very happy with that progress, just to review from a hiring perspective, we typically hire in Q4 of the prior year, in the Q1 of the current year.

So, sitting here today in August, we were very happy to have all of our quota carriers in at the conference being able to take advantage of some of the training we’re able to put in front of them. So, we’re fully staffed.

Terry Tillman - Raymond James

And then one of these newer sales reps, when did they start to hit kind of their, yield kind of full productivity, is it the third or fourth quarter of the upcoming fiscal year or is it earlier?

Steve Beauchamp

It certainly depends on the start date, because we obviously can start bringing them on as early as the start of fourth quarter. But we generally try to think about it in terms of really takes six months before we start seeing decent levels of productivity. And then from a full year perspective, it's probably another quarter before on a run rate basis they're at – the full first year productivity that we expect them at.

Terry Tillman - Raymond James

Okay. And just my final question. Peter, in terms of acquiring a reseller, there is a benefit to gross margins on the recurring side but just remind us is there any kind of impact on the top line or there is no impact?

Peter McGrail

There is no impact on the top line.

Terry Tillman - Raymond James

Thanks guys.

Peter McGrail

Thanks Terry.

Operator

Our next question comes from the line of Nandan Amladi with Deutsche Bank. Your line is open.

Nandan Amladi - Deutsche Bank

Hi, thanks for taking my question. So, I might have asked this before on the last call, but since you came public and you have more of a public presence now, is there any change in the size of your typical customer? And also in the regional presence that you've had obviously started out in the Midwest and that's where you have your highest density today?

Steve Beauchamp

So, let me start with the second part first. Our history obviously is the company started here in the Chicago land area. We really started expanding nationally, call it six or so years ago. And today we've got at least small presence in most of the major markets across the countries.

So, as we add new business, it's happening more outside of the Chicago land area than it is here. And so, from a new business perspective, I think you can absolutely think about it as a national presence from that perspective.

So, the number of customers in the Illinois marketplace has shrunk on a percentage basis simply because of that national expansion strategy.

From a customer size perspective, we generally stick to our target market of 20 to a thousand employees. In an employment growth environment, when you look at GDP numbers, we do typically get a little bit of increase in our customer base as they add employees a very small percentage when you think about growing 40% and customers adding 1% or 2% of employees.

It does slightly increase the average size but not materially, no change in our target market focus.

Nandan Amladi - Deutsche Bank

Okay. And then, second question on Ultimate's recent earnings call, they talked about creating a new segment to address the 300 to 500 employee market. Historically they've played in the two tiers about that. What is your response or perhaps any commentary you might have heard from your prospects about whether you might end up competing with them?

Steve Beauchamp

I think I would echo, what I said last time in terms of Ultimate, which is, we don’t run into them very often in the marketplace at all. They were for a time period if we go back several years, they were in the 100 plus marketplace and we didn’t see them frankly very much in the marketplace then. It's a very large market opportunity.

So, they certainly can have some success in that strategic account marketplace. But we think that we will continue to have success in our core market segment even where it overlaps with them, we take a different approach to the marketplace from the sales and marketing perspective, we think from an implementation perspective and from a product design perspective.

And so, when we compete with them, we think that we can be successful but we really don’t see them at all in the marketplace and although that might increase a little bit with this new focus, we don’t think it will be material.

Nandan Amladi - Deutsche Bank

Thank you.

Operator

(Operator Instructions) Our next question comes from the line of Pat Walravens from JMP. Your line is open.

Peter Lowry - JMP Group

Thank you, it's Peter Lowry in for Pat. Can you talk about whether you’re seeing a more favorable or perhaps even accelerating demand environment for SaaS payroll solutions overall? And then, if you are maybe you could talk about what your take is on what might be driving there?

Steve Beauchamp

I think, if you go back, several years ago, I talked about our national expansion starting almost six years ago. At that point in time, I would tell you that the sales force was doing a lot of market education in terms of what are the benefits of a cloud-based provider, SaaS based payroll offering.

Today, we do not have to do a lot of market education. In many cases, that some of the first questions that we’re hearing from the prospects. And I think the market is becoming much more educated in terms of a SaaS alternative to traditional payroll providers.

The other part of your question is, are we seeing increased momentum there? I would tell you that it's been that way for probably the last couple of years. So, it's incrementally becoming much more acceptable. But I think a lot of that shift has occurred in from a knowledge perspective.

Now clearly many of the clients have not made this shift to a SaaS provider. And that’s obviously why we’re very excited about the opportunity in front of us because we don’t have to spend the time educating them. We just have to spend the time telling them why Paylocity is the best cloud-based alternative as they evaluate options in the market.

Peter Lowry - JMP Group

Okay. And then, can you talk about – it sounds like you’re very much in the land - part of your land expend strategy, but sort of when - if there is some sort of time period when you might see a shift more towards your expense side?

Steve Beauchamp

Well, I think when you look at less than 2% penetration rate into this large market opportunity, we would really like to land as long as we can. We think that getting customers onto the platform is the number one priority at this stage of our growth cycle. So we will stay focused on that.

At the same time as we see demand in our customer base, we want to be able to react and provide them the products that we’re looking for. We just haven’t come up with a targeted effort to really push that simply because we want to use all of our implementations resources to make sure that that new client experience is a great one and one that allows us to retain the customers at the rates that we have, which has been greater than 92% revenue retention.

So, at this point in time, we will stay focused on the land, part of the land and expand strategy.

Peter Lowry - JMP Group

Okay. Thank you and nice quarter.

Steve Beauchamp

Thank you very much.

Operator

Our next question comes from the line of Michael Turn with Needham & Company. Your line is open.

Michael Turn - Needham & Company

Thanks very much. Hey guys.

Steve Beauchamp

Hey, how're you doing?

Michael Turn - Needham & Company

Doing well. Couple of questions for you. First of all, obviously the acquisition of reseller benefits gross margin, I was wondering if there is kind of any other benefits on top of some of the cost of sales benefits that you’re seeing here. And then I didn't know this was at all kind of a hugely relevant question here, but in terms of when you’re thinking about why one reseller acquired versus the other. Was there any rational behind kind of people ordering that you're doing?

Steve Beauchamp

Okay. So, let's just talk about the benefits associated with the reseller acquisition. So, the cost of the resellers was paid back as part of our cost of revenue. And so as we purchase that reseller those cost go away and that gives us a lift in gross margin, and we completed that acquisition in May.

So, we will obviously continue with that lift in gross margin through on a go forward basis and obviously through this fiscal year. So, think about it in the couple 100 basis point range. And that's really the benefit associated with it.

In terms of why we chose to do one or the other, we had an option, based off the IPO and that option had certain notice provisions and periods associated with it. So, that was the only reseller that we had the option to acquire during fiscal year 2014.

We have the option to acquire the second reseller in fiscal year 2015. We have not made any decisions around timing of that nor have we started some of those conversations, that option does not even become available till fall of this year.

Michael Turn - Needham & Company

Got you, okay. And then in terms of kind of the headcount that you picked up there, was that part of your quota sales headcount that you shared with us?

Steve Beauchamp

Yeah. So, it was a great market. One of things that we did is expanded the head count in that marketplace beyond what was there at the time. And we interviewed the people who were in that market at the time we make a decisions on whether we want to bring them onboard but regardless we - the Southern California market was the one that we took over and we've added to that marketplace and that is included in the total 126 headcount.

Michael Turn - Needham & Company

Got you, okay. And then, I know that you’ve mentioned several times that there is no real change here in your target market focus and unit count is pretty steady on a year-over-year basis but I was just curious, could you share with us what are some of the larger deals that you're doing in the quarter maybe in terms of headcount. And is this kind of upper bound at all trending in any upper direction? Thanks.

Steve Beauchamp

Yeah, sure. So, I think it is true. We absolutely stick to our core target market 20 to a thousand employees. When do we go over a thousand employees. Well, first of all it doesn’t happen that frequently and one of the things we’ll point to is, we don’t have any customers that represent any concentration of revenue, which is certainly a proved point to that. It does happen on occasion.

When it happens is, you might get an organization let's say with 2000 employees and maybe they have 100 employees in 20 different locations and they operate like 2,100 employee company.

When that's the case, we may have a product that is a perfect fit for that organization. And that's something that we evaluate very carefully. We don't just let our sales force evaluate that. We have a sales engineering team. We get operations involved and if that happens to be a fit, that's when we bring those types of customers on. That customer above 1000 employees have not increased on a percentage basis, overtime we’ve been pretty consistent. So, I would call it opportunistic about that 1000 employees.

Michael Turn - Needham & Company

Great, thanks guys.

Operator

And I'm not showing any further questions at this time. I'd like to turn the call back to Steve, for closing remarks.

Steve Beauchamp

I'd love to thank all of you for taking the time today for the call. And I will actually be presenting with Peter at the Deutsche Bank Technology Conference in Las Vegas. So, for anybody on the call who would like to meet with us, we would love the opportunity to share our story and look forward to talking with you in the coming months. Thank you.

Operator

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

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