The Ultimate Software Group (ULTI) Scott S. Scherr on Q2 2016 Results - Earnings Call Transcript

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The Ultimate Software Group, Inc. (NASDAQ:ULTI)

Q2 2016 Earnings Call

July 26, 2016 5:00 pm ET

Executives

Mitchell K. Dauerman - Chief Financial Officer, Executive Vice President & Treasurer

Scott S. Scherr - Chairman, President & Chief Executive Officer

Analysts

Michael Nemeroff - Credit Suisse Securities (NYSE:USA) LLC (Broker)

Scott Berg - Needham & Co. LLC

Justin A. Furby - William Blair & Co. LLC

Brad Reback - Stifel, Nicolaus & Co., Inc.

Richard Kenneth Baldry - ROTH Capital Partners LLC

Mark R. Murphy - JPMorgan Securities LLC

Jesse Hulsing - Goldman Sachs & Co.

Terry F. Tillman - Raymond James & Associates, Inc.

Ross MacMillan - RBC Capital Markets LLC

Patrick Falzon - Evercore Group LLC

John S. Byun - UBS Securities LLC

Alex Zukin - Piper Jaffray Companies

Jeff Houston - Northland Securities, Inc.

Steve R. Koenig - Wedbush Securities, Inc.

Operator

Hello and welcome to Ultimate's Second Quarter Financial Results 2016 Conference Call. At this time, all participants are in a listen-only mode. Today's conference is being recorded. Your presenters today will be Mr. Scott Scherr, Chief Executive Officer, President and Founder of Ultimate; and Mitchell K. Dauerman, Executive Vice President and Chief Financial Officer. We will begin with comments from Mitchell Dauerman.

Mitchell K. Dauerman - Chief Financial Officer, Executive Vice President & Treasurer

Thank you, Brian, and good afternoon and thanks to everybody for your interest in Ultimate Software. Before we begin, please be aware that we will be discussing our business outlook and we'll be making other forward-looking statements regarding our current expectations of future events and the future financial performance of the company. These forward-looking statements are based upon information available to us as of today's date and are subject to risks and uncertainties. Please review our filings with the SEC for additional information on risk factors that could cause actual results to differ materially from our current expectations. We assume no duty or obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.

Unless otherwise noted, our discussion will be on a non-GAAP basis for all costs, gross margins, operating and net income, as well as EPS. The primary differences between GAAP and non-GAAP financial information are noncash, stock-based compensation and the amortization of acquired intangible assets. Please refer to the reconciliation of our financial information on a GAAP basis to that on a non-GAAP basis included in the press release published on our website.

I'm going to begin by reviewing our Q2 financial results and then we'll provide guidance for the third quarter of 2016. For the quarter, recurring revenues grew by 27.4% to $158.5 million and total revenues grew by 26.7% to $186.5 million. Revenue retention from our cloud customers was in excess of 97%, the gross margin on recurring revenues expanded by 70 basis points to 74.3%. Service revenues were $28.1 million, the nominal gross margin rate was in line with our expectations. The gross margin rate for total revenues expanded by 70 basis points to 63.2% this quarter from 62.5% in the second quarter of last year largely due to the favorable recurring gross margin rate expansion.

Operating expenses were $80.5 million for the quarter and were favorable to our expectations, mostly in the general and administrative area. Operating income grew by 25.9% to $37.4 million and our operating margin was 20%, both in line with our expectations. Our non-GAAP income tax rate for the year-to-date was 39% and net income was $22.7 million and the related net earnings per share was $0.76.

Now, turning to the balance sheet. Cash and marketable securities were $104.9 million. The average daily float balance for our Payment Services business was approximately $877 million for the year-to-date. Our cash and marketable securities balance reflects a total of $48.3 million used to purchase shares of our common stock in the open market through our stock buyback plan and also shares acquired to settle employee tax withholding liabilities associated with their restricted stock divested.

Additionally, during the quarter, we acquired the assets of Vestrics for a total of $10.1 million, of which $9.1 million was paid in the quarter. Vestrics' predictive technology enables the company to identify and analyze the connections between its investments in unit capital and the performance related business results of those investments. We will leverage Vestrics' technology as we continue to expand our analytics capabilities across UltiPro.

Operating cash flows for the year grew by approximately 20.3% to $52.5 million, and that's compared to $43.6 million in the first half of 2015. Our capital expenditures for the first half of 2016 were $33.6 million, and that included capitalized R&D costs of approximately $15.1 million. This compares with 2015 CapEx of $21.3 million, and that included $11.4 million of capitalized R&D costs for the same first half of the year. Also included in the first half of this year were higher than usual leasehold improvement costs, which are associated with our expansion in Weston.

And finally, I'd like to talk about our financial guidance. We are reaffirming our full-year guidance for 2016. Recurring revenues are expected to grow by approximately 26%. Total revenues are expected to grow by approximately 26%. And we expect our operating margins to be approximately 21%. We're maintaining our full-year operating margin guidance while at the same time making the necessary investments to effectively support the strength of our sales growth as well as the increased revenue growth opportunity before us.

For the third quarter of 2016, we expect recurring revenues to be approximately $165 million. We expect total revenues to be approximately $197 million, and our operating margin to be approximately 19%.

Turning to our upcoming conference schedule during the next quarter, I'll be in Boston for the Oppenheimer Technology Conference and Canaccord Genuity's Growth Conference on August 9 and 10, respectively. I'll also be at Deutsche Bank's Tech Conference in Las Vegas on September 13. If you're available at those conferences to meet, please let me know.

And now, I'll turn the call over to Scott.

Scott S. Scherr - Chairman, President & Chief Executive Officer

Thanks, Mitch. And thank you, everyone, for participating on our call this evening. In the second quarter, we again executed on all of our objectives, and we are positioned well to achieve our 2016 and longer range plans. Recurring revenues grew by more than 27% to more than $158 million, and total revenues grew by 27% to approximately $187 million, both compared with Q2 2015. At the same time, our non-GAAP operating margin came in at our targeted 20% while the year-over-year customer retention rate again exceeded 97%.

On the sales side, Q2 this year was the best single quarter for new business in our history as a company. The record-setting performance of our global enterprise and enterprise teams reflects the market's continuing strong desire for our solutions and our team's ability to differentiate us in the marketplace. We are now identifying organizations with more than 2,500 employees as global enterprise and those with 1,501 through 2,500 employees as enterprise. And we have sales teams dedicated to each of these market segments.

Enterprise had the best quarter in its history and the overall attach rates of the two teams for new customers in the quarter were: on-boarding, 67%; time management, 63%; recruiting, 53%; and performance management, 37%. Some of our new global enterprise customers in Q2 were: a restaurant chain with 14,000 employees that added recruiting, on-boarding, compensation, performance management and succession management; a retailer of major sports brands with 9,200 employees; and a diversified technology company with 8,000 employees that added recruiting, on-boarding, compensation management, performance management and succession management.

A couple of our new customers in our enterprise space were: a not-for-profit organization with 2,500 employees that added recruiting, on-boarding and time management and a business services company with 1,700 employees that added recruiting, on-boarding, comp management, time management, performance management and succession managements.

Our mid-market and strategic teams continued their record setting pace as well, delivering the second best quarter in their history. Their attach rates for the quarter were on-boarding 88%, time management 81%; recruiting 72% and performance management 72%. Some new midmarket customers in the quarter were a county government with 1,500 employees that added all of our optional solutions, recruiting, on-boarding, time management, performance management, comp management and succession management; a paint manufacturer with 1,500 employees that also added all of our optional solutions and a Canadian-based agricultural company with 1,500 employees that added on-boarding and time management in addition to our Canadian functionality.

A couple of our new strategic customers in the quarter were: an engineering firm with 500 employees that added recruiting, on-boarding and performance management and a dental association with 500 employees that added all of our optional products.

Market demand for our solutions continues to grow. Q2 2016 was our best second quarter ever in terms of campaign responders looking to purchase in 12 months or less and it was the number two highest quarter in our history. The increase over 2015 second quarter was 15%.

We had a 34% increase in traffic to our website compared to Q2 2015 and our inside sales teams had an 11% increase in new sales opportunities uncovered versus Q2 2015.

At the end of the quarter, we were pleased to be recognized as a leader in the Summer 2016 Core HR Software Grid reported by G2 Crowd, the world's leading business software review platform. It is a great honor that our UltiPro solution was awarded the highest overall customer satisfaction rating among a field of 96 solutions, with satisfaction scores determined by reviews from actual users of the software. UltiPro earned a score of 98% for customer satisfaction from our users exceeding the category average of 56%. According to G2 Crowd, our users agreed that UltiPro's reporting tools are flexible. They allow you to create reports on almost any field within the system. UltiPro offers a user friendly platform for both end users and administrators, and the integration between modules are seamless, and that integrating the core HR module with other modules such as payroll significantly increases the system's functionalities.

Ultimate received recognition from several other sources in the past quarter. Ultimate was named Best Customer Service Department of the Year by Network Products Guide in its 2016 IT World Awards. Forbes Magazine ranked Ultimate number eight on its 2016 list of the Most Innovative Growth Companies. NetSuite named Ultimate its 2016 Worldwide Partner of the Year and 2016 SuiteCloud Partner of the Year, Achievers recognized Ultimate as one of the 50 Most Engaged Workplaces in North America, InformationWeek identified Ultimate as The Most Rewarding Place to Work in IT, and its Business Innovation People's Choice Awards building upon Fortune's recognition of Ultimate as the Number One Technology Place to Work in the first quarter this year.

Fortune also recognized Ultimate as number five on its list of Best Workplaces for Gen X'ers, number five on its list of Best Workplaces for Millennials, and number 14 on its list of Best Workplaces for Giving Back to Our Communities. And Texas Roadhouse, a restaurant chain with more than 40,000 employees and our customer, awarded Ultimate its Legendary Service award in recognition of our high regard in the industry and our legendary partnership with them.

At the close of the second quarter this year, we were 3,300 strong. We support approximately 30 million people records in our cloud, and we continue to lead the cloud industry in numbers of customers, using a unified HCM that includes human resources, payroll, talent, comp, and time and labor management. Our UltiPeeps put our customers at the center of the work we do every day. The focus on the simple principle has given us the power to create solutions and services that result in industry recognition like G2's highest customer satisfaction rating for our UltiPro product and the highest award for Network Products Guide's World Awards.

Since the beginning, we have believed in finding the best people, putting them first and giving them what it takes to produce unequal products and services. We are stronger than we've ever been and expect to keep getting stronger for a very long time.

This is Mitch's and my 74th conference call together. We want to thank you for taking this journey with us over the years and look forward to your continued support. Let's go to the Q&A.

Question-and-Answer Session

Operator

Thank you. And we'll now take our first question from Michael Nemeroff with Credit Suisse.

Michael Nemeroff - Credit Suisse Securities (USA) LLC (Broker)

Hey, guys. Congratulations. Thanks for taking my questions. Scott, one for you. I just want to help frame what we're trying to understand. When you say that you had in Q2 the best quarter for new business contracts, I'm curious. Is that in terms of the dollar amount or the growth rate? And wouldn't mind if you gave that growth rate, considering how strong it was.

And then for Mitch. Just you don't do acquisitions all that often. Just on the Vestrics one, how much do you expect that will contribute to revenue in 2016? And I assume that that's going to be in the recurring line. Thanks.

Mitchell K. Dauerman - Chief Financial Officer, Executive Vice President & Treasurer

Mike, it's the highest dollar amount we've ever done in a quarter, highest annual recurring revenue.

Scott S. Scherr - Chairman, President & Chief Executive Officer

Yeah. And, Mike, on the Vestrics acquisition, as I mentioned, it's a $10 million deal. It is technology that provides infrastructure for us to build our analytics solutions across the platform. So there is no immediate revenue from it. But as we build it into our core offering, it will expand the value proposition of our products.

Michael Nemeroff - Credit Suisse Securities (USA) LLC (Broker)

And is that going to replace some of the other analytics products that you have purchased from third parties in the past?

Scott S. Scherr - Chairman, President & Chief Executive Officer

I don't believe we've purchased any in the past. You might be thinking about another company. But it will be additive to, for example, the current predictors that we self-developed in our product, talking about predicting employee turnover, predicting high performers. So this is an addition to it and provides a strong platform for continuing to build on that expanding analytics.

Michael Nemeroff - Credit Suisse Securities (USA) LLC (Broker)

Okay. Thanks. I was under the impression that you had a contract with IBM Cognos on some analytics products.

Scott S. Scherr - Chairman, President & Chief Executive Officer

No, we use IBM Cognos actually since 1997 for doing reporting analysis there. But I think when you talk about analytics like Vestrics or analytics like predictors, it's a different level than just the reporting and the analyzing. And that's an area that we expect to take our product into.

Michael Nemeroff - Credit Suisse Securities (USA) LLC (Broker)

Okay, great. Thanks for taking my questions. Congratulations.

Operator

And we'll take our next question from Scott Berg with Needham & Company.

Scott Berg - Needham & Co. LLC

Hey, Scott and Mitch. Congratulations on a good quarter. Two quick ones here. First of all, following on the Vestrics question. Scott, could you detail a little bit more on maybe thoughts around the exact product, analytics products that you had maybe in the pipeline? Is it more broader workforce analytics? Is it something a little bit more detailed on that? And then do you have some timelines in mind to bring some products to market? Do you think this is a quick turnaround? Or a couple years before we see some products impact from that acquisition?

Mitchell K. Dauerman - Chief Financial Officer, Executive Vice President & Treasurer

I would think it would be some time next year we'd see something from it that would increase the value of UltiPro. And I think one of developments main charges is to get us from $30 of product PEPM to $40 entering 2019. And this is part of that business plan.

Scott Berg - Needham & Co. LLC

Great. And I guess a follow-up for me is I had a data point out during the quarter. Mitch and I talked a lot about a win you had with a large SI on a relatively small deal. But found it interesting because it was your first time working with this SI. Broader partner question. In general, are you seeing more impact with some of these larger Sis, opportunities with these large SIs as you continue to delve better into the large global enterprise segment that you've carved out?

Scott S. Scherr - Chairman, President & Chief Executive Officer

I believe we put that program together maybe two years ago – like two years to three years ago, the SI program. So we've been getting business. And I know he was talking about with that large one. But we look to build the funnel in all different ways, so that's just one way we build a funnel. And I believe it's been successful.

Scott Berg - Needham & Co. LLC

Great. That's all I have. I'll jump in the queue. Thank you.

Operator

And we'll take our next question from Justin Furby with William Blair & Company.

Justin A. Furby - William Blair & Co. LLC

Great. Thanks, guys, for taking my questions and congrats on another great quarter. I guess first for Scott, I'm wondering if you could compare the competitive dynamics you're seeing in the midmarket and the strategic as it relates to the enterprise? And if there's any notable difference you're seeing in terms of win rates across those markets? And it seems like your commentary on the enterprise bookings has picked up this quarter, is that a fair read? I'm just curious what you would attribute that to? And I have got one quick one for Mitch. Thanks.

Scott S. Scherr - Chairman, President & Chief Executive Officer

Well, I think we've always had a great enterprise team. They've delivered for us for multiple, multiple years since the beginning when I started. So this was just an exceptionally great quarter for them. I think it wasn't like they weren't delivering right up to this point. So I think on the midmarket and strategic, you know, it's a buildup. The enterprise sales team, the average tenure is eight years. The midmarket sales team, the average tenure is 3.4 years, and the strategic is 10 months. So you build it over time to get people to tenured. We have very low turnover.

Competitive dynamics, I think, remain the same. We're seeing the service bureaus 65% of the time. We're seeing ERPs about 35% of the time. Our win rates tend to remain the same. With the service bureaus we're up in the 80%s win rates and we're about – in the ERPs I'd say we're right around 50% win rates in the opportunities we get. So everything is about building the pipe, getting in the right opportunities, and then trying to win it.

Did that answer it, Justin? Hello?

Operator

Please check your mute function. And with no response, we'll now take our next question from Brad Reback with Stifel.

Brad Reback - Stifel, Nicolaus & Co., Inc.

Thanks a lot. Scott, with the productivity gains you're seeing on the sales force fairly consistent, we hear, I guess a two-part question. Number one, is there a lot of room left on that front? And number two, does it accelerate your plans at all for hiring to hit a, I believe, it's about 130 [people] plus goal for 2018.

Scott S. Scherr - Chairman, President & Chief Executive Officer

Yeah, my goal for 2018 was about like 135 [people]. But again, the acceleration is in the tenure of the people. I think I mentioned the strategic channel, first half of the year we only had 11 people on quota, because to be a quota person, we have to hire him in the seventh month. So the goal is to try and get over time 41% on quota. We're at 36% right now. Probably next year we'll be at 41% there. So I think that's how you build it. You build tenure, you build average annual productivity per person and you get as many people to quota as you can. And then you try to keep the quota carriers at – you try and keep 90% of your people on quota and keep your retention rate of your sales force under 10%. And that's how – I think that's how we were able to produce what we've produced with a sales force of 120 quality, quality salespeople out there.

Brad Reback - Stifel, Nicolaus & Co., Inc.

Got it. Thanks a lot.

Scott S. Scherr - Chairman, President & Chief Executive Officer

Okay.

Operator

And we'll now take our next question from Richard Baldry with ROTH Capital.

Richard Kenneth Baldry - ROTH Capital Partners LLC

Thanks. Guidance implies a little bit above average services growth sequentially for the third quarter. So I'm wondering if there's something new or different drivers behind that. And then maybe another update sort of just broadly on the strategic segment sort of geographically and by head count how you're feeling about where that's sitting now versus your goals. Thanks.

Mitchell K. Dauerman - Chief Financial Officer, Executive Vice President & Treasurer

So, Rich, as you call it, the acceleration services revenue is tied to the stronger sales production we're talking about. It does mean we expect to have more lives in January and the service revenue will precede it.

Scott S. Scherr - Chairman, President & Chief Executive Officer

On the strategic staffing we were – our plan this year was 36. We're at actual 35 right now. We had one turn and I believe hopefully within a week we'll place that person. The person's coming down here. So I believe we'll be at full staff in another week in strategic.

Richard Kenneth Baldry - ROTH Capital Partners LLC

Great. Thanks.

Operator

And we'll take our next question from Mark Murphy with JPMorgan.

Mark R. Murphy - JPMorgan Securities LLC

Yes. Thank you. I'll add my congratulations. So, Scott, just given the record-setting bookings performance that you mentioned, how would you characterize the level of visibility as you look forward into 2017 and beyond? And just wondering is it normal or perhaps better than normal? And I have a quick follow-up.

Scott S. Scherr - Chairman, President & Chief Executive Officer

Enough. It's almost every year since I can remember we've been going into visibility within the mid 90s when we – or low 90s when we guide in October, I don't see what would change that. Well, it's not going to change. We're going to go along with visibility into next year in the 90s. And then depending on what happens the second half of the year hopefully after Q1 we can say what we said this year and we'll be 99% visible into 2017.

Mark R. Murphy - JPMorgan Securities LLC

Okay, great. And just as a follow-up I'm wondering how would you characterize any potential impact of the overtime regulations? And is there a way that you can productize an ability to do the calculations or optimizations for customers in a way that is monetizable or is it not really material of a catalyst and essentially just business as usual.

Scott S. Scherr - Chairman, President & Chief Executive Officer

When I believe it's business as usual, I think the opportunity for us is that there'll probably be more people paid. After more people paid, we'll get more PEPM. But I think it's business as usual from what we have to do regarding compliance of it and the reporting of it.

Mark R. Murphy - JPMorgan Securities LLC

Thank you.

Operator

And we'll now take our next question from Jesse Hulsing with Goldman Sachs.

Jesse Hulsing - Goldman Sachs & Co.

Yeah. Thanks for taking my question, guys. Scott, can you give us a sense of in the global enterprise stage who you're seeing most often? And to drill a little bit further into your commentary about win rates versus the ERP vendors, I think you've said about 50%. How has that been trending? Thanks.

Scott S. Scherr - Chairman, President & Chief Executive Officer

I think it's been pretty consistent at 50% for a while there. And I think one thing like we like to try and get into deals that we believe we can win. I'll give you the exact numbers in a minute. We're about 55% in – in enterprise and global about 55% of our business, the first half of the year came from service bureaus and the other 45% came from ERPs.

Jesse Hulsing - Goldman Sachs & Co.

Perfect. Thanks, Scott. I appreciate it.

Scott S. Scherr - Chairman, President & Chief Executive Officer

Okay.

Operator

And we'll now take our next question from Terry Tillman with Raymond James.

Terry F. Tillman - Raymond James & Associates, Inc.

Hey, guys. Good afternoon. And I'd echo my congratulations. Mitch, I guess the first question is with the different types of segments of business you have of global enterprise, midmarket and strategics, is there any way to frame maybe kind of the gross margin profile over the next couple of years? And could it change notably?

Mitchell K. Dauerman - Chief Financial Officer, Executive Vice President & Treasurer

Terry, I think we can answer that question a lot of times. And each year – and again, remember, we went to Workplace back in 2008. So we were selling down low. So the gross margins have grown modestly each year. When you take everything in aggregate, it's still something I would think it's going to happen going forward on the recurring revenue whether it goes up 50 basis points or 100 basis points as we expand into these different areas.

If you think about we do have a higher percentage of what you would – new stuff, midmarket, strategic that we had a year or two ago yet the gross margin has gone up a little bit, although it's small. But I think that's kind of how it works out. We do have different activation strategies. I guess the short answer to the question is, I think, when you take everything combined, we'll still see some modest improvement in gross margin year-over-year in recurring revenue.

Terry F. Tillman - Raymond James & Associates, Inc.

Okay. And I guess my follow-up question just relates to the theme that I guess, Scott, you're talking about is just the motivation of your customer base and even smaller organizations now being global in nature. I guess could you frame that in terms of how you benefit monetization wise with your product either on just the global core side? Or is there anything you could do to try to even capture some of the payroll opportunity? Or would that be through partnering or integration? Thank you.

Scott S. Scherr - Chairman, President & Chief Executive Officer

Yeah. I think when people have global employees and they put them through UltiPro it increases the per employee per month. And I think we're not looking at going gross to net around the world anywhere other than North America and we do partner with Celergo for people who do want to produce payroll in other parts of the world. And then that gets uploaded into UltiPro. So a North American company would have access and visibility into the worldwide workforce.

Terry F. Tillman - Raymond James & Associates, Inc.

I see. Thank you.

Operator

And we'll now take our next question from Ross MacMillan with RBC Capital Markets.

Ross MacMillan - RBC Capital Markets LLC

Thanks a lot for taking my questions and my congrats as well. Scott, just two for you and maybe a quick follow-up for Mitch. Workday had been making some commentary around lowering the cost of implementation and they think it may make them more competitive down market. Just curious if you've seen any change at all in the competitive environment with Workday specifically? And then I heard your comments on the strategic hiring. Was just wanting to get an update across the broader sales force in terms of your hires to date and where you stand relative to the plans for the end of the year.

Scott S. Scherr - Chairman, President & Chief Executive Officer

Okay. Workday remains pretty consistent. We saw them about 10% of the time. In the quarter, there was really no change from when we saw them and we were, I mean, pretty consistent about 50/50 in our win rates with them. In the sales force, the enterprise sales team is 100% staffed, the midmarket sales team is down one person from 41. We're at 40 and same thing we're looking. We have people in the pipe who we think we'll hire fairly quickly. And as I mentioned, strategic, which is 36. We're at 35. And hopefully by next week we'll fill the 36 slot. And we have managed services which is three, and we're staffed in managed services with the three. That gets you to the 120.

Ross MacMillan - RBC Capital Markets LLC

Great. And then, Mitch, just curious on the Q3 operating margin guidance which is a bit lower than what we had. And I think the consensus, is there any impact from the asset acquisition that you made? Or is it just the cadence is operating expense growth?

Mitchell K. Dauerman - Chief Financial Officer, Executive Vice President & Treasurer

Now, Ross, the impact of Vestrics is fairly nominal. It is a matter that we are hiring people in support, activation ahead of time than we would have normally. And that's on the heels of the strong sales growth. So that's why you see a little bit of the dip in Q3.

Ross MacMillan - RBC Capital Markets LLC

Great. Thanks again.

Operator

And we'll now take our next question from Kirk Materne with Evercore ISI.

Patrick Falzon - Evercore Group LLC

Hi. This is actually Patrick Falzon on for Kirk. Thanks for taking the questions. Congrats on the quarter. Piggybacking off that last question, can you maybe talk about some of the factors that are going to make 4Q bounce back a bit from a margin standpoint? And then also if you could provide any update on the NetSuite partnership and how things are trending there? Thanks.

Mitchell K. Dauerman - Chief Financial Officer, Executive Vice President & Treasurer

Yeah. So, on the operating margin growth in the fourth quarter, as I mentioned before, because of the higher live units, we're going to end up with higher services revenue kicking in, in the fourth quarter, getting ready for January start. So you do have a ramp-up in revenue in the fourth quarter. And we would have already hired the people, so we have the costs in place. There's some other minor adjustings that happened in the fourth quarter of labor costs around how we account for PTO and benefits, stuff like that. But that pretty much explains what has been in the past a normal trend in the fourth quarter to see the margin improve.

Scott S. Scherr - Chairman, President & Chief Executive Officer

And on NetSuite, it's been a great partnership. We mentioned before last year the 5% of our annual recurring revenue that was sold was somehow related to our partnership with NetSuite. And year-to-date, the first six months 12% of our business that we sold was somehow related to our partnership with NetSuite. And I believe – well, I know on the NetSuite side, that dollar amount, they got equal dollars on their side that we got on ours. So I'm really happy with the partnership. I couldn't be happier with the partnership. And I believe and hope Zach feels the same way.

Patrick Falzon - Evercore Group LLC

Great. Thanks.

Operator

And we'll now take our next question from John Byun with UBS.

John S. Byun - UBS Securities LLC

Hi. Thanks. The first question if you could give an update on the implementation of the large hospitality customer that's due to go live early next year? And in terms of the overtime rules as well as maybe aftermath of the ACA, are those still part of conversations at all with customers? Is that a topic that's coming up in the usual sales process? That's it. Thank you.

Scott S. Scherr - Chairman, President & Chief Executive Officer

I'd take the second one, I don't – again I think it's just normal business for us. I think anything in compliance helps us. The more complicated it becomes, it helps us. ACA helped us on new sales. On large hospitality, I believe it's going to go live some time the first half of next year. I don't know exactly it's going to be January 1, it's going to be April 1 or it's going to be May 1. But it's a large deal. We're working on it. It's going good, but I'm sure it will be the first half of next year.

John S. Byun - UBS Securities LLC

Okay. Thank you.

Operator

And we'll now take our next question from Alex Zukin with Piper Jaffray.

Alex Zukin - Piper Jaffray Companies

Hey, guys. Thanks for taking my question. I just have one for Scott and one – quick one for Mitch. Scott, I wanted to ask you, just piggybacking on the competitive environment, are you seeing any more at bats than usual as kind of Oracle and ADP are increasingly pushing some of their legacy customers to the cloud with more force?

Scott S. Scherr - Chairman, President & Chief Executive Officer

Yeah. When it comes with having more people on the street. And I think on the enterprise side we had the most amount of deals, over 5,000 employees in our history, which contributed to enterprise having the best quarter they had. And a lot of those deals were, especially on the ERP side, people looking to change and giving us an at-bat that maybe we wouldn't have gotten in the past. And I think on the lower end, I think it's more people on the street, especially the strategic team. The numbers overall, 75% of our units, came from mid and strategic, and 25% of our units came from enterprise. But those 25% of enterprise units accounted for 60% of our total sales, annual recurring revenue. So it was a perfect storm for us in the quarter.

Alex Zukin - Piper Jaffray Companies

Yeah, that's helpful. And then, Mitch, it seems both anecdotally from Scott's comments and kind of from the numbers on the income statement that you've increased your focus and spend on marketing and then obviously sales the last four quarters to take advantage of the strong demand environment. I guess, my question is when do you feel like you're kind of – you've reached the right run rate that you can start moderating or dialing that back so that sales and marketing growth rate goes back to more historical levels at or below top line growth?

Mitchell K. Dauerman - Chief Financial Officer, Executive Vice President & Treasurer

You're referring to sales and marketing?

Alex Zukin - Piper Jaffray Companies

Yeah.

Mitchell K. Dauerman - Chief Financial Officer, Executive Vice President & Treasurer

Yeah, it's running – it's going to run around 21%, which is pretty consistent with where we've been. We get leverage in the – we pay commissions once, we keep a 97% retention rate and that gives us leverage. But we're always going to invest in sales and marketing if it's going to drive business the way it's been driving. So I don't see it as something you would dial back, rather I think it's something you would invest in to generate more revenue.

Alex Zukin - Piper Jaffray Companies

Got it. Thanks.

Operator

And we'll now take our next question from Jeff Houston with Northland.

Jeff Houston - Northland Securities, Inc.

Hi, Mitch and Scott. Thanks for taking my questions. Wanted to follow up about the acquisition. Could you talk a bit about why it made more sense to buy versus build with this technology and does it indicate an increased appetite for M&A? I know you guys have been – haven't acquired too many companies in the past.

Mitchell K. Dauerman - Chief Financial Officer, Executive Vice President & Treasurer

Well, let's put it into perspective. I think that was our fourth acquisition ever. So it is 33% more but it is only one. So the product development team, product management team, as Scott mentioned, how do we get $40 in PPM exiting 2018. So you're always going through that analysis of buy versus build. Vestrics was a great opportunity. We have people out there that we're looking at. Again, small stuff, great cultures from companies, people who fit in, something we can leverage and bring more value to our customers. So that's the decision tree today.

Scott S. Scherr - Chairman, President & Chief Executive Officer

Yeah. I love the strategy. I mean, we pick up a great team, great people, great opportunity with product and technology. So that is something I believe you'll see more from us in the future. Along the same lines as like Mitch said, this is only our fourth. But I think around the ones we've done we're looking.

Jeff Houston - Northland Securities, Inc.

Got it. Thank you.

Operator

And we'll now take our next question from Michael Nemeroff with Credit Suisse.

Michael Nemeroff - Credit Suisse Securities (USA) LLC (Broker)

Hey, guys. Just as the follow-up. When I'm looking at the services revenue for 2016 and compare it to the growth rate of services revenue in the last several years, it's substantially higher. I know that there was a little extra for some printing stuff in Q1. But I'm curious. How should we think about services going forward? The growth rate, should it be in line with recurring revenue? Or should it grow slower? And how should we think about that going forward?

Mitchell K. Dauerman - Chief Financial Officer, Executive Vice President & Treasurer

Hey, Mike. I think in the past, I've said it was hard to have a correlation when I looked at that thinking that, that question would come up. It's probably a couple percentage points away. This year the back end's driven by the stronger growth. If I had to guess, it's close to being the same. But I'll feel more comfortable answering your question after we do our preliminary guidance in October and we take a look at how that's going to layer out.

Michael Nemeroff - Credit Suisse Securities (USA) LLC (Broker)

Are you guys making a conscious choice to do more implementations? Is that part of the reason for the growth? I know that there are some other factors that drive the services revenue other than implementations.

Mitchell K. Dauerman - Chief Financial Officer, Executive Vice President & Treasurer

No. We still use third parties. Or somebody asked before, SIs, to handle a certain percentage of our business. It provides elasticity in some respects. So it's in that 10% to 15% range. And it's something that we like that relationship. So, no, we have not made any changes. This is a result of strong sales production.

Michael Nemeroff - Credit Suisse Securities (USA) LLC (Broker)

Okay, great. Thanks, guys.

Mitchell K. Dauerman - Chief Financial Officer, Executive Vice President & Treasurer

You're welcome.

Operator

And we'll now take one more question from Steve Koenig with Wedbush Securities.

Steve R. Koenig - Wedbush Securities, Inc.

Hi, guys. Thanks for squeezing me in.

Mitchell K. Dauerman - Chief Financial Officer, Executive Vice President & Treasurer

Sure.

Steve R. Koenig - Wedbush Securities, Inc.

Wanted to ask on services revenue. So last quarter you guys got a whole bunch of questions about services outperformance due to ACA. Since nobody has asked, I'll go ahead and ask. This quarter, services looked like it was a little bit light relative to your guide. It wasn't much. Is there a shift to services from Q2 into Q3? Or is there just something else there that caused that? And I've got one follow-up, if you don't mind.

Mitchell K. Dauerman - Chief Financial Officer, Executive Vice President & Treasurer

Steve, it was in line with our expectations. I'd had no additional comment on that.

Steve R. Koenig - Wedbush Securities, Inc.

Okay. Okay. And then I wanted to ask you guys, when you think longer term about ADP's market and ADP's market cap, I'm curious to get your thoughts on how much of their market is addressable in relation to company size or need for services or territory. And ultimately, where are you headed? How much of that market of theirs do you think you can address ultimately?

Scott S. Scherr - Chairman, President & Chief Executive Officer

Oh, I don't know the answer to that. But I do know that $1 billion will have less than 10% of our addressable market in North America. So I think we're investing 20% of our resources into the R&D and if we're – 50% of our people remain in services, keep making that better. We always had a quality sales force. I would say of the overall market, I don't see why we couldn't double that over some time. And then go from there. It's taken us 26 years to get here. Who knows what we'll be able to accomplish in the next 26 years.

Steve R. Koenig - Wedbush Securities, Inc.

Okay. Well, then, you guys will have to give us how many quarters you've been doing these calls together. Not sure if I heard that upfront but anyway, congrats on the good quarter.

Mitchell K. Dauerman - Chief Financial Officer, Executive Vice President & Treasurer

74.

Steve R. Koenig - Wedbush Securities, Inc.

Congrats, guys.

Scott S. Scherr - Chairman, President & Chief Executive Officer

Okay. Thank you.

Operator

And that does conclude today's question-and-answer session. At this time, I would like to turn the conference back to Mr. Scott Scherr for any additional or closing remarks.

Scott S. Scherr - Chairman, President & Chief Executive Officer

As always, thanks for your time. Appreciate the support. We'll talk to you next quarter.

Operator

And ladies and gentlemen, that concludes today's conference call. We thank you for your participation.

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