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Paylocity Holding Corp
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Good day, ladies and gentlemen. And welcome to the Paylocity Q4 and Full Year 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct the question-and-answer session and instructions will be given at that time [Operator Instructions]. As a reminder, this call is being recorded.
I would now like to turn the conference over to Ryan Glenn, Vice President of FD&A and Investor relations. Sir, you may begin.
Good afternoon. And welcome to Paylocity’s earnings results call for the fourth quarter of fiscal year 2018, which ended on June 30, 2018. I am Ryan Glenn, Vice President of FD&A and Investor Relations. And joining me on the call today is Steve Beauchamp, CEO of Paylocity and Toby Williams, CFO 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 Web site under the Investor Relations tab.
Before beginning, we must caution you that today’s remarks including statements made during the question-and-answer session contain forward-looking statements. These statements are subject to numerous important factors, risks and uncertainties, which could cause actual results to differ from the results implied by these or other forward-looking statements. Also, these statements are based solely on the present information and are subject to risks and uncertainties that can cause actual results to differ materially from those projected in the forward-looking statements. For additional information, please refer to our filings with the Securities and Exchange Commission for the risk factors contained therein and other disclosures. We do not undertake any duty to update any forward-looking statements.
Also, during the course of today’s call, we will refer to certain non-GAAP financial measures. We believe that non-GAAP measures are more representative of how we internally measure the business. And there is a reconciliation schedule detailing these results currently available in our press release, which is located on our Web site at paylocity.com under the Investor Relations tab and filed with the Securities and Exchange Commission. 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 reconciliation is unavailable at this time without unreasonable effort.
In regards to our upcoming conference schedule, Toby and I will be attending the Raymond James SMID Cap growth conference in Chicago on August 21st, the HR Tech conference in Las Vegas on September 12th and the Deutsche Bank Tech conference, also in Las Vegas on September 13th. Please let me know if you would like to schedule time with us at any of these events.
With that, let me turn the call over to Steve.
Thank you, Ryan. And thanks all of you for joining us on our fourth quarter and fiscal 2018 year-end earnings call. We completed fiscal year 2018 with total revenue growth of 25.8% and total recurring revenue growth of 26%. Total revenue growth for the fourth quarter was 27%, which exceeded our guidance and was driven by another strong quarter of new sales. We were pleased with the consistency of our revenue growth this fiscal year, which included more than 24% recurring fees growth in each quarter. This also marks our sixth straight quarter of total revenue growth between 25% and 28%.
In addition to our strong revenue growth in fiscal 2018, we also continued to make significant progress on our current key financial targets, including adjusted EBITDA margin of 21.5%, an increase of 280 basis points from fiscal 2017. Our growth formula continues to be driven by adding new clients to our platform and selling more products to each client. We increased our total clients by 15%, finishing fiscal 2018 with 16,700 clients compared to 14,550 at the end of last fiscal year. We also increased average recurring revenue per client by 10% to $21,768 from $19,825, primarily by selling more products to new clients. We also continued to gradually expand efforts to sell our growing HCM portfolio back into our client base. Overall, we are pleased by the attach rates we are realizing throughout our target market as clients continue to see the value in our comprehensive product suite.
Broker referrals remained a consistent driver of sales activity, representing more than 25% of new business revenue for fiscal 2018. We continue to invest in our broker portal and our data integration capabilities, including our newly announced integration marketplace, which extends our commitment to provide a superior client experience by allowing clients to quickly review our more than 300 integration partners and capabilities across various HCM functions. We have also continued to invest in our sales force by adding new sales reps, while at the same time, investing in training initiatives and marketing programs to drive productivity. We have expanded the sales force by 21% this fiscal year from 257 sales reps in fiscal 2018, to 310 sales reps in fiscal 2019.
As I discussed on our February earnings call, we began recruiting for our sales reps earlier this fiscal year. And I am pleased to report these efforts were very successful with our sales team fully staffed earlier than last fiscal year. Being fully staffed as we enter the fall season is very important milestone to position us for a strong start to the fiscal year. In addition to our continued investment in growing our sales force, we continue to invest in sales optimization initiatives across our target market. Sales and marketing investments include continued support of our broker channel relationships, lead generation initiatives, sales engineer support and reengineering our sales process for larger deals.
In fiscal 2019, we will also be investing in the lower end of our market as we’ve continued to see strong demand from new client with less than 50 employees, both in terms of our ability to sell to new businesses with under 50 employees and our ability to sell more HCM products to those new clients. We have started building a sales team, focused on emerging market clients who are at the lower end of our target market with most of those businesses in this segment below 20 employees. Smaller clients are increasingly demanding HCM components as part of their solution, and we believe we are uniquely positioned to deliver a single SaaS based product across the entire SMB market.
We do not expect this emerging-market initiative to have a material revenue impact in fiscal 2019. However, we are excited about the potential to expand the total addressable market and continue to grow our client base. We also increased our investment in research and development in fiscal 2018 by 24.9% when you consider what we expensed and capitalized. Continued investment in research and development positions us to extend our industry leading platform by introducing new products, such as compensation management and survey solutions which help increase the PEPY from $285 to $320 in fiscal 2018. We have increased our PEPY by 60% since our IPO in March of 2014 and we remain focused on continued innovation and continued new product introduction with our PEPY target now set at $400. We also continue to make progress on the integration efforts with BeneFLEX as we work to provide a differentiated and modern user experience across the TPA product suite, and we expect to release these products broadly in fiscal 2019.
In addition to launching new modules, we continue to invest in research and development efforts associated with features and functions within our existing product suite as we look to drive increased product utilization by our clients. We continue to be pleased with the increased usage we see throughout our product suite, including nearly 500,000 unique daily users to our self-service platform and mobile app. Our newer products have also been well received in the marketplace and continue to see increased usage, including over 1 million applications received in our recruiting product, over 50,000 courses launched in our compliance dashboard and millions of dollars of merit increase processed with our Compensation Management product that we released just this past January.
Throughout fiscal 2018, our operations team is focused on delivering world-class service experience to our 16,700 clients, while at the same time, implementing a number of new initiatives that help provide a unified service experience across our payroll and HCM platform. This combination of service and technology allowed us to once again deliver revenue retention of greater than 92% for fiscal 2018.
We are also very proud of Paylocity’s culture and are honored to have one of number of best places to work towards this past fiscal year, including Crain's Fast 50 best places to work in Idaho and Florida, America's Best Midsize Employers by Forbes, the 25 highest rated public companies to work for and the number 29 best places to work in Glassdoor's Employees' Choice Award. We continue to focus on maintaining our strong culture and I’m pleased to announce that the majority of our Chicago land employees are working in our new corporate headquarters. And we recently held a grand opening event at our new facility in Boise. Our new facilities include a number of employee centric features, including state-of-the-art fitness centers and entertainment areas, modern dining facilities, as well as ample space for training and development and collaboration environments for our teams to work cross functionally. I would like to thank our more than 2,500 highly dedicated employees across the country for all the efforts this past fiscal year.
Let me now turn the call over to Toby to discuss our financial results in more detail.
Thanks, Steve. And before I jump into our results, I would like to congratulate Steve on his second straight year of receiving Glassdoor's Employees' Choice Award, which recognizes the highest rated CEOs. It’s a great honor and reflects the view of our employees on your leadership and our culture, so congratulations Steve.
Okay, jumping into the results. Total revenue for the fourth quarter was $96.6 million, which is 27% increase from the same period in the prior year. Total revenue for the fiscal year with was $377.5 million, up 25.8% from last fiscal year. For the fourth quarter, our total recurring revenue was up 26.7% from the same period last year with recurring fees up 24.6% and interest income on client funds up 160.4%, primarily as a result of balance increases, increased average interest rates and because we continue to invest a portion of client funds in high-quality available-for-sale securities during the quarter. For the year, our total recurring revenue was up 26% and interest income on client funds was up 150.4%. For the fourth quarter, implementation services and other revenue was up 36.2% from the same period last year and was up 21.1% for the fiscal year.
For the fourth quarter, our adjusted recurring gross profit was 75.7%, which is 200 basis points improvement from the fourth quarter fiscal 17. For the fiscal year, adjusted recurring gross profit was 76.2%, which is 170 basis points improvement over last fiscal year. Adjusted gross profit in the fourth quarter was 65.1%, which is 310 basis points improvement. Adjusted gross profit for the full fiscal year was 65.5%, which is 240 basis points improvement. We continue to make significant investments in research and development. And to understand our overall investment in R&D, it is important to combine both what we expense and what we capitalize. On a combined non-GAAP basis, total R&D investments were 14% of revenue in the fourth quarter compared to 13.7% in the year ago quarter.
Full year total R&D investments were 13% of revenue, which is consistent with fiscal ‘17. On a dollar basis, our investments in total R&D increased by 24.9% in fiscal ’18 when compared to fiscal ’17. On a non GAAP basis, sales and marketing expenses were 25.9% of revenue in the fourth quarter as compared to 25% of revenue in the same period last year. For the full year, sales and marketing expense was 23.3% of revenue as compared to 23.6% of revenue in the prior year. On a non-GAAP basis, G&A costs were 17% of revenue in the fourth quarter as compared to 16.5% of revenue in the same period last year. Full year G&A costs were 15.3% of revenue as compared to 15.5% of revenue in fiscal ’17, and we continue to be pleased with our ability to consistently leverage G&A costs on an annual basis as we steadily move closer to our long-term range of 10% to 15% of revenue.
Our adjusted EBITDA was $15.7 million or 16.2% of revenue for the quarter versus $11.5 million or 15.1% of total revenue for the year ago quarter, which is 110 basis point improvement. Our adjusted EBITDA for the year was $81.3 million or 21.5% of total revenue versus $56.2 million or 18.7% of total revenue in the prior year, a 280 basis point increase. On a dollar basis, our fiscal ‘18 adjusted EBITDA increased by 44.7% over fiscal ’17. As Steve discussed, in the fourth quarter we completed the move of our corporate headquarters to our new facility in Schaumburg, Illinois ahead of schedule.
In connection with our move, we have accelerated depreciation on certain property and equipment related assets that will not be used in the new facility. And we have taken certain leased exit costs in the quarter related to our old headquarters as we were able to accelerate the move of our teams to the new facility. As a result, adjusted EBITDA in the fourth quarter and the full fiscal ‘18 includes the add-back of $4 million of one-time non-cash leased exit costs associated with the move. Please refer to the GAAP to non-GAAP reconciliation table included in the press release issued after the market closed today for more information.
Briefly covering our GAAP results: For the quarter, gross profit was $57.9 million; operating loss was $5.2 million; and net loss was $1.6 million: And on a full year basis, gross profit was $228.3 million; operating income was $15.9 million; and net income was $38.6 million. In regard to the balance sheet, we ended the year with cash and cash equivalents of $137.2 million as compared to $103.5 million as of the end of last year, an increase of $33.7 million or 32.6%. From a cash flow perspective, we generated $97.9 million in cash from operating activities in fiscal ‘18 as compared to $62 million for the prior year, which is 57.9% increase.
Free cash flow, which we define as cash from operating activities less capitalized internal used software costs, purchases of property and equipment and lease allowances used for tenant s, was $48.8 million or 12.9% of revenue in fiscal ‘18 versus $24.2 million or 8.1% of revenue in fiscal ‘17, a 480 basis point improvement. Purchases of property and equipment were $21.7 million or 5.7% of revenue in fiscal ’18, which includes build-out related to our corporate headquarters and the first phase of our new office in Boise.
Going forward, we expect purchases of property and equipment to be a source of free cash flow leverage as we are targeting annual PP&E spend as a percentage of revenue of 4% to 5%, which is below our historical average spent of 6% to 7% of revenue. As a result of our strong financial performance and expanding leverage and cash generation realized to-date, including fiscal ’18 adjusted EBITDA of $81.3 million and cash flow from operating activities of $97.9 million that have resulted in our total cash on balance sheet of $137.2 million. Our Board of Directors has approved $35 million stock repurchase plan, which is available through August 14, 2019. As we continue to grow the business and our balance sheet, we will continue assessing our uses of cash to both drive growth and optimize our capital structure.
With respect to ASC 606, we adopted the standard effective July 1st under the modified retrospective method. The primary impact of 606 is a tailwind to full year fiscal ’19 adjusted EBITDA of approximately 600 to 700 basis points with a varying impact on a quarterly basis. Roughly 40% of the impact is from amortizing certain sales expenses over a seven year amortization period and the remaining 60% comes from amortizing certain implementation expenses over the same. Previously under ASC 605, we would have taken each of these expenses as incurred without any amortization. Also as of July 1st, we will begin recognizing implementation revenue ratably over a period of up to 24 months. Previously we accounted for implementation fees on a stand-alone basis, which meant that we recognize implementation revenue upon completion of our implementation obligation that client go live.
The impact of this change is a headwind of approximately $7 million to revenue in fiscal ’19. To be clear, these impacts are all non-cash and are accounting common driven changes to facilitate the comparability of our fiscal ’18 quarterly revenue to our fiscal ’19 guidance and results. In our press release issued after the market closed today, we have provided a supplemental non-GAAP pro forma table as if we recognize implementation revenue ratably over a period of up to 24 months for each quarter of fiscal ’18.
Before I provide our financial guidance, I would like to update certain of our key financial targets. Since the time of our IPO, in March 2014, we have demonstrated consistent leverage in our business model, both in adjusted gross margin and in our operating expenses. In the last four fiscal years, adjusted EBITDA has increased from $5.4 million or 5% of revenue to $81.3 million or 21.5% of revenue, a 1,650 basis point improvement. As a result of our strong financial performance and because of ASC 606 related changes outlined earlier, we are revising certain key financial targets as follows.
In regards to revenue; our goal of 20% plus growth remains our target and we continue to be confident in our ability to achieve this goal; our adjusted total gross margin target is now 70% to 75%, increased from 65% to 70%; EBITDA target is now 30% to 35% increased from 20% to 25%; and we are introducing a free cash flow target of 15% to 20% of revenue as we are confident we will continue to expand free cash flow margin on an annual basis, including in fiscal 19.
Finally, I would like to provide our financial guidance for the first quarter and full year fiscal ’19; for the first quarter of 2019, total revenue is expected to be in the range of $97.5 million to $98.5 million, or approximately 22% to 24% growth over non-GAAP pro forma first quarter fiscal ’18 total revenue of $79.7 million; and adjusted EBITDA is expected to be in the range of $20 million to $21 million; and for fiscal ’19 full year, total revenue is expected to be in the range of $451 million to $453 million, or approximately 21% to 22% growth over non-GAAP pro forma fiscal ’18 total revenue of $372.1 million; and adjusted EBITDA is expected to be in the range of $126.5 million to $128.5 million. In summary, we are very pleased with our operational performance during the fourth quarter and full fiscal year ’18 with 25.8% total revenue growth and adjusted EBITDA margin of 21.5%.
Operator, we’re now ready for questions. Thank you.
[Operator Instructions] Our first question comes from Justin Furby of William Blair. Your line is now open.
Maybe just to start, Toby, on the 606, just so I got it right. If you were to stay in 605 world, your revenue guidance $7 million higher, is that the take away?
So the accounting changes adopted as of July 1st resulted in $7 million headwind to fiscal ‘19 revenue, which is 100% rev rec timing driven by the accounting rules and on cash and non-operational as I said in the prepared remarks. The reason we included the pro forma revenue table in the press release is to be able to provide an apples-to-apples compare to fiscal ’18. So the revenue guide for fiscal ‘19 of 451 to 453 is after taking out the impact of the $7 million rev rec timing impact.
So to be clear then the recurring growth should be faster than the services growth this year just given that headwind you have on implementation fees. Is that fair?
Yes. And is not changed yet.
And then Steve just on the new down market, I am interested in -- is that part of your sales headcount number that you gave, the 21% growth is the carve-out for that below 20 space. And then what do you think the market opportunity looks like there and how does it impacts you from a margin standpoint when you look out over the long term?
So first, I would say the 21% headcount growth that we were able to bring on going into this fiscal year, we feel really good about. That's really in our core marketplace. So there’s no new market initiative associated with that that’s 21% expansion. I think the call out on the under 50 marketplace is really reflects that fact that we’ve seen more demand in that space. I think you see that with a 15% unit growth year-over-year. We definitely are seeing these clients looking for more comprehensive HR capabilities. And so our plan is throughout the fiscal year to invest in some sales folks that would be dedicated to go after that opportunity. We really don't think it’s going to have much of a revenue impact, think about this as a longer-term investment opportunity. There’s clearly millions of businesses in that under 20 marketplace. And so we think the more demand in that space the bigger the opportunity is for us. And we’ll try to size the TAM as we start figuring out our exact go to market there. We’re early in that process but we’re excited about some of the early clients that we’re bringing on, both below 50 and even as small as 10 or 15 employees.
Our next question comes from Brian Peterson of Raymond James. Your line is open.
This is Vince Celentano on for Brian. I want to see, which modules show the most year-over-year growth on this past year on absolute basis? And how do you see that changing in the coming fiscal year?
So we do a lot of bundling and packaging in terms of trying to make the buying process easy for our customers. So sometimes it's a little bit more difficult to be specific around the modules. What I would say is the talent management category for us is definitely the category where we’ve seen a fair amount of growth. You saw the color in our prepared remarks around more than a million applications in our recruiting platform, which has been released now for about 18 months. So I think if I were to highlight something in that talent management category, I’d probably go to recruiting, because it’s been out there for a while and we’ve had really good traction there.
And I was hoping you can give a little more color about your average employee size per client and how do you see that trending in fiscal year ’19?
If we’re successful with our investments at the low end of the marketplace then that’s going to have a bit of a different mix shift. So I would imagine over an extended period of time that strategy would yield to slightly higher unit growth and maybe a slightly smaller average client size. But again, we’re at the very initial stages of those investments. So if you look at this past fiscal year, I would tell you that our average customer size at the end of this year is very similar to what our average customer size is at the end of last year. So no real changes, the changes are really potentially in front of us if we’re successful in expanding in the emerging markets.
Our next question comes from Scott Berg of Needham. Your line is now open.
I just wanted to start off on the new intermediate-term goals, or longer term goals from a revenue in profitability standpoint, Toby, that you laid out is. Do you have any timeframe for us to think about a retaining, maybe the EBITDA margin goals or the free cash flow goals? I guess to start off of.
So I would probably draw back to the time of the IPO when the original targets were set. I think you saw us crossing into those in those in that two to four year-ish timeframe. And I think when we thought about these, we thought about these as achievable in the next -- in a similar timeframe. When you think about EBITDA payment, obviously with 606, we take a big step forward one year all at once. And so I would think about that as probably moderating a little bit over time but that's how we’re thinking about it.
I think the only thing I’d add is we’re defiantly focused on 20% plus growth as a key part of that formula. And the fact that we’ve had pretty consistent recurring revenue growth this past fiscal year is definitely encouraging. And I think it would be a gradual move towards those long-term targets over time. It took us four years -- four plus years really get to the adjusted EBITDA target. But we’re mostly focused on keeping 20% plus growth and if that that requires a little bit more investment to be able to do so, we’re certainly willing able to do that. And we believe even by doing that, we still march our way gradually toward that long-term model.
And the growth trajectory, Steve, just question on the move to what you’d call the emerging customer area is. How do you think about that segment? I guess right now and over the next couple years, maybe in terms of product. I don't know yet for your eyes they buy and purchase the same product, maybe pricing that's there. And as we get a couple years out, do you think you of that 20% growth on an absolute basis to maybe a third or half or quarter of your revenue growth coming from that segment versus your current quarter? Thanks.
So I would say we’re already in that segment. If you think about when we -- couple years ago, when ACA was coming into law, we talked about the fact that 50% of our clients have less than 50 employees. So this isn’t necessarily a brand-new initiative or a market that we haven't been to before, really this is about putting some dedicated folks targeting those type customers to see if we can get a little bit more growth in that segment. And it’s also lowering the size of the target market. We’ve been really 20 plus. We certainly have the opportunity to go a little bit lower than that 20 employee segment. And I think the key drivers really are those businesses are often faced with very similar challenges to our customers who are typically going to be -- many of our customers over hundred employees. It’s a tight labor market.
The talent management components are becoming important to them. You’ve got younger generation entering the workforce. So they’re looking for platforms that are a little bit more engaging than maybe the traditional and options that are available to them. So those are the conversations that we’re having in the market, they’re excited about what we’ve got to offer. And we can bundle our existing staff platform and take out maybe some of the complexity in that bundle so that we can really balance both the features that they're looking for, but make it even easier to use. So that we can implement them faster, it’s easier for them to get up and running. So it's really a bundling and packaging going at it with the same platform, some new folks targeting that market. But it's definitely some where we have a lot of experience.
Our next question comes from Terry Tillman of SunTrust. Your line is open.
This is actually Eric Lemus on for Terry Tillman. And question on BeneFLEX admin product, it sounds like you guys are in good shape on releasing that in this coming year. But have you guys been showing that to some customers, and if so what has been early response on that product?
So I think if you go back to the plan that we talked about last quarter was really after the acquisition, we’ve got a product team really working with some of the knowledgeable folks that we were able to bring on board to be able to build the differentiated user experience. And our goal is to launch that this fiscal year. So we certainly have been working with either existing customers of ours or from the BeneFLEX acquisition in terms of showing them prototypes, getting their input and involvement. We will certainly also, as we get closer to launch, bring people on from an early adopter perspective, so lots of input.
I think we’re hearing is really there isn’t not a lot of great options from a user experience. It’s often a separate application that you download that you might use once-a-year not a lot of mobile app usage. So if you really think about the 500,000 plus people we get on to our portal and mobile and we just integrate this HSA and FSA information, we can really ease the experience, both from an administrative perspective but particularly from an employee perspective. And those are the sentiments that we’re hearing from these early conversations with prospects and existing clients.
And then my next question on the integration marketplace that was launched just recently. How do you think about that moving forward as far as the adoption of people actually using that integration and how has the response been with the integration marketplace so far?
So I think data integration as a strength really goes back more than 10 years for us as a company. We've always integrated with a variety of third-party providers, particularly 401(k) providers, and health insurance product providers. And so you see even as we launch the integration marketplace, we’ve got 300 different partners in that marketplace that we already have integration established with. The purpose of the marketplace is to make it easier for clients to get those integrations, making those more real time with the APIs that we’ve developed and made available.
So we think that this is just a continued evolution of our focus on data integration been a core strength, which we think is also very important to be able to attack our broker channel, and has allowed us to continue to drive more than 25% of our new business from brokers.
Our next question comes from Corey Greendale of First Analysis. Your line is open.
Just a couple of questions. In terms of the growth in the rep force, I think it's a little bit slower -- I think you’ve grown the first 25% the couple of years, 21% this year. Just if you think about investment what was the thinking behind slower growth this year?
So I would say that we look at our setting the quota based off the amount of revenue that we need sold. And so it’s a formula based off the number of people we need and the overall amount of revenue. And so obviously productivity fits into that equation. We had a strong back half of the year from a sales perspective. You saw that in the acceleration in our recurring revenue. So I think as we put that all together we felt like we could achieve our goals with 21% more headcount. On top of that, we’re going to be investing in this new opportunity in emerging as well.
So we haven’t necessarily finalized what those numbers look like and we’re very early. But I think when you add that into the mix, we’re going to be adding more similar overall percentage by the end of the fiscal year. Even though the emerging won't have much of an impact to this year, we feel pretty good about the total heads that we’ll end up with at the end of the fiscal year.
And on that latter point, I know you’re working to go to market. I would think that the emerging market would fit well with the broker channel. But you just speak to how you think that that looks going forward?
I think, historically, we definitely got referrals in that sub-50 employees space and we’ve got a significant number of referrals there. I think traditionally when you look at that market as a whole, it’s been more CPA driven in terms of referrals than it has necessarily been broker, so we definitely think we can get some leverage out of the broker channel. But at the same time, we’ve got to be able to open other channel opportunities that will help us grow that business long-term. And all that will obviously be part of our -- us figuring out the right strategy and the right go to market. But we would anticipate new channels as well as leveraging the existing one.
Our next question comes from Ross MacMillan of RBC Capital Markets. Your line is now open.
Toby, just first of all on like-for like EBITDA in fiscal ’19 versus fiscal ’18, as I do my quick math and it appears your initial guidance looks to be about the same EBITDA margin, maybe slightly up. And I wondered if you could just maybe double-click on that. And then the other financial question I had for Toby was just when we look at the adjustment on implementation services revenue, it was a much bigger adjustment in Q1 of last year relative to Q4 of last year. And so I’m just wondering as we think about that rolling into fiscal ’19. Does that continue such that you were getting pretty much close to like-for like as go through the year that that delta gets smaller and smaller? Thanks.
Ross, let me hit the last one first. I think the answer is, yes, you’re reading that the right way and then in terms of how it flows in the quarters. And then from an EBITDA perspective, I think you’re reading that the right way too. I think we’ve talked about especially as we’ve gone into Q4 of ’18 and we talked about incremental investments in sales and marketing. And I think for this year its incremental investment in sales and marketing and R&D to help us continue to drive growth. And I think that the result of that is a guide to a more flat EBITDA for the year, coming off a year last year where we had 280 basis points improvement. And obviously, we’re getting the tailwind of 600 to 700 basis points from 606. So I think you're reading that right way.
And then a follow-up just for Steve, if he can. Just going through the data you gave us on customer adds and those numbers look pretty good. In fact, we didn’t really -- I mean that healthy growth seem to be pretty similar to last year’s. And I think you talked a little bit earlier in the year about some mix shift in customer size. So I wondered if that mix shift prevailed or whether it changed, or if it's just a function of you actually selling more products per customer. And so even though you got mix down, you got more products for customer mix up?
So I think if you got to go back, we were trying to signal a slight change in client size. And I think that the word slight seems to not necessarily always have a great definition around it. And so I think what you're seeing is we had 10% average revenue per client growth. And the client size the new client size might have been down a little bit, so that might have been a little bit higher, but it’s not a big difference. And so we ended up exactly what we said at the time, the unit growth to be very similar to what we thought it was last year. And the rest of the revenue growth will come from average revenue per client. So there's no question that we had a little bit more product sales in there and just a slight impact from the client size, but it wasn't much.
Our next question comes from Walravens of JMP Securities. Your line is open.
This is Matthew Spencer on for Patrick Walravens. Thank you for taking my question. Just two quick ones if you don’t mind. First is, how you think about M&A going forward? And second have you seen any change whatsoever in the competitive environment? Thanks.
From an M&A perspective, so BeneFLEX was really the first acquisition that we've done. And obviously, we talked earlier in the call about how we’re integrating that and excited about the product launch next fiscal year. I would tell you that our DNA is to build first, it always has been. We definitely believe that organically building the platform and delivering a unified experience is a competitive advantage and creates a better user experience for our clients. Having said that though things like BeneFLEX, we’ll look at opportunistically and we think about those as product extensions, tuck-ins. And we’ll continue to be actively looking at it and also to be fairly picky in terms of what we might think about moving forward. But it's definitely the potential for that is there. Obviously, we’ve got a balance sheet and we have the ability to do it. So I think it's a potentially another opportunity in front of us.
And then just on the competitive environment I guess have you seen any changes there?
I think from competitive environment perspective, we’re seeing the same people that we’ve seen for years. It's always been competitive. It’s still competitive today. We feel good about the product differentiation that we can bring to market. Revenue retention over 92% speaks to our ability to deliver the right service experience. And so we feel pretty good up against whatever the competitive and competitor happens to be and we wouldn’t necessarily call it any different than the competitive environment.
Our next question comes from Jeff Van Rhee of Craig-Hallum. Your line is open.
Just for me, on the interest income line. Can you just help us in that 451 to 453 annual guide? How the puts and balance around the interest income. Just trying to get a -- give us a little over under in terms of the drivers and sensitivity to rates; obviously, nice number this quarter. So just maybe start there how to think about that number?
So from an interest income standpoint, we haven’t modeled any rate increase into the guide for fiscal ’19. I think our view on that tends to be a push forward from ’18 from that perspective. There is no -- no incremental rate increase baked in. And so to the extent that that was to happen, I mean there could be upside. But as we’ve said before, it usually takes a while for any rate increases to follow through to us from our banking partners. So that’s how we’re looking at it.
And then the second and just with respect to pipeline open-ended. Any observations about variation in the deals in the pipeline and in particular the size and scope of initial entry of customers, mainly the breadth of the portfolio that they look like they’re taking versus what they’ve mined in the past, or any other notable callouts?
No, I would say that we continue to get expansion in terms of number of products people are buying at the point-of-purchase and that’s evident in that 10% increase in average revenue per client. We do have some sales back to existing clients, so that’s embedded in that. But I would tell you that most of that 10% increase still comes from selling more to the new customers that are coming on board. And I think we've added a lot of products in the talent management suite, recruiting we've added -- we’ve added expense, we've added compensation and surveys just in the last two years alone. And so we’ve been pleased with the ramp-up of our talent management suite as a whole.
Our next question comes from Mark Marcon of R. W. Baird. Your line is open.
Just wondering with regards to the emerging businesses. Any change in terms of the profile of the types of salespeople that you might recruit in order to attract that market?
So what I would say is we have experience in that marketplace selling those customers. But we haven't really dedicated people towards that effort. And so I think it's a fairly similar profile. We end up with a mix of industry experienced folks, as well as people that are used to B2B sales. But you might be looking at folks that might be a little bit earlier in their career, because you’re dealing with smaller businesses so the complexity of the product is a little bit less. But other than that, it's a pretty similar profile.
And then with regards to the revenue per client that obviously increased nicely this year. Do you think that that -- as you push --- even as you push down. Do you think that that can continue even with the really small clients?
So what I would say is, I definitely think that, when you look at our core segment of midsize businesses. We definitely have an opportunity to continue to add product and continue to increase that revenue per employee per year. Now, if we’re successful in emerging, which is obviously very early for us and we start to bring on more units and those units on average are little bit smaller. We definitely think that you could see that mix shifts in units versus average revenue per client. But if you then start looking at those clients individually and think about what that per employee per year opportunity looks like, so even if someone has 15 employees. We think of per employee per your opportunity can still approximate what it looks like in majors. And by the way that's still a very profitable space for us.
So I think when you just look at the attractiveness of the market it’s a big TAM, lots of opportunity there, great industry dynamics where people are being much more focused on attracting and retaining talent, and a market where you can generate some pretty solid product bundles that will yield good PEPY opportunity. So overall, we think it's a great market to go after.
Can you talk a little bit about the gross margins on the server side just the implication of the rev rec change and how we should model that out and how we should think about it.
So if I go back to the impacts of 606, the most of the impact -- so we said it’s about 600 to 700 basis points total impact. And how that breaks down is roughly 40% from the sales commission and bonus amortization and then other 60% is from the spread of implementation costs, both against the seven year. So that’s how I would think about the impact of both of those pieces of amortization against the P&L.
And then just going to the 30% to 35% target. When we think about it midpoint to midpoint, you were clearly moving towards the upper end of that old target already. So I guess from a longer-term perspective, how much is scale versus 606 in terms of the 600 and 700 bps?
I think that 600 to 700 is from 606, and…
I just meant if you think about it longer-term, do you think it stays there or…
Well, yes…
So I think the way to think about this is if you take a step back obviously we get a leap forward in one year that would have taken us many years to get to. And so when you look at what our guidance is for this year, we’re below what our long-term target is. And so I would think about a little bit more of a slower cadence to be able to get into that long-term target and achieve that simply, because we’ve gotten so much of the benefits in one year if that makes sense.
And I guess the only thing I’d add to that is I mean I think we still believe in the long term EBITDA margin expansion that comes with the scale in the business. But to Steve’s point, we’ve taken a big step forward with 606. And so I would expect to see the in-year basis points of leverage perhaps moderate on a go forward basis. But that I think we still feel good about the ability to leverage EBITDA longer-term…
And I think worth mentioning too on the long-term model is us introducing a cash flow target as well that we've put into the model, which obviously can take out some of this accounting noise that makes comparability a little bit more challenging at times. And so we feel pretty good about the improvements we’ve had in cash flow generation the last couple of years and the opportunity for us to get into this 15% to 20% free cash flow target.
On that 15% to 20% free cash flow target. What are you thinking over the longer term effective tax rate?
In thinking about that, I think we would have pegged to the same tax rate that we would have described being in that mid to high 20s type range.
Our next question comes from Siti Panigrahi of Wells Fargo. Your line is open.
My apologies if this question has been asked, I was going back and forth between calls. So I think going back to 605-606, you talked about the beginning of FY19 impact. Could you double tick that on Q1, how does that impact revenue as well as EBITDA?
From an EBITDA standpoint, we’ve laid out -- just going to the top of it, we’ve laid out the 600, 700 basis points change coming from 606. We’ve taken that apart between both the sales and then the implementation. As it relates to the flow-through in Q1, we’re guiding to 21ish margin guide. And I think we’re guiding to 28ish on the year. And so I think you would expect to see EBITDA through the course of the -- so if you plug the Q1 and you plug to the full year, I think you would expect to see the EBITDA contribution from each one of the quarters roughly follow the path that we would have in fiscal ’17 or ’18 from how does EBITDA flow in through the year perspective.
Steve, going back to the expense management and recruiting, that’s now more than a year old and is in the new product compensation and management. So just wanted to know what’s the penetration of those modules within your install base?
So we have this philosophy that says we love to be able to work with our clients and feel comfortable that we can get into penetration rate of 10% to 20% in a fairly reasonable period of time. And so which is reasonable boy, if we can get there in a year that’s really fast, if we get there within two that’s kind of great. I think we feel pretty good that the products that we released more than a year ago, things like expansion recruiting get us into that range. And we also feel like there’s opportunity for that to continue to drive higher over time as we continue to enhance those products based off of the feedback that we’re getting from clients.
Our next question comes from Shankar Subramanian of Bank of America. Your line is open.
Question on retention rate, so as you’ve spoke on the emerging market and try to had more customers there on long run. How do you see your retention rate play out from here on?
I think we’re very early in this idea of expanding into emerging. And so what you’re really talking about is the potential mix shift if we’re successful in that marketplace, which would be great. And obviously, we think we've got a great opportunity there. Yes, the business rate in that emerging market is defiantly higher, so you do lose more clients. Now they are on average a little bit smaller. So there is the potential that over time we’d have to give you a different type of target for what that retention rate would look like if we’ve got a big client base in that space. I don't think that's necessarily an issue as we look at this fiscal year, it’s probably something to think about in years to come as that new initiative for us starts to gain momentum.
So as a follow up to that if you see the products you released in the past year and you’re gaining lot of traction in that. How do you think about expanding on the higher end of the market, meaning 500 above, 1,000 above, have you given any thought to that? As part of the app market place you’re releasing, is there any benefit from that that can help you a little on the higher end?
So I think -- overall, I think the trend on utilization is positive for us. I’m not sure of any more or less positive at the higher to the market. We want employees to be utilizing all of the things we’re building for them across our market segment. And remember for us our target market historically has been 22,000. So we’ve got a number of customers that are above that 500 employee mark already today and some that exceed thousand. I would say we’re doing the same thing where we see a fit we defiantly go after those. We definitely improve some of our sales processes and some of the resources and some of the marketing capabilities we have up market. So we feel better about it today than we did a year ago.
But I wouldn't call it out as a different strategy it’s just one that we’re tweaking and trying to get better at so that we can continue to grow the number of clients that we have at the upper end of our market.
And with no further questions, I would like to turn the call back to Steve Beauchamp for any closing remarks.
Well, thank you very much to all those who dialed in. We really appreciate your interest in Paylocity. And if anybody of you need some more time with us, we’ve got some conferences up coming, so feel free to reach out, we’re happy to jump on the phone. Have a great night.
Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone, have a great day.