Paylocity Holding Corp (PCTY) 2018 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Paylocity Q4 and Full Year 2018 Earnings Conference Call.

(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 FP&A and Investor Relations.

Sir, you may begin.

Good afternoon, and welcome to Paylocity's Earnings Results Call for the Fourth Quarter and Fiscal Year 2018, which ended on June 30, 2018.

I am Ryan Glenn, Vice President of FP&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 website 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 website 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 the directly comparable GAAP financial measure, because the information, which is needed to complete a 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 21, the HR Tech Conference in Las Vegas on September 12, and the Deutsche Bank Tech Conference also in Las Vegas, on September 13.

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 to 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 continue 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 salesforce by adding new sales reps, while at the same time investing in training initiatives and marketing programs to drive productivity.

We've 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'm 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 clients 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 component as a 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 increase 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 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 won a number of Best Places to Work awards 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 Cloud Companies to Work For and the #29 Best Places to Work in Glassdoor's Employer (sic) [Employee] Choice Awards.

We continue to focus on maintaining our strong culture and I'm pleased to announce that the majority of our Chicagoland employees are working in our new corporate headquarters.

And we recently held the grand opening event at our newest 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 team to work cross-functionally.

I would like to thank our more than 2,500 highly dedicated employees across the country for all of 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'd 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 congratulation, Steve.

Okay.

Jumping into the results.

Total revenue for the fourth quarter was $96.6 million, which is a 27% increase from the same period in the prior year.

Total revenue for the fiscal year 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 150.4%, primarily as a result of balance increases, increased average interest rates and because we continued 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 a 200 basis point improvement from the fourth quarter of fiscal '17.

For the fiscal year, adjusted recurring gross profit was 76.2%, which is a 170 basis point improvement over last fiscal year.

Adjusted gross profit in the fourth quarter was 65.1%, which is a 310 basis point improvement.

Adjusted gross profit for the full fiscal year was 65.5%, which is a 240 basis point 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 investment 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 a 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 lease 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 onetime noncash lease 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 a 57.9% increase.

Free cash flow, which we define as cash from operating activities, less capitalized internal-use software costs, purchases of property and equipment and lease allowances used for tenant improvements 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 spend 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 a $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 1 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 7-year amortization period and the remaining 60% comes from amortizing certain implementation expenses over the same period.

Previously, under ASC 605, we would have taken each of these expenses as incurred without any amortization.

Also, as of July 1, we will begin recognizing implementation revenue ratably over a period of up to 24 months.

Previously, we accounted for implementation fees on a standalone basis, which meant that we recognized implementation revenue upon completion of our implementation obligation at 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 noncash and our accounting-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 recognized 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 of 2014, we have demonstrated consistent leverage in our business model, both in adjusted gross margin, and in our operating expenses.

In the last 4 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'd like to provide our final 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 of 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% over a 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 are now ready for questions.

Thank you.

(Operator Instructions) Our first question comes from Justin Furby of William Blair.

Maybe just to start, Toby, on ASC 606.

Just so I got it right, if you were to stay in ASC 605 world, your revenue guidance is $7 million higher, is that the takeaway?

Yes, so, Justin.

So the accounting changes adopted as of July 1 resulted in the $7 million headwind to fiscal '19 revenue, which is 100% rev rec timing-driven by the accounting rules.

Noncash and nonoperational, as I said in the prepared remarks.

The reason we included the pro forma revenue table in the press release was to be able to provide an apples-to-apples compare to fiscal '18.

So the revenue guide for fiscal '19 of $451 million to $453 million 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.

Okay.

Recurring growth has not changed, yes, yes.

Okay, perfect.

And then Steve, just on the new sort of down market, I'm interested in, sort of, is that part of your sales headcount number that you gave, the 21% growth as a carve-out for that below-20 space?

And then what do you think the market opportunity looks like there?

And how does it impact you from a margin standpoint, when you look out over the long-term?

So first I would say that 21% headcount growth that we are able to bring on going into this fiscal year, we feel really good about, that's really in our core marketplace.

So there is no new market initiative associated with that.

That's kind of a 21% expansion.

I think the call out on the under-50 marketplace is, really reflects the 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 this fiscal year, to invest in some sales folks that will be dedicated go after that opportunity.

We really don't think it's going to have much of revenue impact.

Think about this as a long-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 yes, we'll try to size the TAM, as we start figuring out our exact go-to-market there.

We are early in that process, but we are excited about some of the early clients that we are bringing on, both below 50 and even as small as 10 or 15 employees.

Our next question come from Brian Peterson of Raymond James.

This is Vince Celentano on for Brian.

I want to see which module showed the most year-over-year growth on this past year on an absolute basis, and how do you see that changing in the coming fiscal year?

Yes, so we do, 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 call out in our prepared remarks around more than a million applications in our recruiting app -- 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.

Okay, perfect.

And I was hoping if you could give a little more color about your average employee size per client, and how you see that trending in fiscal year '19?

Yes.

If we are 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 are at the very initial stages of those investments.

So if you look at this past fiscal year, I would tell you that our average consumer 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 are successful in expanding in the emerging market.

Our next question comes from Scott Berg of Needham.

Sorry, I was on mute.

I guess I want to start off on the new intermediate-term goals, I guess, or longer-term goals from a revenue and profitably standpoint, Toby, that you laid out.

Do you have any sort of time frame for us to think about of attaining maybe the EBITDA margin goals, or the free cash flow goals, I guess, to start off with?

Yes, 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 sort of that 2- to 4-year-ish time frame.

I think when we've thought about these, we've thought about these as achievable in the next -- in a similar time frame.

When you think about EBITDA attainment, obviously, with 606, we take a big step forward in sort of one-year, sort of all at once.

And so I would think about that as probably moderating a little bit over time, but that's how we are thinking about it.

Yes, I think the only thing I would add is we are definitely 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 4 years -- 4-plus years really to get just to the adjusted EBITDA target.

But we are mostly focused on keeping 20%-plus growth, and if that requires a little bit more investment to be able to do so, we are certainly willing and able to do that, and we believe, even by doing that, we can still march our way gradually towards that long-term model.

Got it.

Helpful.

And the growth trajectory, Steve.

I guess, it's a question on the move to, forgot what you called it, the emerging customer area is -- how do you think about that segment, I guess, right now and over the next couple of years, maybe in terms of product?

I don't know if through your eyes they buy and purchase the same product, maybe pricing that's there, and as we get a couple of years out, do you think of that 20% growth on an absolute basis, just maybe 1/3 or 1/2 or 1/4 of your revenue growth end up coming from that segment versus your current quarter?

Yes, so I would say we are already in that segment.

If you think about it when we -- a couple of years ago when ACA was coming into law, we talked about the fact that 50% of 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 size customers to see if we can get a little bit more growth in that segment.

And it's also lowering the size of that 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 are over a 100 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 options that are available to them.

So those are kind of the conversations that we are having in the market.

They are excited about what we've got to offer and we can bundle our existing SaaS 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 it up and running.

So it's really kind of a bundling and packaging, going at with the same platform, some new folks, targeting that market, but it's definitely somewhere we have a lot of experience.

Our next question comes from Terry Tillman of SunTrust.

This is actually Eric Lemus on for Terry Tillman.

One question on the benefit 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?

Yes, so I think of 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 are able to bring on board to be able to build the differentiated user experience.

And our goal is so large 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, what we are hearing is, really there had -- there isn't 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 onto our portal in mobile, and we just integrate this HSA and FSA information, we can really ease the experience.

Both from and administrative perspective, but particularly from an employee perspective.

And those are the sentiments that we are hearing from these early conversations with prospects and existing clients.

Okay.

That's great to hear.

And then the 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 the people actually using the integration?

And how is the -- how is the response been with the integration marketplace so far?

Yes, so I think data integration as a strength that 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 kind of a continued evolution of our focus on data integration being 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.

In terms of the growth in the rep force, I think it's a little bit slower.

I think, you've grown the force like 25% the last couple of years, 21% this year, if you think about investment, what is the thinking behind kind of slower growth this year?

Yes, 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.

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 kind of put that all together, we felt like we could achieve our goals with 21% more headcount.

On top of that, we are going to be investing in this new opportunity in emerging as well.

So we have -- 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 are 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.

Okay.

And on that latter point, I know you're working through the go-to market.

I would think that the emerging market would fit well with the broker channel, but can you just speak to how you think that looks going forward?

Yes, I think, historically, we definitely have gotten referrals in that kind of a sub-50 employee space.

And we've got a significant number of referrals there.

I think traditionally when you look at the 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 us figuring out the right strategy and the right go-to market.

But we would anticipate new channels as well as leveraging the existing ones.

Our next question comes from Ross MacMillan of RBC Capital Markets.

Toby, just first of all, on like-for-like EBITDA in fiscal '19 versus fiscal '18, I was doing 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 we are getting pretty much close to sort of like-for-like as we, kind of as we go through the year, that delta gets smaller and smaller?

Yes, 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, 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, we talked about incremental investments in sales and marketing.

And I think for this year, it's 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 point improvement.

And obviously, we are getting the tailwind of 600 to 700 basis points from 606.

So I think you're reading that the right way.

And then a follow-up, just for Steve, if I can.

Just going through the data you gave us on customer adds and PEPY, those number looks pretty good.

In fact, we didn't really -- I mean that PEPY growth seemed 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 product per customer, so even though you've got size mix down, you got more products per customer mix up?

Yes, so I think if you kind of go back, we were trying to signal a slight change in client size and I think that 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 yes, 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, unit growth would be very similar to what we thought it was last year, and that the rest of the revenue growth will come from average revenue per client.

So there is 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.

This is Mathew Spencer on for Patrick Walravens.

Just two quick one, 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?

Sure.

Sure, 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 are 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 will look at opportunistically.

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 strong balance sheet and we have the ability to do it.

So I think it's a potentially another opportunity in front of us.

Thank you, and then just on the competitive environment.

I guess, have you seen any changes there?

Yes.

I think from a competitive environment perspective, we are 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 competitor happens to be, and we wouldn't necessarily call it any different in the competitive environment.

Our next question comes from Jeff Van Rhee of Craig-Hallum.

Just 2 for me, on the interest income line, can you just help us in that $451 million to $453 million annual guide.

How to sort of put some bounds around the interest income, just trying to get a, I guess, a little over under in terms of the drivers and sensitivity to rates.

Obviously a nice number this quarter, so just maybe start there, how to think about that number?

Yes, I mean, 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, it's sort of a push forward from '18 from that perspective.

There is no incremental rate increase baked in and so, to the extent 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 funnel through to us from our banking partners.

So that's how we're looking at it.

Yes.

And then second, just with respect to pipeline, sort of open ended, do you -- any observations about variation in the deals in the pipeline?

And in particular, the size and scope of initial entry of customers, namely the breadth of the portfolio that they look like they're taking versus what they might in the past?

Or any other notable callouts?

Yes, 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 2 years alone.

And so we've been pleased with kind of the ramp-up of our talent management suite as a whole.

Our next question comes from Mark Marcon of R.W. Baird.

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 attack that market?

Yes, so what I would say is, we have experience in that marketplace selling those customers, right?

So -- but we haven't necessarily 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 business, so the complexity of the product is a little bit less.

But other than that, it's a pretty similar profile.

Okay.

And then with regards to the revenue per client, that obviously increased nicely this year.

Do you think that, as you pushed -- even as you've pushed down, do you think that, that can continue even then with the really small clients?

Yes, so what I would say is, I definitely think that when you look at our core segment of kind 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 are successful in emerging, which is obviously very early for us, and we start to bring on more units and those units on average are a little bit smaller, we definitely think that you could see that mix shift in kind of the 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 employers, we think the per employee per year 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 unattractiveness 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 opportunities.

So overall, we think it's a great market to go after.

Yes, I've seen your company in Rochester, New York that's done pretty well there.

Can you talk a little bit about the -- can you talk a little bit about the gross margins on the service side, just the implication of the rev rec change?

And how we should model that out, and how we should think about it?

Yes, so if I go back to the impacts of 606, I mean, the -- most of the impact -- so we've said, it's about 600, 700 basis point total impact and how that breaks down is roughly 40% from the sales commission and bonus amortization.

And then the other 60% is from the spread of implementation costs, both against the 7-year.

So that's how I would think about the impact of both of those pieces of amortization against the P&L.

Okay.

And then just going to the 30% to 35% target.

When we think about it midpoint-to-midpoint, I mean, 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 to 700 bps?

Yes, I mean, I think we -- that 600 bps to 700 bps is from 606.

I know, I just meant that if you think about it longer-term, do you think of it stays there or?

Well.

So I think a 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, that makes sense.

And I guess, the only thing I'll add to that is 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 end 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.

I think, worth mentioning too on the long-term model is, us introducing kind of the cash flow target as well that we 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 over the last couple of years, and the opportunity for us to get into this 15% to 20% kind of free cash flow target.

On the 15% to 20% free cash flow target, what are you thinking of as a longer-term effective tax rate?

I mean, in thinking about that, I think we would have pegged to the same tax rate that we would have described being in sort of that mid- to high-20s type range.

Our next question comes from Siti Panigrahi of Wells Fargo.

My apology if this question has been asked, I was going back and forth between calls.

So I think going back to ASC 605, ASC 606, you talked about the beginning of FY'19 impact.

Could you double tick that on Q1, how does that impact revenue as well as EBITDA?

So -- well, from an EBITDA standpoint, yes, we've laid out the -- just going to the top of it, we've laid out the 600 to 700 basis point change coming from 606.

And we've taken that apart between both the sales and then the implementation as it relates to the flow-through in Q1, we are guarding to sort of our 21-ish margin guide and I think then, we're guiding to 28-ish on the year, and so I think you'd expect to see EBITDA through the course of the -- so if you plug to 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 a -- how does EBITDA flow in through the year perspective.

Okay, that's helpful.

Now Steve, going back to the expense management and recruiting, that's now more than a year old and is in the new product compensation management.

So just wondering, what's the penetration of those margins within your installed base?

Sure, so we kind of have this philosophy that says, we love to be able to work for their clients and feel comfortable that we can get into penetration rate of kind of 10% to 20% in a fairly reasonable period of time.

And so, what's reasonable, boy, if we can get there in a year that's pretty fast.

If we get there within 2, that's kind of great.

I think, we feel pretty good that the products that we released more than a year ago, things like expense and 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 are getting from clients.

Our next question comes from Shankar Subramanian of Bank of America.

Question on retention rate.

So as you poke on the emerging market and try to add more customers there in the long run, how do you see your retention rate kind of play out from here on?

Sure.

That's a good question.

I think we are very early in this idea of expanding into emerging.

And so, what you're really talking about is a potential mix shift, if we are successful in the marketplace, which would be great.

And obviously, we think we've got a great opportunity there.

The other business rate in that emerging market is definitely 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 kind of give you a different type of a 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 kind of 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.

Got it.

So as a follow-up after that, if you see the products that you released in the past year and you being out of traction on that, how do you think about kind of expanding on the higher end of the market, meaning 500 above, 1,000 above?

Have you given any thought to that and as part of the app marketplace you're releasing, is there any benefit from that, that can help you grow on the higher end?

Yes, so I think, overall, I think the trend on utilization is positive for us.

I'm not sure it's any more or less positive at the high end of the market.

I mean, we want employees to be utilizing all the things that we are building for them across our market segment.

And remember, for us, our target market historically has been 20 to a 1,000.

So we've got a number of customers that are above that 500 employee mark already today, and some that exceed a 1,000.

I would say that we are doing the same thing.

Where we see it fit, we definitely 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 are tweaking and try to get better at, so 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'd like to turn the call back over to Steve Beauchamp for any closing remarks.

Well, thank you very much to all those who dialed in.

We really appreciate your interest in the Paylocity and if anybody of you needs some more time with us, we've got some conferences upcoming.

Feel free to reach out, we'd be 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.