Good afternoon. Welcome to Paylocity's earnings results call for the second quarter of fiscal year 2020, which ended on December 31, 2019. I'm Ryan Glenn, Vice President of FP&A and Investor Relations. 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.
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. 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, Steve will attend the JMP Technology Conference in San Francisco on February 24th. Toby and I will be attending the Raymond James Institutional Investors Conference in Orlando on March 3rd, and I will be attending the RBC One on One Software Conference in New York on March 12th. Please let me know if you'd 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 second-quarter fiscal 2020 earnings call. Our strong and consistent revenue growth continued in the second quarter, led by recurring and other revenue growth of 24.6%. We had another very strong sales quarter throughout our target market, and we're pleased to be able to raise fiscal 2020 total revenue guidance by $5 million, despite the headwind of three interest rate cuts since July. We continue to invest in sales and marketing initiatives to drive growth, and through the first half of the fiscal year, our sales team is off to their best start in quite some time. Similar to last year, we continue to see unit strength coming from clients with under 50 employees, as well as healthy momentum in the core and upper end of our market.
Channel referrals once again represented more than 25% of new business for the second quarter. Adjusted EBITDA for the second quarter was $30.3 million, or 22.9% margin. We continue to drive leverage in gross margin and G&A costs while we remain focused on incremental investments in research and development and sales and marketing initiatives in fiscal 2020 to drive growth. Our sustained investment in product development continues to pay dividends in the marketplace, with our product suite being a differentiator versus our competition. We continue to receive strong feedback on Community, our employee-focused social communication platform designed for clients to increase employee connection, engagement, and productivity. Monthly average users continue to increase. Clients have found Community helpful in communicating to their employees on a wide variety of topics, such as benefit open enrollment and company events.
More than half of our clients using Community have also taken advantage of our Groups feature in order to increase collaboration and drive cultural initiatives. In addition, we've been very pleased with the utilization of Community by our clients' employees with more than 15,000 posts and over 100,000 reactions to content just in this last quarter. Our commitment to providing innovative software like Community and On-Demand Payment that appeals to the modern workforce is also evident in our adoption toolkits, which continue to gain traction with prospects and existing clients. The toolkits help clients adopt and roll out our solutions, understand common use cases, and drive employee engagement across the platform. Our adoption toolkits provide clients with everything they need to plan, configure, and launch our products, including instructional videos and expert guidance on product utilization, best practices, and product rollout strategies.
The positive feedback we've received from prospects and clients continues to be confirmed by third-party research, as Paylocity has once again been named an overall leader in 10 product categories in G2's Winter 2020 Grid Report, including being named a leader in payroll for the enterprise segment for the first time. The second fiscal quarter is a very busy time of year for our operations employees as they work closely with clients on year-end processing of payrolls, W-2s, 1095s, and annual tax form filing to federal, state, and local agencies. I want to thank all of our employees for their hard work and dedication during this very busy time of year. I would now like to pass the call to Toby to review the quarter's results in detail and provide updated guidance.
Thanks, Steve. Total revenue for Q2 was $132.4 million, an increase of 23.4%, with recurring and other revenues up 24.6% from the same period last year. As Steve noted, our sales team had another strong quarter, and we're pleased with the consistency of our performance, specifically the growth we're seeing in recurring and other revenues in both Q1 and Q2, offsetting some of the headwind of three interest rate cuts since July.
Our adjusted gross profit was 70.3% for Q2, an increase of 50 basis points from the same period in the prior year, as we continue to focus on driving scale in our business model, while also adding operational resources to handle the increased client volume resulting from a strong start by our sales force in fiscal 2020. We continue to make significant investments in research and development. 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 14.4% of revenue in Q2, and on a dollar basis, our year-over-year investment in total R&D increased by 20.9%. On a non-GAAP basis, sales and marketing expenses were 25.6% of revenue in Q2, reflecting the strength of the sales performance in the first half of fiscal 2020.
On a non-GAAP basis, G&A costs were 14.9% of revenue in Q2 versus 15.7% in Q2 of last fiscal year, an 80 basis point improvement. We remain focused on consistently leveraging our G&A expenses on an annual basis. Adjusted EBITDA for the second quarter was $30.3 million, or 22.9% margin, as compared to our guidance of $30 million-$31 million. While we are pleased to deliver in the range and continue to focus on driving leverage, we did see margin headwind in the quarter from the lower interest rate environment and from higher sales expenses associated with our strong sales performance. Covering our GAAP results. For the quarter, gross profit was $87 million, operating income was $6.1 million, and net income was $5.5 million.
In regard to the balance sheet, we ended the quarter with cash equivalents, and invested corporate cash of $152.4 million, and we generated $27.8 million in cash from operating activities in Q2, as compared to $27 million for the same period last year. Finally, I'd like to provide our financial guidance for Q3 and updated guidance for fiscal 2020. For the third quarter of fiscal 2020, total revenue is expected to be in the range of $168.5 million to $169.5 million, or approximately 21% growth over third quarter fiscal 2019 total revenue. Adjusted EBITDA is expected to be in the range of $63.8 million- $64.8 million. For full fiscal year 2020, total revenue is expected to be in the range of $572.5 million- $573.5 million, or approximately 23% growth over fiscal 2019 total revenue.
Adjusted EBITDA is expected to be in the range of $163.5 million-$165.5 million. In conclusion, we are pleased with our Q2 results, including our consistent revenue growth, particularly in recurring and other revenue, as well as our ability to continuously demonstrate scale in our business in both gross margin and G&A, and we continue to focus on making progress towards our long-term financial targets. Operator, we're now ready for questions. Thank you.
Thank you. To ask a question, you need to press star one on your touch tone telephone. To remove yourself from the queue, press the pound key. If you would like to ask a question, star one. Our first question comes from Scott Berg with Needham. Your line is open.
Hi, Steve, Toby. Congrats on a good quarter, and thanks for taking my questions. I guess, Steve.
Yeah.
Yeah, let's just expand upon some of the sales successes that you said in the quarter.
Yeah
You said your sales teams were off to the best start ever. Sounds like your move down market's having some fruition. Are you seeing any changes in the environment, and I guess in terms of demand trends, what customers are asking for, maybe modules, or is it just kind of strong productivity across your sales force today?
Yeah. I think overall, a lot of the enhancements that we've made to the product over the last several years, including new modules and feature adds, we definitely are seeing great reception in the market for those additions. I mentioned Community in the prepared remarks as a highlight for us in terms of both differentiation and utilization. I think the other thing I would say is the strength in the sales force, in the first six months of the year, really is across the board. Continued strength in units below the 50 employee mark. Our core mid-market offering has done really well, and at the top end of our target market, we've done well. When you put all that together, it's definitely the best start we've had in a number of years.
Great. Helpful. Toby, on the margin guidance for the year, you raised revenue, you kept your adjusted EBITDA on an absolute basis flat, though, from your prior guidance.
Yeah.
How should we think about that delta? Are you spending in a couple of areas or maybe being conservative around interest rate changes?
Yeah, it's probably a little bit of both, Scott. I think we're definitely seeing it from a sales expense standpoint, which is a result of the sales performance that Steve was just talking about, which I think we're really happy with. Obviously we've had the headwind from the through-rate cuts since July, which have had an impact both from a revenue standpoint, but also from an adjusted EBITDA perspective. I think those are the two main points. I think overall, to be able to raise from a revenue standpoint and sort of keep the guide from an adjusted EBITDA perspective, overall feels pretty good.
Yeah. That's all I have at the moment. I'll jump back into the queue. Thanks.
Thanks.
Thank you. Our next question comes from Terry Tillman with SunTrust. Your line is open.
Hey, how are you guys? This is actually Nick on for Terry. Thanks for taking our questions. First one was around R&D. I guess how should we think about R&D investment moving forward? Should we expect further increases in PPY? In the near term, were you focusing more on iterating on the current products? Thanks.
Yeah. I think we have opportunities to do both. We are definitely seeing increased penetration of a number of modules that we've released over the last several years, and that certainly helps us from a realized PPY that we're getting across our clients.
At the same time, we've got an inside sales team really selling those products back to current clients, so we're getting a little bit of a lift there. It's not a huge part of our new business revenue, but it gets bigger and bigger every single year. Lastly, we do think that we'll continue to be able to add modules over time that we're going to be able to monetize. The ability for us to continue to drive new product innovation, both from a feature set and new modules, is definitely part of our long-term plan. We believe that the range for R&D when you expense and capitalize is really 10%-15%. We've been solidly in that range for a number of years, and I think we would continue to look at that same type of investment on a go-forward basis.
Got it. Okay. That's helpful. Just a follow-up. I guess any updates on, and you touched on Community in the prepared remarks, but on, I guess, attach rates or usage across the customer base for Community or data insights? I know you mentioned around 50% of customers are using data insights at the user conference. Like I said, just any update you have there would be helpful. Thanks.
Yeah. We definitely are seeing increased overall client utilization in our data insights module, which comes with any purchase, so it's not a separate purchase. We have been driving new and different analytics for those customers to be able to benefit from that. We've got a utilization dashboard that customers can use and see exactly what employees are doing and how that translates to both saving the client's time and driving higher levels of engagement, is probably the newest analytics that we've added to the platform. Community, we've rolled out. We completed the rollout in the fall. We've been really happy with the uptake of that feature. It really drives a lot of employee engagement, unlocks some pretty interesting use cases for our customers.
I think I said in the past, when we introduce a new module like that, we really look to try to get 10% or 20% of our customers on that module within a reasonable period of time. I think we're on pace or even ahead of where I would have expected with Community.
Got it. Okay. Thank you.
Thank you. Our next question comes from Pat Walravens with JMP Securities. Your line is open.
Oh, great. Thank you, and congratulations, you guys.
Thanks.
I wanted to talk a little bit about how big this business can get. You have some slides in your deck that are really helpful, but I'm going to drill down just a little bit. You have 20,000 customers roughly, right, Steve?
Yep
600,000 in your target market.
That's correct.
You can't get all 600, right? How many of those are really up for grabs? What sort of market share can you eventually end up with?
Sure. I think a couple things. There's 600,000, our core market of 20 to 1,000 employees. As you said, at the end of the last fiscal year, we had a little more than 20,000. I think our viewpoint is, we're trying to continue to grow the business at above 20% per year. Increasingly so, that's coming from units, as we saw last year, which was over 20%. The idea of every between three and four years at that metric, you can end up doubling the business. If you think of that, and 20,000 clients being 60,000 clients, that's still just 10% market share.
We look at that as within a reasonable timeframe, and you look at kind of our long-term model, that's something that we're kind of executing towards based off last year's metrics, and we're going to kind of stay focused on that. We think there's room beyond that, but that's a great near-term target. Let's think of doubling the business and getting to $1 billion and beyond as our next big milestone.
All right. Awesome. Thank you. Then just as sort of a follow-up on that is, you also have a great slide on the competitive landscape. One that sort of came across my radar recently, and I don't see on here, do you run into Paycor? Is that a competitor?
Yeah, I think we would characterize Paycor as being one of the largest privately held companies that we see. A lot of the privately held companies are smaller companies operating in a very narrow geography. I think Paycor would definitely be much larger than that. We would kind of put that still, at this point in time, that local or regional. That's not saying anything about Paycor. They're a tough competitor. We see them fairly often. Not enough to necessarily call out specifically.
Okay, perfect. Thank you very much, and congratulations again.
Thank you. Our next question comes from Brad Reback with Stifel. Your line is open.
Great. Thanks very much. Steve, if you think forward, given the amount of engagement that you're seeing with the Community product, does that fundamentally change the type of solutions you can put into your customer base going forward? Thanks.
Sure. One of the ways that we think about it is we're really trying to add value in three different ways for our customers. One is we're really trying to save them time and really digitize the entire HR back office. That does create a lot of interactions and a lot of transactions, and it drives a lot of utilization on our platform. We look at daily users and weekly users and monthly users, and we see that increasing based off the transactions. Secondly, what we're trying to do is find more engaging use cases that aren't just automation of transactions. You think about our survey product. You think about performance management and journal capability, reward and recognition with impressions, and Community, which creates a whole other level of engagement.
We take all of that data from both these engagement-oriented products and transactional products, and then we combine that to deliver interesting insights back to our clients. We do think that that data that we have about the employee and the frequency of which they engage certainly opens up interesting product opportunities on a go-forward basis that likely surround that workforce, but that might be a little bit different than what we would have thought of maybe three or four years ago.
Great. Thanks very much.
Thank you. Our next question comes from Mark Marcon with Baird. Your line is open.
Good afternoon, Steve, Toby, and Ryan. Wondering, what are the implications of the strong G2 scores, particularly in the upmarket. Does that represent a new opportunity? You're clearly doing really well from that perspective. just wondering what the plans are to capitalize on that.
Yeah, I think we're really proud of those G2 scores overall. I think it reflects our focus on a strong client experience that we're ultimately delivering. We've been consistently delivering over 92% revenue retention as a proof point. I think mobilizing our customers as advocate has been really, really positive for us. I'm not so sure that I would look at the first time winning the enterprise as unlocking some brand new potential. I think it probably speaks to the success that we're actually having in that market. I think it's important to mention that the strength in the sales force has really come across all segments. That 500 plus, 500-1,000, sometimes it goes a little beyond 1,000, has been a really strong start to us. I think it's just another proof point.
That's great. Toby, with regards to the guidance, how are you thinking about float balance growth and effective yield and how that compares and contrasts relative to last year?
Yeah. Obviously we have seen three rate cuts since July, and that's certainly a headwind, as I said, both from a revenue and from an adjusted EBITDA perspective as that flows through. I think that there will be continued flow-through. We've seen the impacts in Q1, Q2. There will be continued flow-through into Q3 and Q4. I think directionally, you'll see that come through, even though we have average daily balances are up from around $1.1-$1.3 in Q2. You'll continue to see that impact flow through into Q3 and Q4.
Okay, great. With regards to the deferred contract costs on the free cash flows, how should we think about that as the year unfolds?
I think what you see there is some of the proof point of the sales force execution that Steve was talking about. We have seen strength in Q1 and Q2, and if you look at Q1 and Q2 performance of this year versus prior years, that's one of the areas where you start to see the impact of that.
Yeah. Clearly.
I think it references the strength of the sales performance in the first half so far and in Q2.
Yeah, it's been great. Terrific. I'll follow up offline. Thank you.
Yep.
Thank you. Our next question comes from Samad Samana with Jefferies. Your line is open.
Hi. Thanks for taking my questions. Maybe first, I just wanted to, Toby, on the sales and marketing expense side, just for clarity, that's driven by more commissions because sales was stronger than expected. Any change on the customer acquisition cost side if we just kind of held it like for like in similar size deals?
No. I think what you're seeing in the sales and marketing costs, if you take a step back, we've talked about incremental investments in sales and marketing over the course of call it the last year or so. I think you're just seeing some incremental investment there, I think you're also seeing the other significant part of it is the incremental sales expense from the sales performance in the course of the year and in the quarter.
I think just to add to that, if you compared that line item to last year at this time, we would say the incremental percentage spend is largely driven by sales performance, staffing levels in the sales organization directly related to our producers. The marketing initiatives we think are relatively small. We're excited about some of the things that we're doing with channels and marketing, but most of that is really coming from our sales organization performance.
Okay, great. Then maybe one for you, Steve. As you think about competitive dynamics, any changing in pricing behavior or discounting behavior? Some of your larger competitors have not had such great quarters, so I'm just curious if you're seeing any change in behavior. I know price isn't the number one factor, but it certainly is something that we get asked about.
Yeah. I definitely don't think price is the number one factor, but you're right. It's a competitive market, and we're used to a highly competitive market. We really have not seen any changes to those dynamics. At the end of the day, it's really the strength of our product and the service offering that we can provide those customers to kind of unlock the value that we're giving them is really probably more important than price, and we haven't seen any abnormal behavior from a pricing perspective.
Great. Appreciate you taking my questions. Thanks, guys.
Yep, thanks.
Our next question comes from Brian Peterson with Raymond James. Your line is open.
Thanks. This is Alex Sklar for Brian. Steve, I just want to follow up on the sales momentum comments. Can you elaborate on what metrics that might be on? Is it simply just new customer growth, or are you also seeing momentum on larger initial deal sizes or upsell as well?
Yeah. I think if you look at new business revenue is how the sales organization is compensated, so new annual recurring revenue is really where we're talking about seeing that strength. Last year we saw a lot of strength in units under 50, and so I would say that has continued into this year. We've seen even better strength in our mid and upper end of our marketplace. If I were to characterize last year versus this year, last year we had a good year from a sales perspective. It's been even better in that mid-market and upper end with continued strength downmarket.
Got it. Thanks. Toby, I know this has come up on some prior calls, but I just wanted to ask about the higher % of cash being used for corporate investments this quarter. I thought the commentary on the prior calls was more so tied to a higher % of client funds being invested. Just wanted to ask about that.
Yeah. We do both. We have a portion of funds held for clients that we're investing, and we also have a portion of corporate cash that we're investing as well. Similar from a portfolio standpoint, but we're investing a piece of each, and I think that just on the corporate cash piece, just sort of reflects nothing more or less than responsible placement of cash from the balance sheet.
Okay. Thank you.
Yep.
Thank you. Our next question comes from Nandan Amladi with Guggenheim Partners. Your line is open.
Thank you. Good afternoon. Thanks for taking my question. A competitive question here. The traditional service bureaus have also reported improving retention rates over the last couple of quarters, despite having some pricing actions as well. I'm wondering how much of a function this is of a healthy economic backdrop overall relative to any competitive sort of displacements and things like that. What are you seeing from your vantage point?
I think, the way we see the economy manifest in our client base is how many employees are being paid and how many active employees that they have. I would say we haven't seen any change to what that run rate looks like. That has been kind of a slow growth environment for a while, and that continues to look that way. I don't think that's necessarily a factor for us, because it hasn't changed. Secondly, we don't sell a whole bunch of new businesses, so that's not a key part of what we do, which sometimes you see with economy increasing, more new business formation. I don't think the economy in itself has been really helpful or hurtful to us. The biggest impact's really just been the interest rate declines.
Of course, our own performance in terms of driving that acceleration that you see in recurring revenue these first two quarters of this fiscal year versus the last two quarters of last fiscal year.
Right. A quick follow-up on the operational side. I know you talked about adoption tools for customers to begin to adopt some of your newer features. How about on the onboarding side? How automated is that process and how much opportunity is there for you to make that perhaps more efficient?
Onboarding's been a great product for us. We've had it in the market now for a number of years. We've got a significant portion of our customers that are completely digitized the onboarding process using our platform. You could imagine that prior to starting the first job, you'll go online, you'll fill out all the information, fill out your required federal and state forms, and you can include some content in there, some welcoming content from the company, and then be able to show up to work, and not necessarily have to go through whatever, a couple of two or three hours of paperwork like you normally would. That's been a really great product for us. It's one of those products that we've even seen get adopted at the lower end of our market, more than we would've expected. We feel good about it.
All right. Thank you.
Our next question comes from Matt Pfau with William Blair. Your line is open.
Hey, guys. Thanks for taking my questions. Wanted to ask on the sub 50 employee market, how is the effort to build out or partner with additional businesses in that area to help you generate customer leads progressing? Also, as you put some more focus on the sub 50 market, have you seen any competitive response from companies where that's more their target market?
Sure. I think on the first part, if you look at our channel strategy, which is more than 25% of our new business revenue comes from brokers. Brokers do refer us fairly frequently under 50 employees. It's not a new market for us. It's one that we're seeing opportunity and we're expanding into. We are creating more relationships with CPAs who are often operating, and I think we believe that that does take a while to be able to get a client referral, show that you do a great job, get another referral, and build that relationship over time. We are gradually doing that, and I think you see that in the unit success that we were able to drive last year at over 20%. We're really happy with the progress that we're making.
We think it's really more about expanding our channel approach than some sort of brand new channel approach to be able to continue the success in that under 50 market.
Then on the competitive side, any response from some of the companies where that's their target market as you've had more success there?
Yeah. It's not a new market for us, so I think that's an important point. We've always competed in that 20 to 50. Maybe we're seeing more deals in the 10- 20 than we ever had before, as we've kind of accelerated the unit growth down market. I think it's really mostly for us, the usual competitors that we've always seen. We might just see them a little bit more as we drive more activity there, but nothing new.
Great. That's all I had, guys. Thanks a lot.
Thanks.
Thank you. Our next question comes from Siti Panigrahi from Mizuho. Your line is open.
Thanks for taking my question. Just a follow-up to Nandan's question. You guys mentioned about ADP and Paychex. You get almost 50% of your new clients. Besides the improvement in the retention, they talked about seeing strength on their 50, 2,000, that segment. They talked about that recently, and also they talk about the new platform, Paylocity as well. I'm wondering, are you seeing any kind of changes or expecting any kind of changes in competitive landscape as they get more aggressive and come up with a new platform?
Sure. As I go back to the prepared remarks, the last two quarters have been the best two sales quarters that we've had in a number of years. We continue to have success against what we think is all of our competitors. Just by the fact that ADP and Paychex are the larger ones in the space, then we run into them more frequently. We continue with that same level of success. We haven't seen any differences from a competitive landscape. We really feel good about the win rates that we're driving and the sales momentum that we have. I'm not sure that a small change in retention from some of those big players really affects the size of our opportunity. Go back to 10% market share, 60,000 clients. We got a lot of room before we even get there.
We feel really good about the start we've had.
When you think about growth, you talked about some of the modules getting traction. How do you see the growth coming from increase in employee within your install base versus cross-selling new products into the install base and versus new logos?
Sure. First of all, new logos has always been the biggest driver of our growth. Last year you saw new logos accelerate to above 20% for the first time in a number of years. We continue to have momentum in that under 50 marketplace, so that's probably the right way to think about that. I think in terms of add-on sales, it's something that we're growing faster than maybe our sales force, but it's still relatively small when you look at the total amount of new business revenue. We do think that that's a great opportunity on a go-forward basis. The fact that our clients are asking for these products and adopting them is a great sign that we're going to be able to continue to do that. I think the last part of your question was clients adding employees.
That's a really small part of our growth rate. Very low double-digit % in a slow growth economy, and that's been fairly consistent over the last number of years.
Okay. Last question. Steve talked about On-Demand Pay pretty early stage, some feedback. I'm wondering if you have any update on that On-Demand Pay. When are you going to roll out?
We've had On-Demand Pay in the market. We rolled it out to customers starting in the fall. We made it available to all of our customers as of January 1st. We definitely have had a number of those customers adopt it. I think what we've always said about On-Demand Pay is it's a great option for an employee who might get stuck with unexpected expenses and need to be able to get pay that they've already earned available to them. At the end of the day, we haven't seen customers adopt it en masse. We've seen customers sometimes be a little bit hesitant and want to understand what are the controls that they're going to have in place, which we have a number of.
I would say it's rolled out slowly to our customers, although any of our 20,000-plus customers could turn that on today and offer that to their employees.
All right. Thank you.
Thank you. Our next question comes from Daniel Jester with Citi. Your line is open.
Yeah, thanks for taking my question. I just wanted to go back to free cash flow question a little while ago. Year to date, free cash generation is maybe flattish to down compared to the same period last year. You talked about the deferred contract cost, but as we go throughout the rest of 2020, is there any other kind of puts and takes to be thinking about in terms of how EBITDA gets converted to cash?
Yeah. I think we've talked about, from a measurement of free cash flow perspective, is looking at that on an annual basis and continuing to drive free cash flow leverage. Maybe think back to where we were, we went from basically 12.9%- 16.3% over the last prior fiscal year, and I think we've said focus was on being able to drive continued free cash flow progress on an annual basis. We're into the range that we had called out. I think we feel pretty good about that. I think we remain focused on being able to drive continued free cash flow leverage on an annual basis. I think you see some timing elements sort of quarter to quarter within the year. I think if you look at it on an annual basis, that's still how we think about it.
Got you. That's helpful. Just on On-Demand Pay, you just commented maybe some of your customers are taking a look at it. Can you give any specific examples of some of the reasons why they may not be as fast to adopt or maybe some of the pushback that they've given to you more explicitly? Thank you.
Sure. I think it comes down to some of the controls that they have in place in terms of their internal processes. It's definitely something that you see more demand for hourly workers. If you think about it, I need to make sure that that supervisor has approved the hours that have worked, and I need to feel confident before I advance them that pay, that that pay was actually earned. A lot of the business processes that clients have are to do that on a weekly basis or on a biweekly basis, depending on their payroll frequency, and that's where they have those double checks.
They don't necessarily do that every single day. That's what they need to think about, is they need to make sure that if that person's asking for an advance, that yes, they were there that day prior, my processes are verified so that a supervisor understands that and signs off of it. I think there's this need for hourly workers and demand for hourly workers that does require a customer feeling comfortable that they have the right processes to make that available.
Great. Thank you.
Yep.
Thank you. Our next question comes from Drew Kootman with Cantor Fitzgerald. Your line is open.
Hi, thanks for taking my question. Just one from me, and wanted to follow up also on On-Demand Payment. I know the hesitancy from some customers, but just curious what the reaction has been from the people that are using it.
Yeah.
Any idea on that 10%-20% penetration, how long that might take, and any impact to revenue or any timeframe that you think there could be?
Sure. I think overall, when we introduce a new modular product, we think about that as could be a two or three-year timeframe before you get into that 10% or 20% kind of range. Some products have definitely gone faster than that. A number of products have definitely gone faster than that. I think On-Demand Payment is off to a good start. I don't think that this is going to have any immediate impact short run. There's a relatively small fee structure associated with it. You need a whole bunch of volume for it to be material. It's a nice add-on and great feature to have, to differentiate us in the marketplace, but I wouldn't think that it's going to be material in the near term.
We believe it's going to take a while for customers to be able to drive that adoption, and it's going to be a little bit more of a slower rollout. From an employee perspective, those that have used it, and by the way, we offer it to all of our employees as well. We've got great feedback overall. You think about the holiday season, and depending on when your paycheck falls, I need to be able to I'm doing some gift giving, I need some extra cash. You feel like a scenario where somebody runs into some sort of unforecasted expense and they need new tires for their car or something like that. We've heard different examples where they're really advancing themselves.
What it does is it takes the employer out of the conversation to say, "Hey, can you advance me my pay?" They can go on the app, they can see exactly what they've earned in real time, and immediately request that, it gets deposited in their bank account. I think the employee experience that we've delivered has gotten great feedback. I think it's just going to take a little bit of time for customers to roll that out. From a revenue perspective, therefore, we'll have a fairly minimal impact as we look at the balance of this fiscal year.
Perfect. Thank you.
Thank you. Our next question comes from Robert Simmons with RBC Capital Markets. Your line is open.
Hi. Thanks for taking our question. Following up on these earlier questions, and sorry for this new question on the topic, but can you talk about On-Demand Payment and how your offering and approach are differentiated versus what others provide?
Sure. The way it works from an employee perspective is you log on to your mobile app, which we have significant mobile app utilization, so employees are used to going on there to do a whole bunch of things. They can look at their pay. They can actually look at how much of their pay for the next payroll period has been earned. You can see it in real time. "Oh, so far I've earned $475." You can actually see it from gross to net with all the taxes and all your deductions taken out. You can request whatever amount is available for you to request, and there's some settings that a customer can put in to manage that. Then it'll be direct deposited into your account, either same day, depending on the time of day or next day.
That's as easy as it is to use.
What is the revenue model actually for you? Is it based on transfer fees or what else?
Yep. The client selects whether they want to offer that as a benefit to their employees and pay a small transactional fee, or whether they want to have that employee pay that small transactional fee. It's up to the customer.
Got it. Great. Thanks.
Thank you. Our next question comes from Arvind Ramnani with KeyBanc. Your line is open.
Hey. Yeah, thanks for taking my question. My first question is based on my checks with your core market, certainly feedback on the product among users as well as prospective clients is very positive. Win rates seem to be also very good. Can you talk a little bit about win rates with larger clients and, in particular, if one of your clients gets acquired by a larger employer, how are your win rates in those types of situations?
Sure. I think one of the things that I've said a couple of times is we've definitely seen strength across the entire market. We would think about that as below 50-500, and then 500 plus. That 500-1,000 is really the space at the upper end. Again, sometimes those customers are even a little bit larger there. I would tell you that we feel really good about our retention rates in that space, so the strength of our product as clients' needs change over time. Secondly, that's been a big piece of the sales story for the first part of the year. We've had strength in both our core market as well as that 500 plus.
We definitely feel really good about the win rates, and they're part of that contribution to a strong start to the year.
Great. I also think your tone on this call as well as underlying growth rates all seem to be very positive. Are there any areas of concern or I understand you have some higher costs, but that's certainly offset by higher sales performance and all of that? Is there any real area of softness or weakness you're focused on?
No, I think the challenge for us this year is you've got three interest rates cuts as wind in our face. The last couple of years, we had wind behind our backs. I think that puts more pressure on adjusted EBITDA than any other line item. You overlay a great start to the year and strong sales performance. You see us, we feel pretty good that we're able to be in our EBITDA range, that we're able to maintain that guidance for the year, absorb those rate cuts for the year, and then be able to also handle the expense associated with the strong sales start. That's really what we're trying to manage through the back half of the year. I would always say those are the kind of problems I'd like to have.
Great. Just last question for me, I feel I should also ask a question on this on-demand compensation. We have talked about it offline quite a bit, but the one topic I want to get clarification is the IRS rules around on-demand pay, is that clear? I know until a few months back, there was lack of clarity on some of the tax implications.
Sure. I think anytime there's change in the way people are working, whether it's the impact of the gig economy and the number of 1099 workers and legislation that you've seen in California around that or On-Demand Pay and the idea of getting an advance on my pay, there's going to be catch-up from a legislation perspective. We haven't seen a lot of clarity as of yet. What we're really doing is offering people pay that they've earned, and we're providing them an advance ahead of their regularly scheduled payday before they get there. We definitely believe our product gives them a compliant offering based off the current structure, but we monitor that closely, and we feel that if there are changes to it, we could easily adapt.
Great. Thank you very much. Good luck for the rest of the year.
Thanks.
Thank you.
Thank you. Our next question comes from Jeff Van Rhee with Craig-Hallum. Your line is open.
Thanks, guys. One brief one here. Maybe we just touch back on the EvoShare and Compete relationships, how those have come out of the gate relative to expectations and any implications for wanting to be more or less aggressive with other similar relationships down the road.
Yeah. We talked about it on last call that we really traditionally focused on brokers and financial advisors and generating that 25% plus of our revenue from that channel. EvoShare partnership, which we've been really happy with the start, is really targeted at the financial advisors and really helps provide the financial advisors differentiation and really integrates our product offerings. The Compete is definitely something a little bit newer for us, and that's really a software partnership where you might have either vertical market software or horizontal software offerings that we would then create a much more integrated offering for our mutual customers and then be able to jointly market that. So we've been really happy with that one as well. Now, none of those are really that material.
I think it's more about the concept and the idea that we could create more of these over time, and that that would be a component of how we drive channels to continue to be that 25% plus of our revenue.
Very helpful. Thanks.
Thank you.
Thank you. I'm showing no further questions in the queue. I'd like to turn the call back to Steve Beauchamp for closing remarks.
Great. Well, I just want to take a brief moment to once again thank all of our employees during the busiest time of the year, and then, of course, thank everybody on the call for your interest in Paylocity. Have a great night.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect. Everyone, have a great day.