Ladies and gentlemen, welcome to the Paylocity Q4 and full year 2018 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. If anyone should require operator assistance, please press star then zero on your touchtone telephone. 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, welcome to Paylocity's earnings results call for the fourth quarter and fiscal year 2018, which ended on June 30th, 2018. I'm 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.
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, Toby and I will be attending the Raymond James Midcap Growth Conference in Chicago on August 21st, the HR Technology Conference in Las Vegas on September 12th, and the Deutsche Bank Tech Conference also in Las Vegas on September 13th. Please let me know if you would like to schedule time with us at any of these events. With that, let me turn the call over to Steve.
Thank you, Ryan, and thanks 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%-28%. In addition to our strong revenue growth in fiscal 2018, we also continued to make significant progress on our current key financial targets, including adjusted EBITDA margin of 21.5%, an increase of 280 basis points from fiscal 2017.
Our growth formula continues to be driven by adding new clients to our platform and selling more products to each client. We increased our total clients by 15%, finishing fiscal 2018 with 16,700 clients compared to 14,550 at the end of last fiscal year. We also increased average recurring revenue per client by 10% to $21,768 from $19,825, primarily by selling more products to new clients. We also continued to gradually expand efforts to sell our growing HCM portfolio back into our client base. Overall, we are pleased by the attach rates we are realizing throughout our target market as clients continue to see the value in our comprehensive product suite. Broker referrals remained a consistent driver of sales activity, representing more than 25% of new business revenue for fiscal 2018.
We continue to invest in our broker portal and our data integration capabilities, including our newly announced integration marketplace, which extends our commitment to provide a superior client experience by allowing clients to quickly review our more than 300 integration partners and capabilities across various HCM functions. We have also continued to invest in our sales force by adding new sales reps, while at the same time investing in training initiatives and marketing programs to drive productivity. We have expanded the sales force by 21% this fiscal year from 257 sales reps in fiscal 2018 to 310 sales reps in fiscal 2019. As I discussed on our February earnings call, we began recruiting for our sales reps earlier this fiscal year, and I'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 a 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 re-engineering our sales process for larger deals. In fiscal 2019, we will also be investing in the lower end of our market as we have 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 components as part of their solution. 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 expense and capitalize.
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. We expect to release these products broadly in fiscal 2019. In addition to launching new modules, we continue to invest in research and development efforts associated with features and functions within our existing product suite as we look to drive increased product utilization by our clients.
We continue to be pleased with the increased usage we see throughout our product suite, including nearly 500,000 unique daily users to our self-service platform and mobile app. Our newer products have also been well-received in the marketplace and continue to see increased usage, including over 1 million applications received in our recruiting product, over 50,000 courses launched in our compliance dashboard, and millions of dollars of merit increase processed with our compensation management product that we released just this past January. Throughout fiscal 2018, our operations teams 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 number 29 Best Places to Work in Glassdoor's Employees' Choice Awards. We continue to focus on maintaining our strong culture. I'm pleased to announce that the majority of our Chicagoland employees are working in our new corporate headquarters. We recently held a grand opening event at our new facility in Boise. Our new facilities include a number of employee-centric features, including state-of-the-art fitness centers and entertainment areas, modern dining facilities, as well as ample space for training and development, and collaboration environments for our teams to work cross-functionally.
I would like to thank our more than 2,500 highly dedicated employees across the country for all 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. 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. Congratulations, Steve. 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 160.4%, 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 2017. 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 continued 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% 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 2017. On a dollar basis, our investment in total R&D increased by 24.9% in fiscal 2018 when compared to fiscal 2017. 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 2017. 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%-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 2018 adjusted EBITDA increased by 44.7% over fiscal 2017. 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. 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 2018 includes the add-back of $4 million of one-time non-cash 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. 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 2018 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 2018 versus $24.2 million or 8.1% of revenue in fiscal 2017, a 480 basis point improvement. Purchases of property and equipment were $21.7 million or 5.7% of revenue in fiscal 2018, 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%-5%, which is below our historical average spend of 6%-7% of revenue. As a result of our strong financial performance and expanding leverage and cash generation realized to date, including fiscal 2018 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 1st under the modified retrospective method. The primary impact of 606 is a tailwind to full year fiscal 2019 adjusted EBITDA of approximately 6 to 700 basis points, with a varying impact on a quarterly basis. Roughly 40% of the impact is from amortizing certain sales expenses over a seven-year amortization period, and the remaining 60% comes from amortizing certain implementation expenses over the same period. Previously, under ASC 605, we would have taken each of these expenses as incurred without any amortization. Also, as of July 1st, we will begin recognizing implementation revenue ratably over a period of up to 24 months. Previously, we accounted for implementation fees on a 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 2019. To be clear, these impacts are all non-cash and are accounting-driven changes. To facilitate the comparability of our fiscal 2018 quarterly revenue to our fiscal 2019 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 2018. Before I provide our financial guidance, I would like to update certain of our key financial targets. Since the time of our IPO in March 2014, we have demonstrated consistent leverage in our business model, both in adjusted gross margin and in our operating expenses.
In the last four fiscal years, adjusted EBITDA has increased from $5.4 million or 5% of revenue to $81.3 million or 21.5% of revenue, a 1,650 basis point improvement. As a result of our strong financial performance and because of ASC 606-related changes outlined earlier, we are revising certain key financial targets as follows. In regards to revenue, our goal of 20%+ 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%-75%, increased from 65%-70%. EBITDA target is now 30%-35%, increased from 20%-25%. We are introducing a free cash flow target of 15%-20% of revenue, as we are confident we will continue to expand free cash flow margin on an annual basis, including in fiscal 2019.
Finally, I'd like to provide our financial guidance for the first quarter and full year fiscal 2019. For the first quarter of 2019, total revenue is expected to be in the range of $97.5 million-$98.5 million, or approximately 22%-24% growth over non-GAAP pro forma first quarter fiscal 2018 total revenue of $79.7 million. Adjusted EBITDA is expected to be in the range of $20 million-$21 million. For fiscal 2019 full year, total revenue is expected to be in the range of $451 million-$453 million, or approximately 21%-22% growth over non-GAAP pro forma fiscal 2018 total revenue of $372.1 million. Adjusted EBITDA is expected to be in the range of $126.5 million-$128.5 million.
In summary, we are very pleased with our operational performance during the fourth quarter and full fiscal year 2018, with 25.8% total revenue growth and adjusted EBITDA margin of 21.5%. Operator, we're now ready for questions. Thank you.
Ladies and gentlemen, if you have a question at this time, please press the star, then the number 1 key on your touch-tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Once you've asked your question, we ask that you please place your line on mute to prevent any background noise. Our first question comes from Justin Furby of William Blair. Your line is open.
Hey, guys. Congrats on the fabulous quarter. Maybe just to start, Toby, on 606, just so I got it right. If you were to stay in 605 world, your revenue guide is $7 million higher. Is that the takeaway?
Yeah. Hey, Justin. The accounting changes adopted as of July 1st resulted in a $7 million headwind to fiscal 2019 revenue, which is 100% rev rec timing driven by the accounting rules.
Okay.
It's non-cash and non-operational, 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 2018. The revenue guide for fiscal 2019 of $451 million-$453 million is after taking out the impact of the $7 million rev rec timing impact.
To be clear, 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. Steve.
Recurring growth has not changed. Yep.
Okay, perfect. Steve, just on the new sort of down market, I'm interested in, is that part of your sales headcount number that you gave, the 21% growth? Is the carve-out for that
Sure
below 20 space? 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? Thanks.
Yep. First I would say the 21% headcount growth that we were able to bring on going into this fiscal year, we feel really good about. That's really in our core marketplace. There's no new market initiative associated with that. That's kind of a 21% expansion. I think the call-out on the under 50 marketplace really reflects that fact that we've seen more demand in that space. I think you see that with a 15% unit growth year-over-year. We definitely are seeing these clients looking for more comprehensive HR capabilities. Our plan is, throughout this fiscal year, to invest in some sales folks that'll be dedicated to go after that opportunity. We really don't think it's going to have much of a revenue impact. Think about this as a longer-term investment opportunity. There's clearly millions of businesses in that under 20 marketplace.
We think the more demand in that space, the bigger the opportunity is for us. We'll try to size the TAM as we start figuring out our exact go to market there. We're early in that process, but we're excited about some of the early clients that we're bringing on, both below 50 and even as small as 10 or 15 employees.
Got it. Thanks very much. I'll jump back in the queue.
Our next question comes from Brian Peterson of Raymond James. Your line is open.
Thanks. This is Vince Celentano on for Brian. I wanted to see which modules showed the most year-over-year growth this past year on an absolute basis, and how do you see that changing in the coming fiscal year?
Yeah. We do a lot of bundling and packaging in terms of trying to make the buying process easy for our customers. 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 1 million applications in our recruiting platform, which has been released now for about 18 months. 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 in it.
Okay, perfect. If you can give us a little more color about your average employee size per client, and how you see that trending in fiscal year 2019.
Yeah. If we're successful with our investments at the low end of the marketplace, that's going to have a bit of a different mix shift. 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. Again, we're at the very initial stages of those investments. If you look at this past fiscal year, I would tell you that our average customer size at the end of this year is very similar to what our average customer size is at the end of last year. No real changes. The changes are really potentially in front of us if we're successful in expanding in the emerging markets.
Okay, perfect. Thank you very much.
Our next question comes from Scott Berg of Needham. Your line is open.
Hey, Scott.
Scott, please ensure that you're not on mute.
Sorry, I was on mute. I didn't think I was. My apologies. Congrats on a great quarter.
Thanks, Scott.
Thanks for taking my questions, guys. I just wanted to start off on the new intermediate term goals, I guess, or longer term goals from a revenue and profitability standpoint, Toby, that you laid out.
Yep.
Do you have any sort of timeframe for us to think about of attaining maybe the EBITDA margin goals or the free cash flow goals, I guess, to start off with?
Yeah. 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 two to four year-ish timeframe. I think when we've thought about these, we've thought about these as achievable in a similar timeframe. 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. I would think about that as probably moderating a little bit over time, but that's how we're thinking about it.
Yeah, I think the only thing I would add is we're definitely focused on 20%+ growth as a key part of that formula. The fact that we've had pretty consistent recurring revenue growth this past fiscal year is definitely encouraging, and I think it would be at a gradual move towards those long-term targets over time. It took us 4+ years, really, to get to the adjusted EBITDA target. We're mostly focused on keeping 20%+ growth, and if that requires a little bit more investment to be able to do so, we're 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.
Yep.
Got it. Helpful. The growth trajectory, Steve, I guess it's a question on the move to, I 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.
Yeah.
If through your eyes, they buy and purchase the same product, maybe pricing that's there. As we get a couple of years out, do you think of that 20% growth on an absolute basis, does maybe a third or a half or a quarter of your revenue growth end up coming from that segment versus your current core? Thanks.
Yeah. I would say we're already in that segment. If you think about a couple of years ago, when ACA was coming into law, we talked about the fact that 50% of our clients have less than 50 employees. 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. It's also lowering the size of that target market. We've been really 20+. We certainly have the opportunity to go a little bit lower than that 20 employee segment. I think the key drivers really are those businesses are often faced with very similar challenges to our customers who are typically going to be many of our customers, over 100 employees.
It's a tight labor market. The talent management components are becoming important to them. They've got younger generation entering the workforce, they're looking for platforms that are a little bit more engaging than maybe the traditional options that are available to them. Those are kind of the conversations that we're having in the market. They're excited about what we've got to offer, and we can bundle our existing 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 up and running.
It's really kind of a bundling and packaging, going at it with the same platform, some new folks targeting that market, but it's definitely somewhere where we have a lot of experience.
Very helpful. Thanks again, and congrats on a great quarter.
Thanks.
Our next question comes from Terry Tillman of SunTrust. Your line is open.
Hey, guys. Thanks for taking the question. This is actually Eric Lemus on for Terry Tillman. A question on the benefits admin product. It sounds like you guys are in good shape on releasing that in this coming year. Have you guys been showing that to some customers? If so, what has been the early response on that product?
Yeah. I think if you go back to the plan that we talked about last quarter was really, after the acquisition, we've got a product team really working with some of the knowledgeable folks that we were able to bring on board to be able to build a differentiated user experience. Our goal is to launch that this fiscal year. 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. Lots of input. I think, what we're hearing is, really 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. If you really think about the 500,000 plus people we get onto our portal and mobile, and we just integrate this HSA and FSA information, we can really ease the experience, both from an administrator perspective, but particularly from an employee perspective. Those are the sentiments that we're hearing from these early conversations with prospects and existing clients.
Okay. That's great to hear. My next question on the integration marketplace that was launched just recently. How do you think about that moving forward as far as the adoption of people actually using the integration? How has the response been with the integration marketplace so far?
Yeah. I think data integration as a strength really goes back more than 10 years for us as a company. We've always integrated with a variety of third-party providers, particularly 401(k) providers and health insurance product providers. 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, excuse me, making those more real-time with the APIs that we've developed and made available. We think that this is just 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.
Got it. Thanks, Steve.
Our next question comes from Corey Greendale of First Analysis. Your line is open.
Hi. Thanks. Just a couple of questions. In terms of the growth in the rep force, I think it's a little bit slower. I think you've grown the force 25% the last couple of years, 21% this year. Just as you think about investment, what was the thinking behind slower growth this year?
I would say that we look at our setting the quota based off the amount of revenue that we need sold. It's a formula based off the number of people we need and the overall amount of revenue. 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. I think as we put that all together, we felt like we could achieve our goals with 21% more headcount. On top of that, we're going to be investing in this new opportunity in emerging as well.
We haven't necessarily finalized what those numbers look like, and we're very early, but I think when you add that into the mix, we're going to be adding a more similar overall percentage by the end of the fiscal year. Even though the emerging won't have much of an impact this year, we feel pretty good about the total heads that we'll end up with at the end of the fiscal year.
Okay. 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?
Yeah. I think historically, we definitely have gotten referrals in that sub-50 employee space, and we've got a significant number of referrals there. I think traditionally, when you look at that market as a whole, it's been more CPA driven in terms of referrals than it has necessarily been broker. 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. All that will obviously be part of us figuring out the right strategy and the right go-to-market. We would anticipate new channels as well as leveraging the existing ones.
Great. Thanks very much.
Our next question comes from Ross MacMillan of RBC Capital Markets. Your line is open.
Thanks so much. Congrats from me as well. Toby, just first of all, on like for like EBITDA in fiscal 2019 versus fiscal 2018, I was doing my quick math, and it appears your initial guidance looks to be about the same EBITDA margin, maybe slightly up. I wondered if you could just maybe double-click on that. 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. I'm just wondering, as we think about that rolling into fiscal 2019, does that continue such that we're getting pretty much close to like for like as we go through the year, that delta gets smaller and smaller? Thanks.
Hey, Ross. Let me hit the last one first. I think the answer is yes, you're reading that the right way. Then in terms of how it flows in in the quarters, 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 2018, we talked about incremental investments in sales and marketing. I think for this year, it's incremental investment in sales and marketing and R&D to help us continue to drive growth. 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. Obviously, we're getting the tailwind of 600, 700 basis points from 606. I think you're reading that the right way.
Thank you. A follow-up just for Steve, if I can. Going through the data you gave us on customer adds and PEPY, those numbers look pretty good. In fact, that PEPY growth seemed to be pretty similar to last year's. I think you talked a little bit earlier in the year about some mix shift in customer size. 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. Even though you got size mix down, you got more product per customer mix up.
Yeah. I think if you go back, we were trying to signal a slight change in client size, I think that that word slight seems to not necessarily always have a great definition around it. I think what you're seeing is we had 10% average revenue per client growth. Yeah, 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. 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 would come from average revenue per client. There's no question that we had a little bit more product sales in there and just a slight impact from the client size, but it wasn't much.
Super helpful. Thanks again. Congrats.
Thank you.
Thank you.
Our next question comes from Walravens of JMP Securities. Your line is open.
Hi, this is Mathew Spencer on for Pat Walravens. Thank you for taking my question. Just two quick ones, if you don't mind. First is, how are you thinking about M&A going forward? Second, have you seen any change whatsoever in the competitive environment? Thanks.
Sure. From an M&A perspective, BeneFLEX was really the first acquisition that we've done, and obviously we talked earlier in the call about how we're integrating that. 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. 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.
I think it's a potentially another opportunity in front of us.
Thank you. Then just on the competitive environment, I guess, have you seen any changes there? Yep. Thanks.
Yeah. I think from a competitive environment perspective, we're seeing the same people that we've seen for years. It's always been competitive. It's still competitive today. We feel good about the product differentiation that we can bring to market. Revenue retention over 92% speaks to our ability to deliver the right service experience. So we feel pretty good up against whatever the competitor happens to be, we wouldn't necessarily call it any different in the competitive environment.
Great. Thanks again. Congratulations.
Thank you.
Our next question comes from Jeff Van Rhee of Craig-Hallum. Your line is open.
Great. Thanks. Just two from me. On the interest income line, can you just help us in that $451-$453 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. Just maybe start there, how to think about that number.
Yeah, from an interest income standpoint, we haven't modeled any rate increase into the guide for fiscal 2019. I think our view on that tends to be it's sort of a push forward from 2018 from that perspective. There's no incremental rate increase baked in. To the extent that that was to happen, there could be upside. As we've said before, it usually takes a while for any rate increases to funnel through to us from our banking partners. That's how we're looking at it.
Yep. The second, with respect to pipeline, sort of open-ended, any observations about variation in the deals in the pipeline, 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 call-outs?
Yeah, 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. I would tell you that most of that 10% increase still comes from selling more to the new customers that are coming on board. I think we've added a lot of products in the talent management suite. Recruiting, we've added expense, we've added compensation and surveys just in the last two years alone. We've been pleased with kind of the ramp-up of our talent management suite as a whole.
Got it. Okay, great. Thank you.
Our next question comes from Mark Marcon of RW Baird. Your line is open.
I was 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?
Yeah. What I would say is, we have experience in that marketplace selling those customers, right?
We haven't necessarily dedicated people towards that effort. 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. You might be looking at folks that might be a little bit earlier in their career because you're dealing with smaller businesses, the complexity of the product's a little bit less. Other than that, it's a pretty similar profile.
Okay. With regards to the revenue per client, that obviously increased nicely this year. Do you think that, even as you've pushed down, do you think that that can continue even with the really small clients?
What I would say is, I definitely think that when you look at our core segment of mid-sized businesses, we definitely have an opportunity to continue to add product and continue to increase that revenue per employee per year. If we're successful in emerging, which is obviously very early for us, and we start to bring on more units, and those units on average are a little bit smaller, we definitely think that you could see that mix shift in kind of the units versus average revenue per client. If you then start looking at those clients individually and think about what that per employee per year opportunity looks like, even if someone has 15 employees, we think the per employee per year opportunity can still approximate what it looks like in majors. By the way, that's still a very profitable space for us.
I think when you just look at the attractiveness of the market, it's a big TAM, lots of opportunity there, great industry dynamics where people are being much more focused on attracting and retaining talent, and a market where you can generate some pretty solid product bundles that will yield good PEPY opportunities. Overall, we think it's a great market to go after.
Yeah. I've seen a company in Rochester, New York, that has done pretty well there. 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?
Yeah. If I go back to the impacts of 606, most of the impact. 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 years. That's how I would think about the impact of both of those pieces of amortization against the P&L.
Okay. Then just going to the 30%-35% target.
Yep.
When we think about it midpoint to midpoint, you were clearly moving towards the upper end of that old target already. I guess from a longer-term perspective, how much is scale versus 606 in terms of the 600 to 700 basis points?
Yeah. I think that 600 to 700 is from 606. The way I would
I know. I just meant if you think about it longer term, do you think it stays there, or?
Yeah.
I think a way to think about this is, if you take a step back, obviously we get a leap forward.
Yes
In one year that would've taken us many years to get to. When you look at what our guidance is for this year, we're below what our long-term target is. 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 benefit in one year, if that makes sense.
I guess the only thing I'd add to that is, I think we still believe in the long-term EBITDA margin expansion that comes with the scale in the business. To Steve's point, we've taken a big step forward with 606, and so I would expect to see the in-year basis points of leverage perhaps moderate on a go-forward basis. 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 a 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. We feel pretty good about both the improvements we've had in cash flow generation the last couple of years and the opportunity for us to get into this 15%-20% free cash flow target.
On that 15%-20% free cash flow target, what are you thinking of as a longer-term effective tax rate?
In thinking about that, I think we would've pegged to the same tax rate that we would have described being in that mid to high 20s type range.
Great. Thanks a lot. Congrats.
Thank you.
Thank you.
Our next question comes from Siti Panigrahi of Wells Fargo. Your line is open.
Thanks for taking my question. My apologies if this question has been asked. I was going back and forth between calls. I think going back to 605, 606, you talked about the beginning about FY 2019 impact. Could you double-click that on Q1? How does that impact revenue as well as EBITDA?
From an EBITDA standpoint.
Perfect.
Sorry, what? Yeah. From an EBITDA standpoint, just going to the top of it, we've laid out the 600, 700 basis point change coming from 606. We've taken that apart between both the sales and then the implementation. As it relates to the flow-through in Q1, we're guiding to a 21-ish margin guide. We're guiding to 28-ish on the year, I think you'd expect to see EBITDA if you plug to Q1 and then 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 2017 or 2018 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 even the new product, Compensation Management. Just wondering, what's the penetration of those modules within your installed base?
Sure. We have this philosophy that says, we love to be able to work with our clients and feel comfortable that we can get into a penetration rate of 10%-20% in a fairly reasonable period of time. What's reasonable? Boy, if we can get there in a year, that's pretty fast. If we get there within two, that's 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, we also feel like there's opportunity for that to continue to drive higher over time as we continue to enhance those products based off of the feedback that we're getting from clients.
Thank you.
Our next question comes from Shankar Subramanian of Bank of America. Your line is open.
Hi. Thanks for taking my question. Question on retention rate. As you focus on the emerging market and try to add more customers there over long run
How do you see the retention rate play out from here on?
Sure. That's a good question. I think we're very early in this idea of expanding into emerging. What you're really talking about is a potential mix shift if we're successful in that marketplace, which would be great, and obviously, we think we've got a great opportunity there. The out-of-business rate in that emerging market is definitely higher. You do lose more clients. Now, they are on average a little bit smaller. There is the potential that over time we'd have to give you a different type of target for what that retention rate would look like if we've got a big client base in that space. I don't think that's necessarily an issue as we look at this fiscal year. It's probably something to think about in years to come as that new initiative for us starts to gain momentum.
Got it. As a follow-up to that, if you see the products you've released in the past year and you're gaining a lot of traction on that, how do you think about expanding on the higher end of the market, meaning 500 above, 1,000 above? Have you given any thought to that? As part of the app marketplace you're releasing, is there any benefit from that can help you grow on the higher end?
Yeah. Overall, I think the trend on utilization is positive for us. I'm not sure it's any more or less positive at the higher end of the market. We want employees to be utilizing all of the things that we're building for them across our market segment. Remember, for us, our target market has historically been 20 to 1,000. We've got a number of customers that are above that 500-employee mark already today, and some that exceed 1,000. I would say we're doing the same thing. Where we see a fit, we definitely go after those. We've definitely improved some of our sales processes and some of the resources and some of the marketing capabilities we have up market. We feel better about it today than we did a year ago. I wouldn't call it out as a different strategy.
It's just one that we're tweaking and trying to get better at so that we can continue to grow the number of clients that we have at the upper end of our market.
Got it. Thank you.
With no further questions, I'd like to turn the call back over to Steve Beauchamp for any closing remarks.
Thank you very much to all of those who dialed in. We really appreciate your interest in Paylocity. If any of you need 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, you may all disconnect. Everyone have a great day