Good day, ladies and gentlemen, welcome to the Paylocity Q2 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Following management's prepared remarks, we will host a question and answer session. Our instructions will be given at that time. If during the conference you require operator assistance, please press star then zero. An operator will be happy to assist you. As a reminder, this conference call may be recorded. It is now my pleasure to hand the conference over to Mr. Ryan Glenn, Senior Director of Finance and Investor Relations. Sir, you may begin.
Good afternoon, welcome to Paylocity's earnings results call for the second quarter of fiscal 2018, which ended on December 31st, 2017. I'm Ryan Glenn, Senior Director of Finance 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 in this discussion, 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. There's 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. The non-revenue financial measures we will discuss today are non-GAAP unless we state the measure as GAAP.
Please note that we are unable to reconcile any forward-looking non-GAAP financial measure to their directly comparable GAAP financial measure because the information which is needed to complete a reconciliation is unavailable at this time without unreasonable effort. In regards to our upcoming conference schedule, Steve and I will be attending the JMP Securities Technology Conference in San Francisco on February 26th. Toby and I will be attending the Raymond James Institutional Investors Conference in Orlando on March 6th. Toby will be attending the William Blair Technology one-on-one conference in Boston on March 14th. With that, let me turn the call over to Steve.
Thanks to all of you for joining us on our second quarter fiscal 2018 earnings call. We posted strong results in the second quarter of fiscal 2018 with total revenue of $86 million, an increase of 25.3% versus the same period last year. Recurring revenue grew by 25.7%, driven by new client additions, improved HCM product penetration, and an increase in interest income on fund held for clients. Adjusted EBITDA expanded from $9.9 million or 14.4% of revenue in the second quarter of fiscal 2017 to $15.2 million or 17.7% of revenue in the second quarter of fiscal 2018. The increased leverage in the business continues to translate to improved operating cash flow, which more than doubled versus the first six months of last fiscal year. We did receive a number of awards and accolades during the second quarter.
We were very pleased to be recognized as number 29 on Glassdoor's annual Employer of Choice Award in the large employer category. This is the third time we've been recognized as an employer of choice in Glassdoor's annual rankings and the second time in the large employer category. Paylocity was also recognized as one of the 2017 Best and Brightest Companies to Work For in the nation by the National Association for Business Resources. Finally, we were once again ranked on Deloitte's list of 500 fastest-growing technology companies in North America. This is the fifth year in a row that we've been included on the Fast 500 list. The second fiscal quarter is an important time of year for our sales organization, as many medium-sized businesses look to change providers at the start of a calendar year.
We had good sales execution in our core target market, albeit with a slightly smaller average client size, including another quarter of more than 25% new business sales from our broker channel. We are on pace to deliver similar client growth to FY 2017 after the first six months of our fiscal year. We have also been pleased to see the market reception and demand for our newest products. The continued investment in research and development is once again resulting in higher revenue per employee per year, driven primarily by selling more products to new clients. We do intend to take advantage of our strong performance in adjusted EBITDA in the first half of this fiscal year by investing more in sales and marketing in the back half of the fiscal year and into fiscal 2019.
We intend to focus these investments across our sales and marketing teams as we prepare for fiscal 2019. We increased our total investment in R&D by 20.3% over the second quarter of last fiscal year when you consider what we capitalized and what we expensed. The investment in R&D continues to drive more adoption and higher utilization of our platform across our clients. During the quarter, we crossed a significant user milestone with more than 1 million unique users logging on during a single month. Clients are taking advantage of the ability to automate manual processes while at the same time using many of our newest features to create a more dynamic and engaging HR experience for all of their employees. Our newest modules, compensation and surveys, were made available to new clients in January. More than 100 clients have already signed up for our compensation module.
Our compensation product allows clients to automate a previously manual process, which included emailing spreadsheets and signing paper approvals, while at the same time improving visibility across the organization. We are also quickly approaching 100 clients on our new survey module. New survey clients are taking advantage of our pulse survey capabilities in an effort to take a quick temperature check of their workforce, while other new clients are building and launching completely customized surveys. Every year-end results in a number of local, state, and federal tax changes, requiring our research and development team to apply numerous changes to our platform. This year included late-breaking changes to federal taxes, and we were very pleased to have those changes tested and implemented by mid-January. Year-end is also a very busy time of year for our operations employees who are focused on delivering a seamless year-end experience to our clients.
Despite having a number of open positions at the end of the first fiscal quarter, we were able to make up ground and enter year-end fully staffed and ready to handle the annual increase in volume of calls and emails from our clients. Client interactions peak every year, starting in December through the end of January, with an increased number of questions relating to year-end payrolls, W-2s, 1095 and annual tax filing forms 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. We continue to believe that focusing on employee satisfaction and engagement allows us to deliver both an industry-leading product and service experience to our clients. Part of our investments in our employees include modernization of our work environment.
Our new headquarters is a significant upgrade, and we have received very positive feedback about the work environment and the amenities from employees who have moved in the first two phases. We plan to complete the next phase of our headquarters move in June 2018, along with a move to a brand-new building in Boise early next fiscal year. At this point, I would now like to pass the call to Toby to provide more details on our financial results and our outlook for the balance of our fiscal year.
Thanks, Steve. Total revenue for the quarter was $86 million, which represents a 25.3% increase from the same period in the prior year. For the second quarter, our total recurring revenue of $83.1 million was up 25.7% from the year ago quarter and represented 97% of our total revenue. Recurring fees were up 24.4% in the quarter, and interest income on client funds was up 143.9% year-over-year as a result of balance increases, increased average interest rates, and because we are currently investing approximately $100 million of client funds in high-quality marketable securities. Implementation services and other revenue was $2.9 million for the second quarter, up 13.7% from the year ago quarter. Our adjusted recurring gross profit on recurring revenues was $61.5 million, or 74% in the second quarter, up from $47.9 million or 72.5% in the year ago quarter, which is a 150 basis point improvement.
Adjusted gross profit in the second quarter was $53.6 million, representing a gross profit margin of 62.3%, as compared to $41.2 million or 60% in the year-ago quarter, which is a 230-basis point improvement. The improvements we saw in adjusted recurring and adjusted total margin are primarily a result of the natural scale in our business and the increasing penetration of our HCM products, which carry lower implementation fees. If I turn to our operating expenses, as Steve mentioned, we have continued to make substantial investments in research and development. In order 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 $11.7 million, or 13.6% of revenue in the second quarter, compared to $9.7 million, or 14.2% of revenue in the year-ago quarter.
On a dollar basis, our year-over-year investment in total R&D increased by 20.3%. On a non-GAAP basis, sales and marketing expense was $19.4 million, or 22.5% of revenue in the second quarter, compared to $16 million or 23.4% in the same period last year. On a non-GAAP basis, G&A costs were $13.9 million or 16.2% of revenue in the second quarter, compared to $11.4 million or 16.7% of revenue in the year-ago quarter, which is a 50-basis point improvement, and we continue to be pleased with our ability to consistently leverage our G&A expense. On income and loss, our adjusted EBITDA was $15.2 million, or 17.7% of revenue for the quarter versus $9.9 million or 14.4% of revenue for the year-ago quarter, which is a 330-basis point improvement. On a dollar basis, adjusted EBITDA increased by 54.5% over the second quarter of last fiscal year.
Non-GAAP net income was $9 million or $0.16 per share for the quarter versus $5.4 million or $0.10 per share in the year-ago quarter. Briefly covering our GAAP results. For the quarter, gross profit was $49.2 million, operating income was $0.1 million, and net income was $0.4 million. As discussed on our first quarter earnings call, we continue to assess the factors relating to maintaining or releasing our valuation allowance. Given that we continue to demonstrate GAAP profitability, including net income in both the first and second quarters of this fiscal year, it is reasonably possible that some or all of the valuation allowance may be released in either the third or fourth quarter of this fiscal year. A release of our valuation allowance would result in a one-time non-cash benefit to net income, which is not included in the financial guidance provided today.
With respect to taxes more broadly, Paylocity is not a payer of corporate federal income tax today. That said, we continue to review the potential impacts of the new tax legislation on our business as we may become a payer of corporate federal income tax in future periods. In regards to estimated effective tax rate on a go-forward basis, we expect to provide additional details in future earnings calls. With respect to the balance sheet, we ended the quarter with cash and cash equivalents of $111 million as compared to $82.3 million as of the end of the second quarter of fiscal 2017, an increase of $28.7 million or 34.9%. From a cash flow perspective, we generated $26 million in cash from operating activities in the second quarter of fiscal 2018, as compared to $13.5 million for the prior year second quarter, an increase of $12.5 million or 92.6%.
Finally, I'd like to provide our financial guidance for the third quarter and updated guidance for fiscal 2018. For the third quarter, total revenue is expected to be in the range of $110 million-$111 million, or approximately 22%-23% greater than the prior year. Adjusted EBITDA is expected to be in the range of $32.3 million-$33.3 million. Non-GAAP net income is expected to be in the range of $25 million-$26 million or $0.45-$0.47 per share based on approximately 55 million diluted weighted average common shares outstanding. For full fiscal year 2018, total revenue is expected to be in the range of $369 million-$371 million, or approximately 23% greater than the prior year.
Adjusted EBITDA is expected to be in the range of $76 million-$77 million, or approximately 20.7% of revenue at the midpoint, an increase of 200 basis points from fiscal 2017. Non-GAAP net income is expected to be in the range of $48 million-$49 million or $0.87-$0.89 per share based on approximately 55 million diluted weighted average common shares outstanding. Operator, we're now ready to begin the Q&A session. Thank you.
Thank you, sir. Ladies and gentlemen, at this time, if you would like to ask a question over the phone lines, please press star and then one on your telephone keypad. If your questions have been answered or you wish to remove yourself from the queue, simply press the pound key. Once again, ladies and gentlemen, to ask a question, press star, then one. Our first question will come from the line of Justin Furby with William Blair. Your line is now open.
Hey, guys, this is actually Vinay on for Justin. Steve, had a quick question for you. Just on the demand environment and pipeline, is there anything that you'd want to call out that you're seeing in this calendar quarter? If you could provide any commentary on productivity in the sales force, that'll be helpful. Thanks. I will follow up for Toby.
Sure. Yeah, I think, as I said in the prepared comments, we were pretty pleased to be able to increase guidance a little bit and continue to gain momentum. It's a pretty important time of year. We get a lot of new starts in January. We had a successful selling season. Certainly would always love to see more productivity as possible, but I think we were pretty happy with being able to give a slight increase to guidance and be able to hit our numbers for the quarter.
Got it. Thanks. Toby, if you could provide any additional commentary on the cash flow performance. I know some of the leverage went through, but is there anything else to call out there?
I wouldn't say so. I think most of what you're seeing there is just from a result from operations. I think there's a little bit of noise from tenant improvement allowance in the quarter, but I think that's the only thing that I'd call out there. Nothing else.
Got it. Thanks.
Thank you. Our next question will come from the line of Scott Berg with Needham. Your line is now open.
Hi, Steve and Toby. Congrats on a good quarter, and thanks for taking questions. Quick piggyback, Toby, on the last question there on cash flows. Is there any reason not to see the improvement that you saw in the first half of the year carry forward into the second half of the year? Just because the growth was so big in the first half.
Yeah, we're guiding towards not the same type of leverage on the back half of the year from an EBITDA perspective. I think you're not going to see that same type of % increase just because a lot of that EBITDA translates into cash flow.
Yeah.
That's probably the one thing I would mention. Anything else?
No, I agree with that. Yep.
Got it. Steve, I wanted you to see if you can quantify your comments on sales and marketing investments here in the back half of this year and next year. Is that more driven in a particular area or product? Maybe it's more inside sales to drive some upsells a little bit more efficiently. Just wanted to see maybe if we can get some color there.
Sure. I think anytime that we have a really strong front half of the year from an adjusted EBITDA perspective, we look at investment opportunities on the back half. I think that's kind of normal cadence for us. We typically will target those investment opportunities in terms of hiring people for the sales force, getting them on as early as we possibly can. We won't finalize what our headcount is until we're going into the year, but we certainly can get a good start on that. I would say some of it's people-oriented in terms of headcount, and I think the second thing, our marketing opportunities, where we think we can maybe have an impact from a lead gen perspective that will ultimately translate through the sales funnel to increase sales. It's all about getting a ramp going into fiscal 2019.
Got it. That's all I have at the moment. Thanks for taking the questions.
Thank you. Our next questions will come from the line of Nandan Amladi with Deutsche Bank. Your line is now open.
Hi, great turn out. Thanks for taking my question. Steve, you touched on this a little bit, but, this is about the time of year you begin to hire a new sales headcount in preparation for next fiscal year. Do you feel like you're on track, and will the team growth be relatively consistent with historical trends?
Yeah. I think our process is as we get through year-end and we start the planning process really more in the spring timeframe for next fiscal year, we start to try to look at what's the number of headcount we think we need to be able to hit our revenue targets for next year. As I just mentioned earlier, we certainly like to be in a position where we give our sales team the go-ahead to start that recruiting process earlier than we've come to target. I don't think we have the right target. We increased headcount last year about 25%. We're certainly focused on continuing to go after our long-term model of 20% plus growth. I think when we put all that into the hopper, we'll come up with the right number.
I think the important point is, stronger performance from an EBITDA perspective on the front half of the year gives us the ability to start that process right now. There's no question we've historically seen, the earlier we get these people on board, the faster we get through that ramp-up period, and the bigger impact they can have next fiscal.
All right. A follow-up on the seasonality. Is there anything unusual about this upcoming March quarter? Because you said you staffed up ahead of the inbound call traffic that you were expecting. The average customer size was a little bit smaller, but you have more product to sell them. The ACA stuff is probably anniversaried now, so we shouldn't see anything. Any other one-time factors we should keep in mind?
No, just the normal seasonality where we have a little boost to the revenue in terms of W-2 revenue. That's obviously all been factored in, and doesn't have any impact on a year-over-year basis. There would be no real other call-out besides that.
Okay, great. Thank you.
Thank you. Our next question will come from the line of Siti Panigrahi with Wells Fargo. Your line is now open.
Yeah, thanks for taking my question. Just piggyback on that last question on the acquisition. You usually see in January where most of your majority of a customer that switch platform, and you talked about average customer size, client size was smaller. Could you give some color in terms of comparison that to last year, last few years? The other thing is, ADP talked about getting good traction of their Workforce Now product this quarter. Are you seeing any kind of impact from that in this quarter?
Yeah. I would say, in the prepared remarks, I highlighted the fact that six months into the year, we feel like client growth is in the same range that it was last year at this time. We feel really good about that as we scale the sales force. Being able to bring on clients is a very important part of our growth formula. I think the second part of the comment was, we are seeing good penetration rates of our new products, and that is driving a higher average per employee per year attach rates for those new customers. That's positive. I think that's just slightly offset when you look at the client size. We're just seeing more demand in our core marketplace. Our average size customer is around 120 employees.
If you remember, probably a year and a half ago, we talked about 50% of our clients being less than 50. That's where most of the customers are. We're having traction there, but on the flip side, sometimes that has a little bit of an impact to that average revenue per customer, with the size being a little bit smaller. For us, really hitting those unit numbers is positive.
On the expense management and recruiting, that's now more than a year old. Just wondering, what's the penetration of those modules within your install base right now? You usually talk about 10%, 20%.
Sure.
It would take one or two years.
Yeah. I'd say, just to give you a little bit of color on that, we feel good about both those modules. I think recruiting's probably a little bit ahead from a pace perspective, and is getting into that target range of 10%-20% within a couple of years. I think expense management is on the right track. It's probably just a little bit behind where recruiting is, but both, really good reception on both of them. Also importantly, really good feedback from the customers that are using the platform. We've got dedicated agile teams that continue to enhance those products. We also feel like there's opportunities for us to increase those penetration rates over time.
Perfect. Thank you. I appreciate the call.
Thank you. Our next question will come from the line of Terry Tillman with SunTrust Robinson. Your line is now open.
Hey, Steve and Toby. Congrats on the quarter as well from me. Steve, just the first question. It's a little bit related to, in your prepared remarks around maybe with the new units, a little bit more leverage to less than 50 employees. I guess what I'm curious about is, because you did call it out, it must have been a little bit of a shift. I'm curious, was that just related to your channel and your partners, that maybe they were more exposed to 50 employees and below, or was it more on the direct side? Do you actually think that that could stay consistent like that, or do you think that could actually just swing around a lot?
Yeah, I think the positive side of the equation is broker referrals were once again above 25%. That was pretty consistent. I think we've said in the past, they do tend to refer a slightly smaller customer than our direct channel. I wouldn't say they're a driver because it's been pretty consistent. What we're seeing is the demand in this sub 100 employee marketplace for the broader platform does seem to be growing. We're pretty happy with the fact that customers are looking for something that goes beyond payroll and are really spending time evaluating the HCM modules. I think on the flip side, there's an opportunity for us to continue to execute at the top end of our target market so that we don't have the same type of average client decline. That's something that we're going to focus on going forward.
I'm very happy to see the unit growth be similar to last year, and I'm really happy with the penetration rates on the products.
Okay. That's good to hear. I guess my second and last question is just, as it relates to the actual hiring environment for salespeople, also, how tough is it? I mean, there's a war for talent. How tough is it?
In terms of hiring now versus maybe the last couple of seasons.
Yeah
in terms of your hiring. Secondly, as it relates to the people that actually have to help deploy the software, is there any kind of governing factor on your growth in terms of.
Sure
Are you able to keep finding a lot of people to help make these deployments successful? Thank you.
Yeah, it's a fair question. I think if you go back three or four years ago, really, our gating factor on growth was really implementation resources and finding those people, getting them trained internally, and getting them up and running. I think now that you see our growth kind of in this 20% plus range, the gating factor is definitely more on the sales side in terms of bringing on the people, getting them productive. We've been able to bring on a number of implementation resources across the product platform and do that very successfully. In addition to, as we grow, we're able to grow that talent from within. I think that's not necessarily an area of concern for us.
All right, thanks.
Thank you. Our next question will come from the line of Corey Greendale with First Analysis. Your line is now open.
Thanks. This is Ken Wang on for Corey. Thanks for taking my question. Just wondering if you can speak to whether revenue growth, the split between new customers and upsell, has changed during the quarter. Do you have any expectation for any change for the remainder of fiscal year 2018?
Sure. Certainly don't know what's going to happen the rest of the year. We incent our sales force to go and get annualized new revenue. From a first six months of the year perspective, unit growth is very similar to last year. We are seeing higher product penetration rates, so that ARPU number is positive, but it is offset a little bit with slightly smaller client sizes. We definitely are focused on that. We like the fact that there's receptivity down market. That's where most of the customers are, but we still think we have an opportunity to execute at the top end of our target market, and so we think that remains an opportunity for us to make some improvement. Overall, in terms of looking at the mix between units and products, if you take out this client size slight difference, it's pretty similar.
Okay, thanks. Just on the compensation management and survey modules, I know it's still very early, but have you seen any change in your client conversations as a result of releasing these modules?
No. What I would say to you is thematically, as we've released more capability and more capability for the managers and the employees to be using, a lot of these conversations do move away simply from automating manual processes. They get to conversations that are more about engagement, employee interactions, employee engagement. Things like surveys and the ability to be able to take temperature checks of the employee base, gather feedback, analyze the data, are really becoming pretty important elements of that conversation. We just have another feature that's been growing pretty quickly in terms of the ability to journal conversations and do performance management on an ongoing basis instead of waiting till annually. I would say just thematically, those conversations become a little less transactional and much more about engaging with your employees and driving recruitment efforts and retention efforts in the employee base.
Got it. Thank you.
Thank you. Our next question will come from the line of Brian Peterson with Raymond James. Your line is now open.
Hi, gentlemen. Thanks for taking the question. I wanted to hit a bit on the bookings dynamic and some of the customer things that you've mentioned and how that may impact revenue. If your mix is shifting more towards clients that are smaller, does that actually mean that you recognize revenue or the implementations for those clients are quicker? Is that maybe offset because you could be having more modules with those clients? How should we be thinking about that?
I think Steve's point on the modules, he's kind of hit that, but I wouldn't see any material impact in terms of recognizing the revenue faster. We're not seeing enough of a shift that would say the implementation times are being changed in any material way.
Got it. Just one question on sales productivity, and I know you guys managed to kind of revenue dollar bookings, but if you think about potential productivity improvements for your sales force, do you think there's a bigger opportunity from potentially just selling more clients? Is there a bigger opportunity to expand the per employee per month? Thanks, guys.
Yeah, we're obviously always trying to focus on making improvements across the board. I would say the receptivity down market certainly gives us some optimism that we can continue to drive unit growth. On the flip side, the additional products that we're releasing, as those products continue to strengthen, we think that also helps us up market a little bit. I would tell you, I think from a longer-term perspective, we're going to focus on both of those areas and would be very happy if we can drive improvements in both categories.
Great. Thank you.
Thank you. Our next question will come from the line of Brad Reback with Stifel. Your line is now open.
Great. Thanks very much. Steve, as you think about the increased sales and marketing spend that you mentioned, without getting too specific on numbers, as you look into 2019, do you think revenue grows faster than sales and marketing, or does sales and marketing grow faster than revenue?
We're not there yet in terms of where our planning process is. At this point in time, we're just focused on taking advantage of the strong first half performance on adjusted EBITDA and making those investments as early as possible. We've obviously forecasted that into the guidance that we've given as well. You can kind of get a sense of order of magnitude in terms of what that look like. We're just talking about investing a little bit earlier, probably has more of an impact on the fourth quarter than it does on the third. We'll see what we think going into next year, but I'm just not in a position yet to give you any color on next year's sales and marketing spend.
Great. If I may, just one more question on this smaller customer size. Does that have anything to do with competition a little further up market, or was it just where the pipeline fell out this quarter?
I wouldn't say this is a long-term trend. We saw this in the first half of the year. I thought it was important just to call out, because when we get to the end of the year and we look at ARPU, we're going to have to dissect between average customer size and product penetration for the first time. We still got six months here on the back half of the year, so we'll see if that trend does continue. I don't think at this point in time, we believe it's competitive market driven. It's probably just our own execution and where most of the businesses are and most of the opportunity is in front of us.
Great. Thanks very much.
Thank you. Our next question will come from the line of Ross MacMillan with RBC Capital Markets. Your line is now open.
Thanks a lot, Ross. Sorry, Steve, just to beat the dead horse here, just curious on the slightly skewed towards smaller in the first half. Is that consistent with your marketing program? When I think about lead gen, that ultimately all your sales folks are taking their lead from, is that also skewing down market, or was that less skewed and it just so happened that your sales folks ended up closing more business in these smaller average customers?
Yeah. What I would say to you is, I think if you look at the 600,000 businesses in our target market of 20 to 1,000 employees, you're going to have a natural skew in the sub 100, and there's even more in the sub 50 and so on. I think you just get a lot of businesses down at the lower end of our market. As we continue to grow the sales force and grow our lead gen channel, there's some logic to the fact that you're going to get more lead activity at the lower end of that space. From our perspective, this probably wasn't necessarily a targeted approach. It's probably a function of us growing the organization and staying focused on the same target market we have been historically focused on more than any type of difference in lead gen activity.
You've talked a lot historically about your dollar quotas based on just dollars. They're not dissected between units of customers or employees per customer, nor number of modules per customer. It's just a quota. From that regard in the quarter, when you think about your plan, I'm sorry if I missed this earlier, were you at target in terms of that hitting your bookings plan?
Yeah, I don't think we get into the specifics around booking. Obviously, we felt like the quarter was strong enough that we were able to raise the year slightly from a guidance perspective, the biggest variable for us on beating or hitting our guidance is driven by the sales organization. That certainly will give you a flavor on performance. I think to your point, we still think this is a huge opportunity in front of us. We got an opportunity to continue to grow units aggressively, and we also believe with the investments we're making in R&D and the penetration rates that we're seeing, that we have an opportunity to grow product penetration, ultimately, we think we have a really strong value proposition across our target market from 20 employees all the way to 1,000.
Great. Thanks so much. Congrats.
Thank you. Our next questions will come from the line of Pat Walravens with JMP Securities. Your line is now open.
Great. Thank you. Hey, Steve. Competitively, if you look at sort of the traditional service bureaus, the Ceridian, ADP, Paychex, are any of them getting a little bit better?
It's always been a competitive market. It certainly is a competitive market today. I think everybody in this marketplace understands that this is a software sale that's largely occurring. There's clearly a service component, but this is the platform in terms of where the evaluation is made. Everybody's investing in the platform. What I would tell you is I feel really good about our pace of innovation. Not only the modules that we're adding, but the features that we're adding. Although many of our competitors are making improvements, we do feel like for our target market, we are very well-positioned and able to win. I think part of the answer is yes, everyone gets better over time. You have to be able to compete. It's probably more important to look at your pace of innovation relative to others.
We feel good about that part.
Great. Thank you.
Thank you. Our next question will come from the line of Shankar Selvarajan with Bank of America. Your line is now open.
Hi. Thanks for taking the question. Congrats on the quarter. I have a question on the 500, 1,000 employee and above. Last quarter, you talked about the increased interest from that customer segment at the end of your annual event. Can you talk about the conversations you're having with those clients, and what are they interested in? When do you expect that part of the market to drive your unit growth?
Yeah, I don't think, or I didn't intend to communicate that we have a focus on 1,000 plus employees. I think when asked the question, I said over time, as we continue to invest in the product portfolio, it's possible that we can become a little bit more appealing to those clients that are larger. I think that's absolutely the case, but our clear focus is to be a dominant player in that mid-market. We do have clients over 1,000 employees, and oftentimes they go through an evaluation process, and they find that what we have is a great fit for them, and we can be competitive in those situations. We definitely win business there. It's just not necessarily our primary focus. We're definitely focused on the 20 to 1,000 space. When it works over 1,000, we absolutely will bring those customers on.
I think that's how we look at the opportunity.
Got it. Another question on the PEPM. I think last quarter, you mentioned your PEPM opportunity is 320. Now, given the investment you're making in R&D, which is growing pretty rapidly, how should we think about the growth in PEPM? Do you see FY 2019 see an exponential upside in terms of PEPM opportunity, or it's going to be a steady growth?
Yeah. I think I would look at our history of growth. Over four years, we've gone from $200 per employee per year to $320 per employee per year. That's probably the best way to look at it. A lot of the increased investment in R&D goes to a variety of things, and that's making the feature set stronger. We don't just build a product and then we're done. We talked about recruiting and expense. We have teams dedicated to making those products better based off our client feedback over time. I would look at our history in terms of our PEPY increase is probably the best predictor of what we're doing going forward.
Okay. Thank you. That's all I have.
Thank you. Our next question will come from Mark Marcon with Robert W. Baird. Your line is now open.
Good afternoon. Let me add my congratulations, and thanks for taking the questions. With regards to the PEPY, can you talk a little bit about what you're seeing on the down market in terms of the change in behavior, in terms of how many modules they typically are becoming interested in?
Sure
The world's getting more complicated.
Yep
more diverse needs.
Yeah. I would say if I were to call out a category where we're seeing increased level of interest in maybe slightly smaller clients would be the talent category for us. Whether that's our recruiting product, our onboarding product, we're definitely seeing what we think is higher levels of interest in those products. Compensation and surveys is still relatively new, but pretty good early traction early on. I think as the economy continues to grow, the war for talent gets a little bit more challenging. We see our customers wanting to make sure they have the most modern platform to really engage with their employees, in a way that makes them competitive.
Great. With those smaller clients, what sort of increase are you actually seeing in terms of the PEPY that, if there's a way to dimensionalize it in terms of relative to, not necessarily last year, but a few years ago, just thinking broadly.
Yeah. I would say, hard to give you numbers around that. At the end of this year, we'll give you the number of clients that we have. You'll be able to look at what our overall penetration rates look like in terms of per employee per year, because we'll give you an average size customer. I think the point I was trying to make on this call was, you know what our revenue growth is. Units are pretty similar to last year. It kind of gives you a sense of how we're doing from an ARPU perspective.
Okay. This is also a time of the year when clients turn over.
Yeah.
Just wondering, can you talk a little bit about client satisfaction, retention rates?
Sure.
I know that at the end of the year, we'll get the full color, sounds like things have been getting better.
I would say our operations team did a fantastic job this year end, managing the increased volume. As I mentioned in the prepared remarks, going in staffed is always very important. We were able to get W-2s to customers' hands efficiently, manage the tax law changes, produce 1095s, and handle all the extra questions that we get at this time of year. Yeah, we've had very consistent performance from a revenue retention above 92%, and we definitely had above 92% again this quarter when you look at the trailing 12 months.
Great. A quick question for Toby. Can you talk a little bit about the client fund balances and just how that structure is going, and what you would expect over the next 12 months in terms of the balance growth?
Sure. The average daily balance was around the $875 million mark in Q2. I think we saw boost there, benefit from the balance increases, increased average interest rates, and because we're investing a portion of the client funds in, as I said in the prepared remarks, the high-quality marketable securities. I think everybody understands the interest rate environment that we're in. Guidance doesn't reflect that, but to the extent that there is further rate increases, we would certainly get the benefit of that. I think it's a little bit hard to map it exactly just because I think as Steve has said before, we don't always get the benefit immediately upon a rate increase, but that's generally how we think about it.
Do you think the balances will end up growing commensurate with revenue, just in terms of the unit growth?
I mean, you'd look at unit growth rather than revenue growth as being a better predictor.
Yeah. Sure.
Remember, the federal tax law change will lower balances from a federal perspective a little, then you got to look at what all the states are doing. I think that has a slight impact. You would think it'd be slightly less than unit growth if all else held the same.
Yeah.
Great. Thank you.
Thank you. Our next question will come from the line of Abhey Lamba with Mizuho. Your line is now open.
Yes, thanks. This is Parthivan Prabhai. Just a follow-up to a prior question. On the productivity ramp for new hires maybe that have come on board in the past six to nine months, is that ramp generally in line with the expectations in your internal plan?
Yeah. I would tell you that's always the key variable that we're focused on. We bring on a fair number of reps. Last year, 25% more reps, and we've been around that number, even a little higher at times in the last four years. We're always focused on improving productivity. I think we feel like we've got the right training and development program in place, but the reality is the earlier you get them on, the better it is. Going into the back half of the year, we really like the opportunity to bring on as many hires as possible. We think we've got a proven track record of ramping people. It is something that we're constantly focused on improving in, because that can really impact the following fiscal year if we can move that needle at all.
Okay, got it. On the topic of non-payroll attach rates, you just talked about the revenue retention rate in the 92% range. That's on a gross basis, I believe. Can you talk to maybe what that metric looks like on a net basis once you bake in upsells and expansion activity?
Yeah, sure. We do focus on and disclose the calculation specifically, so you can go look at that, but it is more of a gross basis. We still tell you that we don't do a ton of upsell. I'll go back to comments I made prior. We have a small team who's focused on upselling back to the client base, and there are times that our sales reps will actually upsell back to the client base as well. Most of that average revenue per customer increase is coming from selling more product to new customers. We do think there's an opportunity to continue to gradually increase that. That is something that we will do. We did this past fiscal year. We'll look at that again going into next year. That's more of a gradual process than some sort of big change.
I think the consistency of our revenue retention, the consistency in terms of the way we calculate it, we feel really good about being in mid-market and having greater than 92% revenue retention for really as long as we've been measuring it.
Okay, perfect. Thanks for taking the question.
Thank you. There are no further questions in the queue. Now it's my pleasure to hand the conference back over to Mr. Steve Beauchamp, Chief Executive Officer, for some closing comments and remarks.
Well, I just wanted to take a brief moment to thank everybody for logging on and all of their interest in Paylocity, and to give one last thanks to all of our employees whose dedication and hard work made us have a really positive experience for our clients through year-end. Thanks, everybody.
Ladies and gentlemen, thank you for your participation on today's conference. This does conclude our program and we may all disconnect.