Operator
please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce you to your host, Rachel White, Vice President of Investor Relations. Thank you, Rachel. You may begin.
Rachel White
Good afternoon and welcome to PACOR's earnings call for the fourth quarter and fiscal year 2024, which ended on June 30th. On the call with me today are Raul Villar, Jr., PACOR's Chief Executive Officer, and Adam Ante, PACOR's Chief Financial Officer. Our financial results can be found in our press release issued today, which is available on the investor relations section of our site. Today's call is being reported and a replay will be available on our website following the conclusion of the call. Statements made in this call include forward-looking statements related to our financial results, products, customer demand, operations, and other matters. These statements are subject to risks, uncertainties, and assumptions and are based on management's current expectations as of today and may not be updated in the future. Therefore, these statements should not be relied upon as representing our views as of any subsequent date. We also will refer to certain non-GAAP financial measures and key business metrics to provide additional information to investors. Definitions of non-GAAP measures and key business metrics and a reconciliation of non-GAAP to GAAP measures are provided in our press release on our website. With that, I'll turn the call over to Raul.
Raul
Thank you, Rachel, and thank you all for joining us to discuss PACOR's fourth quarter and full year results. Our unique value proposition of empowering leaders to drive people and business performance continues to win in the market and help drive revenue growth of 18% for the quarter. For the fiscal year, our team executed against our strategic growth initiatives. increasing the average number of employees on our platform by 9% and expanding the amount we earn per employee per month, or PEPM, by 6%, resulting in 19% revenue growth. We delivered significant adjusted operating income and free cash flow margin expansion this fiscal year while strategically investing in our platform and customer experience. Demand remains healthy as most employers are struggling with antiquated and incomplete HCM tools. Top of funnel metrics, including leads and first-time sales appointments, increased significantly year over year, and our win rates remained elevated as our value proposition resonates in the market. We continue to focus marketing investments and sales hiring on in the 50 largest cities in America, where we see the most opportunity. Our sales team grew 9% this year to 600 sales professionals, which increased our sales coverage in the 50 largest US cities from 52% to 55%. Average tenure, which drives seller productivity, increased 20% among our field sellers. A core component of our go-to-market strategy is developing and maintaining partnerships with key centers of influence. Benefit brokers help us identify employers that are dissatisfied with their legacy HCM tools and influence nearly half of our field bookings this year. Our mid-market product, client experience, and sales investments over the last few years continued to pay off as our average customer size and average deal size expanded for the third consecutive year. Since the IPO, the average size of our new mid-market customers increased 30%, helping to grow our average deal size by 55%. We are efficiently extending our distribution via the indirect embedded channel we announced earlier this fiscal year. Our strategic partners enhance their revenue per client and customer retention by offering a modern embedded HCM solution to their clients and prospects. In this past quarter, we continued converting our third partner's portfolio and the three new partners we announced last quarter began selling. We also signed several new partners this quarter, tripling our indirect partners over the last year. Our team also continued expanding our award-winning HCM platform with valuable new capabilities for our customers. Our product investment remains focused on deepening our core platform, further enriching our talent solution and enhancing the connectivity of our platform. This year, we released technology that empowers leaders such as pay benchmarking, pay core paths, and labor forecasting, and increased the value of our suite by $8 to $53. Within our core platform, we recently launched a new compensation management solution that streamlines budgeting and pay cycles and adds another $2 to our suite. Our collaborative tools foster alignment across teams, helping leaders ensure equitable and competitive compensation within budget while driving employee engagement. Revenue from our robust talent suite increased nearly 40% again this fiscal year. validating our unique value proposition of empowering leaders to coach, optimize, and retain top talent to drive business results. Using our unrivaled talent tools, frontline leaders are improving employee engagement, which is increasing employee retention by 10% and helping drive better business outcomes. We also significantly advanced our interoperability strategy this year. According to Finch, half of HR professionals leverage seven or more employment systems, and most of these applications are not integrated, leading to errors and inefficiencies. API use on our platform increased approximately 300% this fiscal year, demonstrating growing demand to extend HCM software to other business applications. We provide customers unrivaled flexibility to seamlessly connect their data and systems, enabling leaders to automate time-consuming, error-prone manual tasks. We have 300-plus pre-built integrations in our marketplace and made it easier to create custom integrations by increasing the number of API endpoints and our developer portal by more than 40% this fiscal year. The innovative developments we've made in our HCM platform continue to garner industry recognition. In May, PACOR won five Titan Business Awards spanning HR, analytics, workforce management, and talent. These tools empower leaders to connect and automate their back office. freeing them up to focus on what matters, building winning teams and driving business results. As we entered fiscal 25, we reflected on our strategy execution progress since the IPO. Over the last three years, we have grown revenue by over 85%, increased and adjusted operating income by over 130%, and generated nearly $50 million more in free cash flow, while expanding our sales capacity by greater than 60% and advancing our industry-leading HCM platform, growing our list pepum by more than 50%. We have made tremendous progress, and the opportunity before us is significant. On our path to $1 billion in revenue, we remain confident in our ability to deliver attractive growth while accelerating margin expansion. We believe there is a long runway to drive durable growth given the size of our market opportunity and the ongoing success we have had displacing legacy solutions, which represents 75% of our bookings. Our go-to-market motion has strong momentum as we are staffed to deliver our fiscal 25 targets and encouraged by how sales tenure and retention are trending. We have significant room to drive leverage as we scale, and our top priorities are to drive sales efficiency and accelerate cash conversion. As such, we are introducing a new long-term adjusted free cash flow margin target of greater than 20%. We will do that while continuing to invest in our strategic growth initiatives, namely adding employees through sales expansion and increasing PEPM through product innovation. This progress wouldn't have been made possible without the efforts of our dedicated associates. I'd like to thank the team for their hard work and support in delivering these strong results. Now I'll turn the call over to Adam to discuss our financial results and guidance.
Adam
Thanks, Raul. I'll discuss our fourth quarter and full year financial performance and then share our outlook for the first quarter and next fiscal year. As a reminder, my comments related to the financial measures are on a non-GAAP basis. We had another solid quarter, delivering total revenues of $165 million, an increase of 18% year-over-year. Recurring revenue grew 17% over the prior year. For the fiscal year, total revenues were $655 million, increasing 19% year-over-year. Our recurring revenue growth is primarily driven by expanding the number of employees on our platform and the amount we charge per employee per month. This quarter, employees grew 8% over the prior year, driven by new business wins with a modest contribution from labor market growth. Net revenue retention was 98% this year, in line with our expectations as the labor market growth moderated. In a typical macro environment, labor market growth contributes a point or two of our revenue growth. While the U.S. labor market growth moderated over the last 24 months from historical highs of three to four points of revenue contribution, now closer to zero, it has remained slightly positive. We finished this quarter with approximately 30,500 customers, utilizing our platform to help coach, optimize, and retain nearly 2.7 million employees. We continue to see our average customer size and average deal size increase as we continue to move up market, demonstrating the success of our product and service investments. Similar to last year, mid-market customers represented 80% of our portfolio, with enterprise contributing 15% and a micro-segment of under 10 employees contributing just 5% of revenue. Effective PEPM increased 8% year-over-year to nearly $19 this quarter. Excluding embedded HCM deals, Effective PEPM increased 10%, fueled by expansion of our product suite. The growth and effect of PEPM is attributable to cross-sales, pricing initiatives, and higher bundle attach rates, and Talent has consistently demonstrated strong attach rates and cross-selling traction. Our embedded HCM channel continued to ramp and contributed two points of employee growth again this quarter. We have increasing demand from partners, and our pipeline grew sequentially for the fourth consecutive quarter. Although we are pleased with the progress and expect to at least double our embedded revenue in fiscal 25, it will take some time before it materially impacts our revenue. We continue to invest to scale and capitalize on this opportunity by expanding our capacity, our offering, and sales enablement tools to drive mutual success. This quarter, we generated $14 million of interest income on average client funds of approximately $1.2 billion, an effective rate of 490 basis points. In addition to achieving consistent top-line growth, we have continuously expanded operating margins on an annual basis. Adjusted gross profit margin excluding depreciation and amortization was 79% for the quarter and year. This quarter, it decreased by 40 basis points over the prior year due to macro headwinds, however, expanded by 40 basis points for the full year. This quarter, sales and marketing expense was $51 million, or 31% of revenue, down nearly 300 basis points from a year ago, largely driven by more moderated sales headcount growth and our focus on efficiency and scale. For the year, sales and marketing expense was $198 million, or 30.2% of revenue, an improvement of 160 basis points year over year. On a gross basis, we invested $25 million, or 15% of revenue, in R&D this quarter to continue differentiating our HCM suite and expanding our PEPM opportunity. We also invested 15% of revenue in R&D for the year, similar to prior years and in line with our long-term targets. As we scale the business, we have consistently driven leverage in G&A. G&A expense was $20 million or 12.1% of revenue this quarter, an improvement of 280 basis points from last year. On the full year, we achieved 150 basis points of leverage from G&A. Quarterly adjusted operating income increased over 60% to $25 million with margins of 15.2%, up 420 basis points from 11% last year. For the full year, adjusted operating income rose 36% to $112 million, up 215 basis points while differentiating our service and solution. During the quarter, we generated $37 million of adjusted free cash flow at 23% margin, up nearly 9 points. For the full year, we generated $40 million, or 6% margin, an improvement of 430 basis points. Free cash flow margins expanded at twice the rate of adjusted operating income margins as we scale the business and continue to focus on efficiency. We ended the year with $118 million in cash and no debt. In addition, our stock-based compensation expense decreased year-over-year to less than 10% of revenue with less than 1% share dilution. Entering fiscal 25, our top priorities are to drive sales efficiency and accelerate cash conversion. While growth remains our top priority, we believe a more balanced approach to profitability will maximize shareholder value. As Raul mentioned, we are introducing a new long-term adjusted free cash flow margin target of greater than 20%. We plan to achieve this by balancing sales headcount growth with sales productivity to improve go-to-market efficiency and continuing to drive leverage in G&A as we scale. Similar to the dynamics this year, we expect adjusted free cash flow margins to continue expanding at roughly twice the pace of adjusted operating income margins. Our outlook for fiscal 25 remains positive, based on a healthy demand environment and opportunity to drive continued PEPM expansion. However, our guidance does reflect a fluid macro backdrop, including labor market headwinds and a declining rate environment, and of course, some conservatism at this point in the year. For the first quarter, we expect total revenues of between $161 and $163 million, or 14% growth at the high end of the range, which includes $12 million of interest income on average client funds balances of just over $1 billion. And adjusted operating income is expected to be between $17.5 and $18.5 million. For the full year, we expect total revenues of $722 to $729 million, or 11% growth at the top end of the range, including $48 to $50 million of interest income, which contemplates up to 200 basis points of rate cuts over the next fiscal year. And we expect adjusted operating income of $123 to $126 million. On a recurring basis, that implies more than 100 basis points improvement in adjusted operating income margins. In summary, we remain optimistic about our opportunity in HCM. Demand remains healthy for our innovative HCM solution that empowers leaders to unlock the potential of their people and business performance. Our solution is mission critical to attracting, paying, and retaining great talent. We're confident in our strategy and focused on executing a proven go-to-market playbook to deliver greater sales efficiency and free cash flow margins. With that, we'll open the call for questions. Operator?
Operator
Thank you. We will now be conducting a question and answer session. Please limit yourself to one question and one follow-up. If you would like to ask a question, please press SAR1 on your telephone keypad. a confirmation to indicate your line is in the question queue. You may press star two if you would like to remove your question. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions.
Samad
Thank you.
Operator
Our first question comes from the line of Terry Tillman with Truist Securities. Please proceed with your question.
Terry Tillman
Yeah, hey there, Raul, Adam, and Rachel. Hopefully you can hear me okay. I've added a question and a follow-up per instructions. The first question is just on maybe Raul, kind of ending the year, you know, looking for a strong finish in bookings. How did, what's the report card on the enterprise segment, which you've been excited about those thousand plus employee businesses, and then mid-market? What was the bookings like versus your expectations in The second part of that first question is, you know, I heard something about conservatism. Are you assuming kind of, you know, kind of slower kind of close rates or what are you assuming around bookings activity in both of those key segments? And then I had a follow up for Adam.
Raul
Yeah, the bookings. Thanks, Terry. The bookings for the quarter were really consistent and were well positioned to deliver our FY25 guidance. And we feel good about the trajectory here. of the organization.
Terry Tillman
Okay. And then maybe just to follow up, it's interesting in terms of a bunch of comments here on free cash flow progression and acceleration and then that 20% target. Adam, I was hoping maybe we could unpack a little bit more, you know, just any guardrails in terms of duration, the size of the business to get to that target, and is there anything more notable on gna or sales and marketing leverage to get there as well just a little bit more hopefully to unpack on you know when you get to that what that would look like in terms of some of those dynamics thank you yeah hey terry
Adam
Yeah, I mean, no explicit time frame other than, you know, sort of medium to long term as we think about our continued progression. There's not going to be any sort of structural pops that are going to get us to 20%. I think it's going to be, you know, continued expansion. And this year, clearly, it looks like we're on that sort of inflection point. And we think about, you know, continuing to expand and driving faster free cash flow conversion. So I think that trajectory makes sense for us. And in terms of getting there, I think you're going to see it, of course, across the board. There's still opportunity across G&A. Over time, we think that there's some further opportunity across R&D and gross margin. But I think the majority, where we're going to see the real difference is going to come out of the cost of acquisition. So between our implementation and our go-to-market teams, it's really around leveraging that investment. And we're starting to drive some of that efficiency now. So you're seeing some of that show up. But we have probably 8 to 10 plus more points to go over the next couple years that I think will be a big contributor to free cash flow margins.
Operator
Thank you. Our next question comes from the line of the board with Goldman Sachs. Please proceed with your question.
Gabriela
Hi, good afternoon. Thank you. I'll ask Terry's question on the long-term free cash flow margins in a slightly different way. Raul and Adam, we've spoken before about your conviction in KCOR being a 20% plus growth company. Do you aim for being a rule of 40 company when delivering 20% plus free cash and margin, meaning how do you think about the long-term normalized profile of revenue growth given some of the changes in the sales and marketing and some of the newer options like embedded finance that you've talked about in the last couple of quarters?
Adam
Yeah. Hey, Gabriela. Yeah, we feel still really good about the opportunity. I mean, the market, it continues to be huge. We see a huge opportunity. We're well positioned in the product. We see some sluggishness right now in the macro that is going to make that harder. Clearly didn't achieve the target here in this last year, but we've been actually really consistent and close to the 20% growth over the last couple years on a recurring basis. So it's still our long-term target. And I do think that we think that it requires some labor market growth. It's going to require a little bit stronger macro than where we are. But nothing structurally is in the way from us continuing to grow and achieve that, to your point, sort of the rule of 40 on both the revenue and free cash flow target. So I think we're going to balance that in. We're going to lean into the productivity right now or make sure we're set up from a sales perspective. And we feel good about...
Gabriela
that set up into 25 and as we think about long-term you know we're not coming off of what we see in them in the market opportunity and and again our product is so well positioned right now we feel really good about that all over the long-term that makes sense and I'll ask a follow-up on veneertem it talks us a little bit about how you're feeling about your ability to retain train and enable the salespeople you mentioned that bookings have come in nicely towards the end of the year so Give us a status update on how the churn in the sales growth is trending, and how many sales count ads do you expect, or how much do you expect to grow sales count capacity in fiscal year 25? Thank you.
Raul
Yeah, thanks, Gabriella. I think, you know, in Q4, retention improved, and we feel that the territory redesign was well executed and well received. And, you know, we're looking at our sales capacity, and we feel like we have plenty of capacity to achieve our FY25 targets. And, you know, obviously, to Adam's earlier point, you know, we'll balance in, you know, more sales hiring as the macro gets better. But we feel well positioned today, both from a tenure perspective and a capacity perspective to achieve our targets.
Operator
Thank you. Our next question comes from the line of Seti Pongrahi with Mizuho. Please proceed with your question.
Mizuho
Hi. Thanks for taking my question. Very good execution in this tough market. So, Raul, my question is, I understand the sluggishness you talked about. Maybe that's impacting the new logo acquisition. But what are you seeing in terms of customer and across selling your new products to the customer base? I know you have been expanding the product footprint and recently added even compensation. How should we think about the effective PayPayM growth this year? What's the jumps in your guidance?
Adam
Yeah. Hey, Sidney. I mean, what we saw in Q4 was actually some slight acceleration, which was actually a little bit overweighted from some of the cross-sell opportunities. So we saw a little bit more success here in Q4. And I think as we go forward, we're really expecting to see a little bit bit less pepum growth, a little bit less pepum expansion as we add more in the enterprise space, as we add more in these embedded partners. We're going to see the pepum slow down and really lever into the employee growth. But I think actually in this quarter and maybe in the near term, you might see a little bit more of that balance in the pepum expansion as we've seen some success on the cross-sale side pick up even a little bit further. So we're seeing good attach rates, good success like we called out earlier on the talent, and that progresses or that continues.
Mizuho
Yeah. And then a follow-up to that embedded HCM. I know it's been a few quarters since you launched. So how is the progress so far, and what kind of traction are you seeing among your partner base and even through their customers?
Adam
Yeah, so the traction has been really strong. Since we announced it in Q1, we've seen continued growth in the pipeline each quarter. We've tripled the number of partners that we've added this year. We continue to go through the migration of some of our larger partners as well. And so it's becoming a, you know, it's really gaining traction. It's still a relatively small portion of the overall portfolio, less than half a point of the revenue here in 24. We think we'll double that into 25. But there's a lot more room to grow and continue to, you know, overall meaningfully impact our revenue over the long term. So we're still, you know, really optimistic about this channel and its long-term potential.
Operator
Thank you. Our next question comes from the line of Samad Samana with Jefferies. Please proceed with your question.
Samad Samana
Hi, good evening. Thanks for taking my question. Maybe first, just as a follow-up on the embedded side to Citi's question, on your comment that you expect embedded revenue to double in fiscal 25, and you're kind of, no pun intended, embedding that in your guidance, how should we think about that between you adding additional ISVs that will embed the software versus growth of the existing partners that you've already inked and what you foresee in terms of their ramp, and Can you just remind us how those contracts work? Are there any guaranteed minimums? Just anything that helps us kind of get a view on the visibility that you have there.
Adam
Yeah, hey, Samad. Yeah, we wouldn't include new partnerships that we haven't signed necessarily inside of our guidance. So all of the revenue is really going to be and the expectation is going to be from partners that already exist. And those partners, of course, include their existing portfolios and new business that they're signing. As we think about what's reasonable is what we would include in our guidance going into 2025. In terms of the structure of those deals, there are some that have minimums for sure. We try to balance those in as, depending on sort of the size and the need of the portfolios and how much needs to come over and how much work we need to do to necessitate it. But we do have structures that may include some minimums. Most of it is really based on more of the usage and how much business our partners are adding to the platform, though.
Samad Samana
Understood. And then, Raul, maybe just a question for you. In terms of upmarket success, you guys continue to call that out. It's been increasing in the mix. And I know you've talked about some changes in the sales organization. How should we think about how the sales organization's composition looks today and how well it's going to prepare to attack that larger customer opportunity? And as you think about fiscal 25, Is there a different type of rep that you're aiming to hire, or is there a different type of training program to target those larger, more sophisticated customers?
Raul
Yeah, Samad, thanks. You know, from a training perspective, obviously, we continually enhance our training to meet the different needs of the different segments that we have. So we're continuing to do that. And the way to think about it is a third of our organizations pointed at that you know, 500 plus segment and the two thirds are pointed below. And we think that's a really good optimal mix for us today. And, you know, we're seeing the benefits of our platform really pulling us up market. And now we're pointing, you know, you know, really qualified tenure, you know, our best of the best Navy SEALs type of reps against those opportunities.
Samad
And so we're seeing success there. Thank you.
Operator
Our next question comes from the line of Scott Burge with Needham & Company. Please proceed with your question.
Scott
Hi, everyone. Nice quarter, and thanks for taking my questions here. Raul, I wanted to see if you can help us reconcile your view on the market versus other competitors, both public and private, that talk about maybe a little bit more of a slowing market than you all talked about. You described really healthy sales and pipelines and what you thought was a pretty robust market, but maybe you can help us dissect why your view seems to be at least marginally different than others in the space.
Raul
Yeah, I mean, when we look at the market and our platform and our position in the market, you know, we just look at, you know, the key components of, you know, first appointments, deals that are in process, the velocity of the transactions. And when we look at it, we think, you know what, the market's pretty strong and You know, we finished the year with 16% recurring revenue growth and, you know, without headwinds, we would have been, you know, close to 20%. And so we still feel like it's a big macro market with 75 plus percent, you know, of the opportunity on what we would consider legacy antiquated incomplete solutions. And we have a great product, modern, robust, with some great tools that's really attractive. So for us, it's just about execution and continuing to execute. And we see the market, you know, really strong and robust. And some of it could be, you know, Scott, the size of Paycor compared to others. But outside of that, we think the market is, you know, really big and still in the early innings of transformation.
Scott
Understood, helpful. And then, Adam, in your guidance, you talked about 200 basis points or rate cuts for the year. I view that certainly on the conservative side relative to what we're seeing out there today, which is probably appropriate. But how should we view seat usage at existing customers? You talked about how that went from a nice tailwind to more of a flat metric year over year. But how are you thinking about seat counts in the guidance?
Adam
Yeah, hey, Scott. We intentionally didn't include any incremental labor market growth in our guidance. So we're effectively assuming a flat labor market contribution similar to what we saw in 23. So there might be a slight headwind 23 to 24, but there wasn't much contribution in 23, and we're assuming the same thing here into 24. Excuse me, 24 into 25 now. Thanks, Scott. Thank you.
Operator
Our next question comes from the line of Brian Peterson with Raymond James. Please proceed with your question.