Paylocity Holding Corporation — Form 10-K Summary
Reporting period: Fiscal year ended June 30, 2020. The request references “2019 Q4,” but the supplied filing is the fiscal 2020 annual report and includes quarterly data for the quarter ended June 30, 2020.
Business context
Paylocity provides cloud-based payroll and human capital management software to medium-sized U.S. organizations, generally those with 20 to 1,000 employees. Its unified SaaS platform includes payroll, core HR, workforce management, talent and benefits modules. As of June 30, 2020, Paylocity served approximately 24,450 clients, excluding clients acquired through acquisitions, and had approximately 3,600 employees. The company operates as one reporting segment.
Annual revenue retention exceeded 92% in fiscal years 2018, 2019 and 2020. More than 25% of fiscal 2020 new-client revenue originated from the company’s referral network.
Financial performance
| Metric | Fiscal 2019 | Fiscal 2020 | Change |
|---|---|---|---|
| Total revenue | $467.6 million | $561.3 million | 20% |
| Recurring and other revenue | $447.8 million | $546.2 million | 22% |
| Interest income on client funds | $19.9 million | $15.1 million | (24%) |
| Gross profit | $313.8 million | $379.3 million | 21% |
| Operating income | $56.2 million | $66.2 million | 18% |
| Net income | $53.8 million | $64.5 million | 20% |
| Diluted EPS | $0.97 | $1.15 | 19% |
| Adjusted EBITDA | $134.0 million | $159.8 million | 19% |
Margins: Gross margin improved from 67% to 68%; operating margin was approximately 12% in both years; and net margin was approximately 11.5% in fiscal 2020 versus 11.5% in fiscal 2019. Adjusted EBITDA margin was approximately 28.5% in fiscal 2020 versus 28.7% in fiscal 2019.
Sales and marketing expense increased 29% to $145.1 million, research and development increased 25% to $62.8 million, and general and administrative expense increased 11% to $105.2 million. Fiscal 2020 general and administrative expense included $2.1 million related to settlement of a legal matter and related litigation costs and $1.6 million of lease-exit and acquisition-related costs.
Cash flow, liquidity and debt
- Net cash provided by operating activities was $112.7 million, compared with $115.0 million in fiscal 2019.
- Net cash used in investing activities was $48.8 million, including $25.7 million of capitalized internal-use software costs, $16.6 million of property and equipment purchases and $16.7 million for the acquisition of VidGrid.
- Cash and cash equivalents totaled $250.9 million at June 30, 2020, compared with $132.5 million at June 30, 2019.
- Corporate investments totaled $34.6 million on the balance sheet; management reported total corporate investments of approximately $37.2 million for liquidity purposes.
- Funds held for clients were $1.327 billion and were matched by client fund obligations of the same amount. These amounts are not available for general corporate use.
- Paylocity borrowed $100.0 million under a five-year revolving credit facility in April 2020 to enhance financial flexibility during the COVID-19 uncertainty. The facility provides commitments of $250.0 million, expandable to $375.0 million, and expires in July 2024.
- The company was in compliance with its debt covenants at June 30, 2020. Contractual obligations included $104.3 million of debt obligations, $99.5 million of operating lease obligations and $12.9 million of unconditional purchase obligations.
- Management stated that cash, investments, operating cash flow and available credit were sufficient to meet expected liquidity requirements for at least the next 12 months and thereafter for the foreseeable future.
Material changes versus the prior comparable period
- Client count increased approximately 21%, from 20,200 to 24,450, excluding acquired clients.
- Recurring and other revenue grew 22%, while interest income on client funds declined 24% because of lower interest rates, particularly following Federal Reserve rate cuts in March 2020.
- Gross margin increased one percentage point to 68%, primarily reflecting operating leverage and business scaling.
- Operating cash flow declined modestly despite higher earnings, primarily because of changes in operating assets and liabilities, including increased deferred contract costs.
- Paylocity acquired VidGrid, Inc. in April 2020 for preliminary consideration of $17.3 million, adding video-based workplace learning and communication capabilities. The acquisition was not material to the consolidated financial statements on a pro forma basis.
- The company adopted the lease accounting standard in fiscal 2020, recognizing operating lease right-of-use assets of $48.7 million and operating lease liabilities of $81.4 million at June 30, 2020.
- The company adopted the revenue recognition standard in fiscal 2019. The adoption materially increased deferred contract costs and affected the timing of revenue and expense recognition, although management stated it did not materially affect the overall timing or amount of revenue recognized.
Quarterly and COVID-19 developments
Fiscal 2020 fourth-quarter revenue was $130.6 million, gross profit was $84.7 million, operating income was $6.3 million and net income was $5.0 million. The filing states that fourth-quarter recurring and other revenue was adversely affected by lower client employee counts, a more difficult new-sales environment and delayed client starts. Interest income was significantly reduced by lower market interest rates.
Paylocity moved nearly all employees to remote work during the third quarter and reported no material disruption to operations or client service. It added functionality supporting the CARES Act and FFCRA, remote engagement, mobile health attestations, scheduling, recruiting, rehiring and virtual onboarding. Management expected COVID-19 to continue adversely affecting revenue growth, client employee counts, client retention, demand, sales cycles and interest income, but did not provide formal fiscal 2021 numerical guidance in the supplied filing.
Other risks, contingencies and unusual items
- Client contracts are generally cancellable on 60 days’ notice or less, although some term agreements are generally two years. A significant increase in cancellations could reduce revenue and margins.
- Payroll processing involves significant client funds. In fiscal 2020, Paylocity processed more than $158 billion in payroll transactions and could need to advance funds if client payments are reversed or fail to clear.
- Key risks include COVID-19, client business failures and headcount reductions, lower interest rates, competition, sales-force execution, technology or service interruptions, cybersecurity breaches, privacy regulation, regulatory changes and the ability to retain qualified employees.
- Cybersecurity exposure is significant because the platform handles payroll, tax, bank-account, Social Security, benefit and other sensitive personal information, as well as the movement of client funds.
- The company reported no material pending or threatened legal proceedings. A former-employee wage-and-hour class and collective action was settled without a material impact on financial position, results or liquidity.
- Stock-based compensation expense was $47.5 million in fiscal 2020, and adjusted EBITDA excludes stock-based compensation and related employer payroll taxes.
- The company has not paid dividends and does not anticipate paying cash dividends for the foreseeable future.
- Management and the independent auditor concluded that internal control over financial reporting was effective as of June 30, 2020.
Investor verification checklist
- Verify the actual fiscal 2020 fourth-quarter impact of COVID-19 on client employee counts, retention, new sales and client starts.
- Assess the sustainability of the 68% gross margin and approximately 28.5% adjusted EBITDA margin after normalizing for capitalization and stock-based compensation.
- Review the composition, liquidity and permitted use of funds held for clients versus unrestricted corporate cash and investments.
- Monitor the $100 million revolving-credit borrowing, variable interest exposure, covenant headroom and the company’s stated liquidity outlook.
- Evaluate whether interest income remains a material contributor to revenue and earnings under a prolonged low-rate environment.
- Review deferred contract costs of $158.0 million and the related seven-year amortization assumptions, including their effect on reported margins and cash flow.
- Review the VidGrid acquisition accounting, including the $12.1 million of goodwill and preliminary valuation of acquired intangible assets.
- Reconcile non-GAAP Adjusted EBITDA to GAAP net income and operating cash flow, particularly the $50.4 million of fiscal 2020 excluded stock-based compensation and related items.