Paylocity Holding Corporation — Form 10-Q Summary
Business Context and Reporting Period
Paylocity provides cloud-based payroll and human capital management software to medium-sized organizations, generally those with 20 to 1,000 employees. The filing covers the three and six months ended December 31, 2017, representing fiscal second-quarter and year-to-date results. The financial statements are unaudited.
Financial Performance and Position
| Metric | Three Months Ended Dec. 31 | Six Months Ended Dec. 31 |
|---|---|---|
| Total revenue | $86.0 million, up 25% | $167.5 million, up 25% |
| Recurring revenue | $83.1 million, up 26% | $162.0 million, up 26% |
| Gross profit | $49.2 million; 57% margin | $95.7 million; 57% margin |
| Operating income | $0.1 million; 1% margin | $0.6 million; 1% margin |
| Net income | $0.4 million; $0.01 diluted EPS | $1.0 million; $0.02 diluted EPS |
| Adjusted EBITDA | $15.2 million | $29.8 million |
| Operating cash flow | Not separately provided | $34.2 million |
- Recurring fees increased 24% in the quarter and 25% year to date, primarily from incremental revenue from new and existing clients.
- Interest income on client funds increased 144% in the quarter and 135% year to date, reflecting higher average interest rates, larger client-fund balances and investments in marketable securities beginning in July 2017.
- Recurring gross margin remained 69% in both comparable periods. Implementation services remained loss-making, with a quarterly gross margin of negative 282% and year-to-date gross margin of negative 300%.
- Cash and cash equivalents were $111.0 million at December 31, 2017, compared with $103.5 million at June 30, 2017.
- Funds held for clients were $1.346 billion, matched by client fund obligations of $1.346 billion. These amounts are client-related and should not be viewed as unrestricted corporate liquidity.
- The filing does not disclose outstanding borrowings or material funded debt. Principal contractual commitments were operating leases of $114.1 million and unconditional purchase obligations of $1.8 million.
- Stock-based compensation was $14.4 million for the six months ended December 31, 2017, compared with $12.4 million in the prior-year period.
Material Changes Versus the Prior Comparable Period
- Quarterly net income improved from a $1.7 million loss to $0.4 million of income; year-to-date net income improved from a $4.2 million loss to $1.0 million of income.
- Operating income improved from a $1.6 million quarterly loss to $0.1 million of income and from a $4.2 million year-to-date loss to $0.6 million of income.
- Operating expenses increased 23% in the quarter and 20% year to date, driven by continued hiring and investment in sales and marketing, research and development, administration and infrastructure.
- Sales and marketing expense increased 22% in the quarter and 20% year to date; research and development increased 28% and 25%, respectively.
- Net cash provided by operating activities increased from $15.4 million to $34.2 million year to date, partly due to improved operating results, noncash expenses and a $6.0 million tenant-improvement allowance.
- Cash flows from investing activities were negative $424.2 million, primarily reflecting changes in client funds and purchases of available-for-sale securities. Related client-fund financing flows were positive $397.6 million.
- Available-for-sale securities totaled $71.9 million at December 31, 2017, with $0.1 million of unrealized losses recorded in accumulated other comprehensive loss. No other-than-temporary impairment was recorded.
Guidance, Outlook, Risks and Unusual Items
- Management expects to continue investing in personnel, sales and marketing, research and development, client implementation, data centers and infrastructure. It expects costs to rise in absolute dollars but anticipates long-term operating leverage and margin improvement as the business scales.
- Management stated that existing cash and operating cash flow should be sufficient for working capital, capital expenditures and other requirements for at least the next 12 months.
- The business is seasonal. The fiscal third quarter ending March 31 typically benefits from W-2 preparation, higher client-fund balances, increased interest income and more calendar-year implementations. Historical quarterly results may not be indicative of future results.
- The company expects to adopt the new revenue recognition standard in fiscal 2019 using the full retrospective method. It expects a material change in the treatment of contract acquisition costs, including selling and commission costs, which are expected to be deferred and amortized rather than expensed as incurred.
- The Tax Cuts and Jobs Act produced a $0.2 million quarterly income-tax benefit from revaluation of a deferred tax liability. The company’s broader accounting for the Act remained incomplete, with provisional amounts subject to further analysis.
- The company maintained a valuation allowance against substantially all net deferred tax assets and stated that a release of some or all of the allowance was reasonably possible if operating results continued to improve.
- Principal risks include client cancellations on generally 60 days’ or less notice, competition, failure to manage rapid growth, cybersecurity and data privacy incidents, service outages, dependence on banking and ACH providers, risks associated with client funds and marketable securities, regulatory changes, tax-law changes, and continued profitability risk.
- The company reported no material pending litigation, no material off-balance-sheet arrangements and no defaults upon senior securities. Management concluded that disclosure controls were effective as of December 31, 2017.
Most Important Facts for Investors to Verify
- Whether recurring revenue growth remains near 26% while recurring gross margin remains approximately 69%.
- Whether operating investments translate into sustained GAAP profitability and improved operating margins, rather than only higher Adjusted EBITDA.
- The composition, duration, credit quality and liquidity of the $1.346 billion of client funds, including exposure to interest-rate and market-value changes.
- The eventual financial statement impact of adopting the new revenue recognition standard, especially deferred sales commissions and other contract acquisition costs.
- Whether the valuation allowance on deferred tax assets is released and how that affects future tax expense and cash taxes.
- Future capital spending, lease obligations and any need to establish borrowing or additional ACH capacity as the business grows.
- Client retention, implementation capacity, cybersecurity controls and reliance on third-party banks, data centers and software providers.