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 through a SaaS platform. This filing reports the fiscal quarter and nine-month periods ended March 31, 2015, compared with the comparable periods ended March 31, 2014. Although the request metadata refers to “2014 Q3,” the filing period is fiscal third quarter 2015.
The fiscal third quarter is seasonally stronger because of year-end W-2 preparation, increased client funds held, and new clients beginning service after calendar year-end.
Financial Performance and Position
| Metric | Three Months Ended March 31 | Change | Nine Months Ended March 31 | Change |
|---|---|---|---|---|
| Total revenue | $47.3 million | +40% | $112.7 million | +41% |
| Recurring revenue | $43.9 million | +41% | $105.9 million | +42% |
| Gross profit | $28.0 million | +49% | $59.9 million | +50% |
| Gross margin | 59% | Up from 56% | 53% | Up from 50% |
| Operating income (loss) | $1.7 million | Down from $2.1 million | $(9.7) million | Down from $(0.7) million |
| Net income (loss) | $1.8 million | Up from $1.2 million | $(9.5) million | Down from $(0.4) million |
| Adjusted EBITDA | $7.5 million | Up from $5.2 million | $7.7 million | Up from $5.7 million |
| Operating cash flow | Not separately provided | — | $10.2 million | Up from $8.1 million |
Recurring fees increased primarily from new clients and higher revenue per client. Recurring revenue represented 93% of nine-month revenue. Recurring gross margin improved to 71% for the quarter and 67% for the nine months, principally due to lower reseller expenses and lower amortization expense.
Operating expenses increased materially as the company expanded its sales force, development organization and administrative infrastructure. Nine-month sales and marketing expense increased 61% to $31.2 million, research and development increased 113% to $14.4 million, and general and administrative expense increased 63% to $24.1 million.
Stock-based compensation increased to $10.7 million for the nine months, compared with $1.7 million in the prior-year period, and was a significant contributor to the GAAP operating loss. The nine-month effective tax result was near zero because of a valuation allowance against most deferred tax assets.
Cash and cash equivalents were $93.2 million at March 31, 2015, compared with $78.8 million at June 30, 2014. Funds held for clients were $731.6 million and were fully offset by client fund obligations. The company states that these funds are restricted solely for client obligations and should not be viewed as corporate liquidity.
The company had no notes payable outstanding at March 31, 2015. Contractual obligations included $13.7 million of operating lease obligations and $1.9 million of unconditional purchase obligations. The company stated that cash on hand and operating cash flow should be sufficient for working capital, capital expenditures and other investments for at least the next 12 months.
Material Changes Versus the Prior Comparable Period
- Revenue growth remained above 40%, driven by new clients and increased revenue per client.
- Gross margin improved despite continued investment in growth.
- GAAP profitability weakened for the nine-month period as sales, research and development, administrative costs and stock-based compensation grew faster than revenue.
- Adjusted EBITDA improved, but the reconciliation depends substantially on excluding stock-based compensation and depreciation and amortization.
- Sales personnel increased by 50 and sales lead-generation personnel by nine; development personnel increased by 55 and general and administrative personnel by 25.
- The company completed a follow-on offering in December 2014, receiving net proceeds of $18.4 million. Existing shareholders also sold shares but the company received no proceeds from those sales.
- Capital expenditures were $6.3 million and capitalized internally developed software costs were $2.5 million for the nine months ended March 31, 2015.
Guidance, Outlook, Risks and Unusual Items
The filing does not provide clear numerical revenue, earnings or margin guidance. Management expects to continue investing in sales and marketing, research and development, personnel, data centers and infrastructure. Management expects long-term operating leverage and margin improvement as the business scales, but cautions that investments may precede related revenue benefits.
In April 2015, after the balance-sheet date, Paylocity terminated its remaining reseller agreement and acquired substantially all of the reseller’s assets for an estimated $9.5 million. It paid $9.0 million at closing, with estimated additional payments of $0.2 million in August 2015 and $0.3 million in January 2016, subject to indemnification claims. The acquisition accounting and allocation of purchase price were not finalized in the filing.
Key risks include continued GAAP losses, seasonality, short customer termination periods of generally 60 days or less, intense competition, dependence on hiring and retaining qualified personnel, implementation capacity, technology outages and cybersecurity breaches, protection and processing of client funds, ACH and banking-partner risks, interest-rate exposure, regulatory and tax changes, and the need for additional capital to support growth.
Management reported no material pending litigation, no material off-balance-sheet arrangements, effective disclosure controls as of March 31, 2015, and no material changes in internal control over financial reporting during the quarter. The company was evaluating adoption of ASU 2014-09, the new revenue recognition standard, planned for July 1, 2017 or as otherwise required by final FASB guidance.
Important Facts for Investors to Verify
- Whether revenue growth and customer additions can continue after the seasonally strong fiscal third quarter.
- Whether expanding sales, product and administrative investments produce sustainable GAAP profitability rather than only higher adjusted EBITDA.
- The future magnitude and timing of stock-based compensation and its effect on earnings and dilution.
- The final purchase-price allocation, operating impact and cash requirements associated with the April 2015 reseller acquisition.
- The distinction between corporate cash of $93.2 million and restricted client funds of $731.6 million.
- Whether operating cash flow remains adequate as capital expenditures, software development and acquisition spending increase.
- Customer retention and cancellation trends given generally short contractual termination periods.
- Exposure to cybersecurity, service interruption, ACH settlement, banking-partner, client-fund and interest-rate risks.
- The eventual impact and adoption method of the new revenue recognition standard.