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 unaudited Form 10-Q covers the three months ended September 30, 2020, the first quarter of fiscal 2021, and compares results with the three months ended September 30, 2019.
Key Financial Metrics
| Metric | Q1 FY2021 | Q1 FY2020 | Change |
|---|---|---|---|
| Total revenue | $135.8 million | $126.7 million | Up 7% |
| Recurring and other revenue | $134.9 million | $121.9 million | Up 11% |
| Interest income on client funds | $0.9 million | $4.8 million | Down 81% |
| Gross profit | $86.4 million | $84.1 million | Up 3% |
| Gross margin | 64% | 66% | Down 2 percentage points |
| Operating income | $3.4 million | $6.0 million | Down 43% |
| Operating margin | Approximately 2.5% | Approximately 4.7% | Down approximately 2.2 percentage points |
| Net income | $12.5 million | $13.9 million | Down 10% |
| Basic diluted EPS | $0.23 / $0.22 | $0.26 / $0.25 | Down |
| Adjusted EBITDA | $30.9 million | $30.5 million | Up 1% |
Revenue growth was driven by incremental revenue from new and existing clients, partially offset by lower client employee counts related to COVID-19. Cost of revenues increased 16% to $49.4 million, primarily from $5.3 million of additional employee-related costs and $0.9 million of higher internal-use software amortization.
Research and development expense increased 30% to $18.6 million, while sales and marketing expense increased 2% to $37.7 million. General and administrative expense was essentially flat at $26.6 million. The effective tax rate was negative 290.3%, compared with negative 114.8% in the prior-year quarter, primarily reflecting excess tax benefits from employee stock-based compensation. The income tax benefit was $9.3 million.
Cash Flow, Liquidity, Debt, and Balance Sheet
- Cash and cash equivalents were $221.5 million at September 30, 2020, compared with $250.9 million at June 30, 2020.
- Corporate investments were $18.6 million on the balance sheet; total corporate investments, including certain amounts classified elsewhere, were approximately $21.1 million.
- Funds held for clients were $1.379 billion, matched by client fund obligations of the same amount. These balances are primarily related to payroll and tax funds and are not available for general corporate purposes.
- Net cash used in operating activities was $1.6 million, compared with $8.3 million provided in the prior-year quarter.
- Net cash provided by investing activities was $27.6 million, primarily reflecting $37.5 million of investment sales and maturities, offset by $7.9 million of capitalized internal-use software costs and $2.0 million of capital expenditures.
- Net cash provided by financing activities was $18.3 million, including a $51.7 million increase in client fund obligations, partially offset by $33.4 million of taxes paid on net share settlements of equity awards.
- The company had $100.0 million outstanding under a $250.0 million senior secured revolving credit facility, which may be increased to $375.0 million. The facility matures in July 2024.
- Paylocity was in compliance with its debt covenants at September 30, 2020. Contractual obligations totaled $211.6 million, including debt, operating leases, and unconditional purchase obligations.
- Management stated that cash, investments, operating cash flow, and available credit are sufficient for at least the next 12 months and thereafter for the foreseeable future.
Material Changes Versus the Prior Comparable Period
- Recurring and other revenue increased 11%, but interest income on client funds fell 81% because of Federal Reserve rate cuts and the resulting lower interest-rate environment.
- Gross margin declined from 66% to 64% as service delivery costs grew faster than revenue.
- Operating margin declined from approximately 4.7% to approximately 2.5%, reflecting higher cost of revenues and increased research and development spending.
- Net income decreased 10%, while Adjusted EBITDA was relatively stable because higher operating costs were substantially offset by adjustments for stock-based compensation and other items.
- Operating cash flow turned negative, primarily due to changes in accrued expenses, including sales incentive payouts, and higher prepaid expenses.
- Stock-based compensation expense increased to $14.3 million from $12.1 million. The company also recorded $0.9 million related to modification of performance targets for fiscal 2020 performance-based restricted stock units.
- Paylocity completed purchase accounting for its April 2020 acquisition of VidGrid without changes to the preliminary purchase price allocation during the quarter.
- The company adopted new credit-loss, fair-value-disclosure, and income-tax accounting standards on July 1, 2020; none had a material effect on the financial statements.
Guidance, Outlook, Commentary, and Risks
Management did not provide specific quantitative revenue or earnings guidance in the filing. It expects to continue investing in personnel, product development, data centers, infrastructure, sales, marketing, and client service, with the expectation of long-term operating leverage and margin improvement.
COVID-19 remains the principal near-term uncertainty. Management expects the pandemic to continue to pressure revenue growth through lower client employee counts, potential client losses, delayed sales and implementations, business closures, reduced economic activity, lower spending by medium-sized organizations, and continued low interest rates. The duration and severity of these effects remain uncertain.
Other relevant risks include interest-rate exposure affecting income on client funds and the value of fixed-income investments, variable-rate interest expense on the credit facility, execution risk from continued investment, seasonal fluctuations, client retention and employee-count changes, and potential collectability or credit losses. The investment portfolio consisted of investment-grade securities, with no recognized credit impairment losses and no securities in an unrealized loss position at September 30, 2020.
The company reported no material pending legal proceedings, no material changes to the risk factors in its most recent Form 10-K, and no material off-balance-sheet arrangements. Disclosure controls were effective as of September 30, 2020. A new financial system was implemented during the quarter, with related enhancements to internal controls.
Important Facts for Investors to Verify
- Whether recurring revenue growth and client employee counts remain resilient as COVID-19 effects continue.
- The sustainability of the 64% gross margin and the timing of expected operating leverage.
- The effect of persistently low interest rates on income earned from client funds.
- Operating cash flow trends after the quarter’s working-capital movements and equity-award tax payments.
- Outstanding borrowings, interest-rate exposure, covenant compliance, and remaining revolver capacity.
- The treatment and future amortization of capitalized contract acquisition, fulfillment, and software-development costs.
- The effect of the VidGrid acquisition and the company’s continued investments in product development and infrastructure.
- Future changes in COVID-19-related assumptions, deferred tax benefits, and stock-based compensation expense.