Paylocity Holding Corporation Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended December 31, 2019. The filing was signed February 5, 2020. Paylocity is a cloud-based payroll and human capital management software provider serving primarily medium-sized organizations.
Financial performance and liquidity
| Metric | Three months ended Dec. 31 | Six months ended Dec. 31 |
|---|---|---|
| Total revenue | $132.4 million, up 23% | $259.1 million, up 25% |
| Recurring and other revenue | $128.0 million, up 25% | $249.9 million, up 25% |
| Gross profit | $87.0 million | $171.0 million |
| Gross margin | 66%, versus 65% | 66%, versus 64% |
| Operating income | $6.1 million | $12.1 million |
| Net income | $5.5 million, versus $5.7 million | $19.4 million, versus $15.6 million |
| Diluted EPS | $0.10, unchanged | $0.35, versus $0.28 |
| Adjusted EBITDA | $30.3 million, versus $26.1 million | $60.7 million, versus $49.4 million |
| Net cash from operations | Not separately provided for the quarter | $36.1 million, versus $34.3 million |
Recurring and other revenue represented 97% of quarterly revenue and 96% of six-month revenue. Quarterly operating expenses increased 30%, led by a 40% increase in sales and marketing, a 20% increase in research and development, and a 24% increase in general and administrative expense. Stock-based compensation was $12.8 million for the quarter and $24.8 million for the six months.
- Cash and cash equivalents were $75.9 million at December 31, 2019, compared with $132.5 million at June 30, 2019.
- Corporate investments were $69.8 million on the balance sheet; management identified $76.5 million of total corporate investments as a principal liquidity source.
- Funds held for clients were $1.845 billion and were matched by client fund obligations. These amounts primarily reflect client payroll and tax processing and are not ordinary corporate liquidity.
- Total investments, including client funds, were $1.998 billion, compared with $1.557 billion at June 30, 2019.
- The company generated $36.1 million of operating cash flow but used $153.7 million in investing activities, primarily for purchases of available-for-sale securities, capitalized software, and property and equipment.
- Capitalized internal-use software costs were $12.1 million and property and equipment purchases were $12.4 million for the six months.
Debt and commitments
- In July 2019, Paylocity entered into a five-year senior secured revolving credit facility of up to $250 million, expandable to $375 million subject to conditions, maturing in July 2024.
- No amounts were drawn as of December 31, 2019, and the company was in compliance with its leverage and interest coverage covenants.
- Operating lease liabilities totaled $84.6 million, including $76.9 million long term. Total undiscounted operating lease payments were $104.3 million.
- Operating lease right-of-use assets of $51.7 million were recorded following adoption of ASC Topic 842 on July 1, 2019, with no reported income statement or cash flow impact from adoption.
Material changes versus the prior comparable period
- Revenue growth was driven primarily by incremental revenue from new and existing clients.
- Gross margin expanded as revenue grew faster than cost of revenues. Management attributed higher costs principally to additional personnel, delivery costs, and processing fees.
- Sales and marketing investment increased substantially to expand the sales organization, while research and development spending increased to support product development.
- Quarterly net income declined slightly despite strong revenue growth because of increased operating expenses, including a $1.6 million legal settlement and related litigation costs in general and administrative expense.
- Six-month net income increased substantially, aided by income tax benefits. The six-month effective tax rate was negative 50.5%, compared with negative 36.2% in the prior year, primarily because of excess tax benefits from employee stock compensation.
- Net cash provided by financing activities increased to $428.2 million from a use of $17.8 million, primarily because client fund obligations increased by $450.8 million. This change is driven by payroll-processing timing and should not be treated as recurring corporate financing.
- Deferred contract costs increased to $125.5 million from $82.3 million at December 31, 2018, reflecting higher capitalized contract acquisition and fulfillment costs.
- The company simplified its revenue and cost-of-revenue presentation by combining recurring fees with implementation services and other revenue and reclassified prior-period amounts accordingly.
Outlook, commentary, risks, and unusual items
Management expects to continue investing in personnel, sales and marketing, research and development, platform infrastructure, data centers, and other capacity. It expects absolute operating expenses to rise while pursuing longer-term economies of scale and improved gross and operating margins. The filing does not provide a clear numerical revenue, margin, or earnings outlook.
- The company expects current cash, corporate investments, and operating cash flow to fund working capital, capital expenditures, and other requirements for at least the next 12 months.
- Fiscal third-quarter results are seasonally stronger because of W-2 preparation, year-end payroll activity, and higher client fund balances; historical third-quarter results may not predict future performance.
- A former employee filed a wage-and-hour class and collective action complaint. Paylocity reached an agreement in principle to settle, subject to court approval, and stated that the settlement should not materially affect its financial position, results, or liquidity.
- Key risks include client cancellations because most agreements are cancellable with 60 days’ notice or less, competition, execution of rapid growth, cybersecurity and data privacy incidents, service outages, software defects, regulatory changes, interest-rate and investment risks, and failures or disruptions involving banking and ACH partners.
- Client fund processing exposes the company to potential short-term liquidity needs if client payments are rejected or reversed after payroll and tax amounts have been disbursed.
- A 25-basis-point increase in interest rates would have reduced the market value of available-for-sale securities held for clients by approximately $0.3 million as of December 31, 2019.
- Management reported effective disclosure controls and procedures and no material changes to internal control over financial reporting other than process changes associated with lease accounting adoption.
Investor verification checklist
- Verify that recurring revenue growth and client additions remain durable despite the high level of agreements cancellable on short notice.
- Assess whether rising sales, research and development, personnel, stock-based compensation, and infrastructure spending produces sustainable operating leverage.
- Separate corporate cash and investments from restricted or client-related funds when evaluating liquidity and cash generation.
- Review the effect of unusually favorable tax benefits on six-month net income, EPS, and adjusted performance measures.
- Monitor the legal settlement, other litigation exposure, cybersecurity controls, service availability, and regulatory developments involving payroll, privacy, money transmission, and taxation.
- Evaluate the credit facility’s covenant requirements and potential interest-rate exposure if borrowings are drawn.
- Reconcile non-GAAP Adjusted EBITDA to GAAP results, particularly the exclusion of stock-based compensation and legal, lease-exit, and transaction costs.