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 nine months ended March 31, 2018, the company’s fiscal third quarter and nine-month period. The request metadata identifies “2017 Q3,” but the filing itself reports fiscal 2018 third-quarter results.
Financial Performance and Position
| Metric | Three months ended March 31 | Year-over-year change | Nine months ended March 31 | Year-over-year change |
|---|---|---|---|---|
| Total revenue | $113.4 million | 25.6% | $280.9 million | 25.4% |
| Recurring revenue | $108.6 million | 26% | $270.6 million | 26% |
| Gross profit | $74.8 million | 28.5% | $170.5 million | 28.0% |
| Gross margin | 65.9% | Up from 64.5% | 60.7% | Up from 59.4% |
| Operating income | $20.5 million | 37.5% | $21.1 million | 96.7% |
| Net income | $39.2 million | 164.7% | $40.2 million | 280.2% |
| Adjusted EBITDA | $35.8 million | 33.3% | $65.6 million | 46.9% |
| Net cash from operations | Not separately provided | — | $69.3 million | 60.0% |
Recurring fees increased 24% in both the quarter and nine-month period, primarily from new and existing clients. Interest income on funds held for clients increased 161% in the quarter and 146% year to date, reflecting higher rates, larger client balances and investments in marketable securities beginning in July 2017. Recurring revenue represented 96% of total revenue in both comparable periods.
Operating expenses increased 25.3% in the quarter and 22.0% year to date. Sales and marketing increased 22% in the quarter and 21% year to date; research and development increased 30% and 27%, respectively; and general and administrative expenses increased 27% and 21%, respectively. The company continues to invest in personnel, product development, infrastructure and sales capacity.
As of March 31, 2018, cash and cash equivalents were $129.5 million, compared with $103.5 million at June 30, 2017. Funds held for clients were $1.35 billion, matched by $1.35 billion of client fund obligations. The filing does not report outstanding debt or borrowings. Total stockholders’ equity was $204.5 million, compared with $147.6 million at June 30, 2017.
Operating cash flow was $69.3 million for the nine months ended March 31, 2018, compared with $43.3 million in the prior-year period. Investing cash flow was $(439.6) million, primarily reflecting changes in client funds, purchases of available-for-sale securities, capitalized software, capital expenditures and the BeneFLEX acquisition. Financing cash flow was $396.4 million, primarily reflecting the change in client fund obligations.
Material Changes Versus the Prior Comparable Period
- Revenue growth remained approximately 25%, with recurring fees up 24% and recurring revenue up 26%.
- Quarterly gross margin improved to 66% from 64%; nine-month gross margin improved to 61% from 59%.
- Operating margin improved to 18% from 16% for the quarter and to 8% from 5% year to date.
- Net income benefited substantially from an $18.5 million quarterly income tax benefit, including a $22.6 million release of substantially all of the deferred-tax-asset valuation allowance and $11.0 million of excess tax benefits from employee stock exercises, partly offset by estimated Tax Cuts and Jobs Act effects and current tax provision.
- The company began investing a portion of client funds in marketable securities. At March 31, 2018, available-for-sale securities had a fair value of $74.9 million, with $249 thousand of gross unrealized losses and no other-than-temporary impairment.
- In March 2018, the company acquired substantially all assets of BeneFLEX HR Resources for a preliminary purchase price of $9.3 million, including $3.8 million of goodwill and $5.6 million of identifiable intangible assets. The company may owe an additional $1.0 million based on performance.
- Capitalized internal-use software increased to $20.0 million net from $17.4 million at June 30, 2017; property and equipment increased to $50.4 million from $40.8 million.
Guidance, Outlook, Risks and Unusual Items
Management did not provide specific numeric revenue or earnings guidance in the filing. Management expects to continue investing in sales and marketing, research and development, personnel, data centers, infrastructure and client service. It anticipates long-term economies of scale, operating leverage and improvement in gross and operating margins, but expects expenses to increase in absolute dollars.
Management believes cash and operating cash flow will be sufficient to meet working capital, capital expenditure and other investment requirements for at least the next 12 months. Principal contractual commitments at March 31, 2018 were $112.9 million of operating lease obligations and $5.2 million of unconditional purchase obligations. The company reported no material off-balance-sheet arrangements and no material pending legal proceedings.
Results are seasonal. The fiscal third quarter generally benefits from W-2 preparation, higher client fund balances and payroll-tax collections, and increased implementations following calendar year-end; therefore, third-quarter results may not be indicative of full-year performance.
Key risks include short-term cancellability of most client agreements, competition, dependence on continued client and employment growth, execution risk from rapid expansion, service outages and software defects, cybersecurity and data privacy breaches, risks related to payroll funds and ACH processing, interest-rate and investment risks on client funds, dependence on third-party infrastructure and software, regulatory and tax changes, and the possibility that profitability may not be sustained.
The company expects to adopt the new revenue recognition standard in fiscal 2019 using the full retrospective method and expects a material change in the treatment of certain contract-acquisition costs, including selling and commission costs. It expects to adopt the new lease standard in fiscal 2020. Accounting for certain Tax Cuts and Jobs Act effects remained provisional, with completion expected by December 2018.
Facts Investors Should Verify
- Separate recurring operating performance from the unusually large fiscal 2018 tax benefit when evaluating earnings growth.
- Confirm the sustainability of approximately 24% recurring-fee growth and the company’s client retention and new-client trends.
- Assess whether sales, implementation, research and development and infrastructure investments generate the expected operating leverage.
- Monitor the composition, credit quality, liquidity and interest-rate sensitivity of the $1.35 billion of client funds, including the $74.9 million securities portfolio.
- Evaluate the integration and performance contribution of the BeneFLEX acquisition, including the potential $1.0 million contingent payment.
- Model the effects of the upcoming revenue recognition and lease accounting changes, including retrospective impacts on reported results.
- Consider the seasonal nature of third-quarter results and the risks associated with client cancellations, cybersecurity, ACH processing and service continuity.