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, 2016, corresponding to the second quarter and first six months of fiscal 2017. The financial statements are unaudited.
Financial performance and position
| Metric | Three months ended December 31 | Six months ended December 31 |
|---|---|---|
| Total revenue | $68.7 million, up 24% | $133.7 million, up 33% |
| Recurring revenue | $66.1 million, up 26% | $128.7 million, up 35% |
| Gross profit | $38.3 million | $74.9 million |
| Gross margin | 56% | 56% |
| Operating loss | $1.6 million | $4.2 million |
| Net loss | $1.7 million, or $0.03 per share | $4.2 million, or $0.08 per share |
| Adjusted EBITDA | $9.9 million | $17.8 million |
| Operating cash flow | $15.4 million for the six months, versus $10.8 million in the prior-year period |
- Recurring revenue represented 96% of total revenue in both the quarter and six-month period. Interest income on client funds was $0.7 million for the quarter and $1.4 million for the six months.
- Recurring gross margin was 69% in both comparable periods. Implementation services remained materially loss-making, with a six-month implementation gross margin of negative 281%.
- At December 31, 2016, cash and cash equivalents were $82.3 million, compared with $86.5 million at June 30, 2016. Funds held for clients were $1.09 billion, matched by client fund obligations.
- The filing reports no debt balance or borrowings. Total liabilities were $1.13 billion, primarily reflecting client fund obligations; stockholders’ equity was $125.3 million.
- Capital expenditures were $10.0 million and capitalized internal-use software costs were $6.3 million during the six months. Total contractual obligations were $114.0 million, including $111.1 million of operating lease obligations.
Material changes versus the prior comparable period
- Quarterly recurring fees increased 26% to $65.3 million, while six-month recurring fees increased 35% to $127.3 million, driven by new and existing clients and the company’s ACA compliance solution.
- Implementation revenue declined 9% for the quarter and 2% for the six months, primarily because elevated implementation activity related to ACA compliance occurred in the prior-year period.
- Sales and marketing expense increased 24% for the quarter and 33% for the six months, reflecting expansion of the sales organization, including 128 additional sales-related personnel.
- Research and development expense increased 6% for the quarter and 19% for the six months, while capitalized development costs also increased.
- General and administrative expense increased 33% for both the quarter and six months due to additional personnel, higher stock-based compensation and increased occupancy costs.
- Stock-based compensation increased to $12.4 million for the six months from $8.5 million in the prior-year period, including $5.8 million in general and administrative expense.
- Operating cash flow improved, but total cash declined by $4.2 million because of capital investments, equity-award tax settlements and other financing activity.
Guidance, outlook, commentary and risks
- Management expects to continue investing in sales and marketing, research and development, client implementation, data centers and infrastructure. It expects costs to rise in absolute dollars and anticipates longer-term economies of scale and operating leverage.
- Management believes cash on hand and operating cash flow will fund working capital, capital expenditures and other investments for at least the next 12 months.
- The business is seasonal, with the fiscal third quarter generally benefiting from W-2 preparation, higher client-fund balances and increased implementations following the calendar year-end.
- Interest income remains sensitive to interest rates, and historically low rates have negatively affected returns on client funds.
- The company has incurred recurring losses and states that it may not achieve or sustain profitability for the foreseeable future.
- Client agreements are generally cancellable on 60 days’ or less notice, creating renewal and retention risk. Implementation costs and sales commissions may be incurred before sufficient revenue is generated.
- Key operational risks include cybersecurity and data breaches, service interruptions, software defects, data-center capacity, dependence on banking and ACH partners, client payment failures and the ability to recruit and retain personnel.
- Potential changes to the Affordable Care Act could reduce demand for ACA products, affect margins and require impairment of related capitalized software costs.
- The company is evaluating the effects and adoption timing of new accounting standards, including revenue recognition, leases, stock compensation and credit losses.
- There were no material pending legal proceedings identified in the filing. However, Paylocity was appealing a Delaware Court of Chancery ruling concerning a bylaw fee-shifting provision related to its exclusive-forum provision.
- Management reported effective disclosure controls and procedures and no material changes to internal control over financial reporting.
Important facts for investors to verify
- Whether recurring revenue growth, client additions and retention support continued growth after the ACA-related comparison benefit diminishes.
- Whether increased sales, implementation, infrastructure and research spending produces sustained operating leverage and eventual GAAP profitability.
- The composition and liquidity of the $1.09 billion of client funds and the matching client fund obligations; these balances are restricted and are not equivalent to corporate cash.
- The magnitude and timing of future capital expenditures, capitalized software costs and lease commitments.
- Exposure to interest-rate changes, banking-partner concentration, ACH settlement failures and potential short-term liquidity needs.
- The effect of any ACA amendments or repeal and the company’s assessment of related capitalized software and revenue exposure.
- The level and future effect of stock-based compensation and potential equity dilution.
- The outcome and financial impact of the Delaware bylaw litigation and appeal.