Business Context and Reporting Period
Paylocity Holding Corporation provides cloud-based payroll and human capital management software to medium-sized organizations. The supplied filing is a Form 10-Q for the quarter and nine months ended March 31, 2020, corresponding to fiscal 2020 third quarter—not 2019 Q3 as stated in the request. The filing was signed May 8, 2020. Amounts below are in thousands, except per-share data.
Financial Results and Key Metrics
| Metric | Three Months Ended March 31, 2019 | Three Months Ended March 31, 2020 | Nine Months Ended March 31, 2019 | Nine Months Ended March 31, 2020 |
|---|---|---|---|---|
| Total revenue | $139,552 | $171,646 | $347,260 | $430,740 |
| Recurring and other revenue | $133,355 | $167,095 | $333,096 | $416,948 |
| Gross profit | $99,807 | $123,565 | $233,503 | $294,605 |
| Operating income | $36,212 | $47,741 | $47,015 | $59,855 |
| Net income | $28,026 | $40,132 | $43,582 | $59,505 |
| Diluted earnings per share | $0.51 | $0.72 | $0.79 | $1.07 |
| Adjusted EBITDA | $54,816 | $68,247 | $104,179 | $128,989 |
- Third-quarter total revenue increased 23%; recurring and other revenue increased 25%. Nine-month total revenue increased 24%, while recurring and other revenue increased 25%.
- Gross margin was 72% in the quarter versus 72% in the prior-year quarter, and 68% for the nine-month period versus 67% previously.
- Operating margin was approximately 27.8% in the quarter versus 25.9% and approximately 13.9% for the nine months versus 13.5%.
- Net margin was approximately 23.4% in the quarter versus 20.1% and approximately 13.8% for the nine months versus 12.6%.
- Interest income on funds held for clients declined 27% in the quarter to $4,551 and 3% for the nine months to $13,792, primarily due to lower interest rates.
- Net cash provided by operating activities increased to $86,795 for the nine months from $79,159. Net cash used in investing activities increased to $183,343, largely reflecting purchases of available-for-sale securities, capitalized software, and property and equipment.
- Capitalized internal-use software costs were $19,213 for the nine months, compared with $14,706; property and equipment purchases were $14,578, compared with $9,621.
- At March 31, 2020, cash and cash equivalents were $114,325, corporate investments were $66,308 on the balance sheet, and funds held for clients were $1,729,176. Client funds were matched by client fund obligations and are not corporate liquidity.
- No amounts were drawn under the revolving credit facility at March 31, 2020. The facility permits borrowings of up to $250,000, expandable to $375,000, and matures in July 2024.
Material Changes Versus the Prior Comparable Period
- Recurring revenue growth was driven primarily by incremental revenue from new and existing clients.
- Cost of revenues increased 21% in the quarter and 20% for the nine months, primarily from additional employee-related costs and delivery and processing fees.
- Sales and marketing expense increased 36% in the quarter and 39% for the nine months as Paylocity expanded its sales organization and incurred higher stock-based compensation.
- Research and development expense increased 23% in both periods, reflecting additional development personnel, partly offset by increased capitalization of internal-use software costs.
- General and administrative expense decreased 3% in the quarter but increased 12% for the nine months. The nine-month increase included $2.9 million of legal settlement, litigation, lease-exit, and transaction costs and $2.5 million of higher occupancy costs.
- The effective tax rate declined to 16.7% from 23.7% in the quarter and to 2.5% from 9.5% for the nine months, primarily reflecting research and development credits, excess tax benefits from equity compensation, and valuation allowance changes.
- Paylocity adopted ASC 842 lease accounting on July 1, 2019, recording operating lease right-of-use assets of $52,083 and lease liabilities of $83,852 at adoption. At March 31, 2020, operating lease liabilities totaled $82,867.
- Performance-based stock compensation was reduced by $2,053 in the quarter because management lowered its estimate of achievement in light of COVID-19.
Guidance, Outlook, Risks, and Unusual Items
- The filing does not provide specific numerical revenue or earnings guidance. Management expects continued long-term investment in personnel, product development, infrastructure, and sales capacity, with anticipated longer-term operating leverage.
- COVID-19 had no material impact on reported results through March 31, 2020 because the financial effects became more observable only in the latter half of March. Nearly all employees transitioned to remote work without material operating disruption during the quarter.
- Management expects COVID-19 to adversely affect future recurring revenue growth through lower client headcounts, client losses, reduced demand, pricing pressure, delayed sales and longer sales cycles. Lower interest rates are expected to continue reducing interest income on client funds.
- In April 2020, after the reporting period, Paylocity borrowed $100,000 under its revolving credit facility to provide flexibility during uncertain market conditions, although management stated it had no anticipated need for the additional liquidity.
- In April 2020, Paylocity acquired VidGrid, Inc. for purchase consideration of $17,500, subject to customary adjustments. Management expects no material impact on the consolidated financial statements.
- The company reached an agreement in principle to settle a former employee class and collective action concerning alleged employee misclassification. Management stated the settlement was not material to financial position, results of operations, or liquidity.
- Principal risks include COVID-19 effects on clients and payroll volumes, interest-rate sensitivity, client attrition and short cancellation periods, cybersecurity and data privacy, service interruptions, dependence on third-party data centers and banks, competitive pressure, regulatory changes, litigation, and the ability to manage rapid growth.
- The company reported no material off-balance-sheet arrangements and stated that disclosure controls and procedures were effective as of March 31, 2020.
Important Facts for Investors to Verify
- Confirm the intended period: the supplied filing is for March 31, 2020, not March 31, 2019.
- Separate corporate cash and investments from the $1.729 billion of client funds, which are offset by client fund obligations.
- Assess the impact of subsequent-period COVID-19 effects on client employee counts, retention, new sales, recurring revenue, and interest income.
- Review the terms, interest rate, covenants, and balance of the $100 million borrowing made in April 2020.
- Evaluate the sustainability of reported margins and adjusted EBITDA given higher sales and marketing investment, capitalized costs, and substantial stock-based compensation.
- Review the accounting and integration risks associated with the VidGrid acquisition and the settlement of the employee classification litigation.
- Monitor interest-rate exposure and unrealized losses in the available-for-sale securities portfolio, as well as liquidity and credit risks affecting client funds.