Paylocity Holding Corporation: FY2019 Form 10-K Summary
Reporting period: Fiscal year ended June 30, 2019. The filing is an annual Form 10-K, not a “2018 Q4” filing; it includes quarterly data for the quarter ended June 30, 2019 and comparable fiscal-year information for 2017 and 2018.
Business context
Paylocity provides cloud-based payroll and human capital management software to U.S. medium-sized organizations, generally those with 20 to 1,000 employees. Its unified SaaS platform includes payroll, core HR, workforce management, talent, benefits, implementation and client services. The company operated as a single reporting segment.
- Approximately 20,200 clients as of June 30, 2019, excluding clients acquired through BeneFLEX.
- Annual revenue retention exceeded 92% in fiscal 2017, 2018 and 2019.
- Approximately 3,050 full-time employees at June 30, 2019.
- More than 25% of fiscal 2019 new client revenue originated from the company’s referral network.
Financial performance
| Metric | FY2019 | FY2018 | Change |
|---|---|---|---|
| Total revenue | $467.6 million | $377.5 million | +24% |
| Recurring revenue | $456.8 million | $363.5 million | +26% |
| Recurring fees | $437.0 million | $354.4 million | +23% |
| Interest income on client funds | $19.9 million | $9.1 million | +119% |
| Implementation services and other | $10.8 million | $14.0 million | -23% |
| Gross profit | $313.8 million | $228.3 million | +37% |
| Operating income | $56.2 million | $15.9 million | +253% |
| Net income | $53.8 million | $38.6 million | +39% |
| Diluted EPS | $0.97 | $0.70 | +39% |
| Adjusted EBITDA | $134.0 million | $81.3 million | +65% |
Margins: Gross margin improved to approximately 67% from 60%; recurring gross margin increased to 73% from 71%; operating margin increased to approximately 12% from 4%; and net margin was approximately 12% versus 10%. Adjusted EBITDA margin was approximately 29% versus 22%.
- Sales and marketing expense increased 18% to $112.6 million, primarily reflecting expansion of the sales organization.
- Research and development expense increased 34% to $50.3 million as Paylocity added development personnel and continued product investment.
- General and administrative expense increased 19% to $94.6 million, including higher employee-related and stock-based compensation costs.
- Stock-based compensation expense increased to $38.8 million from $30.4 million.
Cash flow, liquidity and capital structure
- Net cash provided by operating activities was $115.0 million, up from $97.9 million in fiscal 2018.
- Net cash used in investing activities was $43.3 million, compared with $179.3 million in fiscal 2018; fiscal 2018 included substantial purchases of marketable securities and the BeneFLEX acquisition.
- Capitalized internal-use software costs were $20.1 million, and purchases of property and equipment were $11.3 million.
- Cash and cash equivalents were $132.5 million, and corporate investments were $29.3 million at June 30, 2019.
- Funds held for clients were $1.394 billion, matched by client fund obligations of the same amount; these balances primarily reflect payroll and tax funds and are not ordinary corporate liquidity.
- Working capital was $140.1 million. The company stated that existing cash, corporate investments and operating cash flow were sufficient for at least the next 12 months.
- The balance sheet showed no drawn debt at June 30, 2019. In July 2019, after year-end, Paylocity entered into a five-year secured revolving credit facility of up to $250 million, expandable to $375 million; no amounts had been drawn as of the filing.
- Operating lease obligations totaled $108.2 million, and unconditional purchase obligations totaled $10.9 million.
- The company repurchased 442,000 shares for approximately $35.0 million during fiscal 2019. It does not anticipate paying cash dividends in the foreseeable future.
Material changes and unusual items
- ASC 606 adoption: Effective July 1, 2018, Paylocity adopted the new revenue standard using the modified retrospective method. The adoption did not materially affect the timing or amount of revenue overall but materially changed the balance sheet and timing of implementation-related revenue and costs.
- Implementation fees for proprietary products are now generally deferred and amortized over periods of up to 24 months rather than recognized upon completion.
- Certain contract acquisition and fulfillment costs are capitalized and amortized over an expected seven-year benefit period. Deferred contract costs totaled $103.1 million at June 30, 2019.
- ASC 606 adoption increased retained earnings by $52.7 million at July 1, 2018, primarily from deferred contract costs and related tax effects.
- Fiscal 2018 net income benefited from a nonrecurring $22.8 million tax benefit related to releasing a valuation allowance. Fiscal 2019 therefore is not directly comparable on an after-tax basis.
- The BeneFLEX acquisition completed in March 2018 expanded benefits administration capabilities. Paylocity paid an additional $1.0 million of contingent consideration in fiscal 2019.
- Paylocity relocated its headquarters and recorded $0.4 million of lease-exit costs in fiscal 2019, compared with $2.3 million in fiscal 2018.
Outlook, management commentary and risks
Management expects to continue investing in sales and marketing, research and development, implementation and client service, data centers and infrastructure. These investments are expected to increase expenses in absolute dollars, while management anticipates longer-term economies of scale, operating leverage and margin improvement. The filing does not provide specific fiscal 2020 revenue, earnings or margin guidance.
- Most customer agreements are cancellable on 60 days’ notice or less, although the company began entering generally two-year term arrangements in fiscal 2018.
- The business is seasonal, with client additions and payroll-related activity typically higher in the fiscal third quarter ending March 31.
- Paylocity processed more than $134 billion of payroll transactions in fiscal 2019. ACH reversals, client defaults or bank-processing failures could require the company to advance funds and obtain additional short-term liquidity.
- Key risks include competition from larger payroll and HCM providers, failure to innovate, service outages, cybersecurity breaches, privacy and regulatory changes, tax-law changes, dependence on referral partners and key employees, and challenges managing rapid growth.
- Interest-rate changes could affect income earned on client funds and the fair value of available-for-sale securities. A 25-basis-point rate increase was estimated to reduce the fair value of those securities by approximately $0.1 million at June 30, 2019.
- A former employee filed a class and collective action complaint on July 12, 2019 alleging employee misclassification and seeking overtime and other damages. The company could not estimate a reasonably possible loss and intends to defend the matter.
- Management and KPMG concluded that internal control over financial reporting and disclosure controls were effective as of June 30, 2019.
Investor verification checklist
- Reconcile reported fiscal 2019 revenue, profit and cash flow to the audited financial statements and distinguish GAAP results from Adjusted EBITDA and other non-GAAP measures.
- Assess the effect of ASC 606 and deferred contract costs on reported revenue, margins, cash flow and retained earnings.
- Separate corporate cash and investments from funds held for clients when evaluating liquidity.
- Review the terms, covenants and collateral requirements of the post-year-end $250 million revolving credit facility.
- Monitor client retention, client additions, average revenue per client and the sustainability of recurring revenue growth.
- Evaluate the impact of higher interest rates on client-fund interest income and investment valuations.
- Review cybersecurity, data privacy, ACH processing and regulatory risks, including potential money-transmitter or payroll-processing obligations.
- Follow developments in the employee misclassification lawsuit and other litigation contingencies.
- Consider the scale of stock-based compensation, deferred contract costs and future lease obligations when assessing earnings quality and free cash flow.