Paylocity Holding Corporation — Form 10-Q Summary
Business Context and Reporting Period
Paylocity provides cloud-based payroll and human capital management software for medium-sized organizations, generally those with 20 to 1,000 employees. The filing covers the three and nine months ended March 31, 2019, Paylocity’s fiscal third quarter and first nine months of fiscal 2019. The request labels the period “2018 Q3,” but the filing reports fiscal 2019 results.
Financial Performance and Position
| Metric | Three Months Ended March 31 | Nine Months Ended March 31 |
|---|---|---|
| Total revenue | $139.6 million, up 23% | $347.3 million, up 24% |
| Recurring revenue | $136.2 million, up 25% | $340.2 million, up 26% |
| Gross profit | $99.8 million; 72% margin | $233.5 million; 67% margin |
| Operating income | $36.2 million; 26% margin | $47.0 million; 14% margin |
| Net income | $28.0 million; diluted EPS $0.51 | $43.6 million; diluted EPS $0.79 |
| Adjusted EBITDA | $54.8 million | $104.2 million |
| Net cash from operating activities | Not separately provided | $79.2 million |
- Recurring fees increased 23% in both the quarter and nine-month period, primarily from new and existing clients.
- Interest income on client funds increased 128% to $6.2 million in the quarter and 131% to $14.2 million for the nine-month period, reflecting higher rates, larger client fund balances and greater investment in marketable securities.
- Implementation services and other revenue declined 30% in the quarter and 32% year to date because implementation fees for proprietary products are now deferred and amortized.
- Recurring gross margin improved to 76% from 75% in the quarter and to 73% from 72% year to date.
- Cash and cash equivalents were $90.9 million at March 31, 2019, and corporate investments were $49.1 million. Funds held for clients totaled $1.722 billion, matched by client fund obligations.
- Total assets were $2.095 billion and stockholders’ equity was $286.2 million at March 31, 2019.
- The filing does not report outstanding borrowings or debt; principal commitments were operating leases and unconditional purchase obligations totaling $112.7 million.
Material Changes Versus the Prior Comparable Period
- Operating income increased 77% in the quarter and more than doubled for the nine-month period, while total operating expenses rose 17% and 25%, respectively.
- Quarterly net income declined from $39.2 million to $28.0 million despite stronger operating performance, primarily because the prior-year period benefited from an $18.5 million income tax benefit associated largely with the release of valuation allowances. The current quarter included $8.7 million of tax expense.
- Fiscal 2019 year-to-date net income increased from $40.2 million to $43.6 million; the prior-year period also included a substantial tax benefit.
- Sales and marketing, research and development, and general and administrative expenses increased as Paylocity expanded its sales force, development organization and administrative infrastructure.
- Paylocity adopted ASC Topic 606 on July 1, 2018 using the modified retrospective method. The adoption materially increased deferred contract costs and produced a $52.7 million cumulative increase to retained earnings, but management stated that it did not materially affect the timing or amount of revenue recognized overall.
- At March 31, 2019, deferred contract costs totaled $93.5 million, including $73.7 million classified as long term. Remaining performance obligations related to term contracts were approximately $41.0 million, generally recognized over the following 24 months.
- Paylocity repurchased 442,000 shares for $35.0 million during the nine months ended March 31, 2019, completing its authorized repurchase program.
Cash Flow, Liquidity, Outlook and Risks
- Year-to-date operating cash flow increased to $79.2 million from $69.3 million. Investing cash outflow was $74.2 million, including $14.7 million of capitalized software costs and $9.6 million of property and equipment purchases.
- Financing cash flow was $442.9 million, largely reflecting a $496.7 million increase in client fund obligations, offset by share repurchases and taxes paid on equity awards. Client fund movements are not indicative of corporate liquidity.
- Management expects to fund operations, capital expenditures and investments principally from operating cash flow, cash on hand and corporate investments. It believes these resources will be sufficient for at least the next 12 months.
- Management expects continued investment in personnel, product development, data centers and infrastructure, with long-term expectations for economies of scale and improved gross and operating margins. No formal revenue or earnings guidance is provided in the filing text.
- The business is seasonal: the fiscal third quarter typically benefits from W-2 processing, higher client fund balances and increased client additions. Accordingly, third-quarter results may not be representative of full-year performance.
- Key risks include client cancellations because most agreements are terminable on 60 days’ notice or less, competition, execution of rapid growth, service outages and cybersecurity incidents, regulatory and tax changes, dependence on banking and ACH partners, interest-rate and investment risks, and potential client defaults or rejected payroll funding.
- Operating lease obligations totaled $108.4 million at March 31, 2019. The company reported no material off-balance-sheet arrangements and no pending legal matters expected to have a material adverse effect.
- Paylocity expected to adopt the new lease standard, ASC Topic 842, on July 1, 2019, which it expects will add operating lease right-of-use assets and liabilities to the balance sheet.
Investor Verification Points
- Verify that comparisons use the March 31, 2019 fiscal third-quarter filing rather than a calendar 2018 third quarter.
- Separate recurring operating growth from seasonal W-2 activity and interest income earned on client funds.
- Review the impact of ASC 606 on deferred contract costs, implementation revenue, sales commissions, margins and retained earnings.
- Reconcile GAAP results with Adjusted EBITDA and other non-GAAP measures, including stock-based compensation and software amortization.
- Assess corporate liquidity separately from the $1.722 billion of client funds, which is offset by client fund obligations.
- Monitor the effect of tax-rate normalization after the prior-year valuation allowance release.
- Evaluate future operating lease liabilities, capital spending and investments in growth against operating cash flow.