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 through a SaaS platform. This unaudited Form 10-Q covers the three months ended September 30, 2015, the first quarter of fiscal 2016, with comparison to the three months ended September 30, 2014.
Key Financial Metrics
| Metric | Q1 FY2016 | Q1 FY2015 | Change |
|---|---|---|---|
| Total revenue | $45.1 million | $31.1 million | +45% |
| Recurring revenue | $42.9 million | $29.5 million | +45% |
| Implementation and other revenue | $2.2 million | $1.6 million | +38% |
| Gross profit | $24.9 million | $15.7 million | +59% |
| Gross margin | 55% | 50% | +5 percentage points |
| Operating loss | $(3.4) million | $(4.9) million | Improved by $1.5 million |
| Net loss | $(3.4) million | $(4.9) million | Improved by $1.4 million |
| Net loss per diluted share | $(0.07) | $(0.10) | Improved |
| Adjusted EBITDA | $3.3 million | $0.4 million | Improved by $2.9 million |
| Operating cash flow | $3.0 million | $(0.2) million | Improved by $3.2 million |
Recurring revenue represented 95% of total revenue in both periods. Recurring gross margin increased to 69% from 66%, primarily because of lower reseller expenses following the acquisition of substantially all assets of the remaining reseller during fiscal 2015. Implementation services remained unprofitable, with an implementation gross margin of negative 217% compared with negative 236%.
At September 30, 2015, cash and cash equivalents were $78.7 million, compared with $81.3 million at June 30, 2015. Funds held for clients were $542.6 million, matched by client fund obligations of the same amount. The filing does not report outstanding borrowings or a debt balance. Total stockholders’ equity was $106.4 million, and accumulated deficit was $51.6 million.
Material Changes Versus the Prior Comparable Period
- Recurring fees increased 45% to $42.4 million, driven by new clients and higher revenue per client.
- Interest income on client funds increased 45% to $0.5 million, primarily because of higher average client fund balances; historically low interest rates continued to constrain this income source.
- Cost of recurring revenue grew 31%, slower than recurring revenue growth, raising recurring gross margin to 69%.
- Sales and marketing expense increased 37% to $12.5 million, reflecting expansion of the sales force and additional lead-generation and marketing personnel.
- Research and development expense increased 35% to $5.4 million, while capitalized internal-use software costs increased to $2.0 million from $0.9 million.
- General and administrative expense increased 40% to $10.5 million, including higher personnel, stock-based compensation, occupancy and secondary-offering costs.
- Stock-based compensation increased to $3.7 million from $3.3 million and was a significant adjustment in the company’s non-GAAP Adjusted EBITDA reconciliation.
- Operating cash flow improved to $3.0 million. Capitalized software costs were $2.0 million and purchases of property and equipment were $1.6 million.
Liquidity, Outlook, Risks and Unusual Items
Management stated that cash and cash flow from operations are expected to be sufficient to fund working capital, capital expenditures and other investments for at least the next 12 months. The company expects continued investment in personnel, its platform, data centers and infrastructure, with costs likely to increase in absolute dollars. Management expects scale economies and operating leverage to improve gross and operating margins over the long term, but provided no quantitative revenue or earnings guidance.
Client funds are restricted for repayment of client fund obligations, and period-to-period cash flow is significantly affected by payroll timing. Excluding changes in client funds, investing cash use was $3.8 million in the quarter. Contractual obligations totaled $34.7 million, including $31.6 million of operating lease obligations, $2.8 million of unconditional purchase obligations and $0.3 million of acquisition consideration.
The company completed a secondary offering on September 30, 2015 in which existing shareholders sold 4.3 million shares at $29.75 per share. Paylocity received no proceeds. The underwriters subsequently exercised an option to purchase an additional 0.6 million shares in October 2015, also without proceeds to the company.
Key risks include continuing losses, execution and infrastructure risks associated with rapid growth, short client termination periods of 60 days or less, intense competition, cybersecurity and data privacy exposure, service interruptions, dependence on banks and ACH processing, client payment failures, interest-rate sensitivity on client funds, regulatory and tax changes, and the need to attract qualified personnel. The company reported no material pending legal proceedings, no material off-balance-sheet arrangements and effective disclosure controls as of September 30, 2015.
The company was assessing the impact and adoption method for the then-new revenue recognition standard, ASU 2014-09. It also maintained a valuation allowance against the preponderance of its net deferred tax assets, limiting the benefit of tax losses.
Facts Investors Should Verify
- Whether recurring revenue growth and recurring gross-margin expansion continue as sales and implementation investments increase.
- The sustainability of positive operating cash flow after excluding movements in restricted client funds.
- The effect of stock-based compensation, capitalized software costs and other adjustments on reported versus Adjusted EBITDA.
- Client retention, new-client additions and implementation capacity, given generally cancellable contracts and negative implementation margins.
- Exposure to cybersecurity incidents, service outages, ACH or bank disruptions, client payment reversals and potential liquidity needs.
- The company’s path to GAAP profitability, including the timing and scale of sales, research and development, infrastructure and public-company expenses.
- The eventual impact and adoption method of ASU 2014-09 on revenue recognition and disclosures.