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. This Form 10-Q covers the three and nine months ended March 31, 2014, compared with the corresponding periods ended March 31, 2013. Although the request metadata references “2013 Q3,” the filing is for the third quarter of fiscal 2014. The financial statements are unaudited.
Key financial metrics
| Metric | Three months ended March 31 | Nine months ended March 31 |
|---|---|---|
| Total revenue | $33.8 million, versus $24.0 million | $80.0 million, versus $57.0 million |
| Recurring revenue | $31.2 million, versus $22.3 million | $74.8 million, versus $53.5 million |
| Gross profit | $18.8 million, versus $13.3 million | $40.1 million, versus $28.2 million |
| Gross margin | 56%, versus 55% | 50%, unchanged |
| Operating income (loss) | $2.1 million, versus $2.6 million | $(0.7) million, versus $0.9 million |
| Net income (loss) | $1.2 million, versus $2.0 million | $(0.4) million, versus $1.0 million |
| Adjusted EBITDA | $5.2 million, versus $4.2 million | $5.7 million, versus $5.6 million |
| Net income (loss) per diluted share | $0.01, versus $0.03 | $(0.08), versus $(0.04) |
Recurring fees increased 41% in the quarter and 40% year to date, primarily from new clients and higher revenue per client. Recurring revenue represented 92% of quarterly revenue and 94% of year-to-date revenue. Recurring gross margin improved to 67% from 65% for the quarter and to 63% from 60% year to date. Implementation services and other revenue increased 47% in the quarter and 49% year to date, but implementation gross margins remained negative at (83)% and (143)%, respectively.
Operating expense growth exceeded revenue growth in several areas. Quarterly sales and marketing expense increased 47%, research and development 32%, and general and administrative expense 91%. General and administrative expense included increased staffing, professional fees, public-company preparation costs and higher stock-based compensation.
Cash flow, balance sheet, debt and liquidity
- Cash and cash equivalents were $88.9 million at March 31, 2014, compared with $7.6 million at June 30, 2013.
- Operating cash flow was $8.1 million for the nine months ended March 31, 2014, versus $5.0 million in the prior-year period.
- Capitalized internally developed software costs were $2.9 million and capital expenditures were $5.0 million year to date, compared with $1.1 million and $2.9 million, respectively.
- The March 31, 2014 balance sheet included $541.7 million of funds held for clients and an equal amount of client fund obligations. These restricted client funds materially affect reported investing and financing cash flows and are not available for general corporate use.
- The company completed its IPO in March 2014 and received $82.0 million of net proceeds. It also repaid its remaining debt; no debt was outstanding at March 31, 2014.
- Management stated that cash, cash flow from operations and available liquidity should be sufficient for working capital, capital expenditures and other investments for at least the next 12 months.
- Contractual operating lease obligations totaled $16.3 million, including $3.0 million due within one year.
Material changes versus the prior comparable period
- Revenue increased substantially, but quarterly operating income and net income declined because operating expenses, implementation costs and taxes grew faster than revenue.
- Year-to-date results shifted from operating income of $0.9 million and net income of $1.0 million to an operating loss of $0.7 million and net loss of $0.4 million.
- Stock-based compensation increased to $1.7 million year to date from $0.4 million; total unrecognized compensation cost was $14.7 million at March 31, 2014.
- The company expanded its direct sales force by 28 personnel, added 32 sales lead-generation personnel, and added 23 development personnel.
- The IPO, conversion of all redeemable convertible preferred stock into 11.9 million common shares, and related equity issuance increased total stockholders’ equity from a deficit of $26.6 million at June 30, 2013 to $93.4 million at March 31, 2014.
- The company exercised its right in April 2014 to terminate a reseller agreement and expected to purchase the reseller’s client base in May 2014 for $6.0 million at closing plus an estimated additional $3.0 million within 90 days.
Guidance, outlook, commentary and risks
The filing does not provide formal quantitative revenue or earnings guidance. Management expects to continue investing in sales, implementation, research and development, personnel, data centers and infrastructure. It expects absolute costs to rise, with potential long-term economies of scale and improved gross and operating margins, but cautions that investments may precede related benefits.
Results are seasonal: the March quarter typically benefits from W-2 processing, year-end activity, higher client funds and new client implementations. Management cautions that quarterly results are not necessarily indicative of full-year or future performance.
- Clients generally may terminate agreements with 60 days or less notice, creating retention and revenue-visibility risk.
- Implementation costs exceed implementation revenue in the near term, and unsuccessful implementations or client cancellations could pressure margins and cash flow.
- Interest income on client funds is exposed to declining interest rates; client funds also carry market, credit, liquidity and custodial risks.
- Payroll processing requires sufficient ACH and banking capacity and may require the company to advance funds if client payments fail to settle.
- Key risks include competition, rapid technological change, cybersecurity and data breaches, service outages, software defects, regulatory and tax changes, hiring and retention challenges, and difficulty managing rapid growth.
- The company reports no material pending legal proceedings and no material off-balance-sheet arrangements.
- A principal stockholder agreed in May 2014 to contribute approximately $1.1 million to fund a cash bonus for long-term employees; the company expected to record the contribution to additional paid-in capital and the bonus as compensation expense in the quarter ending June 30, 2014.
Most important facts for investors to verify
- Whether recurring revenue growth can continue while sales, implementation, infrastructure and public-company costs grow rapidly.
- Whether recurring gross-margin improvement offsets persistently negative implementation margins and rising operating expenses.
- The conversion of strong reported cash balances into usable corporate liquidity, excluding restricted client funds.
- The timing, accounting treatment and strategic impact of the planned reseller client-base purchase and its total potential $9.0 million payment.
- The effect of seasonality, interest rates and client employment levels on revenue and client-fund interest income.
- The magnitude and timing of future stock-based compensation, option dilution and public-company compliance costs.
- Whether the company can achieve sustained profitability; the filing specifically states that it may continue to incur losses for the foreseeable future.