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. The filing covers the three months ended September 30, 2019, the first quarter of fiscal 2020, and compares results with the three months ended September 30, 2018. Financial statement amounts are in thousands, except per-share data.
Key financial metrics
| Metric | Q1 FY2020 | Q1 FY2019 | Change |
|---|---|---|---|
| Total revenue | $126.7 million | $100.5 million | +26% |
| Recurring and other revenue | $121.9 million | $97.0 million | +26% |
| Interest income on client funds | $4.8 million | $3.5 million | +38% |
| Gross profit | $84.1 million | $64.6 million | +30% |
| Gross margin | 66% | 64% | +2 percentage points |
| Operating income | $6.0 million | $3.8 million | +59% |
| Operating margin | 4.7% | 3.8% | Improved |
| Net income | $13.9 million | $9.9 million | +41% |
| Basic/diluted EPS | $0.26/$0.25 | $0.19/$0.18 | Increased |
| Adjusted EBITDA | $30.5 million | $23.3 million | +31% |
| Net cash from operating activities | $8.3 million | $7.3 million | +13% |
Recurring and other revenue represented 96% of total revenue in both periods. Adjusted gross profit was $90.3 million versus $70.4 million, while adjusted EBITDA margin was approximately 24.0% versus 23.1%.
At September 30, 2019, cash and cash equivalents were $100.5 million and corporate investments were $29.1 million. Funds held for clients were $1.15 billion, matched by client fund obligations, and should not be viewed as unrestricted corporate liquidity. Total stockholders’ equity was $309.5 million.
Debt, liquidity and cash flow
- In July 2019, Paylocity entered into a five-year senior secured revolving credit facility with borrowing capacity of $250 million, expandable to $375 million subject to conditions. No amounts were drawn at September 30, 2019.
- The facility includes leverage and interest-coverage covenants. Management reported compliance with all covenants at quarter-end.
- Net cash used in investing activities was $33.2 million, including $8.0 million of property and equipment purchases and $6.7 million of capitalized internal-use software costs.
- Net cash used in financing activities was $265.4 million, primarily reflecting a $239.9 million net change in client fund obligations and $24.7 million of tax payments related to net share settlements. No share repurchases occurred in the quarter.
- Management stated that cash, corporate investments and operating cash flow should be sufficient for working capital, capital expenditures and other requirements for at least the next 12 months.
Material changes versus the prior comparable period
- Revenue growth accelerated profitability: gross margin increased from 64% to 66%, and operating margin increased from approximately 3.8% to 4.7%.
- Sales and marketing expense increased 40% to $37.0 million as the sales organization expanded; stock-based compensation also increased.
- Research and development expense increased 26% to $14.4 million, while capitalized development costs increased to $6.6 million.
- General and administrative expense increased 16% to $26.7 million, including approximately $1.0 million of nonrecurring litigation, lease-exit and transaction costs and $1.0 million of additional occupancy costs.
- Stock-based compensation expense increased to $12.1 million from $9.4 million.
- Paylocity adopted ASC Topic 842 on July 1, 2019. The adoption added $50.9 million of operating lease right-of-use assets and $84.1 million of operating lease liabilities at September 30, 2019, without an impact on net income or cash flow for the quarter.
- The company’s effective tax rate was negative 114.8%, compared with negative 143.6% in the prior-year quarter, primarily because of excess tax benefits from employee stock-based compensation. The unusually large tax benefit materially increased net income relative to pretax income.
Guidance, outlook, commentary, risks and unusual items
The filing does not provide specific numerical revenue, earnings or margin guidance. Management expects to continue investing in sales and marketing, research and development, personnel, data centers and infrastructure, with potential long-term operating leverage and margin improvement as the client base grows.
- Remaining performance obligations related to minimum monthly fees under term contracts were approximately $43.1 million at September 30, 2019, generally recognized over the following 24 months.
- Most customer agreements are cancellable on 60 days’ notice or less, creating renewal and retention risk. Term agreements are generally two years.
- The business is seasonal, with stronger activity and revenue typically in the fiscal third quarter ending March 31 due to year-end payroll and W-2 processing.
- Key risks include competition, execution of rapid growth, sales-force productivity, service outages, cybersecurity and privacy incidents, software defects, regulatory changes affecting payroll and benefits, and the ability to maintain banking and ACH relationships.
- Because Paylocity advances payroll and tax payments before client funds fully settle, rejected or reversed client payments could create short-term liquidity needs.
- A former employee filed a class and collective action complaint alleging misclassification of certain salaried employees and seeking overtime and other damages. Management does not currently expect a material impact, but litigation outcomes remain uncertain.
- Available-for-sale securities had $8 thousand of gross unrealized losses at quarter-end; no other-than-temporary impairment was recorded.
Most important facts for investors to verify
- Whether 26% revenue growth and the 66% gross margin are sustained as sales, service and infrastructure investments continue.
- The extent to which the negative effective tax rate and excess stock-compensation tax benefits affect comparability of net income and EPS.
- Operating cash flow conversion relative to adjusted EBITDA, including the effects of deferred contract costs, stock compensation and client-fund timing.
- Growth in stock-based compensation, unrecognized RSU expense of approximately $79.3 million, and potential future dilution.
- Liquidity requirements associated with payroll settlement, ACH reversals, client-fund custody and the company’s $104.2 million of undiscounted operating lease obligations.
- Progress and costs associated with the company’s expansion of sales, research and development, implementation capacity and data-center infrastructure.
- Developments in the employee misclassification litigation and any cybersecurity, privacy, regulatory or service-continuity events.