Paylocity Holding Corp (PCTY) Q2 2021 Earnings Call Transcript

Good afternoon, and welcome to Paylocity's earnings results call for the second quarter of fiscal year 2021, which ended on December 31, 2020. I'm Ryan Glenn, Vice President of FP&A and Investor Relations, and joining me on the call today is Steve Beauchamp, CEO of Paylocity; and Toby Williams, CFO of Paylocity. Today, we will be discussing the results announced in our press release issued after the market closed. A webcast replay of this call will be available for the next 45 days on our website under the Investor Relations tab. Before beginning, we must caution you that today's remarks, including statements made during the question-and-answer session, contain forward-looking statements. These statements are subject to numerous important factors, risks, and uncertainties, which could cause actual results to differ from the results implied by these or other forward-looking statements. Also, these statements are based solely on the present information and are subject to risks and uncertainties that can cause actual results to differ materially from those projected in the forward-looking statements. For additional information, please refer to our filings with the Securities and Exchange Commission for the risk factors contained therein and other disclosures. We do not undertake any duty to update any forward-looking statements. Also, during the course of today's call, we will refer to certain non-GAAP financial measures. We believe that non-GAAP measures are more representative of how we internally measure the business, and there's a reconciliation schedule detailing these results currently available in our press release, which is located on our website at paylocity.com under the Investor Relations tab and filed with the Securities and Exchange Commission. Please note that we are unable to reconcile any forward-looking non-GAAP financial measures to the directly comparable GAAP financial measures because the information, which is needed to complete a reconciliation is unavailable at this time without unreasonable effort. In regard to our upcoming conference schedule, Toby and I will attend the KeyBanc Emerging Tech Conference on February 25, and Steve and Toby will attend the 2021 JMP Technology Conference on March 1 and Toby and I will attend the Raymond James Institutional Investors Conference on March 2. Please let me know if you'd like to schedule time with us at any of these events.

Thank you, Ryan, and thanks to all of you for joining us on our second quarter fiscal 2021 earnings call. Our solid results continued in the second quarter of fiscal 2021 with second quarter total revenue, $146.3 million, an increase of 10.5% versus the same quarter last fiscal year, and coming in $3.3 million above the midpoint of our guidance, despite continued COVID related headwinds. Recurring and other revenue grew by 13.6% and we continue to be pleased with our sales performance across our entire market amidst a still challenging macroeconomic environment with the resurgence of COVID cases and as many states ramped up mitigation efforts through Q2. Despite these COVID related headwinds, we still had a strong selling season and are pleased to have started more business this January than last January. As mentioned on our November call, our sales teams have successfully pivoted to a virtual selling environment and continue to realize the benefits of improved website performance and digital lead generation, use of video throughout the sales cycle, as well as increased multimedia connection points with prospects, including podcasts and webinars. The accelerated investments we've made through the pandemic in digital marketing efforts include enhancing our website capabilities, increased focus on search engine optimization and prospect nurturing campaigns will all continue to serve us well as macroeconomic conditions normalize. Similar to last year, we continue to see unit strength coming from clients with under 50 employees, as well as healthy momentum in the core and upper end of our market, which was a year-over-year total client growth of 19.5% through Q2. Channel referrals, primarily from benefit brokers and financial advisors once again represented more than 25% of new business in Q2 led by increased use of virtual broker connection activities, events, and virtual gatherings that helped us maintain strong channel referral levels. Adjusted EBITDA for the second quarter was $35 million or 23.9% margin, which exceeded the midpoint of our guidance by $7 million. We are pleased with our ability to be efficient with our operational and G&A costs while we remain focused on incremental investments in research and development and sales and marketing initiatives in fiscal 2021 to continue our momentum in product and sales and to position us for driving future growth once we return to a more normalized macroeconomic environment.

Thanks, Steve. Total revenue for Q2 was $146.3 million, an increase of 10.5%, recurring and other revenues up 13.6% from the same period last year. As Steve noted, we were pleased to come in $3.3 million above the midpoint of our guidance despite the continuing COVID-19 related headwinds. Our adjusted gross profit was 68.8% for Q2 with continued pressure from both COVID-19 and interstate related headwinds. We continue to make significant investments in research and development, and to understand our overall investment in R&D, it is important to combine both what we expense and what we capitalize. On a combined non-GAAP basis total R&D investments were 15.9% of revenue in Q2 and on a dollar basis our year-over-year investment in total R&D increased by 22.3%. On a non-GAAP basis sales and marketing expenses were 23.1% of revenue in Q2, as we remain focused on making incremental go-to-market investments in fiscal 2021. On a non-GAAP basis, G&A costs were 13.4% of revenue versus 14.9% in Q2 of last fiscal year, and we remain focused on consistently leveraging our G&A expenses on an annual basis. Our adjusted EBITDA was $35 million or 23.9% of revenue for the quarter, which exceeded our guidance by $7 million at the midpoint. We remain committed to progressing towards our adjusted EBITDA target of 30% to 35% of revenue once we returned to a normalized macroeconomic environment. Covering our GAAP results for the quarter, gross profit was $1.8 million, operating income was $6.4 million and net income was $9.6 million. In regard to the balance sheet; we ended the quarter with cash, cash equivalents and invested corporate cash of $232.3 million. We're pleased with our performance in Q2, which included another strong quarter for our sales team, helping us beat the top end of our revenue guidance. From a cost perspective, we remain focused on incremental investments to drive growth, while also identifying opportunities to demonstrate scale and G&A costs and we're happy with the progress we've made to that end in Q2. In regard to client held funds and interest income. Our average daily balance of client funds was $1.5 billion in Q2. We're estimating the average daily balance will be approximately $1.8 billion in Q3 and we assume an average yield of approximately 5 basis points to 10 basis points in the third quarter. Before reviewing guidance, I would like to provide some additional context on the current operating environment. As Steve mentioned, we continue to be pleased with the performance of our sales fiscal year and this past quarter. We are also pleased with the performance of our operational teams as we started more business this January than last year in the face of a still challenging COVID environment and our service teams continue to help clients navigate new legislation.

Hi gentlemen. Congrats on the results and thanks for taking the question. So first off, just higher level from COVID, in terms of the go-to-market and it sounds like this is a really strong onboarding quarter. What lessons would you say that you've learned in terms of selling and onboarding customers? I'm just curious if there's any to learn from that going forward and how you guys are relating to your customers?

Yes, sure. I think as we said in the prepared remarks, we've been pretty happy with how resilient the sales team has been. Obviously there's a lot of industries in the market that are affected by COVID and the shutdowns. It is a huge market for us and so the sales team, I think, has pivoted really well to focus on those industries that are less affected, and then be able to deliver very similar growth to what we had last year through the first six months of the year. And so I think the lessons learned are that you can do a little bit more virtually than maybe we would have done before, and they've done a great job really managing the whole sales process in a virtual fashion, keeping people engaged and interested. And I think that we will get back to a time where there'll be face-to-face with customers again, but we'll be able to leverage this experience that we've learned virtually to be able to sell, and maybe a little bit more of a hybrid world post-pandemic.

Thanks, Steve. And maybe just another one, when you think about the new customers that are coming to the platform, has that changed over the last couple of quarters? I'm just curious if this displacement Greenfield, I'm just curious what you're seeing here in terms of the new customers added?

No, I don't think a lot has changed. I think you probably feel a little bit less customers from the industries that are impacted the most just because they've got other bigger priorities in front of them, although you definitely still see some customers from those industries like hospitality, making the move. We were very automated in terms of how we interacted with customers prior to the pandemic. So everything was being done remotely. Our implementation specialists didn't typically spend much time on site. We have remote tools that we interacted with clients. We trained them that way, and so I think all of that has been relatively seamless. I think the last comment I would make is there was just sometimes there's a little bit more disruption on the client side. And so, we've had to do some extra work for them at times to get them up and running and really making sure that clients are starting on time. There's a little bit more delays because of COVID and that might just because the person on the other end might have personal issues or their business might be more impacted. And so we've seen in places where there's a little bit delay in starts, but we're still able to get all those customers started and do that very efficiently.

Hey, Steven, Toby and Ryan. Good quarter. Thanks for taking questions. I guess we got two here, Steve. I know we've talked over the last six months or so, it was certainly highlighted at your fall customer conference about engagement in your platform increasing as the Paylocity platform has kind of been a central communication hub. I guess, as you look back over the last nine to 12 months since the pandemic; are you seeing that engagement alter or make changes to what your customer retention rates are today?

Yes. That's a great question. We continue to have over 92% customer retention, and I'm really proud of the job our team has done, staying engaged with our customers through this difficult time with a bunch of changes in legislation, a ton of questions from our customers. And we're really happy with where we sit from an overall client retention perspective. So I don't think we've necessarily seen that move that needle meaningfully. But what we have seen though during the pandemic is customers start to use more of the features that we've delivered to them, particularly more of these modern features such as community, as you mentioned, and then add-on the video capabilities on top of that. And so we see also other leaders within the organization start to use some of these capabilities. So rather than just the HR team, you might see their C level folks actually using our announcement capability and our video capability or managers of their teams interacting in groups. And so it's been really interesting to see the types of activity we see on our platform, expand over a lot last calendar year.

Got it, and helpful. And then I guess from a follow-up question perspective, you obviously serve a customer base that's relatively wide at the end of the day. Customers may be as low as 20 employees, I don't maybe have a few that are smaller than that, but certainly the customers that have 500,000 or maybe more than 1,000 employees, I guess, as you look at that kind of span, is there a segment or two that you've seen drive maybe better net new customer additions over the last quarter or two. We think the trends are pretty strong across the space in general, but I just didn't know if one of those segments you would call out maybe particular having better strength?

I think the interesting thing is, if you look at the unit growth and that's one of the reasons we want to provide that data is pretty consistent with where we were last year and we're getting customers in call it the under 50 market at fairly similar rates, from a growth perspective, the core market's been strong for us, kind of that 50 to 500 space. And then last year I called it the fact that we were doing a little bit better than we had previously in that 500 plus space. And I think that has kind of continued so well. I really feel good about the salesforces that we're seeing, really resilience across the board and that we're actually onboarding a very similar number of customers from a growth perspective than we were last year.

Yes. Gentlemen, can you hear me okay?

Yes, we can.

I'm just curious, Steve, maybe big picture question. I mean, same page is interesting because it kind of – you're delving into potentially every desktop, potentially usage all day long. Collaborate work management is a pretty broad market. What are the conversations like? Are you like, hey, you need to modernize your core HR and your payroll. And so we did help you with that. Oh, by the way, look at this same page thing. I'm not trying to sound flippant or anything, but I'm kind of about the same page because it actually does kind of get you into another potentially interesting, almost stand-alone market. And then I have a follow-up.

Sure. Well, I think the example I would give you is when we first launched community, one of the things that we thought our customers were asking for was the ability to really manage announcements because the reality is different parts of their organization might be using different tools. And so the HR team wanted to be able to make sure they were giving benefit updates, they're announcing policy changes and they were reaching all of the employees and making sure they get that notification on their phone and get the analytics behind that. And so that really drove us to actually create community because we felt like this announcement capability is going to be at the core of it. That is exactly what we saw in terms of utilization. The interesting thing we saw then was people wanted to actually include links to YouTube videos. They wanted to include additional content. They saw employees reacting sometimes with emojis, sometimes with comments. And so that kind of led us to believe, video could play a bigger role here, not just in announcements, but in broader community across the platform, because the HR teams really started to use it for communication. And then the reason I give you that background is we introduced groups and the idea behind a group is it could be your team. It could be a group of people working on a project. It could be just a group of people with a common interest in it could just be fun. And we started to see increased utilization there. And within those groups, we started to see people asking for collaboration opportunities. And so that's what led us to look at same page capabilities and bring them into the full, could really enhance groups in collaboration capabilities. And the reality is the way we develop product is we listen and we learn in terms of how our customers use it. And then we just continue to add features based on their demand. And I see that when we get to the point that we launch collaboration capabilities on top of community, within groups, we're going to learn how our customers use it and we're going to continue to expand on it. And that's always been our product philosophy.

Got it, understood. And I guess my follow-up is, you're talking about digital marketing and it's fascinating through this pandemic on B2B selling and how it's evolving and it's really – there's a lot of innovation going on, but I'm curious from yours perspective, you have been using probably plenty of digital marketing tools in the past, but in terms of refining and making new investments, where are you seeing some kind of payoffs or some observations, whether it's – it's driving more of that sub-50 or it's driving more traffic altogether. And just – is there anything to be said maybe about – maybe the cycle time speeds up with more automation? Just any kind of takeaways or observation so far?

Yes. So I think fortunately we had done a pretty good investment in terms of our new website and some of the branding that we launched really last spring. And we were able to leverage some of those capabilities to put more muscle behind our digital efforts. What I would say is you need a bunch of variety of content, right? So we've got podcasts available people, we've done seminars and webinars on legislation changes. We've done seminars and webinars on social movements that you see in the industry. And so you've really got to be able to connect to the topics that are real-world and top of mind, and you've got to do it in a variety of channels, eBooks, email marketing, all mediums. And so I think that's something that we've expanded a fair amount through COVID. It's really – we've benefited from the lead generation, that's come from it. And then once you get that lead in and you're working with that customer, you've got to find other ways to stay connected during the sales process. And I think probably one of the bigger surprises for us is we've used a lot of asynchronous video where we're recording videos, demo or after an initial meeting with our client. And we actually use our own video platform to be able to do that. And that I think is really helped create momentum and keep that sales cycle moving, which, as you know, for us – for average size customer, still 30 days to 60 days, it still happens fairly quickly. And so we've become adept at using all of those tools probably faster than we would have if it wasn't for the environment around us.

Thanks, solid job.

Thank you.

Great. Thanks very much, Steve, as you're talking to existing customers, any sense what they're waiting for to start adding back employees? What types of things they're looking at?

Yes. What I would tell you when we look at the data, right, because we've got a lot of customers and we examine, where customers are significantly different in terms of whether it's the number of W-2s they produce, which we called out impact of that. Because they've hired less all the way throughout the year, or they're just at a lower employment level, you will find those ineffective industries, right? You find those in hospitality. You find those in retail. You find those in all the places that you would expect, and they're ultimately in many cases fighting different types of restrictions that make it very difficult for their business to operate. And so, I think we feel optimistic that as the vaccine rollout continues to gain momentum and that businesses are allowed to open at capacity levels that were consistent with prior, then we'll start to see the benefit from that, but that's largely the message. We don't usually hear from clients saying I'm waiting for something to do a whole bunch of hiring. I'm waiting for my environment to change around me and the customers to come back, and then I'm going to back that up with the hiring I need.

Hey, guys. Thanks for taking my question. Just one for me. Wanted to ask about the current COVID relief bill that was passed under the Trump administration; you discussed that a bit and the functionality that you've added for that? And then obviously there's another one here potentially going to be passed under the Biden administration; but how does that impact you from a business perspective? Does it help drive new business? Do you see additional inbound when these kinds of bills get passed or is there additional revenue for you associated with that at all?

So I think generally speaking, legislative change is fairly challenging for the market that we serve to be able to manage, absorb and understand. And so you saw that all the way back to ACA and through the most recent legislative changes. So we need to be there for our customers, with content. We need to be – they usually call us and ask us more questions or email us and ask us more questions. And so we've got to do a lot of training when that happens. I think that's probably the place what's the biggest impact is to do a really good job for your customers. So they understand it. Because in this case, they have to make choices in terms of what they're going to do in reaction to that bill, particularly the first iteration of the bill. And so that's something that we spend a lot of time on. I wouldn't tell you that it's different. I think ACA did have a bit of a tailwind into the market when you go back several years ago. I'm not sure that that's the case with what we're seeing right now. This has been enacted so quickly that everyone just has to go into reactive mode. Whereas something like ACA, you had a long time to prepare for it. You had to think about how you're going to manage it. This is happening so quickly that I don't see a demand creation, but just really an opportunity to show your customers how much you can help them.

Great. Thanks guys.

Hi, this is actually Jared Levine on for Bryan. I have two for you. So the first, how did the booking momentum progress in the quarter following the record sales month in October?

Yes. So, I think overall we've sold more than last year. Now, last year, we were on a very strong pace. Prior to the pandemic, we were growing new bookings kind of 40% year-over-year. We're definitely not at that type of pace. We are still selling more than we did last year. So in some ways you do kind of set records when you're selling more than you do last year. So that momentum has actually continued. Year-end is really important to us, right? So we start more business in January than any other month. And then the several months prior to that is kind of our selling season and we were pretty happy with the volume of customers that we were able to onboard. And you kind of see that through the first two quarters with nearly 20% unit growth and that momentum continued through selling season.

Got it. And then in terms of the new unit strength in the sub-50 employee space that you noted, was there a skew towards that more emerging markets of sub-20 employees, or was it pretty balanced between the sub-20 and then 20 to 50 in terms of new units?

No. What I would tell you is, I don't think that the size of the customers has meaningfully changed that we've been bringing on. So that mix has been fairly consistent. Now admittedly, the market as a whole has less employees, right? So there's an employment impact to both your current clients and the customers that you're bringing on. But other than that, we've been focused on the same size customers, and we've been having success from 20 all the way to 2,000.

Good afternoon and congrats on the number of new unit wins considering the environment. I'm just wondering just to be 100% clear, so when we talk about a 19% increase in terms of the number of units that were brought on. Is that across the board, in other words was it primarily skewed by the below 50? Or was it across the board in terms of being close to 19%? I just wasn't 100% around that?

Yes. So to be clear, through the second quarter, the number of clients that we have on the platform, total clients was up 19.5% year-over-year. So that's driven a mix of adding new customers and losses and ending count as the end of December was up 19.5%. And I think to just answer your question specifically; it is not skewed to any of the markets that we serve. It's really kind of across the board, a very similar mix to last fiscal year.

Great. And then can you talk a little bit about the source of the clients, just in terms of ADP and Paychex versus some regional players versus do-it-yourself? Just what do you see from that perspective?

Yes. Obviously, we look at that information. And what I would say is nothing stands out in terms of being an anomaly versus prior years, fairly consistent.

Yes. Hey Mark, it's Toby. I mean, I think there's – you hit on the key elements. So one of our consistent themes throughout the year has been that we would continue to invest in the business all the way through, but specifically in sales and marketing investments that we would continue to drive growth. And from – I think particularly from sales and marketing standpoint, we would have said, pretty consistently through, sorry, at the end of last year. And through this year that in the back half of this year, we would continue to drive those types of investments. And I think that's our intention. And so that is definitely part of the EBITDA equation in the back half of the year. But I think specific to your question on W-2s, I mean, obviously for everybody in the industry, that's included W-2 revenue is fairly high margin. And so you feel the impact of that – you would feel the impact of that anyways from revenue standpoint. I think you feel a little bit of an outsized impact because of the type of revenue that represents. So, I mean, I think that – and so I think that has a probably a little bit heavier impact than just the normal course investments that we would have been calling out pretty consistently.

Thanks for the explanation. Appreciate it.

Sure. Thank you. And our next question comes from Samad Samana with Jefferies. Your line is open.

Hi. This is Jordan Boretz on for Samad. Thank you for taking my question and congrats on the quarter. So a question on the competitive environment. You previously called out that bookings trend amid startups is really strong with record new business formation. Do you think any of your competitors down market whether public or private become more aggressive around pricing or promos to capture share within that segment?

Sure. So when we talk about the lower end of the segment, the under 50, what I would tell you is not many of those are necessarily brand new businesses or startups. So we generally see businesses that they don't have to be super mature, but we don't necessarily get a lot of startup business because we don't really focus in that under 10 markets. So but we do pick them up kind of as they're growing and that has been pretty strong for us in that under 50 market. In terms of competitive environment, I wouldn't say there are either new competitors or very different kind of pricing models that we're seeing in the marketplace. I think it's everyone feels a little bit of the COVID headwind just from the macroeconomic environment, but at the end of the day, when someone is buying our platform and they pay us maybe a little more than $20,000 a year, these are not big payments for those customers relative to the size of their business. And so this isn't necessarily the place where you're going to save a lot of dollars and it's pretty important that they have something that allows them to save the time and connect with all their employees. And it ends up being much more of a product and service conversation than a pricing conversation.

Got it. Thank you.

Hi, great. Thanks for taking my question. On Premium Video, how has demand been out of the gate relative to some other launches recently like surveys and LMS?

Yes. So what I would tell you is it's been pretty similar to some of the other products, I think like LMS and recruiting are well-known HCM modules that people will buy, those both accelerated fairly quickly for us. And then newer products like surveys even looking at utilization on community and Video Premium, those are newer concepts for the market as a whole. And so, they typically can take a little bit longer to drive the penetration, but in the backdrop of COVID and everybody used to spending time on Zoom and understanding the importance of video, I mean, we've been really happy with the uptake for our January starts.

Yes. Yes. It’s a good question, Daniel. I think there is some sense of a little bit of both. I mean, I think when you start to lap the compares, and as we look at our next fiscal year planning, we've talked about the ability to – and you see some of this, I think, even in the implied guidance for Q4 and we said that in the prepared remarks around the implied revenue growth rate. I mean you start to see getting back that that getting EBITDA leverage trajectory that we would have been on pre-pandemic. But I think we've also said you're not going to snap back to unless and until you see some of the employees on the platform come back in a real way, which to date we just – we haven't seen. And so I think both of those dynamics are very real in terms of how you think about the rest of this fiscal year and then as you turn over into fiscal 2022.

Okay. Thanks. And then last quick one on clarification on the guidance, what do you have in terms of macroeconomic change like stable employment base on the platform or any sort of improvements?

No, it's stable. I mean, I think we called out pretty specifically in their prepared remarks, you've seen on a month by month basis, there has not been a consistent trend. You'll have one month step forward, you'll take a small step back. And so, we have seen certainly mild improvements from the depths of the pandemic, but in terms of our guidance for the rest of the fiscal year, we're not assuming any improvement to what we've seen so far this year. Great. I'd like to thank all of you for your interest in Paylocity today, and just take a quick moment to thank all of our employees. This is definitely the busiest time of the year for us. And we've had a very busy January season and the employees are really gone above and beyond to be there for our customers. So thank you everybody.

Ladies and gentlemen, this concludes today's conference call. You may now disconnect. Everyone have a wonderful day.