Paylocity Holding Corp Q3 FY2021 Earnings Call

Ladies and gentlemen, thank you for standing by and welcome to Paylocity's Q3 FY 2021 Earnings Conference Call. I would now like to hand the conference over to Ryan Glenn, Vice President of FP&A and Investor Relations. Please go ahead.

Good afternoon, and welcome to Paylocity's earnings results call for the third quarter of fiscal year 2021, which ended on March 31, 2021. 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.

Thank you, Ryan, and thanks to all of you for joining us on our third quarter fiscal '21 earnings call. Our solid results continued in the third quarter of fiscal '21 with a total revenue of $186.1 million, an increase of 8.4% versus the same quarter last year despite continued COVID-related headwinds.

Thanks, Steve. Total revenue for Q3 was $186.1 million, an increase of 8.4%, with recurring and other revenues up 10.7% from the same period last year. Our adjusted gross profit was 73.5% for Q3, with continued pressure from both COVID-19 and interest rate-related headwinds. We continue to make significant investments in research and development. To understand our overall investment in R&D, it is important to combine what we expense and what we capitalize. On a combined non-GAAP basis, total R&D investments were $22.4 million or 12% of revenue in Q3. On a non-GAAP basis, sales and marketing expenses were 19.4% of revenue in Q3 as we remain focused on making incremental go-to-market investments in fiscal '21 and fiscal '22. On a non-GAAP basis, G&A costs were 11.9% of revenue in Q3 versus 10.7% in Q3 of last fiscal year. We remain focused on consistently leveraging our G&A expenses annually. Our adjusted EBITDA was $66.9 million or 36% of revenue for the quarter, which exceeded our guidance by $6.4 million at the midpoint. We remain committed to progressing toward our adjusted EBITDA target of 30% to 35% of revenue once we return to a normalized macroeconomic environment. Covering our GAAP results, for the quarter, gross profit was $128.7 million, operating income was $39.1 million, and net income was $36.8 million. In regard to the balance sheet, we ended the quarter with cash, cash equivalents, and invested corporate cash of $182.3 million, and we fully repaid the $100 million drawdown on our revolving credit facility during the quarter. We're pleased with our performance in Q3, which included another strong quarter for our sales team while also identifying opportunities to demonstrate scale and operational and G&A costs, and we're happy with the progress we've made to that end in Q3.

Thank you. Our first question comes from Scott Berg of Needham. Your line is open.

Hey, Steve, Toby, Ryan, congrats on a good quarter and thanks for taking the questions here. I guess I had a couple here. Steven, on the second-quarter call, you commented on how your customer additions were in line with the additions that the company saw in the back half of '19 for that six-month period. I didn't hear you comment on that metric here on the call, but how should we think about the pace of adds? Were you able to kind of sustain that rate, which I think was up 19.5% roughly year-over-year? Or was there a meaningful change one way or the other to customer additions?

Yeah, Scott. I think being the midpoint of the fiscal year, we wanted to give some color on that, knowing that we had just kind of made it through the January selling season. The fact that we didn't call it out this year or this quarter was not because we'd seen a change. More it's really continued. We've had really strong unit growth through the first half of the year, and that ran continued momentum in the quarter.

Got it. And then, Steve, one of your comments was about the strength of your sales on the upper end of your target customer segment. Can you point to a factor or two that might be driving better sales there? I assume that means slightly improved win rates, but is there something about the platform or the service that is really resonating well with customers right now?

Sure. I think the investments we've made in product, both in terms of modules that we've added, but also some of the innovations that we've added to the platform with products like Community and the addition of Premium Video, we feel like that's really resonating in the marketplace with the COVID backdrop and the fact that so many employees are working remotely. In many cases, some of the larger clients still have enough resources where they're still out there evaluating HCM platforms and looking at it. So I think it's a combination of the market on the upper end being probably a little bit more robust in terms of the earlier recovery, but more important than that is the fact that our product investments are really resonating.

Got it. And then I'll sneak a quick one in for Toby. Toby, your R&D expense in the quarter is actually down sequentially from Q2, and you didn't spend any more on the capitalized R&D necessarily in the quarter. Any reason for that dynamic? That typically doesn't happen seasonally for you.

No. I think you're seeing some timing things from a quarter-to-quarter, year-over-year perspective, Scott. What we've said pretty consistently is throughout this fiscal year, and I think this will also be true in the back half and in the last quarter, we'll be focused on putting incremental investments against both R&D and everything from a go-to-market and sales and marketing perspective to continue to drive future growth. Despite timing differences, that's still where the effort is. As we look at getting back to 20%-plus growth in Q4 and teeing up for next year, we're still focused on driving R&D and sales and marketing investments to drive future growth.

Great. That is all I have. Congrats again.

Thank you. Our next question comes from Brian Peterson of Raymond James. Your line is open.

Hey gentlemen. Thanks for taking the questions. Good to hear from you, guys. So Toby, it's nice to see the 24% growth guidance for the fourth quarter. I know you just mentioned, maybe the follow-up to Scott's question, that there will be some investments. As we think about that 20% plus growth profile, is there any framework that you would give us in terms of how to think about the cadence of margins as we're thinking about fiscal year '22 and beyond?

Yes. So I guess, I think the big picture backdrop is we've talked about still being focused on getting into that 30% to 35% range over time. I still think that's the right framework that we would point to. I think we've performed better from a margin perspective as we've gone through the year than maybe we would have thought at the outset. A lot of that comes from some of the costs that we've been able to manage through the course of this year in the pandemic, like T&E being down substantially. The consistency in the investment philosophy and strategy is to continue to spend on things like R&D and continue to drive investment in sales and marketing to continue to drive future growth. So I think that's still how we're thinking about coming through this year. That focus will remain constant as we go into next year.

I think the one thing I would add is we're excited about what we're seeing in the market right now as we're starting to see things return to pre-COVID levels when you look at first-time appointments in the sales force, the number of leads coming in, and the number of clients we're bringing on. We definitely want to invest and take advantage of that opportunity. There were constraints last year with travel and T&E, and so we're definitely focused on getting into the mid-20s recurring growth. You can see us forecasting that for the next quarter, and that's our primary focus. We want to invest back in sales and marketing and at a higher rate than we have over this past year, as well as R&D while balancing our long-term EBITDA objective of getting to that 30-plus percentage over time, which we think we can do responsibly.

And Steve, maybe it's too early to ask this question, but if you think about the pipeline and a lot of the early indicators that you're seeing, any changes in where the sources of business may come from? I'm just curious how the competitive dynamics may potentially evolve over time. Thanks, guys.

Yes. First, I would say we're very happy with the sales force. We've absolutely sold more business than we did last year, but it has affected productivity a little bit over this past year. Over the last couple of months, particularly, we've started to see activity levels, the amount of bookings, and the amount of appointments all starting to get much closer to that pre-COVID level, and that's certainly exciting for us. No significant change from a mix perspective. We made a call out that we're seeing a little more traction at the upper end of our target market, but we're still getting customers from the usual sources and the usual competitors in the market.

Thank you.

Thank you. Our next question comes from Brad Reback of Stifel. Your line is open.

Great. Thanks very much. Guys, if you look at the pace of hiring picking up in April, as you talked about, and you play that through to the installed base returning to where it was pre-COVID on their employment levels, do you think it takes a couple of quarters or a year plus to get back to where they were?

I think we've been hesitant to try to forecast the economic recovery. As Toby mentioned in the prepared remarks, we took what we saw in April and incorporated that into our guidance. It is difficult for us to assume anything further out there. Obviously, there are positive news in terms of vaccination rates and the number of cases right now. But I think that's the approach that we'll take. We'll try to give you better color on - as we give guidance toward next fiscal year in terms of what those set of assumptions are. So far, what we've seen has been a very gradual recovery, but whether that starts to accelerate or not is still probably to be determined in our mind.

Great. Thanks very much.

Thank you. Our next question comes from Terry Tillman of Truist. Your line is open.

Yes. Hey, Steven, thanks for taking my question. I guess thanks for the color, Steve, in terms of the April appointments, up 30%. You're going to get in a habit here. We're going to ask you every month how the appointments are coming along. But maybe pre-pandemic, like what was a good month for appointment growth year-over-year? I'm assuming there was growth every year because you're adding more to your sales capacity, etc. But what does 30% growth sound like? I mean I know it's better than the prior couple of months, I assume. Just a little bit more color around that. Is that a lot from the upper end of the target market?

So first of all, I don't think we called out a specific number on it being up 30%. So that would actually be low relative to what we saw, but we're not going to call out the numbers specifically. It was definitely up more than that. We're seeing it really across the board. We're seeing it down at the lower end of our target market, which those businesses were obviously very much impacted during COVID. So we're seeing that come back. It's happening a little bit more in the states that are more open. No surprises there. Midsize has also started to come back. I think throughout COVID, the upper end of the market has probably been the steadiest, and now we're starting to see the mid and lower end of the market really start to bounce back.

Yes. I just looked at my notes, you said substantially. Somehow, I made that 30%. So good call out there. But maybe the second part of the question, and then I had a follow-up for Toby. At the upper end of your target market, what's their propensity right now to buy a plethora of your add-on modules? Are you seeing any changes there? And then I had a follow-up for Toby.

Yes. I think what's really resonating at the upper end of the market is the complete value proposition, the idea of us being the most modern platform and providing our clients with tools to manage a workforce that's gone through significant changes, like flexible schedules, people working from home, and higher demand for transparency. That value proposition is really resonating. If you look at our product roadmap over the last few years, we've added a lot of the HCM modules, so we've got a much more complete offering and modern capabilities. That has translated into our ability to generate leads in the upper end of the market and then ultimately convert those into closed sales. We've really started to see momentum across the entire target market.

Yes, that's great. And I guess, Toby, and maybe Steve actually mentioned this, but the $3.5 million to $4 million impact, I guess, from the lower employment levels, did you talk about or quantify in Q4 what you expect there? I know it sounds like April was better from an employment standpoint, but did you actually quantify the headwind in Q4? Thank you.

Yes. The $3.5 million to $4 million was in reference to W-2s for Q3. That was the call out for that. But in terms of quantifying the employees on the platform as we're looking at Q4, I think we didn't call out the quantification of that. What Steve's comment was, we started to see improvement mostly in the back half of March. We did see improvement in April, and we carried that through to the guide, but we didn't include any incremental improvement from that point forward. That has been consistent with how we've been issuing guidance this year and what we did for Q4 as well.

Thanks.

Thank you. Our next question comes from Mark Marcon of Baird. Your line is open.

Hey. Good afternoon and thanks for taking my question. Just curious regarding the modules and the attach rates. Can you talk a little bit more about Community and Premium Video, what you're seeing there? Separately, there are all sorts of stories about worker shortages and demand for workers. Wondering if you could talk about your talent acquisition modules and if you're seeing a big uptick in usage perspective in helping companies alleviate some of the worker shortages?

Yes. We've definitely seen, throughout COVID, increased utilization in Community. That module is available for all of our customers and allows them to communicate and connect in ways that mirror how people might communicate in their social lives, creating a very social experience. That has continued to grow. We're pleased with the initial launch of Premium Video, which is available to new customers from the start of this last calendar year. That's done better than expected, given the increased use of video for communication today. Another strong module throughout COVID has been learning management and surveys—modules that promote communication and connection with employees in a more digital fashion. We're pleased with this trend, and we continue to innovate around providing a truly modern experience for employees.

Great. And then just on the upper end, when you're discussing the upper end, are you referring to all the way up to the tippy top of your range? Or are you talking about the midpoint to the upper end? Who are you winning from? Because we've heard from the big incumbents about their increases in retention rates. So I'm wondering how that coincides.

Sure. We basically do not cap our sales force. It's really about a product fit to the customer. We focus on companies with up to 1,000 employees. However, we bring on customers above that. I would say it's really the upper half, so it's 500 plus. We have customers with several thousand employees on the platform, and there's been more momentum at the upper end of our target market than we had seen 12 months ago, which is specifically worth highlighting as a strength in the quarter.

Great. And who are you taking business from?

There aren't any real big differences there. We continue to see service bureau providers and in-house offerings. Occasionally, we run into some players in the enterprise space that we don't typically see, but that's fairly infrequent. At the end of the day, our product suite offers a level of difference where if we get pretty far in the process, you won't see some of the enterprise folks alongside of us.

Great. And then for next year, should we expect things like travel and entertainment really creeping back? Should we expect margin improvement next year? Or is it possible that with the sales additions and maybe some expenses coming back, we might have a lower level of margin expansion next year than normal?

Yes, that's a good question. First, we're really excited about investing and growing. The momentum in the market excites us. We recognize that we have not been growing in areas like sales and marketing and R&D in ways we normally do. We paused early in COVID. We are now working to increase those numbers. We're in investment mode. At the same time, we're comping a timeframe where travel was limited, and people weren't getting together. We want to get our people back together. We don't envision everyone being in the office all the time; it will be a hybrid environment. However, the goal is to drive culture and get people together. This might lead to a tougher margin year next year because of that, but long-term, it shouldn't hinder our ability to reach our long-term model. We think those investments are critical because the opportunity ahead is still substantial.

Great. Thank you very much.

Thank you. Our next question comes from Bryan Bergin of Cowen. Your line is open.

Hi, guys. Good afternoon. I wanted to follow up on the employment-related headwinds on the pre-pandemic client base. I'm trying to understand the magnitude of this improvement that you saw through April. So is it still assumed to be a double-digit headwind to recurring in Q4? Or does that kind of move into the single digits?

It's definitely moved into the single digits. I'm not sure we want to get into calling it out specifically. There are different elements. It's mostly driven by employees on the platform. I think about it as gradually getting better and slowly moving out of those double digits and, obviously, being less so in the next quarter. That's the right way to think about it. You can see it in our guide; we are back into that mid-20s guide. We're anniversarying that COVID period. Our anticipation was based on what we saw through April. We didn't include anything else in terms of the assumptions for the guide, but so far, it's been a slow but steady recovery.

Okay. That's helpful. And then can you give us a sense on where sales headcount stands? How would you say you're doing in this environment, adding new sales professionals?

Yes. I mentioned earlier that we had a pause early last fiscal year regarding hiring. The sales team performed well in the COVID environment, and we're working to kick that back up. This is our hiring season right now. Spring is when we typically hire, preparing for next fiscal year with the right headcount. We're pleased with our progress thus far, and we'll provide more updates on the next call regarding where we're at. So far, so good.

Thank you.

Thank you. Our next question comes from Samad Samana of Jefferies. Your line is open.

Hi. Good afternoon. Thanks for taking my question. Maybe on the product side, when I think about the company's last couple of tuck-in acquisitions, could we get an update on the back-end integration process? Along with that, gross margin was quite a bit ahead of what we were looking for. Are we starting to see gross margin gains as those integrations are completed?

Overall, as customers buy more of the HCM modules, we have historically seen an increase in gross margin. Think of something like Premium Video where a lot of the work is on the product development side; there is less support work after we turn that on for customers, who can then take advantage of it. It’s easy to use and that’s the goal for our new modules. Increased module penetration is certainly going to be a primary driver of gross margin. We also mentioned good expansion in surveys and learning management throughout COVID. Another example of this trend. Additionally, there is some travel and expense aspect that we do in the gross margin line, but not nearly as much as seen in sales and marketing. There’s a cost-benefit element to consider as well.

Great. And as I think about the historical trend between rack right PEPY and realized pricing, are you starting to see better conversion there as you add more modules, or how should we think about the effectiveness of add-ons in terms of price uplift or PEPY uplift?

Historically, we've found that when we release a module, we can get it into 10% of our customers. Some accelerate, while others take longer. Overall, PEPY continues to increase, and the module penetration and utilization from clients on those are promising. During COVID, we experienced some mitigating circumstances related to fewer employees on our platform, but from a module perspective, we are optimistic.

Great. I'm going to apologize in advance for squeezing one more in. As I think about CAC, are we seeing any trends there? Especially with retention, as mentioned earlier, at incumbents increasing and a fight for adding more units; are there changes in your customer acquisition costs that we should be aware of?

Samad, I don't think we've seen changes in retention; we've maintained consistent rates above 92%. Throughout the pandemic, we've seen that consistency, and it continued through Q3. We're focused on investing in sales and marketing this fiscal year. As we move into Q4 and the next fiscal year, we aim to ramp up those investments to drive future growth.

Great. Thank you guys for taking my questions.

Thank you. Our next question comes from Matt Pfau of William Blair. Your line is open.

Hey, guys. Thanks for taking my question. Just one for me on the competitive environment. Have you seen any changes in your competitive win rates? I think one of your competitors was talking about better win rates, so just wondering what you guys are seeing out there in the market.

Our win rates have remained fairly consistent over time, with not many changes. However, we are seeing increased activity, which includes first-time appointments, deal flow, and overall activity. That part is encouraging as we feel confident in our win rates and consistency in delivering wins against our competitors.

Great. Thanks, guys.

Thank you. Our next question comes from Robert Simmons of RBC. Your line is open.

Hi. Thanks for taking the question. You mentioned the forms headwind is $3.5 million to $4 million. I want to check two things. That was versus trend, right, not year-over-year? Does that include both W-2s and ACA-related trials?

The $3.5 million to $4 million was the actual impact in the quarter in dollars, primarily related to W-2s—that was almost all of it, yes.

Okay. So was there also an additional ACA impact for the ACA annual form filing requirements?

The ACA impact would be embedded in the ongoing employees on the platform, as we typically bundle it as an ongoing service. Rather than charging one time, it gets spread throughout the year.

Got it. Okay, great. You mentioned retention as being pretty consistent, but can you give a little more color there? Are you still seeing some businesses that dropped down to zero employees and are sticking around but paying minimums?

Overall, retention has been strong. We're focused on revenue retention being above 92%, and that's what we've continued to see. We manage clients that might go down to no employees, engaging them quickly to assess if they will continue. We wouldn't let clients build up without activity on our platform for any period of time. That number is small, both in terms of clients and revenue.

Got it. Thank you.

Thank you. Our next question comes from Alex Zukin of Wolfe Research. Your line is open.

Hey, guys. Thanks for taking my question. I'll try to keep it to just two. Stepping back a bit, Steve. If you think about where your pipelines are, your pipeline coverage, are we back to that pre-pandemic new sales execution mode? Do you see any pent-up demand given that some customers were hesitant to move because budgets were tight?

It's hard to gauge exactly. Before the pandemic, we noted over 40% bookings versus the prior year—significant momentum in activity and getting customers started. Throughout the pandemic, it was more challenging, but we were able to focus on opportunities where they existed. Recently, we've seen increased activity, evidenced in appointments and bookings, approaching pre-COVID levels. This gives us reasons to be optimistic moving forward.

Got it. And then just one for Toby. If I look at the tailwinds going into the next fiscal year, is there anything structurally different in the business affecting seasonality of growth next year?

There's nothing structurally different that would change the quarter-to-quarter growth dynamics we've seen. However, many of the factors mentioned are early tailwinds, and it's tough to predict how those will play out over the next year or their timing. We remain optimistic based on March and April performance, but can't quantify for the upcoming fiscal year.

Understood. Thank you, guys. Congrats on a good quarter.

Thanks.

Thank you. Our next question comes from Siti Panigrahi of Mizuho. Your line is open.

Hey, guys. This is actually Matt Diamond, on Siti's behalf. Thanks for taking the question. I want to ask Alex's question differently. It was noted that Premium Video and the majority of the platform are resonating. With the return to the office for many of your clients, will this affect sales cycles? Will Premium Video and Learning Management Systems still be a priority as in-person interactions resume?

The conversations with customers suggest that the new normal will be a hybrid approach. For instance, people may work in the office three days a week and have more flexibility in scheduling. Companies have gained trust and seen productivity from work-from-home scenarios. It's likely challenging to revert to pre-pandemic interaction models, particularly in a growing economy where talent acquisition is more competitive. Therefore, these products will continue to resonate, as they play an essential role in driving workplace culture in an environment where not everyone is in the office. We see this trend persisting at Paylocity.

Understood. Does this align with your virtual sales approach in the coming months? Will this become a permanent strategy as reopening occurs?

Sales teams are creative and flexible and will adapt to where customers prefer to engage, whether that's in-person or virtually. Some customers are comfortable with on-site meetings while others prefer virtual interactions. Providing the tools necessary for success in both contexts is crucial. Moving forward, we anticipate a hybrid model, where sales reps successfully engage customers in different settings.

Excellent. Thanks so much, guys.

Thank you. Our next question comes from Jeff Van Rhee of Craig-Hallum. Your line is open.

Great. Thanks for taking my question. Just one for me. On the quarter, in terms of the variance, can you just put a little more detail on it? I think you had about $1 million of revenue upside, give or take, about $6 million on the EBITDA side. Could you explain the margin variance during the quarter?

Certainly, some variance arose from recovery observed at the end of the quarter, as Toby mentioned, more so in late March. We initially hoped to resume normal levels of travel and meetings. As a result, we were more successful with expense management than anticipated. Additionally, we achieved higher penetration rates for new products, which contributed to margin expansion. This mix of factors resulted in a larger beat on adjusted EBITDA compared to revenue.

Yes. Thank you.

Thank you. Our next question comes from Arvind Ramnani of Piper Sandler. Your line is open.

Thanks for taking my question. Congrats on a good quarter. I wanted to address the competitive environment. I know it's been mentioned previously, but as legacy players like ADP and Paychex enhance their solutions, and as niche players emerge, have you seen increased competition from either group? And from a product roadmap perspective, are you making the right investments to maintain a competitive edge in the upcoming years?

The competitive environment remains robust. A typical customer evaluates two to three providers, making it standard to see both major players and newer entrants in those assessments. We have not observed any significant changes in our win rate. Concerning product development, macro trends such as work-from-home preferences, flexibility demands from Gen Z, and the need for modern workplace tools correlate well with our product roadmap and strategy. We're excited about our launches, such as our Modern Workforce Index, including a proprietary recommendation engine to help clients measure their effectiveness in communications and employee engagement. This positions us as a modern platform, bolstered further by our investments in data science, as we adapt to the evolving demands of the modern employer.

That's great. Thanks very much, and good luck for the rest of the year.

Thank you.

Thank you. I'd like to turn the call back over to Steve Beauchamp, CEO of Paylocity, for any closing remarks.

Great. Thank you. I'd like to take a brief moment to thank all of you for your interest in Paylocity and definitely want to thank our nearly 4,000 employees across the country who've been working hard during a very challenging time. I hope everyone has a great evening.

Thank you. Ladies and gentlemen, this concludes today's conference. Thank you. You may all disconnect. Have a great day.