Paylocity Holding Corporation (PCTY) Earnings Call Transcript & Summary

All right. Great. Thanks, everyone, for joining us here this afternoon. My name is Matt Pfau. I'm the analyst at William Blair that covers Paylocity. For a complete list of our disclosures, you can visit www.williamblair.com. We have with us here today, Steve Beauchamp, the CEO of Paylocity; Toby Williams, CFO, maybe joining us shortly, but me and Steve are going to kick things off here. So I'm sure most people are probably somewhat familiar with Paylocity, but just so we can make sure everyone's on the same page, Steve, maybe just a 2-minute overview of Paylocity would be helpful. And then maybe how the company has evolved since going public in 2014?

Yes, I'd be happy to. So Paylocity provides payroll and human capital management software for really midsized businesses. Our average size customer is just a little more than 100 employees. And that's been fairly consistent throughout our history. And we really focus on delivering a combination of innovative software that automates a lot of these manual tasks for these midsized businesses and gives them a way to engage with their employees. But at the same time, it has a layer of service on top of that. So that what I mean by service is, these customers oftentimes have questions, where they're hiring employees in new states, where they're rolling out a new feature, but really combining that best-of-breed software solution with the service component. We go-to-market with -- we used to be "feet on the street" salespeople. Now they're virtual salespeople, but it's a direct sales force. And that sales force is really focused on bringing on new customers. And if you look at our growth drivers since going public over 6 years ago, it's largely been, first and foremost, landing new customers. Last year, as an example, our unit growth was 21% on revenue of approximately growth of 25%. And at the same time, we get about 25% of our new business referred to us, still sold by our sales force, but referred to us from brokers and financials' advisers, which is a unique part of our go-to-market motion. And then the last thing that I would mention, just part of the overview, is investment in R&D and product is a key part of our success. And so we started really with payroll. We added HR and then started moving into benefits and time and labor and then into the whole talent management suite. And so over the last 6 years, we've doubled the amount of product that we can sell to customers from $200 per employee per year to $400 per employee per year. And so that's been another part of that growth driver is. The new units that we're landing with our sales force, but also the ability to sell more product to new customers as we bring them on. And then we've increased over the last couple of years an ability to sell more of those products back to the base. So I think that probably gives you a pretty good overview.

Yes, definitely. And so you mentioned primarily target midsized businesses, but you do have a big range of customer size, if you think all the way from 20 to -- some of them have well over 1,000 employees. Does go-to-market strategy differ in those segments? And if you sort of break those up into a few different areas, is there anyone that's maybe where you see more opportunity, or that's performing better right now than other areas?

Yes, sure. So you think of the TAM, we've got over 600,000 businesses in America between 20 and 1,000 employees. And so last year, we finished the year with a little more than 20,000 customers. So still a huge opportunity from a market penetration. And I would say, we kind of think about it as below-50, 50 to 500 kind of our sweet spot, where our history was and then 500 employees plus. And so last fiscal year, and our fiscal year ends June 30, last fiscal year, we started to see more growth in that under-50 marketplace. And really, it was happening naturally. As we had invested in our product portfolio and I think as people were looking for not just the basic of automating my transactions, but they were looking for more engaging solutions. Even companies with 25 or 30 employees started looking at some of these HCM and talent management products that we had. And so we started to see more unit growth in that under-50 market. That has continued this fiscal year. And for the first 9 months of this fiscal year, we've actually grown our new revenue bookings, so new annual recurring revenue by 40%, by continued momentum in the under-50, but accelerated momentum in the 50 to 500 and 500-plus. And so we were really firing on all cylinders for the first 3 quarters of the year from a sales perspective as we entered kind of the COVID pandemic.

Got it. And maybe we can dig into the partner strategy a little bit. Has that evolved at all over time? And is this something that's unique to Paylocity or do you -- competitors leverage that partner strategy as well?

Sure. So I think if you look at the larger competitors, the Paychex and ADP of the world, they're often in these businesses themselves. So they offer 401(k) record-keeping services, they offer insurance products, whether it's workers' compensation or health insurance. And they have PEOs that kind of make money off of those insurance products as well. And so we approach the brokers as really a software-only provider. And we approach them with the idea that we are probably stronger together against some of these natural competitors. And then we leverage the fact that we do a lot of data integration. So we will integrate to hundreds of providers, 401(k) providers, health insurance providers, voluntary providers, dental providers, all of that. And so we offer them a completely automated experience. And then we both can go-to-market, where they refer as existing customers or we go-to-market after prospects together with our sales force, and that's where the relationships are created. And it is fairly unique to us, and it's enabled by our data integration capabilities and I think the strength and experience of our sales force in terms of developing those relationships. None of the bigger players really kind of pursue this strategy. You might see some smaller independent players that aren't public that might be in that space, but we've been doing this for a long time. We've been going after this broker channel network for over a decade and are definitely the clear leader in the space.

Got it. And when you're discussing your growth, you mentioned, primarily driven by adding new customers. But you also have, at the same time, as you mentioned, dramatically expanded the number of applications within your portfolio and the potential average revenue per employee. So how do you think about growing the average revenue per employee from your customer base over time? And is there ever sort of a point where it makes more sense to get more aggressive in terms of trying to sell back into your existing customer base?

Sure. I think that's -- it's a great question. I think it's a good opportunity to bring Toby into the conversation and have him provide some thoughts on that.

Sure. Yes. I mean, I think, over time, we've grown per employee per year from $200 at the time of the IPO to $400 as we sit here today, and we've called out a target of getting to $500. And so we've also said that historically, our customers have roughly half of our PEPY, and so just over $200. And so we certainly do have, I think, a significant opportunity to sell back into the customer base. And going back 2 or 3 years ago, sort of, in that ACA and post-ACA period, we started to invest in an inside sales team to do just that, to sell back into the customer base. And it's still overall in total revenue a small dollar amount, but we've grown that team with increasing investment over the course of the last 2, 3 years. And we still think it's a significant opportunity that lays in front of us to go back to the base with the products that we rolled out.

Great. Anything that you've seen in terms of your applications, more interest and recently, perhaps driven by the movement to work from home and the coronavirus pandemic?

Sure. So if you think of pre-coronavirus, a lot of our product mandate was to really try to be able to develop features that would make our application appeal to the modern workforce. And so the modern workforce is the growing majority of millennials in the workforce, the Gen Z generation that's entering the workforce right now. And so really not just digitizing the backroom kind of processes, but also finding real ways to be able to engage with that workforce. And think about something like performance management, instead of that happening once a year basis, there's an ongoing conversation that we're creating within our platform. So the fact that we are already going down that path, I think, it's really -- it helps us a little bit here because as people have gone to more remote work, they realize that we need to be able to find ways to engage in a digital fashion, not just automate. And that has -- messages definitely helped us and resonated with prospects even during COVID-19. And I think it's made our sales force more resilient in terms of an ability to sell post that mid-March time frame, where it really started to see the shutdowns happen.

Yes. Got it. Maybe it just makes sense now to just continue and talk about some of the impacts we're seeing from -- driven by the pandemic. So it probably makes sense to, first, talk about sort of the more near-term, short-term impacts you're seeing within your business. And then longer term, maybe some trends that you might expect to see either positively or negatively coming out of this?

Sure. So I think the short-term impact, we had our earnings call and we did provide guidance for the fourth quarter. The guidance range was a little larger because it definitely has an impact to us based on employment levels. And so the way to think about it is unemployment level percentage, to say, unemployment is at 15%, we would get impacted on a current client base in terms of our revenue by a little bit less than that number, just the way our pricing model kind of works. And so you can kind of look at that, and we had to make assumptions around employment in terms of providing that guidance. So as you start to see a recovery and people start to come back to work, then those employees come back on our platform and we get the revenue benefit of that. So there is definitely a short-term impact from the pandemic perspective. We think it's probably a little harder to sell in this environment, mostly because there's a segment of the market that their industries are severely affected and less likely for them to look for a change. But there's still a lot of industries that we can go after and continue to sell that market. So it certainly hasn't stopped us by any mean. It's just created a little bit of a headwind for sure. I think on the flip side of that, we're seeing some opportunities. We made an acquisition of a video platform, which is -- as we entered the pandemic. That's something we were clearly working on beforehand. Well, the idea of video being an integral part of your everyday conversations is certainly gaining steam as we all spend most of our time on calls like this. And so that's something that we have plans on embedding into our platform. So you could imagine providing people comments about a great job that they've done via video instead of a note and badges, which is what we have in our system today. You can imagine sending a note to your manager about here's the 4 things I want to cover in our next one-on-one, maybe I'm not doing that e-mail. You can imagine us sending videos to every single employee and having frequent and short communication. And so that's something that we really started investing in. That was a provider that we had used for many years in our LMS and had great success with them. So we're really excited about taking the concept of video outside of LMS and embedding it across the suite. So it's investments like that on top of things like learning management and community, which is a product we've invested in over the last several years to really create online collaboration around a social environment for interacting with employees that we think will benefit us through the COVID crisis, but even beyond.

Got it. And you mentioned it's a little bit -- it's more difficult to sell in the environment now, obviously. But I think the new business commentary, surprised people on the last quarter earnings call. So maybe just help us understand why, I think, relatively, given everything that's going on, the new business has still been pretty robust?

Yes. We've been pleased with the resiliency in our sales force. And I think there's a couple of factors. So one, we came in with a lot of momentum. So we were on a 40% year-over-year clip across all market segments. So we came in with great momentum. Two, we've got a value proposition that really does resonate when you've got more remote workers. It's a really large opportunity. So yes, on skeleton crews, but that's probably not where we're focused. But there's also industries that haven't been as impacted. And because it's such a large opportunity, our sales force can pivot and focus on those. And then you've kind of got these people in between where maybe they're not quite as busy, but their business isn't in jeopardy. And some of them think about, hey, it's a little bit slower. This might be an actually ideal time for you to be able to look at that change. And so I think for those reasons, we believe that we can operate in a fairly resilient fashion for as long as this last.

Makes sense. And then I think last week, the employment report obviously surprised people to the upside. Is there anything that you're seeing in your customer base in terms of employments leveling out? Or any sort of update on those trends you're seeing?

Yes. If you think about unemployment, it's very much a laggard statistic that's looking back, a matter of number of weeks, depending how long it takes people to get -- apply for it and then ultimately receive unemployment. We're really seeing a lot of this data in real time. So if you think of our time and labor application, hourly workers use that to punch in kind of every day. And so we can look at the activity in terms of how many people are coming in every day. We can look how that changed versus prior periods. We look at how many people are paid. We look at how many people might be on the platform that might not be being paid at the moment. And so what I would say is our commentary, I think, rings true, which is we saw us hit the bottom end of April, early May. And we started to see it leveling off. And I think we anticipated, as we provided guidance, as states reopen, we would see a gradual improvement and increase. And I think as you looked at the employment numbers, it took a while to kind of catch up to that. But I think it's consistent with what we said on our earnings call and kind of what we've seen overall.

Yes. Got it. Let's dig into the competitive environment a little bit. We've brushed on this, but maybe just to talk about it more directly. What does the competitive environment look like? And where are your customers typically coming from?

Sure. So it is a competitive environment. I mean there is a number of competitors, and there's certainly alternatives customers can look at. I think it starts with the idea that everybody has to provide payroll in some way, shape or form. They have to get their employees paid. So it's a must-have part of the HCM equation. And so you see the big players who've been in this business for a long time, like ADP and Paychex being the dominant players, right? Between them, they've got well over 1 million customers. And so we continue to see them in the market. We see them both competitively in deals, and then we see them when we're -- they're the incumbent, and we're trying to take away that business. And then I think after those big players, you start to see a bucket of small regional providers. There's thousands of these across the country. Some might get into the category, I've raised money, and I'm trying to be a growth player, that's taking advantage of it. Some might get into the category, where I'm a CPA and I have a side business of payroll. Some might be small payroll providers that are kind of running it a little bit even more like a lifestyle business. You see hundreds if not thousands of these across the country. We compete with those people all the time. And I think after that, you get to kind of smaller percentages. We see Paycom competitively more in deals than we do in terms of taking business from each other. So that would probably be the next one. It's a little bit more in a 100-plus market than it is in the below-100 marketplace. That's probably the universe of who we see. I think most of the time you're dealing with 2, 3 -- 1, 2 or 3 competitors on any deal, pretty common for our customer to be able to look at the software, do a demonstration. It's a pretty quick cycle that we all operate in, in this mid-market. So they can handle 2 or 3 different vendors that they take a look at. And most of the time that decision is really made based off of fit of the platform, the strength of the salesperson and kind of your reputation in the marketplace from a service perspective.

And some of those regional players that you mentioned are really less of a tech solution, more of like an outsourced manual payroll processing, right? How have those types of providers been holding up in this type of environment? Because I assume it would be more challenging when everyone's remote to do that type of service.

I think you've got 2 things when it comes to some of the smaller providers. So one is just what's the strength of the balance sheet and the funding behind the organization, because if you -- as I said, if unemployment is 15%, you could lose close to 15% of your revenue for some period of time, but that really puts strain on the organization. And so we've definitely seen some smaller players do layoffs, salary reductions and really try to find ways to be able to kind of manage costs, which, in some cases, will have an impact on their growth rate, right, depending on those costs that are in kind of a sales and marketing bucket. We've also seen some smaller players. There's been a couple that have come on the market and decided this is the time we get out, it's going to be tough for a while. We're not going to be in that. So I think -- but overall, most of those people are fairly healthy businesses. They're in a position to kind of weather the storm. They're going to really try to differentiate based off that service offering and the kind of local company field. It's not a lot different than what it was historically. I think you just have the players that we're really trying to swing for the fences a little bit, makes it very difficult in this environment from a funding perspective.

Yes. And you mentioned that typically, your customers or prospects, they'll maybe evaluate a few different providers when they're selecting. So when they do go with Paylocity, what are the typical reasons that they choose you over one of these other providers?

Yes. I would say, it usually comes down to a few different things. And it depends on the customer. So first of all, all of the customers are looking for automation, and they want to automate any manual process. They want to digitize the entire process from an HCM perspective so that they can be as efficient as possible. So that's number one. And in this kind of environment, where it might get constrained in terms of revenue growth or you might need to be able to manage your cost, that is a very important part of the equation. Secondly, what I've got is remote workforce trend and even before then, when I'm bringing in younger workers into my organization, I need to find different ways to engage with them because you want to retain your most talented people, and that's another really important factor for us. And then I think the last thing is the relationship that you can create with the customers. I mean when they -- you think about the legislation changes that have occurred with COVID-19, we've had unbelievable number of interactions with our customers. They want to call us and what information do I need for my PPP loan? How does the FFCRA act is going to impact me? And so we're doing a lot of advice as part of the equation, and I think that's an important part. And so all those things kind of mix. And I think the idea of combining those is really what our value proposition is all about.

Got it. Let's move into the financial targets a little bit. Just maybe help us understand how you think of the business longer term, both from a growth and margin perspective?

Yes. So I think you start with revenue. I think on a long-term basis, we still believe that business should grow 20-plus percent, certainly in a post-COVID world. I mean as Steve was talking about earlier, we had a significant momentum in the first 3 quarters, actually accelerating on a first 3 quarters basis, recurring revenue on a year-over-year basis by almost 200 basis points. So I think we continue to believe in the growth potential of the business. And I also think we continue to believe that we can continue to get leverage, both in gross margin and adjusted EBITDA margin over time as we go forward, certainly, again, in a more normalized post-COVID environment with 20-plus percent revenue growth. So we've got the gross margin targets out there, 70% to 75%; adjusted EBITDA, 30% to 35%. Certainly, you get headwind this year for some period as we go through the pandemic period as you have the revenue headwinds impacts from, exactly what Steve said, with unemployment. You also have seen the declining rate environment, which has been a revenue headwind for us. That's high-margin revenue. And so you see a headwind there for sure, and that will sustain for some period of time. And I think, again, with the momentum -- if we can come out of this with the momentum that we came in with from a growth standpoint, continue the 20-plus percent revenue growth, we should also be able to continue to drive leverage in the business as we scale.

Yes. And maybe some day rates will increase and be a tailwind. Okay. So one thing that you guys talked about is -- and you've talked about on prior earnings calls, too, you saw this improvement within your sales organization, I think productivity levels were at some of the highest that you guys have seen. Maybe what has driven that? What made that productivity improve?

Yes. I think if you think of the post-ACA world that we've been in now for a few years, we kind of got spoiled a little bit during that ACA year, where there was a lot of activity in the marketplace. And I think everybody kind of benefited from it. And then we had made a lot of product investments over the last several years, particularly in that talent management category in this idea of trying to really deliver a more modern workforce application. And last fiscal year, we spent some time kind of retraining our sales force, doing booster training, really trying to make sure that we're presenting the value proposition that we've really worked hard to be able to kind of build. And then we focus on a lot of the normal kind of execution things that you would do, nothing dramatic or big. When you add all those things up, it really had an impact. And we started to see sales force gain momentum, both in terms of their ability to gain entry and then win business ultimately. And that's what really drove that 40% revenue, new revenue increase in terms of bookings on a year-over-year basis, is taking advantage of that R&D investment that we've made, the relationship that we had with the existing customers and kind of doing a little bit of a reframing with the sales force so that we just tweak the sales process a little bit, make sure we push back to the forefront of the conversation. And I think we saw that translate into win rates and productivity.

Great. And you mentioned that you acquired a video platform for -- to expand your capabilities there on the MLS side and other areas. How do you think about acquisitions and the decision to sort of build and buy to add functionality to your platform?

Yes. So we have a strong bias towards building for sure. And I think the reason is that we feel like we have a history and a track record of being able to do that, doubling the amount of product in 6 years is probably the proof point to that. And ultimately, we can deliver a much more unified user experience. And so that unified experience from a customer perspective is really important. It really makes it easy to use. It doesn't feel like something different moving across the application. And we've seen historically, some of our competitors buy things and put things together, and you get a lot of debt from that, that you got to be able to deal with at some point in time. And so we love the idea of building and constantly iterating. However, there are times where there's an area where we can actually find an acquisition that we can bring into the company and still create that same user experience. So this is a great example because we've been using this video application in our learning management system for several years. And we started to find other use cases that we can start embedding this across our platform, and that made a lot more sense for us to own that rather than just partner for that technology. And so that allows us to bring it in. And from a user experience, it will be completely embedded as part of our platform, and there is no real difference. We did something similar with TPA a couple of years ago, where we really felt like we needed some capability and some operational scale with TPA. So we bought a relatively small business that offered HSA, FSA, COBRA services. And we actually use our technology team to build the user experience on top of that. And so today, if you're using our platform and you had an HSA, you could go right on your mobile phone, call up your HSA balance, submit claims and do all of that right in our platform. So we don't lose that experience. So we'll be selective. We'll look at different things that we think are similar to the ones that we've done in the past, and we'll continue to lean into our organic capability to create new product.

Got it. I'll take one from the audience here. So, I think maybe the crux of the question is, how is the "less than 50 employee" market performing versus your other segments in this type of environment? Or I guess another way to just ask it is, is COVID impacting certain areas of your business more or less than others?

Yes. So I think the impact of COVID on, say, the less-than-50 market, is probably what people worry about is the out-of-business rate that might be able to spike up, right, because those businesses, particularly in certain industries, may have a harder time weathering the storm. We haven't necessarily seen that yet, but we have seen those businesses reduce the number of employees. So when you look at kind of our revenue guidance, it's already -- we've already felt most of the impact from that, right? Secondly, on the sales and go-to-market side, there's lots of businesses out there, and there's lots of businesses that haven't been impacted as much. So we're still doing quite well in the under-50 market in terms of our sales force being able to sell there. And obviously, not the exact same momentum we had pre-COVID-19, but I would say our sales force has been resilient across all segments under-50, 50 to 500, 500-plus.

Got it. Okay. I think I'll end with one more. And I guess one question that I get on you guys a lot as well as the other SaaS payroll providers is, if you look at Paylocity, Paycom, Ceridian, Ultimate, when it was public, it seems like everybody is doing well and growing and including some of the private guys in the space. So what everyone always wants to know is, how is that possible that everybody can be doing quite well and they haven't run out of opportunity yet.

Yes. So I think it starts with a huge TAM, right? Everybody has to do payroll in some way, shape or form and in today's world, they're going to use a software platform, and it's going to be a SaaS-based online platform. And so you've got a big, big market opportunity there. And you have a bigger opportunity with a lot of these smaller independents, you have a bigger opportunity with people using software or just the payroll part of their accounting software or using their CPA. So there's still a fair amount of share that ADP and Paychex, as an example, don't have. And so that allows organizations like ourselves where you mentioned Paycom or Ultimate to do well. Secondly, we kind of all have overlap, but we focus on slightly different spaces. And so I think that's an important point. So we don't see Paycom that much below 100. I think they talked about trying to make some inroads there. But we do see them a lot above 100, maybe not as much as Paychex and ADP, but we do run into them a fair amount. Ultimate, we don't run into much at all, and it's really at the upper end of our target segment. Ceridian, we don't run into really hardly ever. So when you think about it, you've got to divide it into the market segments. You got to look at the size of the opportunity. You've got to understand that every single person has to solve this problem in some way, shape or form. And so I think that's why you've seen this growth in the industry. And then lastly, there's been a huge push for modernization of these platforms. So the old payroll world, you go a decade ago, most people were calling in payrolls, they were faxing it in, they were using like time sheets online that had no capability. And so over the last decade, you now have a platform where every single employee is using it in a variety of different ways that we couldn't imagine. We have survey products. We have a community product. We've got a learning management product. And so the industry itself has evolved and changed where those function and capabilities that used to be reserved for very large customers has really come down market. So when you put all that together, it's a pretty attractive space.

Perfect. And with that, I think, we're about out of time. So Steve, Toby, thanks a lot for joining us today. And everyone on the call, thanks for joining us as well. Appreciate it.

Thank you very much, everybody. Have a great day.

Thanks, Matt. Take care.