Paylocity Holding Corporation (PCTY) Earnings Call Transcript & Summary

All right. So we're going to try this for a third time now. So welcome, everyone, to the institutional investor conference. We're very excited to have Paylocity back with us today. Toby, Ryan, I think you've been here for a while now, maybe 4, 5 years in a row. So obviously, a virtual setting. But happy to be with you guys. I think we'll join in for a fireside chat. [Operator Instructions]

So Toby, I'm just really going to hop right into this. Start -- I think, obviously, the big news of calendar year '20 was the pandemic. I'm just curious what you've seen in terms of your customer trends. And maybe help us kind of understand what just happened, I think, basically about a year ago today and just kind of like what's really transpired over the last 12 months.

Yes. I mean, obviously, things started to really hit the U.S. around the time of this conference last year. It was just after this that things really caught hold. Yes. I mean I think it's obviously a lot of headwinds for our industry and for us just in terms of the number of employees in the platform, which was a result of the unemployment rates that we've seen resulting from the pandemic. I think that reached the depths in sort of the April, May time frame of last year and has obviously had some level of recovery since then, although I think what we've seen and I think what others in the industry have seen is that has not really been a linear sort of progression on a month-to-month basis. It feels like 2 steps forward and 1 step back in many cases in terms of being a little bit better 1 month and then slightly worse the next. But I think as we sit here today, things have certainly improved from the bottoms. I think the other probably positive point that we have seen so far is as of the end of December, in the middle of our fiscal year, we're really tracking to pretty close to where we would have been in the last 2 years from a number of units sold standpoint. So I think our ability to pivot to a virtual selling environment and the resiliency of the sales team to be able to navigate pretty tough last 12 months from an overall economic and sort of business environment, I think we're pretty happy about that.

Well -- and so that's a good segue. I also want to hit customer impact but then also on internal impact. So you mentioned the virtual selling model. Is there anything that you've kind of learned about the go-to-market motion versus a year ago? And I also kind of wanted to hit on your service delivery, product development, product forward company. How do you think about a post-COVID world or new normal for internal processes of Paylocity?

Yes. I mean I think we've had -- if you go back the 2 years prior to the beginning of the pandemic, I think we had leaned, I think, incrementally heavier around product investment, things like -- what we were working on at that period of time were things like Premium Video, which we launched a few months back. We were working on the collaboration strategy that we -- underlies our acquisition of Samepage. We're working on the learning management system. So I think from a product perspective, we're working on all these things in a couple of years prior to the pandemic. And they have launched over the last 12 or 18 months or so that have really become important in -- more important than they otherwise even would have been in the course of the pandemic. So I think those things have all resonated. And I think part of what we've been dealing with in the course of the pandemic is just -- product and sales and marketing are the 2 biggest growth drivers that we have. And I think our desire and our goal is to be able to maintain those investments, both through the pandemic and then get back to the momentum as we come out of this that we had coming in. Because -- I mean coming into the pandemic for the first 9 months of our fiscal year, fiscal '20, I mean we were seeing, I think, the benefit of those investments in terms of the acceleration of recurring revenue from where it would have been, around 23% to right around 25%. And we were seeing new sales numbers up around 40% year-over-year. So I mean I think the investments were paying off. And the goal is to be able to drive those investments as we come through this period so that we exit with as much momentum as we came in with. And your question around sort of the pivot to virtual from a selling standpoint. I think the team has done a really good job with that. It's definitely been hard. But I think they've done a good job of finding ways to engage with -- first of all, finding the prospects in their territories that are still able to engage and willing to talk about switching systems. And then I think being able to find ways to engage with them to be able to continue some sense of the sales momentum that we had coming into all of this.

And so -- and Toby, just one part of that, too, that you didn't address but just the service delivery aspect, getting customers up and running, the ability to say, "Hey, you signed a customer but a happy customer stays with you forever." So how are you engaging? I know some of that is the product. But get them up and running, understanding -- how does that all work in a COVID world?

Yes. So I mean even before the pandemic, I mean, we would have provided our customers with remote implementation. So that's the way we've always done it. So from a new sales and then get somebody live perspective, there are some changes in the process. But I think we were pretty well positioned in terms of our ability to deliver a really high-quality implementation for a new customer coming on to the service. And I think we were happy to say that we started -- obviously, January is the biggest month in our industry and for us. Happy to say that we had started more business in January than we did last year. So I think we've maintained our ability to bring new business live, although you definitely see some impacts. It's -- you're dealing with average-size customers, around 100 employees. And roughly half of our customer base is in the 50-below segment. So you're dealing with smaller teams. And so if you have any impact to those teams on the client side, you can have some delay to the initial implementation. But I think we try to manage that pretty well and feel like the delivery that we've given people has been pretty darn good. From a service standpoint, I think the -- one of the things that clients have had to deal with in the course of the last year is just -- but certainly, a lot of changes with our workforce but also a lot of changes from a legislative regulatory standpoint. So we were, I think, the first to be able to actually digest the new legislation with CARES Act and actually build the reporting capabilities into our systems and be able to still help our clients navigate all that because we would get, I think, an outsized amount of calls around that time. People looking for help, like, "Hey, how do I do XYZ? And can you help me navigate -- can you help me understand what I need to do from a reporting capability standpoint to access the PPP loans and so forth?" And so I think our service teams, they also did a pretty good job of being able to pivot to a remote environment for those that were not already remote and maintain our level of customer service through all this.

And so last COVID question, I promise. So the one that I get a lot from investors is just thinking about your exposure, the opportunity as we sort of head towards a vaccine kind of recovery scenario in the economy, how does that help Paylocity in terms of growth vectors? Is that the cadence of new business opportunity? I'm not necessarily looking for numbers here. But how do you think about that qualitatively as we kind of enter a different part of the cycle?

Yes. Well, I think there's a few different impacts. I mean one impact from the pandemic has been the number of employees on the platform and that's industry-wide in terms of -- but tied to unemployment. But the other is, I think, there's -- stating the obvious. I mean there are industries that have been more effective than others. And I think you see in those industries certainly a higher degree of decline in employees. And you also see, I think, a more challenged selling environment to those industries. So take restaurants is probably the easiest and toughest of the examples. I mean the business environment for restaurants -- depending on where you are across the country because, obviously, things are different in different states. But as a general sort of category, it's been pretty tough for them. And so while our sales teams, I think, have done a good job of pivoting to other opportunities in businesses where there haven't been as severe impacts, you certainly see a decline in sales to industries like that, that are more impacted. And so I think as things return to normal over whatever period of time, sort of that unfolds over, I think you see the opportunity for employees on the platform to come back. And I think you see a better selling environment for certainly the industry become impacted through the course of the last year. And I think for us, we -- in our last call, we guided to the rest of the year. And as we look at our Q4 as -- our fiscal Q4 as being the first quarter where you're really anniversarying the start, that wasn't the heaviest part of [indiscernible] the pandemic, you start to get back to -- I mean the implied guide for our Q4 was around 22%. So I think we have our eyes on getting back to a 20-plus percent growth cadence as we would have been pre-pandemic. And I think you start to see that in Q4.

Great. Okay. So last COVID question, promise on that. All right. So the service bureaus, I know they've typically been the shared owners. I think they've tried to modernize their offerings. I know there's been some attrition there. Like any update on the competitive dynamics and if you're thinking about where these new customers are coming from? Has that changed at all?

Yes. We haven't really seen it change that much in the course of the last 12 months. I think for us, historically, the biggest source of new business would have been from -- as you said, from the service bureaus between ADP and Paychex. And that still remains the biggest bucket of sort of prior method for us. And I think that's followed by -- pretty similar to what it would have been before, that's followed by local and regional providers, which is around 20% of new business for us. And then pretty close behind that would be in-house solutions, which is 15% to 20% of new business for us. So I mean I think from a competitive landscape perspective, it's always been competitive. I think it has remained competitive throughout the course of the last year. I don't think we've seen any major shifts from any of the players in terms of wildly different strategies, whether it's pricing or otherwise. And so I think it's been fairly consistent over the course of last year.

And anything new from maybe some of the other cloud vendors in this space? Any competitive dynamics that you've seen change over the last 6 to 12 months?

I don't think so. I mean I think we've been squarely focused on executing in our sort of target market in that 10 to 1,000 space. I think we've seen -- coming into the pandemic, we would have called out relative strength from a unit standpoint in that under-50 market. I think that's held true. But I think as we look at how the business is performing over the last 12 months, I think we're really encouraged by the fact that we're seeing equal strength in production in that sort of 50 500 and then the above-500. So I think we see obviously with all the headwinds we discussed. But I think we see strength in terms of every part of the market that we're really focused on. And we haven't seen significant changes from a competitive dynamic perspective. I think we're really encouraged by how much our new product launches have resonated in the market. And that started pre-pandemic but I think it's accelerated in the course of the last 12 months. So things like our Learning Management System, which was -- which included the video offering that we then take to be a Premium Video offering and embedding in other parts of the suite, which is a result of our acquisition of VidGrid just coming up on a year or so ago. And so what we've seen is that those types of applications becoming more and more important in the market and resonating even better with our existing clients and with prospects than they had before because I think they really provide our customers and prospects with the ability to communicate and engage with their workforces, which, with a pivot to remote, I think it became more challenging for customers. And so we've seen those types of products, which we think -- I mean if you look at what we're doing from a Premium Video perspective and with our Community application is sort of the social and engagement and communication part of our platform. Those are differentiated, I think, products and strategies that nobody else really has in the market. And so we've seen those really resonate. And I think that's been a big part of the success that we've seen over the last 12 months.

And so it's interesting with some of the products that you mentioned there with the video or the Community. I'm curious on the feedback and the adoption of those kind of in those buckets that you talked about, right? I mean is it the same as you go to 500-plus versus kind of sub-50? Or just -- how do you think about that resonating in maybe different areas of the market?

Yes. I think we've been -- we've actually been pleased to see that the adoption has been fairly consistent across the different sort of areas of the market from an employee side perspective. And obviously, Community is an offering that we're not charging for today. We've rolled that out to be available across our customer base. And we've seen the utilization, I think, increase pretty significantly over the course of the last 12 months, both in terms of the number of who are using it and then the number of employees. And so I think we're really pleased with the trajectory there. And then I think that really -- the usage of Community and looking at the use cases from a customer -- from an employee standpoint really have, I think, built the foundation around -- for the strategy that we've talked about around bringing more collaboration tools onto the platform, which really was the strategy behind the Samepage acquisition. So what that team is working on now is basically taking those collaboration tools, things like direct messaging and document sharing and the ability to give teams a space -- a team space to collaborate on and work on projects and other things. That's really the focus of that team now in terms of bringing that technology in and creating -- building that into our Community platform. And I think rolling out a premium vertical Community that would be chargeable and gives, I think, the teams and the employees that we've seen using the system to form groups and to really get work done. It gives them a space to be able to do that, builds out our collaboration tools in a way that I think will add a lot of value to clients and prospects and their employees.

So I was going to hit more on some of this later. But I think you actually kind of answered my question. But I do want to hit on the broker channel, right? I think it's obviously been an area of success for you guys. I'm curious how those relationships and that channel has trended due to pandemic? And what are the longer-term ambitions with the brokers?

Yes. So historically, we've gotten 25%-plus of our new business referred to us by the broker channel. And that's usually a mix of insurance brokers and financial advisers. And those are relationships that would be built -- largely built in the field with our reps in their respective geographies. And that has, I think, over time, been more of a face-to-face-type industry, very event-driven and relationship-driven. And I think coming into the pandemic, I mean, honestly, I think there was concern over whether or not we'd be able to maintain that type of -- sort of touch point with those individuals to be able to continue to drive that 25%-plus of new business and drive that level of referral from a new business standpoint. I think we've been really pleased with how that channel has maintained its resiliency over the course of a tough 12 months in any event but certainly a tough 12 months for the more face-to-face relationship-driven areas. And so I think what you've seen our reps do is find different ways to engage with those lead sources, find different ways to engage with the brokers and financial advisers in their communities. And that's -- a great example of that is when all the legislative changes were happening, those brokers and those financial advisers saw their clients coming to them and looking for advice. And we were able to get in front of those folks in that channel, those brokers, those financial advisers and provide them with the content that we have delivered internally to our customers around what all the legislative changes were and how people could navigate that. And so just an example of the ways that I think our team has found to stay in front of those sources, maintain relevancy and maintain dialogue and talk about how do we go together. So I think that we've been really pleased with how that channel has held up a bit north of 25% of new business referrals coming from them in the course of the last 12 months.

Good. Good to hear, yes, because I had a similar thought going through the pandemic. But -- so on sales capacity and sales investments, obviously, I think there's been a pretty steady growth in the sales team. Maybe talk about how you're thinking about sales investments and hiring efforts and how those have trended.

Yes. I think so pre-pandemic, we would have leaned in a little more on sales and marketing and driven a little bit of incremental investment there. And I think we were seeing the benefit of that in the first 9 months of fiscal '20. Obviously, if you look back the last few years, we would have been growing sales headcount in that low 20s range, so 21, 22. And I think last year, the start of the pandemic really hit in the midst of what would have been our sales hiring season. And so given the fact that we paused hiring across the business in April sort of out of an abundance of caution and try to understand what was in front of all of us, this year, we came into fiscal '21 with around 15% year-over-year growth in headcount. I think as we look to the back half of this fiscal year and look forward to next fiscal, the idea would be to get back into that same -- or similar hiring cadence that we would have been in pre-pandemic from a new sales head count standpoint. And I think we've also made some meaningful investments in sales and marketing just before the pandemic in terms of doing a rebranding of the business, revamping the website. And all of that was really geared towards building a foundation for digital marketing, which we -- I think we've seen a good bit of success with as we come through the pandemic. And I think that's an area where we will continue to invest as we look forward. And all of those efforts are really around driving sales productivity, which we saw I think increase as we were in the first 9 months of fiscal '20. That was a big driver of the success we were having. And I think as we come out of this, it's about continuing to drive those types of investments such that we can get back to the same level of momentum that we had coming into all this.

And Toby, longer term, just thinking about sales investments, right, is -- should we be thinking about qualitatively growth in reps at or around the pace? Like I understand a pandemic is we're all adjusting. But getting back to that low 20s, is that the pace of kind of headcount and then supplementing with digital? Is that -- how should we be thinking about that longer term like 5 to 10 years down the road?

Well, yes, I mean I think as you said, in the nearer term, it's trying to get back to a similar type of pace as we would have been coming into all this, so in that sort of low 20s type of ZIP code. But I think as you look out longer term, so the time frame you just referenced was like 5 years or beyond, I mean I think the effort will be to invest in a mix, right? So it's going to -- it's -- we have I think, a relatively low level of penetration across the U.S. with -- we have all markets covered. But you can continue to add reps as we look forward over this period of time, so over the next 5 years. The question is just what's the mix in terms of the number of heads you're adding in any given year and the mix that you're driving from a digital standpoint to try and drive productivity. And I think over time, I think you want to be in a place where you don't have to add as many heads and you have the ability to drive productivity with things like digital marketing. And I think that will be -- that's the path that we're on. And I think that's the -- that is a path to success that we think we can execute against over the next handful of years.

And so if you're thinking about the market opportunity, I guess I'm just curious thinking about not necessarily RFPs but the amount of deals that you see, the pipeline, the cadence of new business opportunities like does that change at all, right? I know we're talking about service bureaus and the opportunity of people rolling off but like -- I guess I'm just curious what you guys have seen in terms of the amount of new opportunities that you're seeing this year? And how do we think about that going forward?

Well, I mean I think this year has been -- it's sort of a tale of 2 worlds, right? I mean I think if you look back a year ago at what we were seeing in the first 9 months of the fiscal year, I think we felt great about our sales execution. We felt really good about the momentum that we had. And then obviously, in the course of the last 12 months, we've all seen all the headwinds that are associated with that. So I think when you step back and you look at the longer term going forward, though, I think we come back to our view on the size of the market, which is we've got order of magnitude end of last year, 25,000 business customers against a market of over 1 million businesses in that 10 to 1,000 space. So -- I mean I think we believe that we have a relatively small share but pretty darn big market. And so the opportunity exists for a fairly long period of time to be able to continue to drive market share against that 1 million business -- or more than 1 million business opportunity.

So -- and Toby, it's also interesting like having gone to Elevate -- and I actually use my -- I know Ryan's got the Paylocity coffee cup. I just used mine yesterday, oddly enough. But so the -- if you think about the road map like, no, it's interesting going to the conference and talk about all the product, the investments in driving the PEPY and really being product forward. So we've mentioned Community. We've mentioned the video learning offering. And so like what -- I guess where do you think that ultimately can go down the road? And maybe help us understand where you're investing to kind of really add value for your customers down the line.

Yes. I mean so we -- with the release of Premium Video, we've just gone from $400 in PEPY to $420. And we've called out, I think, 1 year or 1.5 years ago a target of getting to $500. And that was not meant to be a ceiling of any type, more sort of a next milestone on the map. And I think we feel good about our ability to get there. I think over the last 12 to 18 months, we've actually had a ton of product releases over the last 2 years. So if you think about -- I think if you go through the list, we've delivered our Learning Management System, we've delivered Expense Management. We've delivered surveys, we've delivered the now Premium Video. And now we've delivered TPA. Now we're working on what I was describing earlier around bringing the Samepage technology into the Community platform to build out our collaboration tools, which we also think will be chargeable. So I mean I think there's been -- there's actually been a ton of delivery over the last 24 or so months. And that's what's gotten us to the $420 today. And I think as we look forward, we've certainly got opportunity around premium Community offering with collaboration tools. We also are continuing to invest in the existing products across the platform. So I think as you look forward to that 500 mark and beyond, it's a mix of continuing to invest in existing products to be able to drive, I think, just -- to continue to allow them to be the market-leading solutions that they are today. You can add features and functions. Some of that will be chargeable. Then I also think there's the new module production with things like the collaboration tools that will continue to give us the ability to increase PEPY as we look forward.

And so I was going to ask you like -- because thinking about different segments of the market and what they need. And so how do you develop and think about products and modules and features are certain things more integrated and you see more of a suite adoption, maybe at the lower end of the market versus addressing things in the higher -- into the market? How do you kind of prioritize those different things so much? Am I thinking about the right way in terms of features that might be utilized by different buyers or different-size employees or employers?

Well, I mean, our average-size customer has around 100 employees. And I think what you've seen from us historically, and this continues to be the case is we take a lot of feedback from our customers. We pay attention to what the -- to what they need and what the feedback is from them and their employees and continue to watch the market. But when we're delivering a new solution, we tend to build for that -- just the heart of our target market in that 100-employee average customer. And I think what you see is we're starting there. You're getting the feedback as we roll something out. We tend to roll things out in fairly fluid fashion, get a bunch of customer feedback and then you continue to build on them. So I think our ability to remain agile to deliver solutions, I think, fairly quickly, get feedback on them and then take that feedback and build them out for customer need, I think, is our approach and will continue to be. And I think what that allows us to do is build solutions for the heart of the market and then be able to adjust, whether it's, "Hey, you've got to make something slightly simpler for a 20-employee customer," may change some feature or function for a 1,000-employee customer. I think we have -- that's the way we approach the build. And that's the way we approach our leases and get the feedback and then adjust to accommodate really the heart of the need to expand the market that we're focused on.

So I did have a question coming from the audience. And it's actually about international opportunities. So just thinking about most of what you've looked at today is kind of North America, How do you think about the longer-term opportunity across the globe? Is that on the near-term road map? How do we think about that? I think I got most of the question.

Sure. Yes. I mean -- so I think international is certainly something that we would continue to consider over time. At the same time, I think you go back to the size of the market in the U.S., where we have 25,000-or-so customers against a market of over 1 million businesses there. And so from a prioritization standpoint, I think we have been squarely focused on driving market share within the U.S. in the target market that we've identified. But that's not to say that we don't think longer term about things like international and different ways that we can -- could potentially take advantage of a broader market out there. I mean I think the thing that has always been a challenge in the industry is taking the payroll solution that works across 50 states in the U.S. and expanding that on a global basis and the work that goes into the actual payroll engine to do that. But I think international is something that is certainly -- has been on our longer-term sort of vision. It's just a question of sort of the prioritization of the time frame given the fact that we have a relatively small share of a pretty darn big market in the U.S. and have had all eyes focused on how to drive share in the U.S. market.

So big growth opportunities. So obviously, I'm going to ask you about margins. So obviously, the markets are still pretty healthy. But how do you think about the cadence of margin expansion and kind of balancing that -- the reinvestment, the growth versus margin discussion? Any way to think about that?

Well, I mean I'll ask Ryan to jump in, too. I mean all eyes -- what I would say to tee up, though, is I think we have historically been focused on how to continue to drive that 20-plus-percent revenue growth on a longer-term basis. And I think that's still the priority. But Ryan, do you want to jump in and sort of talk about how we're thinking about margins certainly for this year and then as we look forward?

Sure. So I think the target we have out there on adjusted EBITDA continues to be 30% to 35% adjusted EBITDA margin. And I think that continues to be what we're marching towards. And I think if you look at the business, pre-COVID, we were just a touch under that 30% number. Obviously, the impact of employees on the platform as well as the near 0 interest rate environment we had over the last year has been a headwind where margins go. But we think as we start to come on the other side of COVID and certainly as employment levels increase, we continue to have conviction around that 30% to 35% number, I think, to Toby's point. Within that, you'll continue to see us investing in R&D and sales and marketing that could drive that 20%-plus growth target while looking to find efficiencies of scale in gross margin and G&A.

Okay. So still some -- all right. So we got the growth and we got the margins. So maybe last one and we'll wrap it up here. But just the longer-term uses of cash, I know we've seen some M&A. Obviously, as the cash balances go, there is free cash flow generation. How do you think about deploying that capital going forward and balancing those priorities?

Yes. I mean I think it goes back to the focus on growth. So we have been focused on finding ways to use cash to generate growth. And I think you've seen us do that in several of the acquisitions that we've made. And being able to identify interesting technology that's strategic to us, that we think we can take and actually integrate seamlessly into the platform to be able to provide a seamless user experience, a seamless data integration, I think that's kind of how we thought about it. And I think that, that will be true certainly in the near term going forward. I think all eyes are on growth and being able to use cash flow or cash balances to try and bolster the growth opportunity. I think that's how we think about it.

Okay. Well, I think that's all the time we have. Toby, Ryan, thank you so much. Everybody, thanks for listening in.

Thanks a lot, Brian. Have a good day. See you. Thanks, everybody.