Paylocity Holding Corporation (PCTY) Earnings Call Transcript & Summary

Hi. Thank you, everybody, for joining us. With me, I have recently minted CFO, Ryan Glenn, from Paylocity. So first, congrats on the role, Ryan, and thank you so much for joining us.

Yes, absolutely. Happy to be here. Thanks for having us. Great to be back in person after a couple-of-year break, so it's nice to be back.

It is. It's great to see everybody. It's great to see the audience. Thank you, everybody, for joining us.

Ryan, I want to rip the Band-Aid off and just get the question that we've been getting from a lot of investors out of the way, right? There's a lot of cross-currents right now. You have wage inflation. You have rising rates. You have what appears to be a relatively strong economy. On the other hand, you have people worried about a slowdown, right? And I know ADP put out some employment numbers this morning. So with all of that as the backdrop, maybe -- could you help us understand what you're seeing in the HR payroll market from your customers as you have conversations with them on a daily basis?

Sure. I think our experience so far this fiscal year is obviously very strong growth, right? So we had 34%, I think, growth in Q1 and Q2, 32% last quarter. We've guided to the fourth quarter to kind of 30% or 31% on the top end, so a lot of strong execution from the sales team. Demand continues to be very strong. I think our experience to date has been -- our client base has been very resilient. We're effectively back to pre-COVID levels of employment. We actually have seen continued small but upward trends positively in employment levels through the third quarter and through April. So to date, we have not seen any of that slowness. And likewise, from a sales perspective, we had a record selling season. So January is always the biggest starts month in our industry, had a fantastic Q3 and really strong momentum into the fourth quarter as well. So to date, we have not seen any of those impacts. Obviously, it's something that we will watch closely going forward.

Great. And honestly, after hosting a lot of companies over the past couple of days, that's been a fairly consistent theme, right? So it's great to hear that that's similar for Paylocity. And maybe why don't we touch on -- you talked about a record selling season. You've talked about business doing well. Where is that demand coming from? And maybe how have customers' needs changed as we've gone through a pandemic and now are emerging from it?

Sure. So I think we've seen strength throughout our target market. So all the way -- so up to the top end, we increased that target market to 5,000 employees, and we've seen success in that 1,000- to 5,000-employee space, incremental, but certainly more clients there. As well as in the core space, so sub-500, we've seen really strong execution. We're seeing rep productivity actually up from pre-COVID levels. So the demand is there, and I think what is driving those conversations is really the digital transformation and the need for companies to connect, communicate and sort of cultivate engagement with their employees in a way that maybe they haven't done historically. So much of the discussion is around being able to solve those problems that, for many businesses, I think, they have faced in a new and different way through the pandemic. And fortunately for us, we have a set of modern workforce products that really help solve a lot of those problems. And those are the areas that we've seen, in particular, success in increasing attach rates over the last sort of handful of quarters.

So I want to touch on the larger customers, but since you just -- you ended on the product side, and I think that -- maybe it's worth just jumping ahead to that. The company, I think, has done a really good job in terms of adding both the organic innovation and M&A modules that I think can create more engagement, more collaboration inside of an organization beyond just core HR and payroll. Can you double-click on that and maybe how the company has done that via communities and the Premium Video offering? And what's the goal of modules like that?

Sure. I think that, in particular, to your point, is where we've seen particular success. So Premium Video, for instance, is a product that we've had in the market now for about 2 years, and that has attached at a higher rate than we would have expected. The usage is higher. Community, likewise. We've had Community, which is effectively our sort of social collaboration hub out in the market for a few years on a complementary basis. And likewise, we've seen strong increases in sort of all of the key stats we'd look at from a usage perspective. As an example, in January, we saw 1 million monthly active users on Community. We're seeing massive increases in announcements, group creation, reactions and engagement. And I think all of that, to my point earlier, drives home the -- sort of solving the problem for companies on how they drive the culture that they're looking for, how they engage their workers. And they're looking to do that in a fundamentally different way than they did previously.

So I want to ask maybe on the collaboration side. It's a hot topic you have. If I think about myself at Jefferies, me and my team, we're in Teams almost every day. That's how we're working together. We're collaborating through that. We're also frequent users of Zoom. I guess how should we think about what Paylocity is doing on the collaboration side? And what that means for your customers' employees versus if I compared it to maybe the more traditional, well-known collaboration solutions that even you guys may use?

Sure. And we do use many of those. And I think if you remember back, our average client has about 100 employees. They're not necessarily using some of these enterprise solutions that you may be referencing. But I think within Community, we're seeing communication across many different avenues or different areas. We're seeing examples of sort of group creation. So to my comment earlier on driving engagement, companies are creating individual groups. Employees are kind of communicating back and forth maybe with folks within the org that they wouldn't have in the normal day to day, and that sort of drives some level of engagement and activity within their business that maybe is more challenging today because they have remote workers. They're working hybrid, and you don't have that same level of sort of in-office collision that you may have had pre-COVID. We're also seeing Community being able to be a spot where companies are getting work done, so being able to create groups and being able to have 1:1, one-to-many chat functionality, being able to share, edit, create a file. And we're heavy users of Community internally. Me and my teams are using that to edit a job description, for instance. We're looking for a new role. Rather than going back and forth with 20 or 30 different e-mails, we can create a Community group within the finance org. We can edit. We can provide comments. The team can kind of go back and forth and actually get work done there, so there's a lot of different use cases. And then as you layer on a product like Premium Video, right, being able to add asynchronous video communication across the platform, a lot of really interesting use cases that we use internally, but that our clients are actually starting to use as well. So it's been really exciting to see, not only the increasing attach rates and what that drives in ARPU, but the activity increasing over the last several quarters.

Great. So I want to touch on that part. You mentioned ARPU, and Paylocity has consistently increased the target PEPY and the realized PEPY as well based on your annual disclosures. And I guess how should we think about some of the features that we just talked about? Do you typically go in and upsell and cross-sell those? Are those more just driving larger lands at inception? What's driving that realized PEPY expansion that you've experienced?

Sure. It's a combination of both of those avenues. So on average, our new clients are attaching a broader array of the product suite. So new clients have a higher level of ARPU, on average, even on a per-employee basis, than base clients would. And then likewise, we've had a lot of success over the last several years going back in upselling existing clients. We've had that internal team dedicated to that function for the last 5 or 6 years, and we've added to that team every year. We'll add to it again next fiscal year as well. So for that team, it is not only going back to clients that maybe didn't have an interest in a product when they came on, but we've more than doubled the product suite since we went public in 2014, so going back and being able to articulate that use case. And I think really being able to go to clients and saying, "Hey, these are the actual use cases that we're seeing clients use Community or Premium Video for," and being able to have those real-world examples, I think, has really helped many of the newer products resonate with that existing client base.

That's great. And I guess that brings me to -- there's been organic innovation. There's also been, I think, some smart, strategic M&A. I was wondering if you could maybe touch on a couple of the deals that the company did last year, so Blue Marble and Cloudsnap. And how do they fit into that overall strategy of Paylocity becoming more of a platform inside of an organization?

Sure. I think for different reasons, but both of those are sort of the overall strategy of having the most modern set of software for our clients. So Blue Marble was a business that was founded by Paylocity's founder, Steve Sarowitz. We've known that business obviously very well, dating back to sort of the 2013 time range, and we've had a relationship and a great partnership with them for the last several years. And I think what, in particular, piqued our interest there is what we've seen throughout the pandemic and coming the other side is some subset of our existing clients as well as prospects that, because they've got more comfortable with remote workers, because the war for talent continues, they've had an increasing level of interest in hiring internationally and likewise for prospects, too. So that was something where we've seen a trend again over the last several quarters and still working through the integration. But over time, being able to offer not only full U.S.-based domestic reporting but being able to offer an integrated level of payroll and HCM reporting for international employees as well, we believe, is a real differentiator. Second acquisition that we completed in January was Cloudsnap. A little bit of a different acquisition in that it's not sort of directly monetizable, but Cloudsnap is a sort of flexible, low-code integration automation platform that, as we work to integrate that broadly in their product suite, will allow for a quicker, more efficient, less manual effort to spin up integrations, allows clients to automate processes that were very manual and I think, over time, will allow us to expand kind of the depth and breadth of types of integrations that we're able to offer for clients. So early days there, but I think excited for both of those acquisitions.

So maybe a follow-up on Cloudsnap. Should we think about that as a benefit to Paylocity being able to integrate your own acquisitions that you do or your own back end? Or is it meant to help customers with the rest of their technology stack or both?

I think there's benefits to both, but probably first and foremost would be our client base, right, being able to integrate broader business applications, whether that is a GL or other critical software within their HR or finance stack, and be able to do that in a much quicker, more efficient and automated way and being able to spin those up much quicker than maybe you would have had historically.

Great. So I think that's a good transition point to larger customers. I know the company in the recent past disclosed that you're increasing the target size customer you're willing to go after, and it's more of a function of being pulled upmarket necessarily than pushing it. So how should we think about being more flexible from an architecture standpoint with something like Cloudsnap? Does that help differentiate you as you push upmarket? Or are they still just as likely as smaller businesses take both the HR and payroll side? How are those customers different than maybe your traditional SMB customer?

Sure. I think, on average, they're not materially different. And for us, we have always had some number of clients with greater than 1,000 employees. But certainly, over the last handful of quarters, we've seen incremental success with clients above 1,000 employees. We're seeing some of those newer products that we referenced earlier, Premium Video, Community, Learning Management Surveys, resonating very well upmarket. So for us, it is less of a strategic shift or a movement of resources upmarket and really more of a public acknowledgment of we have clients above 1,000 employees. We've seen incremental success, and let's sort of make it official. But I think to your question, I think Cloudsnap, for instance, is something that is going to be useful throughout the target market.

And to move upmarket, do you have to change the sales go-to-market motion? Or how should we think about the ability for the existing sales organization, which has been really productive? How are they doing in terms of selling upmarket?

Sure. I think we feel like we're making the right investments there. It is a team that is your more experienced sales reps. It is your more experienced implementation and project management folks that are really handling the 500 and up space, and that will be the same process going forward. So you're always thinking about ways to optimize and make tweaks. But we feel like because we've had that incremental success, because the product suite is resonating that we're certainly on the right path there but will be an area that we continue to focus and make investments on.

And do you guys change the type of sales rep that you may be targeting in terms of hiring yourselves? Or in terms of the -- whether it's maybe even the internal training side of it, just how should we think about maybe the rep that Paylocity is not trying to acquire as you think more about serving those larger customers?

Sure. I would not view it as a fundamentally different sales rep. As I referenced, I think the reps that we have on that enterprise space or the way that we would define it would be more experienced folks that either have come from the payroll industry in the past or have experience with B2B sales, and I think that will continue to be the approach going forward. So there's certainly probably a slightly more sophisticated selling process or a buying process upmarket. But again, we feel like we've got the right team in place and have continued to make the investments to be able to be successful upmarket.

Great. I want to stick to the go-to-market theme. Just -- I think one of the big benefits for Paylocity as a company and really software, in general, was virtual selling, right? It allowed people to take more meetings, be more productive in a certain way. Now I think you've talked in the last several calls of employees returning to the office and going back to in-person. How does the company maintain that sales productivity balance achieved where it was all virtual selling? Now we're going back into in-person, so there's a hybrid element. How should we think about sales productivity?

Yes. I mean, I think going forward, there's likely to be a mix of both worlds. So to your point, during the depths of the pandemic and even a bit after, most of the sales were virtual. Our reps were leveraging Zoom, certainly our Premium Video product to be able to create asynchronous video communication for prospects and be able to show the value there, phone calls and the like. And at the same time, we also increased our digital marketing investment, so that's an area where we've seen incremental success as well. So I think where it sits today is reps are allowing prospects to lead that conversation. So in the instance where a prospect is in the office, and they're welcoming folks in, then our rep is more than willing to follow. But if it is a company that is working remotely or would prefer to do the sales -- work through the sales process virtually, we're more than comfortable there as well. So I think the reality is, going forward, it is likely a hybrid approach. But no question, we've seen a lot of benefits of being forced to work and to sell virtually. And I think the fact that we now have rep productivity ahead of where it was pre-COVID, which, for us, was a really high bar. That was a period of time where we felt like that team was operating on all cylinders. And to be back there and actually ahead of it, we feel really good about. But I think it ends up being trying to take the pieces of each of those kind of go-to-market approaches and trying to optimize.

Look, I know I've tried to retain some of writing research in my pajamas at home, so I hear you on the balance between hybrid and back in the office. And so maybe just to kind of round out the go-to-market side, the company has always done a really good job working with the brokers to -- the broker channel to drive new deals. And maybe could you just help the audience understand just how does that motion work with your broker partners? And what are the economics, if any, that you're sharing with those partners?

Sure. So I think we've consistently received 25% plus of our new sales coming from channel partners, which, to your point, is made up of benefit brokers, workers' compensation, 401(k), as well as some sort of broader channel partners as well. And we've been really pleased with our ability to maintain that 25% plus referral rate, and I think that is an area that we continue to focus and invest on internally. And much of that, though, is really driven on a rep-by-rep basis, right? So a good broker may give us a handful of leads a year, so there's not a significant amount of concentration with one individual firm. It is really on a rep-by-rep basis in their territory, spending a portion of their days and weeks out networking, out cultivating those relationships. And what we found over time is the more success we have, the more use cases we have for the sales org, the more we can customize and provide a road map for newer reps. And that also helps with retention as well as when we're adding sales reps. We're able to point out, hey, we have many, many use cases of reps who -- the average is 25% plus, but high-performing reps may get a higher percentage there. So being able to articulate what that road map looks like, and it's certainly an area that we invest in and focus on to make sure that there is value there. And I think having the 92% plus revenue retention is it allows us to go back to those brokers and prove that their clients are very, very happy with Paylocity. But no question, it's an area of focus on a go-forward basis.

Great. And maybe switching gears, I want to talk some about the growth algorithm more broadly, right? And this has a little bit to do with maybe the question we kicked off with. But just generally with where employment is, with new customer acquisition, you mentioned pre-COVID, how the business was improving. So if I think about Paylocity, we sometimes forget that the growth is actually improving before the start of 2020. And now, as you're coming out of it, growth has remained elevated. How should we think about that growth algorithm going forward maybe versus new customer acquisition versus upsell, cross-sell into the base? And just should we think about this as pre-COVID levels of growth? Or just how should we contextualize all of that?

Sure. So I think to your point, our target is 20% plus revenue growth. Obviously, outside the 2 or 3 quarters of the pandemic, we've been well ahead of that for the entire time we've been public. And I think as we've moved to the other side of COVID, the comps have been easier from an employee's and a platform perspective. And to my comment earlier, we have now had 3 straight quarters of 30% plus revenue growth and strong guidance for the fourth quarter as well. I think as you get into fiscal '23, those comps start to normalize. Obvious caveat there would be anything that happens from a macro perspective that sort of may change that. But I think as you get into fiscal '23, you start to get more normalized growth, and I think you probably get back to that 20% plus number. So whether that is mid-20s, low 20s, I think that remains to be seen. And obviously, on the next call, we'll provide fiscal '23 Q1 and full year guidance, so we'll work through that between now and then.

Great. That's really helpful. And then just -- we're in a rising rate environment, and I think that sometimes what people may not appreciate about the payroll software model is the benefits that you may experience from wage inflation and from rising rates. Could you just maybe help us understand what Paylocity's approach is to managing the float balance and how we should think about that with rising rates?

Sure. So for context, we averaged about $2.4 billion of client-held funds in the third fiscal quarter, and we forecasted about $2.2 billion of client-held funds on a daily basis in the fourth quarter, and we are in interest on those funds. So to the extent you continue to see interest rates rise, that would be a tailwind for us. That is revenue, and it's also very, very high margin as well. So I think the future scenarios you get into fiscal '23 is there is a help from a revenue perspective and a help from a margin perspective. For us, the way that we manage those funds, one, that is client funds, right? So it is a focus on very safe, liquid, typically short-term investments. Most of that -- those funds sit in money market accounts at the several banks that we would work with. There is a portion of those client-held funds that we would invest in, typically -- typical how you would see some of the legacy players in the space. That is commercial paper, asset-backed securities and treasury. And I think over time, you'll see us continue to invest in incremental portion. But there's absolutely the potential for a tailwind as you get into '23. We've now seen 75 basis points of rate increases and the likelihood for further, so that would certainly be the potential for upside as we get into next year.

Great. And just -- we have time for maybe a question or 2 more. Just Paylocity has always done a really good job of balancing durable growth while also delivering on the margin side, right, which I think is really valued and important to investors. Just how should we think about what the company continue to invest for growth? How that balance on the EBITDA margin side will look, just maybe more broadly speaking, given that you guys haven't guided beyond this fiscal year?

Sure. So I think it is certainly a balance. I mean, first and foremost, is driving revenue growth, right? So you see us continue to invest in growth-driving initiatives, particularly on the R&D and sales and marketing front, and I think we're going to continue to do that. Where you've seen a scale is in margin and G&A, and those will be the areas that we would focus on in fiscal '23. I think as you look at the guide for fiscal '22, we guided the top end of revenue to about 32% growth, and we're guiding to about 60 basis points of adjusted EBITDA margin leverage. So we feel like we're going to be right at about the Rule of 60 for this fiscal year. So I feel really good about that combination of revenue and profitability, and I think the focus would be to continue to drive leverage going forward as we've done historically.

Great. Maybe just last question, one that we get very often from investors that there's multiple payroll vendors out there. Paylocity's gotten to pretty significant scale and is still growing at a very healthy clip. How should we think about the durability of that? Just how do you think about maybe the market opportunity? And maybe what have investors gotten wrong that you guys have been able to grow stronger for longer than I think many had anticipated?

Sure. So I mean, as I referenced earlier, the focus for us is 20% plus revenue growth. Obviously, we've exceeded that, and we talked earlier about increasing rep productivity. And I think maybe what folks don't fully appreciate is it is a massive market. So for us, we had, call it, 30,000 clients versus a market opportunity of 1.3 million businesses in the U.S. with between 10 and 5,000 employees. So we view it as just a few points penetrated into that broader market opportunity. And you have I think legacy players that, on a combined basis, have several hundred thousand, if not 1 million-plus employees. So it's a growing market. It's one where it certainly is competitive and we've had success, but we feel like there is still a significant market opportunity out there for us, in addition to increasing the product suite, which, over time, would increase average revenue per...

Great. Well, we're out of time. So Ryan, we'll leave it there. Thank you so much for joining us. Really appreciate your time today.

Absolutely. Thanks for having us, and take care, everyone.

Great. Thank you.