Paylocity Holding Corporation (PCTY) Earnings Call Transcript & Summary

Okay. Excellent. We'll go ahead and get started then. So thanks, everyone, for joining us here today. Sorry, I can't be there in person, but I'm Matt Pfau. I'm the analyst that covers Paylocity at William Blair. For a complete list of our disclosures, you can visit www.williamblair.com. And we're happy to have with us here today, Steve Beauchamp, co-CEO of Paylocity Steve, welcome. I'm sure a lot of folks in the room are at least have some idea of what Paylocity does, but maybe just a quick overview to level set would be helpful for everyone.

Sure. I'll keep it high level. So Paylocity offers payroll human capital management software to midsize businesses. Our target market is really 20 to above 5,000 employees. We've expanded a little bit below that target market. We started with and a little bit above that, but we've been relatively consistent since the IPO back in 2014. And we've expanded the amount of products that we've had over the last several years. In fact, at IPO in 2014, it was about $200 per employee per year, if somebody bought everything that we were selling and now it's $440 per employee per year. So part of our story is land and expand, leaning much heavier on land. We've been able to grow the business pretty significantly by attracting new customers, somewhere between 15% and 20%, if you look at the last several years in terms of unit growth. And then we're selling more product to each of those customers that have come on board as well as increasingly so, selling back to the client base over time. So pre-pandemic, we were growing at about 25% revenue per year, and obviously, that went up, and we went down and then back up in the last couple of years. But the last few quarters, we've come out of the pandemic with some real momentum and are growing over 30% per year, and have guided the whole fiscal year to above 30% per year, which ends in June. And our big point of differentiation has really been focused on modernizing our suite so that we're really trying to help HR teams tackle the most pressing trend. So the increased frequency of remote work, Gen Z entering the workforce, some of the demands that you're getting by a more dynamic workforce and really creating modern capabilities. Video is part of our platform. Community, which is really kind of a social element to the platform, is really an add-on to all the staple products that somebody might need, payroll, time and labor, HR software and some of the talent products as well, recruiting, onboarding. And so we've got the entire suite of products. And this modern capability is certainly one of the reasons on top of our sales force execution that we believe we've come out of the pandemic with a whole bunch of momentum.

Great. And maybe just to start with the momentum you're seeing in your business. So when COVID started, new business slowed a bit, but now it's come back really strong, and there's a lot of demand out there for modern HCM and payroll solutions. Maybe you can just discuss what market factors are out there that are really driving companies to maybe rethink their HCM or payroll provider.

Yes. So most of the market factors won't be a surprise to anybody. This is one of the tightest labor markets that we have -- we've seen in our history. And so HR teams are really challenged with attracting and then retaining the talent that we've seen. Everyone's heard of the great resignation. There's definitely more movement from one company to the next. And so if you go pre-pandemic, a lot of the value proposition was about digitizing the back office, saving HR team's time. That's still part of the value proposition that we offer. But increasingly so, we're really selling this idea of engagement, communication, collaboration, connection with employees. Because if we're actually able to help our clients with that problem, it's a bigger problem than saving a little bit of time and automation because if they can actually attract the talent they need and just, as importantly, retain the talent they need, that is a real big win for our customers. And so when we're selling into the customer base, we find most of the conversations are gravitating towards how do I manage my workforce differently and how do I manage them differently such that I'm actually able to retain more of them, and I'm actually creating a great culture and environment to be able to attract the talent that we need. And so those are a combination of the basic transactional capabilities, the human capital management modules, the analytics that we offer but also these modern capabilities to be able to communicate, connect and engage.

Got it. And as you said, you are growing ahead of where you were pre-pandemic, and I think your long-term goal has been to increase recurring revenue about 20%. Maybe discuss some of the factors that are driving Paylocity's growth ahead of that target right now. And what's the sustainability of the growth you're seeing in the business?

Yes. So the way we've talked about our long-term business model is 20%-plus growth is kind of the floor that we are really targeting. We -- Pre-pandemic, we're about 25%, and that dropped a little bit the first year of the pandemic and then has reaccelerated above 30%. So part of that is the comparison, which we certainly understand. But if you look at us relative to our peers, we're actually growing faster than our peers as well. And I think the other part beyond the pandemic comp is just the value proposition that I went through and the execution by our sales force. We're seeing momentum across all size segments in our target market. And the fact that the investments we've made in product, in areas of modern capabilities, video being the most obvious thing, 3 or 4 years ago, HR teams didn't want video in the product. They weren't even thinking about that in that 2 years of living on a video screen, everyone realizes the benefit of actually being able to communicate in video. So instead of sending an HR newsletter. How'd we talk about videos that tells the employees what's happening in the organization, much more engaging experience, click rate on your mobile phone. You can easily watch that and then giving the analytics back to the customer. So that has really been a big source of momentum is this modern capabilities that are creating an engaging platform for our customers, the managers who use it and the employees who use it.

And you mentioned you've been seeing good success across all client size segments. And it's really a wide range. We think 20 all the way up to several thousand. Does it go-to-market differ by client size? And how do you manage that?

Sure. Yes. So on the smaller end of the segment. We had a dedicated sales force pre-pandemic that was doing a combination of selling clients virtually but mostly getting in front of CPAs, getting referrals and going on site with clients. We pivoted during the pandemic to take that team completely virtual. And we also spent more on digital marketing initiatives, which were actually very successful for us and, frankly, even more efficient go-to-market motion. So we've continued with that team, and that team has largely been focused on inbound lead generation in the under 50 employee marketplace and bringing those customers onto our platform. The bulk of our sales force really falls into the midsized customer range. Our advertised customer has a little more than 100 employees. And those folks are still doing a mix of virtual and now getting back on site. They get a little more than 25% of their revenue through broker referrals, which are people who are selling insurance products, health insurance or 401(k) products. That actually hasn't changed. That's maintained all the way through the pandemic. So that has continued now that we're getting back on site, meeting with brokers, meeting with clients. And then on the upper end, we take some of our most experienced folks, and then we allow them to focus on some of the larger clients. We definitely -- as the product investments have matured, and you think about a product like recruiting now been in market for 4-plus years, we've added features to it continually. We become more competitive upmarket. So we have called out over the last several years, increasing momentum upmarket. But as we look at it across the board, it's really across the board that's driving the 30-plus percent revenue growth.

And are there any limiting factors as to how large of a potential customer that you could sell into?

They're not really limiting factors from a system perspective. It really comes down to functionality. It's not typically in payroll. We can do large clients from a payroll perspective. Customers, as they get larger, think about organizations getting more complicated, having much more documented processes, wanting much more configuration, implementation services. That's where it gets more complicated for us. So a lot of our clients that are fairly large often have multiple locations. And all those locations operate like midsized companies, they end up being really good fits for us. But if you got a really large multinational organization in the consulting space or something like that, that is where it typically gets complicated. So our customers often come to us and say, "Hey, let me use your recruiting, your performance management, and I want to automate everything that I've got." And they'll change their processes to be able to take advantage of our platform. A really large customer comes in and says, "Here's my process manual. You need to configure your platform to do all these things." That's not a perfect fit for us. That's not really where we're kind of focused. We try to build the best practices into the platform, and we give them a number of ways to be able to accomplish that, but we're not necessarily wanting to spend 6 months in implementation or 12 months in implementation. Clients that we have don't have the resources to be able to do that. And so that's kind of why we stay into that up to several thousand employee market.

Got it. And then with the HCM suite, which, as you highlighted, you've really expanded the functionality nicely over your time as a public company, on your last earnings call, you called out you're seeing some improved attach rates across some product areas. What product areas are you seeing the greatest uptake in? And then is that with new customers, existing customers or both?

Yes. It's very likely the products you would think of that attack the trends and challenges that HR teams are having. So one of the challenges when you have a lot more remote workers, how do you connect with them, how do you continue to develop them, such that they continue to learn and become more productive. While learning management system allows you to distribute content, track what courses people have had, allow people to kind of develop in a more digital fashion, that product has been really popular for us, both with new customers at a higher attach rate, but we've also seen current customers adopt that at an accelerated rate. Recruiting, another great example. It's hard to find talent. And so I need to be able to put my best foot forward when I'm advertising a job. I need to make sure that I can efficiently get through the number of candidates that I might have. And so that product attach rate has increased significantly. Community is kind of our social interaction on our platform. Think about reimagining the old HR Internet, and having ability to post and react and create emojis and mention people. And so the -- although that's a free product, for us, we've seen mass increase in utilization, and it's become a really important part of the differentiation, and we leverage that capability to recently launch some advanced features on Community called Community Plus, and we launched that a couple of months ago, and so we've seen good traction of that early. And then the last one I'll mention is we have a premium video product. So I can add video job descriptions to recruiting applications. I can recognize employees with video rather than sending them a note, comes across with a badge and video. I can post internally via video, do announcements. That's also been really popular as people become more comfortable with video. And I'd say we probably have gotten more traction selling to every new customer that comes on board than we have back to the client base. But remember, 5 years ago, we didn't sell back to the client base hardly at all. We started the team back then, and we've grown that team at an accelerated fashion where it's not as big as us selling more product back to our customer -- to the new customers yet, but it's much -- growing much faster. And so that has been a great contributor over the last 2 years in terms of selling all those products that I mentioned and the rest of our suite back to clients.

And so some of the functionality you've added has been organic development. And then you've also pieced on some nice functionality through acquisitions. I think Blue Marble and Cloudsnap are some of your more recent ones. Maybe just discuss that strategy around acquisitions. How do you think about them? And how do the more recent ones fit into some of the trends you're seeing?

Sure. So we generally have not been very acquisitive. We've done one or 2 deals over the last several years, and we don't look for like businesses. What I mean by that is we're not going to buy another payroll business or some human capital management software. Because we really want to focus on delivering that unified customer experience. So if I go buy a recruiting application instead of building it, it's a disjointed feel for the customer, and it's a lot of work to be able to integrate that. So what we do look for, though, is technology acceleration opportunities. So I'll use video as the example. We acquired a video platform. I could have went and hired a bunch of engineers. I could have built a video player and then integrated it into our suite, but instead, we had a good partner of ours. We acquired them, great video technology. I embed that in the suite. It looks no different to the customers if I built that. That's an example of a great acquisition. Cloudsnap, the most recent one, is really a Low-Code to No-Code way to transform data in our data integration. And our customers want us to integrate data with a variety of platforms. So it takes the time to bring on a new data integration down dramatically, and it takes the skill level that you need to be able to do that down as well. And so that's something that we just recently acquired, less of a revenue opportunity, but more of an accelerator around data integration. Those are technology acquisitions, and we'll continue to look for those. Typically, there'll be newer tech stacks and things that we could build but we get to market much faster if we buy. The second category, we've done much fewer of these is, are there actual products that would take us a long time to build. And therefore, we think we need to be able to buy those and be able to sell them back to the clients. Typically, there's also other elements than just technology there. So if you look at Blue marble, what Blue Marble does, they offer a client who is headquartered in the U.S. and has international employees potentially in 2 or 3 different countries a software in between them and getting those employees paid. And so they actually have partners in those countries that are actually doing the payments. They put a software layer in between it. So the customer doesn't have to do all the home went providers, different rules and then if there's a service person in there that they can kind of ask questions to. And so that's a great differentiator for it. It's not necessarily something all of our customers want because not all of our customers have international employees. But we felt like there was a lot of unique knowledge in that business. That full network of in-country providers takes a long time to be able to build. And we felt like we could integrate the technology part of the equation over time. And so with international becoming much more commonplace when people are working remote, and that being a nice growth market, it was a really good fit for us. So it gives you a sense of how we think of. Mergers and acquisitions, we don't need to do acquisitions to be successful and continue to hit our long-term growth objectives. I would characterize them as being opportunistic, and allow us to accelerate the strategy that we already have.

And one of the unique aspects of the SaaS payroll businesses is the interest income. And so maybe you can just go over that dynamic a little bit for folks and what the impact of rising interest rates have on Paylocity's business.

Sure. So when we pay somebody, we generally will be holding that money for their net pay. So the direct deposit of their net pay typically for a day, and then their taxes are going to be due either the day after payroll or maybe sometimes even several days after payroll. So the money that we hold on behalf of the customers is what we kind of talk about getting float revenue on. So we get an interest rate on that money. Now the last several years, that interest rate has been near 0, and that hasn't been much of an income stream for us. But as interest rates increase, specifically overnight interest rates, largely because it's a very short-term money flow that we've got, then our banking partners provide us overnight rates on that money, and that is our interest revenue. And so we have over $1 billion on average in balance on an overnight basis for our customers. And so if that goes up by 50 basis points, we then go to our banking partners, and we get rate increases on that overnight money. And it might take us a quarter or so to be able to get all of that from them. But basically, it's simple math, 50 basis points times $1 billion, that becomes the incremental opportunity for us, and most of that flows to the bottom line. So it's certainly -- it's an attractive part of our business model. And certainly, there's a lot of worry about a potential recession or anything like that. Historically, as there was a recession, interest rates are coming down, and that puts more pressure on our business. Interest rates actually coming up become a bit of a counterbalance to any recessionary pressure that you might see in our industry.

Yes, that's an interesting point. And so obviously, the interest income going up has a nice uplift to margins because it's very high-margin revenue. What about just leverage in the business, excluding the impact of interest income? How do you guys think about that? Where are the biggest points of leverage?

Sure. So I would say our thought process is to gradually improve leverage over time, while at the same time, making the right level of investments in R&D and sales and marketing that we think will be long-term growth drivers. We're sitting here today at guidance that's kind of in the mid-$800 million range for the year. And we think we've got an opportunity, very real opportunity to get to $2 billion in revenue over a fairly reasonable time frame and particularly with -- when you're growing 20%-plus, just take a lot of years to get there. So we're really focused on that opportunity. We also think, though, we can actually get leverage as we get there. And so we have been leveraging the business outside of the pandemic year. We've been leveraging the business probably a little more than 100 basis points per year. I think from a guidance perspective, we've always talked about that being more in the 50 basis point. We've actually, at times, guided flat because we wanted to make investments. But if you look at our history, we've always gotten some level of leverage outside of the pandemic year every year. And that's kind of the way we think the business model naturally has scale into it. It may not be the exact same amount every year, but we're in the 28% adjusted EBITDA range in terms of -- pre-pandemic, it was 28.5%. And so we've been moving back up towards that number. As we're coming out of the pandemic, our long-term range is 30% to 35%, and we think we can get into that range and we can get to be a $2 billion company as part of our long-term model and still be growing the business at a healthy clip, and that's the goal and objective.

And with recession or softer macro being top of mind for everybody, Steve, you already talked about it, it's a little bit unique as interest rates are actually going up right now. What other sort of puts and takes should we think about for Paylocity's business in a softer economic environment?

Sure. There's 2 other areas I get questions on when it comes to puts and takes. So one is we get paid based off how many employees are on our platform. And so in a recessionary environment, clients typically are either not hiring as much, not replacing positions and you get slightly less employees on the platform. Outside of the pandemic, what I've historically seen is if GDP is growing 2% or 3%, you're getting 1% or 2% more employees on the platform. If GDP is like minus 2% or 3%, you're getting 1% or 2% less employees on the platform. That's a historical view, having been in the industry for 30 years of what that looks like. Every recession can be slightly different. So we don't know whether that's going to happen or how that's going to happen. But you'll have some pressure on employees on the platform in terms of revenue. That was significant in the pandemic as that dropped precipitously and this the biggest point we probably have ever seen. So that's an impact. The last impact I get asked about is what happens from a sales motion perspective. And that one I worry less about. I can't control the number of employees on the platform, but sales, we can have an impact to. And we've been able to sell pretty effectively through prior recessions. On '08, we're obviously a lot smaller. But as we look at even the pandemic, which was a huge dip, we were able to sell pretty well through the pandemic, which, at the time, I was obviously worried about. And so if customers are going to buy in a precipitous drop during a pandemic because we're selling engagement and efficiency. And so right now, they're really interested in engagement. Sometimes in a recession, they get a little bit more interested in efficiency. But still, you can't not pay your people. And the products that we offer, offer real ROI, and it actually sells pretty well, whether you're in a growth environment or a recession.

Got it. And Steve, would just be a little bit curious to get your opinion on this. I mean a lot of people cut pretty harshly at the start of the pandemic, and then hiring has been a challenge. Do you think your client base might be a little bit more cautious about cutting head count in a softer macro given the difficult hiring environment that we've been in?

Yes. We get to see it in real time. We look at it every week. We look at the business as a whole. We look at the same cohort of clients that we had the year prior, and so we can kind of look at a same-store sales type metric in terms of number of employees on the platform. We called out on the last earnings call that we have not seen any softening in that metric at all. So I don't know how people are going to generally react. I think one thing to keep in mind is our average sized customers are a little more than 100 employees. So these aren't large enterprises that are making capital decisions a year ahead of time. They own 3 different restaurants. They have small businesses. they're looking at real-time traffic patterns into their business, and they're reacting based off that real-time data. So historically, what I've seen in the industry is large clients tend to react early and make bigger longer-term decisions. Smaller clients tend to react more in the moment. And if I own a retail store and I see less customers in my store, then I can reduce the hours of my employees or I'm not going to hire that next employee, but they almost have to see that demand environment change before they react. And as I said, we see no evidence of that as of our last earnings call today.

Great. I'll throw one more out there, and then we'll see if the audience has any to finish up. But you guys recently moved to a co-CEO model. Maybe you can just sort of describe the rationale behind that.

Yes. So I have been with Paylocity 15 years this fall. And we have really -- I really tried to run the business with a team-based approach. And so my CFO at the time, Toby Williams, and the President of the company, we were the people making a lot of the strategic decisions. Our President of the company has been with me for all those 15 years, and I've known him for 20 years. And I think the transparent answer is he really wanted a shot to be able to run something on his own. And my time line doesn't overlap with his time line. And so we had a really good open discussion about this for a while, quite frankly, and he let us know 6 months ahead of time and he's still with us until September and so still work with him very closely every day. But once he decided he was going to do that, I really wanted to lock up Toby, who is our CFO, who was really part of that key people running the business. And promoting him to co-CEO is a great way to be able to do that. And behind him, Ryan, who many of the investors have interacted with, promoting him to CFO really allowed me to kind of put a structure in place that actually is very similar to how we work already. And so I'll get to continue to spend probably more time on the sales and marketing side and the product side, which is what I did before. Maybe a little more on sales and marketing now with Mike leaving. And then Toby's really grabbing a lot of the rest of the organization. So it's I think internally been less of an issue. Lots of questions externally that happen from there, but it works really well for us.

Great. And maybe we'll see if the audience has one or 2 questions to finish this up.

You get to the [Technical Difficulty].

Sure. So first of all, everybody has to do payroll some way. So we're always replacing something. And almost all circumstances, there's some spend involved in that replacement cycle. The larger players in the industry as a whole is ADP and Paychex, right? They've got hundreds of thousands of customers. And so we probably get our share from them relative to their market share. I don't want to give the impression that, that's like where we target customers from, but that's the biggest place that we get customers from probably because they have the biggest market share. In terms of reasons why they come to us, really, it goes to what I said before. We do have some modules that they don't have. So sometimes there's some capabilities that we're offering them. Whether that's LMS or sometimes recruiting in some cases for one versus the other, there's some of these newer modules that we've got. And then some of these modern capabilities that we've added over the last several years are absolutely differentiators versus the competition as a whole. And so that becomes a big part of the value proposition. Price is less of a factor. We're all similarly priced. The average customer spends about $25,000 with us. So 5% or 10% difference isn't probably the needle driver. And then the only other thing I would say is, in our business, people do call and have questions a lot, right? And so the service part of the equation's important and so creating that right relationship with the customer where they feel they can ask you questions. There's been a ton of legislation change over the last few years, so they look to us to help them through that. So it's a combination of the technology and the value proposition we offer there and the service experience we have.

Great. We should have time for one more if anyone else has one. Okay. Well, if not, maybe I'll finish this up then. I guess the question that I get a lot, Steve, is it seems like everyone is sort of doing well in SaaS, HCM and payroll. And people sort of wonder, well, how is that possible. And maybe just be helpful to sort of go over that a little bit, at least from your perspective and what you're seeing in the market.

Yes. So I think that there is an increased level of demand for HR-oriented solutions. And part of that is coming from 2 different areas. One is really automation and digitization of the entire back office. That's been a long-term trend that's happened over time. And people doing things manually or not having software to be able to execute on things like performance management or onboarding employees or even learning, it's just not necessarily very modern to not necessarily have software to do all those things. So that's been an increasing trend, I think, that's helped everybody. And even if you look at the bigger players that, pre-pandemic, we're growing kind of 25%. Some of the bigger players might be growing closer to 10-ish percent or high single digits. A lot of that is coming from selling more product back to the client base for the bigger players, where the newer players are adding customers and selling more product back to the client base. And so that's one element of, I think, what has driven the change is that people are looking for more capabilities. And then I think more recently, Gen Z is now roughly 5% of the workforce. They're creating very different demands on the HR department. People are demanding the ability to work from home and have remote work capability. The gig economy increases and people have multiple jobs, wage inflation, tight labor market. It is the hardest time to be an HR person that I have ever seen. And so HR teams are sitting there and saying, "Hey, I need help to be able to do my job." And by the way, when you talk to CEOs and you say, what's one of your biggest challenges? 4, 5, years ago, access to capital, growing my business. Almost every CEO I talk to, #1 or #2 challenge is attracting and retaining people. That was not the case 3, 4, 5 years ago. And so I think when you create those dynamics, customers are much more likely to look for solutions to things that are really, really important to them. And HR teams are also much more likely to be open to solutions because their job is way more complicated than it has been before. Yes.

You started with Paychex [Technical Difficulty].

It's a great question. So when I started this, most clients in our size would call in payroll or they would have like a dumb terminal and they would input hours, and there was no capability. And I felt like at the time, really, this was going to move to be a software company and every employee at the company would be using it. At the time, I was thinking it was all transactions, request time off, punch in hours. And that has developed over time to every employees using it to actually automate all of these processes. Performance management, onboarding, all of these processes that typically needed to be digitized, that's what really kind of attracted me to that opportunity, and we were able to get a lead there being a newer technology stack. And frankly, I kind of feel like it's Groundhog Day all over we're here again with some of these modern capabilities. These things are being demanded by our customers that don't necessarily exist in the marketplace, and we've got a great opportunity to invest, create differentiation and continue to grow the business.

All right. Great. And with that, I think we're right out of time. So thanks a lot, Steve. Really appreciate you joining us today, and there will be a breakout session immediately following this at Adler. So hopefully, people can join Steve there. Thanks, everyone.

Thank you.