Paylocity Holding Corporation (PCTY) Earnings Call Transcript & Summary

We're going to get started. My name is Brian Peterson. I'm the application software analyst here at Raymond James. Very happy to have Toby Williams with Paylocity with us. So Toby, maybe kind of high level, get things started, spend a minute or 2 just on an overview of Paylocity.

Sure. Thanks for the time. It's great to be here. So Paylocity is a payroll and human capital management software business focused on businesses in the U.S. with between 10 and 5,000 employees. And we have 36,000 clients. We've guided to about [ $1.4 billion ] in revenue this year and that's right around 20% growth rate at that level. And a big part of our growth algorithm over time has been both acquiring new logos in the market. So in that section of the market where we're competing, there's around 1.2 million businesses, and we have 36,000 of those businesses. And so relatively small market share. So new client acquisition has been part of the growth algorithm and another important part has been our ability to grow our product set. So when we went public in 2014, we would have had $200 per employee per year chargeability across the product suite. And as we sit here today, we've grown that to around $550. So we've had a significant increase in the amount of product that we have available to sell. And I think that's been important not just from a growth perspective, but it's also been important for us to be able to differentiate against the competition. A big part of our focus from a product and product strategy perspective as going beyond just sort of the basics of payroll and HR solutions and being able to push into solutions that really go towards engaging and attracting and retaining the workforce, which is I think the biggest thing that is on the minds of C-suite executives in the clients and prospects that we serve, the ability to attract and retain and engage the talent that they have in a -- what remains a very, very tight labor market.

So I want to hit on that, but I also want to hit on the macro. I think everyone's kind of asked about what's going on here. So I'd love to understand -- if you think about like the platform in terms of employment trends and everything else, what did you guys see last year? And how was that trended so far into fiscal year '24?

Yes. I think you've got a couple of different trends at work and -- so one, I'll get to what I think is the heart of your question, but I think there's a -- there has been a generational shift in the labor market and in the workforce and their expectations of technology that they're using at work. And I think one of the -- we have benefited from that from the standpoint of we've been able to differentiate ourselves against the competition by hitting from a technology perspective and from a product perspective, the demands and the expectations of the changing labor market and the changing workforce. It's been a demographic shift over the course of the last 5-plus years. People are expecting consumer-grade technology. They expect to be able to do everything that they want to do on their phones in an engaging way. And I think that's been where we've been focused from a product strategy perspective things like video and communications and community on our platform that really differentiate against anybody else in the market. That's -- I think, the overarching trend that is multiyear in nature and is -- I think, will continue and accelerate in the future. One of the other, which I think is kind of the heart of what you're getting at in the macro question is we would have seen employees on our platform in a normalized economic environment. So you go back to pre-COVID levels, we would have typically seen growth in employees in the platform at somewhere between 2% and 4%. And as we came into -- when you went through COVID, you saw obviously a dramatic decline of employees in the platform that corresponded to the unemployment rates going up. And then for the -- probably 18 months post COVID, you saw employees in the platform come back up to pre-COVID levels. And then through the course of last year, you really saw a flattening out of employees in the platform. You weren't getting that same level of tailwind that you would have seen pre-COVID in a normalized economic environment. So as we came into this fiscal year in July, which is the turn of our fiscal year, when you came into July, what you were seeing was a sequentially flat month-to-month level of employees on the platform. And so in our guidance for the year, we guided to flat and what we saw in Q1 in the last 2 months of Q1, in particular, was a slight decline in terms of the number of employees on the platform.

Okay. And what about macro, I guess, question number 2. Just in terms of net new business and sales cycles, anything that you've called out through the fiscal first quarter?

Yes. The one thing that we talked about on our Q1 call was that you started to see -- again, this was sort of on the edges, around the margins. You started to see things like deal cycles taking slightly longer. And it goes -- I think probably more so true with the upper end of the market and certainly heard that commentary, both from other, I think, software companies and other folks in the industry, but I think we started to see that creep in, in Q1. And I think it's -- I think when you look at all of these different elements, I think it just -- it paints to what we're probably all seeing every day, which is just a bit of a macro overhead.

And I think a lot of people still ask and I ask you this every time I talk to you again, so the competition is the competitive dynamic changed at all as you're looking at win rates or the source of new business, any update there?

Yes, I don't think there's been any fundamental shift in the competitive landscape. So this has always been a competitive industry for more than a decade. And you tend to see -- I don't think there's been any shift in terms of the tactics of those competitors. I don't think there's been any shift in who you're competing with. So it tends to be the same folks that we've competed with for a long time are the competitive set that we're facing day in and day out. And for us, that tends to be we -- from a source of business perspective, we would get the biggest piece of our new business coming from the mix of ADP and Paychex. That's historically been true. It continues to be true. And also probably not surprising even though those are the 2 biggest players in the market. So I think in environments like this, no doubt, competition gets tighter in a tighter economy or with a bit of a macro overhang, but I don't think there's been any fundamental shift in terms of who we're competing with or what that competitive environment looks like. I mean our focus has always been on differentiating through product versus the competition, and I think that continues to be true to that.

And we were just kind of unpacking that lens a little bit, if you're looking at upmarket versus down-market. Have you seen any trends that have diverged a little bit there? Just based on the size of the customer?

No. I mean I don't think we've seen that. The only thing that's probably a little bit different, which is always the case is, I think, deal cycles in larger clients take longer. This is a massive generalization. But deal cycles in larger clients or larger prospects take longer than deal cycles in smaller clients or smaller prospects. That's always been the case. I think that remains true today. But I don't think we've seen any fundamentally different behavior from them nor have they had a divergent set of interest from a product perspective. So the -- our product set has tended to resonate with sort of equal weight across the market that we serve.

And so it's interesting in talking to customers that have adopted the platform. I'd say maybe 5, 6 years ago, like the analytics and the reporting was really mentioned as a key area of why somebody would pick Paylocity. Has that diversified a bit, right? You're hitting on different products that are kind of focused on engagement. So when people ask, like, why are we going with Paylocity? Like I'd be curious maybe how that's changed?

Yes. I mean I think going to your question, if you look back by -- if you go back even further, probably 5 years ago, we started to build out a data and analytics team that was really focused on using machine learning and artificial intelligence in the platform to try and give people better insights, better analytics in terms of -- by their employees, the usage of the platform, sentiment analysis around what that engagement really look like to give people insights into how they're dealing with their workforce is really targeting engagement from a retention perspective. And I think that was a significant differentiator at that point in time. I think we have continued with that engagement focus and what's sitting underneath that is the ability to attract and retain talent in a very tight labor market that has been tight, and I think we all expect it will continue to be tight. That's really been a big part of our focus. So continuing to build out the platform with the products that resonate in the market to differentiate from the competition and that are focused on giving employers the ability to drive engagement with their employees in a different way that really resonates with the next 2 generations in the workforce more so because that's been very, very important in a way that it has not been previously.

I'll let you open your water there. But yes, you mentioned AI, obviously, that's a popular term these days. I'm just been curious, how are you guys thinking about AI as part of the value proposition? And how do you see the evolution as you think about kind of broader market opportunities?

Yes. I mean I mentioned it because while it is certainly an extremely hot topic today, it's been one that we've invested in for more than 5 years building a team and building the technical capabilities to be able to drive the usage of machine learning and AI across the platform, starting with our efforts around data. I think what you see today is the ability to create different experiences in the product. So it starts with things that I think are as simple as giving people ChatGPT type functionality to be able to start communications with. So one of the things that -- I think a lot of people, including HR admins and professionals struggle with is, hey, it takes time to create a job spec. It takes time to create an all employee communication. It takes line managers' time to create commutations for all of their employees. And by leveraging AI, we've been able to give them the ability to describe what they want to say and create comps for them to react to, which I think in terms of the creating of communications is sort of a nice to have, it saves time out of the day. It's much more efficient. When you think about things like creating job descriptions, that is a significant time saver for hiring managers and for talent teams and for HR teams. So I mean, I think those are where you start to see the use of AI bleed into the platform. And I think it also gives you the ability to serve customers better. So if you can anticipate their needs based on the patterns that you've seen and you can deliver answers to the questions in the platform at the point in time when you know they're going to ask them or you should be able to know and anticipate they're going to ask them. That's a much better client experience. And so I think those are all the ways that we're investing in AI at this point across the platform.

And I'd be curious, how do you think about that resonating into the model? I know it's early, but is that just the value provided to customers? Does it drive incremental PEPY? I know it's always a tough balance to think about pricing. But -- how do you think about the monetization AI in long term?

Yes. I mean I think the opportunity exists. I mean, I think it hasn't -- the things that I've just talked about that we've introduced into the platform are not separately chargeable. So I think a lot of the -- the early stages of how we or others might use AI in the platform has not been separate chargeable modules so much as it's been incremental value being delivered. And I think on the other side of the coin, I think over time, there's no doubt that you should be able to create efficiency, but I think out of the gate, it's really about creating just a fundamentally better customer experience.

So $200 million to $550 million PEPY?

Yes.

Plans probably to continue to expand that. What are you guys investing in now? And where do you kind of see the -- see the future frontier on the product side?

Yes. I mean -- so we've introduced to that comment, we've gone from $200 in PEPY to $550 in PEPY since 2014. That's been a fairly steady march of new product introduction. And that's really been a core to our growth strategy. It's about not just growing the PEPY, but delivering more value and differentiating in the market. And if you look at some of the things that we've introduced over the course of the last 3, 4 years, it really was around the employee experience. So things like our community product, which is really the communications hub of the platform, giving employers and giving employees the ability to communicate with each other via the platform. And the differentiation there is really -- it became very, very clearly important during the COVID when you had remote workforce being much more popular. You had employee expectations of a different way of communicating outside of just e-mail. So -- we introduced the ability to communicate with video, I can -- on my phone, take a video, which we did weekly at least during the course of COVID, gave the ability to record a video on your phone, push that out to all of your employees, that was not just a form of engagement communication but here's what's going on in communication. And the ability to do that with video versus doing that in an e-mail resonates really, really well with every generation of the workforce, but particularly the younger generation of the workforce, which are kind of comprising a much larger portion of the mix. So I use that as an example of products that we have introduced that I think have driven a ton of efficiency for people, but they've also been able to drive a level of engagement and certainly differentiated. So those are things that nobody else has on their platform, which has been really important to us. The more recent introductions, things like rewards and recognition, again, giving companies, giving admins, giving managers the ability to recognize the efforts of their employees. Employee voice is another product that we introduced, giving them -- giving employers clients' prospects, the ability to get feedback on the platform from all of their employees. And that being a really, really important part of engagement in terms of that 2-way dialogue of not just being able to communicate with, but get feedback from.

As you think about kind of the adoption curve of some of these products, like where are we? And how would you guys maybe define success of some of these products as we ramp long term?

Yes. So historically, I mean our gauge of product launch has been, "Hey, do you think you can get between 10% and 20% penetration with a product over the first 2, 3 years type time frame." And I think that continues to be the sort of the goal. We have to believe that we'll be able to get that type of adoption in order to be successful. I think that's been the benchmark that still is today. And I think -- so the products that we just launched over the last, call it, 2 quarters, very early in the adoption curve for sure. But some of the others that go back in sort of the wave before that, things like video. I mean we would have seen and some of this was really important during the course of the pandemic, but those have -- you would have expected those to be a little bit lighter. And they've met the same sort of adoption and penetration curves as some of the more core products like benefits of time and labor.

So as you think -- you had around COVID and some of the impacts -- like I think you can totally see, even just for the HR functionality for small and mid-market employer, the need for that remote work, modernizing off of legacy solutions or technology, how big of a growth driver is that now? And like is that something that's maybe an evolution versus a revolution? Like how is that going to change post COVID?

Well, I think it was -- it became -- some of those things, we would have introduced pre-COVID, they just became much more important during the course of COVID. But I think you saw probably a heightened need or a heightened appreciation because of COVID for some of these things. But I think as we've come out of COVID, so much of that has been unchanged. So you still have the expectations of the next generations in the workforce of working that way, having tools like that, engaging with those types of technology offerings. That has not changed nor do I believe that will change. I think that will continue to be the case and to accelerate.

So all right. Go-to-market investments that you still got a lot of opportunity in front of you, but it sounds like you also have a lot of PEPY that you can sell back into the base so...

We do.

How are you thinking about the go-to-market and what are the next steps from here?

Yes. So for us, I mean, we have 36,000-some clients in a market where we're focused of over 1.2 million businesses. So we have a relatively small share of a relatively large market. So the priority focus from a go-to-market perspective has been focused on new logo acquisitions, so sales teams in the field. We've continued to get more than 25% of our new business referred to us from financial advisers and benefit brokers. So that's a really -- highly productive lead channel for us. We still sell those deals, but that's a referral source that's been very valuable to us. So we've continued to lean in on investments from a sales and marketing perspective focused on new logo acquisition. But as we were talking about is we've also grown the client base. And as we have grown the breadth of our portfolio, we've also continue to invest in growing a team that sells back into the client base from a cross-sell, upsell perspective.

I'll open it up to the audience if there's any questions. Go ahead.

[indiscernible] what are the tactics that the other players doing in the market which [indiscernible]?

I mean -- listen, I don't think you see -- we have not seen fundamentally different tactics. I think you see -- maybe a slightly different level of intensity in certain competitive situations. But I don't think we've seen -- I go back to my earlier comment, I don't think you've seen a different set of competitors in the market nor do I think you've seen a fundamental change in how people are competing. And I'll give you an example. For us, I mean we would -- we would typically be driving on differentiation from a product perspective, and that's still the case today. Pricing is -- has always been an important dynamic in the industry, but you -- there has been, I think, historically not a ton of variation in like-for-like pricing, and I still think that's largely the case today. So I don't think there's any dynamic I would point to specifically that's fundamentally different than it would have been a year ago or 2 years ago or...

How do we think about the cost of -- for migrate -- for a customer from migrating off of a legacy solution over to Paylocity, obviously, maybe there's more solutions that they're buying. But how do you think about the price to the customer? And is that ever a point of friction?

Yes, I think that -- so in that example that you asked about, Brian, what you would see sometimes is you would see a business that has a prospect that has used one of the legacy providers and who has gotten a 5% increase year-over-year-over-year compounding for 5-plus years and who hasn't adopted a broader set of products from that provider. And that's a really fruitful conversation for us because we would be able to come in and say, "Hey, we have this really broad and deeply valuable product set that allows you to modernize the -- not just the experience for your business, but the experience for your employees" and they care about that because every CEO or CFO or CHRO that you're talking to, talent is their focus. The labor market remains very tight. And so they're really, really focused on not just driving the ROI of a new system, which is what you always get, but they're interested in driving a different experience. And that is a -- those are great conversations because we're able to come in, deliver that platform and deliver that experience. And most of the time, they're not -- it's not like they're paying some significant upcharge to us versus what they are using after having gotten years upon years of price increase.

How influential is the broker channel in this type of macro environment, more or less? And I'd love to understand, too, like as you think about it, is there room to expand that broker channel to kind of widen the reach in terms of the influence?

Yes. I mean we've always -- so we've gotten 25% plus of our new business referred to us from the broker channel, meaning benefit brokers and financial advisers for a long, long time. And I think we've been very happy with our ability to maintain that level of referral and engagement with that referral source now that we're over $1 billion in revenue. I think it's been outstanding to be able to continue that level of contribution to our go-to-market from that source. And I think when times get tougher, I think people rely more upon the advice of people like brokers and so that's -- it's always been strong in different economic environment, it certainly was during the course of COVID, and I think it is today as well.

So maybe the last question before we wrap up here. As we just think about your key priorities for fiscal year '24 and beyond. What are the top 2 or 3 things that you would highlight there?

Yes. I mean I think our priorities in terms of how you run the business are fairly consistent over time. I mean driving on product strategy and product growth has been a part of our algorithm. I think in addition to that, you have to take really good care of your clients. So you have to drive an incredible client experience from a service perspective. And then, I mean, you are always focused on go-to-market motion, and that's largely investments in our sales team. It's investments in our channel partners. So those that are referring us business benefit brokers and financial advisers and in things like digital marketing to be able to drive efficiency with the go-to-market process. So I think those are all the things that you focus on sort of year in and year out and same is true fiscal '24 for us.

Great. Awesome. Thanks, everyone.

Thanks. Appreciate it. Thanks, Brian.