Paylocity Holding Corporation (PCTY) Earnings Call Transcript & Summary

All right. With us today, we have Toby Williams, Co-CEO and President of Paylocity. Thank you for joining us today, Toby.

Thanks for having me.

All right. So in terms of today's agenda, we'll open it up a little bit later in terms of any audience Q&A, but to get it kicked off. In terms of the demand environment, how would you characterize the currency of the demand environment? And how does it compare to even last year?

Yes. I mean I think we've seen the demand overall be fairly stable, although I think when I say that, I'm thinking of things like the panel business that we have, so we get 25% plus of our new business referred to us from some of our channel partners, which are largely brokers or financial advisers, all of which are sold by our own direct sales force. But I think that's been fairly steady. I think the demand environment overall has been fairly steady. Probably the call out from my perspective would just be -- it definitely feels like there is -- and I think seeing this in other players, too, not specific to Paylocity, but just a bit of an overhang from a macro perspective across the industry. Certainly, seeing that play out in some of the larger deals in terms of elongated sales cycles, elongated closing cycles with those. So I think those are probably the main factors that I'd see across from a demand perspective.

And then in terms of the competitive environment, has there been any change in the competitive environment during the fiscal year in terms of seeing more competitors discounting increasingly or even seeing more competitors participating in bake-offs?

Yes. I don't think we've seen any real change there. I mean -- and part of that is just -- it's always been a very competitive environment in our space. And so I don't think that's -- we haven't seen any acceleration in that or really easing in that. I don't think we -- I also don't think we've seen any significant change from a pricing standpoint.

Got it. And then if you look at your ex float growth for FY '24, can you help us rank the primary headwinds that you're facing this year? And are any of those headwinds anticipated at this juncture to persist into FY '25?

Yes, I think we've seen -- probably the main call out has just been employees on the platform, which is employees at our clients, declining sequentially on a month-to-month basis, coming up on a year, maybe a little over a year now at this point as we head into Q4. And so that's been a headwind throughout. And just for context, I mean, if you think back to pre-COVID, we would have seen in more of a normalized macro environment, we would typically see sort of tailwind from a revenue growth perspective. And this year, that's been a headwind to growth for sure. So on a monthly basis, seeing those levels decline sequentially.

And in terms of the net client hiring, in terms of -- did you also witness, I know you've detailed in terms of starting with August month-on-month declines occurring. Is that also what you win this here most recently in 3Q consistent month-on-month declines?

Yes, when you look at it from a quarterly perspective. If you go back to not this last call, but the call before that, we changed our guide to assume that we would continue to see that throughout the rest of this fiscal year and including last quarter, Q3 and then this quarter, Q4, and that's what we observed in Q3 as well.

And any notable differences in terms of those reductions based on client size or industry vertical? Or is it pretty uniform [ space ]?

Fairly uniform. I mean, we cut it by vertical. We cut it by size, we cut it by geo. I mean we look at all the different dynamics that you would think of. And there has not been any material sort of stand out from any of those factors.

And then in terms of your guidance for 4Q, assuming those ongoing month-on-month declines for exceeding FY '24, would that put you negative on a year-on-year basis in terms of net client hiring? Or would it still potentially be positive year-on-year there?

Yes. Well, it depends on -- I mean it depends on how it plays out in the magnitude. So I think we would still be positive at this point, sort of going into Q3 and headed into Q4. So you have to see how Q4 plays out. I mean I think it's very likely that you end the year still positive, although you start to get into that fall time frame. We're depending on how it trends and what the magnitude of that is, that would be the place where you'd see a change.

Got it. And Paylocity has been increasingly pushing up market in recent years, which you would define as companies with 500-plus employees. What has driven this increasing success there in recent years?

Yes. I think if you go back, probably, call it, 3 years ago, we would have started to see a pull from those sized clients. I mean we would have always had clients that were of that size. But I think we started to see increasing frequency, getting pulled into larger and larger deals. I don't -- it was not a sort of specific strategic pivot on our part to say, "Hey, let's go up market and see what we can find." We've got pulled into larger and larger deals. And I think that was largely a reflection of our investments in the platform, our investments in the breadth of the product suite and those products really resonating in that segment of the market. We -- if you go back to the time of the IPO, we would have really had $200 in PEPY. We're around $550 today. So you've seen the steady year-on-year growth in terms of PEPY, which is owing to the expansion of the platform, building out more modules. And I think a lot of what we've done over the last few years has really been focused on pushing the boundaries of what traditional HCM really means in the market. So we've added things like community, which is really the communication hub across the platform, surveys, more recently, employee voice, rewards and recognition. So really that next sort of circle of things around the core of HR. And I think we've been really happy with the what we've seen from a take rate perspective in those products, many of them still early on. But we've been able to maintain sort of a 50%-ish plus or minus realized PEPY across the handful of years where we've taken that to 550 where it sits today from a base of 200 at the time of the IPO. So I think that, that product set expansion and the differentiation that we've been able to drive, have really sort of drawn us into that segment.

And is there a typical profile of a client with, call it, 1,000-plus employees that makes it a strong fit for Paylocity versus, call it, maybe one more enterprise-focused competitor?

I mean I think the biggest difference, I mean, it's hard to tell where exactly the cutoff point is upmarket. But I think you get to a place where there's an expectation of a higher level of customization. And part of our value prop is you will give you out of the box accelerated time to value, certainly baking in best practices, but from a configuration standpoint, are able to hit most use cases. I think that's our approach from a go-to-market perspective of market.

And what are the primary sources for these upmarket deals? Historically, you've disclosed around across the entire base around 40% to 40% -- or call it, 40% to 50% of new revenues coming from the combination of ADP and paychecks. What about when it comes to more of those larger 1000-plus type clients. Where do those usually stem from?

You don't see a noticeably different mix. I mean, obviously, you have players like -- so when we're competing for 1,000 employee deal just in the example that you gave, I mean, it would be typical to see someone like an ADP, you might see somebody like a Ceridian or a UKG, sometimes at Paycom. I mean those are more or less the usual suspects that you would see there. And I think that tends to be the same mix for when you're taking business. Less so Paychex, obviously, because they're focused on smaller clients.

Makes sense. And then you also have acknowledged this year that the upmarket did catch you a little bit off guard in terms of the lengthening of sales cycle and time to get new reps productive there. Can you discuss the lessons learned and actions being taken to improve on the productivity in that segment of the market?

Sure. Yes. I mean, I think -- I'm not sure that this comment is -- I think this is true across enterprise software, at least that would be the commentary that I think you hear broadly in the market, but started to see in the first half of the year, started to see sales cycles elongate. And I think what you see there is just a higher degree of focus on spend from a software perspective at potential clients at prospects. And it tends to manifest in a couple of different ways. One, could be for us in our industry, you would have a CHRO that might have been able to write that check previously and now there might be another layer or 2 of approval that goes beyond that from either a CIO or a CFO or potentially both. And so I think you're not seeing those deals go lost, but you're also seeing the sales cycles take longer, doing more demos, seeing more levels or layers of approval in those deals. And I think the other thing that you see is engaging in a sales cycle and at some point, the decision maker or the people you're engaging with from prospectors to say, "Hey, I just -- I'm going to put this down for a quarter. Take it back up in 3, 4 months' time." So I think you see those types of situations playing out. And again, I don't know if there's anything unique to our business our even our industry from an enterprise software perspective. I think that is a common tail. You've heard others in the market, certainly reference experiences like that. So I think that's mostly been the experience. I think for us, we've seen an outsized amount of growth in our business over the course of the last 3 years from larger clients. And so as we've ramped up our hiring, we have pulled most of the people from within our business. So both those would have been folks that were focused on sort of mid-market and starting to skew up market a little bit. But we've also hired some folks from outside of the business. And I think any time that you do that, certainly natural from a growth perspective, but those folks often take longer times to ramp and you see this intersection of that happening plus elongated sales cycles, I think, has been the observation over the probably the first 3 quarters of the year.

Got it. And with your most recent earnings, you updated your long-term financial targets, primarily to remove the 20% plus revenue growth and replace it with now a $2 billion-plus revenue milestone. Can you discuss what led to this decision?

Yes. I think where we are right now, I mean, I think our eyes have been on -- we crossed the $1 billion mark. That was certainly a big milestone for us. And I think having done so, the eyes naturally focused on doubling that getting to $2 billion, and we're well on our way with the guide that we have for this fiscal year. And I think as we look at where we are this fiscal year, we'll come in, I think, just below 20%. And I think the Q4 guide bracketed around 13%. I think you draw the focus to, "hey, what's the next big milestone for the business in terms of the overall revenue," and that's $2 billion. And I think I feel good about our ability to get there. And you also I think, start to look down through P&L. And I think the guide that we have in terms of0 the financial targets, you can line that up pretty well. That's a good picture of what the business should look like at $2 billion of revenue.

Got it. And is it possible over the medium term, assuming more of a normalized hiring environment, call it, 2% to 3% like you would get pre-pandemic that you could return to 20% plus ex float organic growth again?

Well, I mean, I think right now with what we're seeing, you have sort of pre-pandemic and then for a period of time coming out of the pandemic, you had an awful lot of tailwinds that are not present right now across macro and across the industry. And certainly, if you see those things come back, depending on the magnitude, you'll get lift from that. But some of those things are outside of our control. So I think for right now, what we're focused on is driving productivity across our go-to-market motion, driving productivity across the business, driving profitability across the business. So we've made a lot of progress from a free cash flow perspective, certainly from an adjusted EBITDA standpoint, really up and down the P&L. And so I think from our perspective, as you go through this fiscal year and you start to pencil out next fiscal year, there is -- I think there's an increased focus on productivity, on driving leverage from a profitability perspective and driving execution from a go-to-market standpoint overall to generate new revenue. So I think those are the points of focus and some of the other things, I think, have become a headwind that used to be significant tailwinds. And whether those things return and when they do and the order of magnitude that those show up is hard to say, but they would be positive if they flipped.

Got it. And then customer support, regardless of vendor seems to be a key customer complaint in terms of time to reach the support, time to resolution or even the quality of the resolution, why do you think it's so difficult for any vendor to really nail it? Is it more so a balancing act between balancing profitability with customer satisfaction there, any thoughts?

Well, I think from -- from an industry standpoint, yes, I think that the reasons that people switch would be either product or service. And I think that's been true for since the beginning of time in the industry. And yes, I think from our perspective, we have tried to hit both very strategically. I think we have invested in our product set in a different way than many other competitors have. I think that's really resonated in the market and created significant differentiation for us. And at the same, we've also tried to provide world-class service. And I think everybody saw in the course of COVID retention rates go up. And I think coming out of COVID, everybody has seen retention rates return to more normalized levels. But I think from an execution standpoint, our focus continues to be on providing world-class service to our clients.

And can you discuss what you've done in recent years to improve on that customer support function as well as anything currently in the works or potentially planned on that function?

Yes. I mean I think our focus has really been starting from a product investment perspective, making sure that we're investing in the product set in the ways that really resonate with clients to give them a good experience. Ultimately, that's the thing that they're dealing with and seeing every day. And then I think, if you go back to COVID as an example, I think that was really a standout period for us in terms of our ability to staff. What you heard in -- during COVID and then coming out of COVID with the great resignation was, I think you heard the competitive set talking about real difficulty in staffing to be able to support customers. And that -- I mean, that was a challenge for everybody, but I think we came through that in a way that you never heard us talk about that. We were always able to staff, and that's really the key from a customer service perspective is, driving the product investments that resonate and create a good experience and then being able to staff to support the level of interaction that you expect.

And then Paylocity, how does the customer support model? Is there a dedicated rep or team that assigned to each client? Or is it more of a just general help line that customers call into?