Paylocity Holding Corporation (PCTY) Earnings Call Transcript & Summary

Paylocity back with us this year. I think it's been a heck of a run. We have CEO, Toby Williams, CFO Ryan Glenn. Fireside chat. If you guys have any questions in the audience, feel free to raise your hand we'll keep this pretty interactive.

But Toby, maybe to get things started, a high-level overview on Paylocity and the value providing to customers.

Sure. Thanks for having us. It's good to be here again. Yes, if I just give you a quick overview. So Paylocity is a payroll and HCM and now finance application software company that's focused on businesses that have between 10,000 and 5,000 employees, so very much a mid-market focus. And from a breadth of suite perspective, think of it as everything from payroll to time and labor and benefits, and the traditional HCM suite of products and then -- we did an acquisition about 5 months ago, which has brought in a set of finance applications. So think about expense management, accounts payable automation, card integrations and some guided procurement capabilities to really bring together, I think the core of what businesses in our market need and focus on from a finance perspective into the payroll and HCM suite, and we're going through the integration right now. We've got about 40,000 clients. I think we've been the fastest-growing business in our public comp set. And I think over the last year or so, I mean, we've put an awful lot of focus on integrating those products and on continuing to drive the growth and also doing that in a pretty profitable way.

And as you think about 40,000 clients, like how do you think about the size of that runway in front of you? And how does that -- like particularly in your target market?

Sure. I mean we have 40,000 clients in a target market that probably has 1.2 million, 1.3 million businesses. So low double digit or low single-digit penetration rate overall. So I think our view is we have a really, really big market opportunity that we're focused on with a really big TAM. And I think our effort is to go out and win new business day in and day out.

And what does the competitive environment look like? And how often are you seeing maybe some of the cloud competitors versus kind of legacy displacement? And has that changed at all over the last few years?

I mean it's always been a really competitive market. I think we would have traditionally seen, call it, 3 or 4 competitors in every single deal. I think that remains true today. So in the core of our market, I mean, we would compete with ADP and Paychex that -- on a combined basis, that's where the biggest bucket of our new business comes from certainly see Paycor, Paycom in the heart of the market, too. And then upmarket, folks like still ADP, but you see UKG and Ceridian up there as well.

And maybe any update on the macro environment. I know it's been an interesting couple of years, actually, since COVID, it's probably been an interesting 5 years. So what are you guys seeing in the macro and any kind of demand cycles you'd call out here?

Yes, I think what we've seen so far, this fiscal year has what we would describe as really a stable macro environment for the first 2 quarters of fiscal '25. I think relative to where we were at this time last year. I think things are in a net better spotted and more stable. So if you think back to the last fiscal year, we saw month-over-month declines in workforce levels. I think we're about a year removed from calling out a bit of a longer sales cycle upmarket, more decision-makers involved in the process, buyers that were probably a bit less certain. And I don't know that we've described it as necessarily improved from there, but it has been stable, so things certainly have not gotten worse. And I think relative to workforce level movement this fiscal year, it's been roughly flat to probably a touch positive. So net better than expectations. But if you think about the results we put up in the first half of fiscal year and the increase the guidance we've had after Q1 and Q2 that has almost entirely been driven off of very strong sales execution.

And what have you guys done on the execution side? I know that's been an effort -- upmarket it's been a solid area for you guys, but you think about in terms of your sales execution. Can you speak to some of the things you've accomplished over the last 12 to 18 months?

Yes. I think we've been really focused on building out the infrastructure to support the sales team. So particularly, if you think about the upmarket motion, that's things like investing in the implementation and product and sales support, sales solution consulting type teams that I think are really helpful in supporting the maturity of that upmarket motion, and that's been, I think, really successful for us over the last -- that's an effort that we have really built over the last, call it, 3, maybe a little bit more 3-plus years. And I think we've made more of those investments over the last 12 months, and I think that's part of what is to Ryan's comments, that's part of what's supporting the execution that we've seen.

And what about sales hiring and the reps that you are bringing in? Has that changed at all? What does it look like the hiring environment out there for sales talent?

Yes. I mean, the hiring environment has been -- has been good. I think we've all throughout, even going back to your earlier question, even through COVID, we've been well positioned as the destination in the industry for best talent. And I think that's part of what has helped us maintain our staffing and maintain access to great talent over time. Part of that, I think, is the success of the business, part of that is the culture of the business. But we have not had the same struggle as some of the other competitive set in terms of accessing talent. And I think that's true today, particularly in the sales realm. I think we came into this fiscal year. In our view, fully staffed, we grew sales headcount by 8% coming into the year. And I think our view was -- we'd really try and drive on productivity this year, which I think has worked well. I think that effort is being successful as we think about where we are a little bit past the halfway point in the year. And so pretty happy with where we sit for a staffing perspective.

Can you talk about what you've seen from the broker channel so far this year, on a consistency? And maybe like longer term, like what is your opportunity to kind of expand your relationships with the brokers?

Yes. I mean, I think -- so we would describe the business that we get from brokers referred to us as more than 25% of our new business is coming from the broker channel referred to us. And I think we've created over time, significant differentiation against the competition with brokers. And part of that is the fact that we don't compete with them. So we don't have an insurance business where we're actively selling insurance or benefits products to their clients and therefore, competing with their businesses. So that's piece one. And some of the other competitive set, that's ADP and Paychex and presumably, Paycor as part of Paychex would have that competitive dynamic, which really, I think, limits the amount of business they can get referred to them through those channels. Then the other part of it is the investment in technology. So we give brokers the ability to see their books of business through our portfolio, through our product, which gives them a sense of the utilization rates. And that gives -- that sort of a health check on their books of business for them. And those -- and I think probably the third leg of that is just the ability to integrate with our systems from a third-party perspective. So the data flows from an insurance and benefits perspective because all the deductions come off of the paycheck. That data integration capability is really powerful for brokers, and it helps drive, I think their view of us as a premier technology partner for them as they're thinking about places to refer business. And I think to the other part of your question, I mean, I think we've been really positioned -- really well positioned with that channel over time. We've maintained that channel as 25% plus of new business to us for a decade plus at this point. So our ability to maintain that in our size and scale, I think, has been fantastic.

Can you talk about the retention of kind of the broker touched clients? Like is that materially different versus the base or anything to pick up there?

I mean I think -- the extent to which you can build those broker relationships and have them be durable over time, certainly helps with retention. So if you have an issue with a client, it's another touch point to help you manage that relationship. And I think it gives you another insight into what the -- what each client is trying to do from a business perspective. So I definitely think it's helpful from a relationship and therefore, from a retention standpoint.

Maybe just pivoting a little bit to the product, PEPY hits $600 this year. Talk about some of the newer products that you're launching and where you see those playing out in the market?

Yes. I mean I think we're really happy to be able to hit that $600 goal that we set in August of 2023. And we continue to see really strong traction with some of those newer products that focus on meeting the needs of the modern workforce. So whether that is some of the advanced functionality within learning management or time and attendance, recognition and rewards. Most recently, adding benefits decision support and headcount planning as we move towards ops to CFO. I think each of those have early days, but each of those have performed well. We continue to see increasing attach rates. And I think that has really been pervasive across our target markets. So that is not really one segment. That is something that I think has been a strong differentiator for us and certainly something that's drive -- average revenue per client up.

Yes. And how do you think about that kind of cross-sell, upsell motion as part of the growth algo over time? Or maybe what has it done historically? And how should we think about that as the PEPY continues to build?

Yes. So that is a separate dedicated sales team that we have added to every single year, fiscal '25 and likely fiscal '26 included, as we've expanded the product suite, that team has continued to grow in scale as over that last 7 or 8 years that we've really had that team in earnest has continued to perform really well. I think that is an area of the business as we've extended the product suite that we are able to upsell existing clients and certainly on the new client side as well, being able to sell more product at time of sale. So I think there continues to be opportunity there really across our target market as we've expanded the product set.

And maybe just build on the Airbase acquisition, just kind of the strategic rationale and how should investors be thinking about the synergies or the strategic aspects there?

Yes. I mean I think if you step back just for context, the heart of the growth algorithm for our business has been the ability to add new clients into the business, so win new logos out in the market. And then to some of Ryan's commentary, it's been expanding the product set over time. So it's developing, delivering new products, which essentially expand your TAM and allow you to drive a higher level of ARPU on a per client basis. And I think Ryan just described a bunch of the new products that we've launched, particularly over the last 12 to 18 months has been a fairly robust period of new product launch for us, which is great. And to your question on Airbase, it's that lens through which we saw that opportunity. So this is just a continuation of our strategy of continuing to find ways that we can add value through products on the platform to clients in our target market. So when you think about some of the challenges that our clients have, it's -- a big part of that is, hey, how can you automate things that would be manual across the office of the CHRO and the CFO. So when you think about things like expense management or accounts payable automation and the process, the workflows for purchasing, well all of this is related to the people in the business and the people record. So you have this ability to leverage the data that you have to create a better experience and automate things that would have otherwise been manual in our client set. And to be able to do that on one platform, I think, has a lot of value. And it's also -- I think one of the things that's interesting to us is it's a common buyer. So we would be talking to the CFOs, of the VPs of Finance or the controllers in each one of these businesses in normal course, either in terms of selling payroll and HR or in terms of managing those client relationships over time. So really natural fit from our perspective in terms of the type of -- the type of client, the type of buyer who we're dealing with and essentially a pre natural extension from a product set standpoint that ties very much to our overall strategy over the course of time of not just winning new logos, but expanding the product set that we can offer.

And what are your customers using today for a lot of those? Is it white space? Or is it Excel or is there any vendors that you would note there?

There's a lot of Excel. I mean there's some vendor penetration, but I think in our target market -- particularly in the core of our target market, the average employee size 150 employees, things are fairly manual. So if you think about just having this conversation earlier today, the experience of an employee, for example, having a business dinner taking a picture of a receipt, e-mailing that to the -- to their manager who e-mails it to the accounting team, who e-mails it to the HR team for approval. And then you have this whole other exchange of e-mails result eventually in a reimbursement on the paycheck. I mean that's a fairly manual process, that's just in the expense management spend. You have the same version of that relative to other business expenses that the finance team is ultimately trying to track approvals for and then do the reconciliation on. And the ability to offer the automation of all of those processes on a single platform when the tie into the HR data is particularly important is, I think, a real opportunity for us.

So strategically, it makes a ton of sense to me. How do we think about kind of the product evolution? And then when do you really start to push the go-to-market maybe?

Yes. I mean, so it's still early days. I mean, we closed the acquisition 5 months ago. And so, we're in the early days of integration from truly a products and systems standpoint. I feel good about where we are. It's just -- it's -- we're in the early phase of it. So we have all the teams integrated. I think the business itself is fairly well integrated, and we're now focused on doing the actual tech integration to bring that product set onto our platform, create a seamless user experience, highly integrated from a data standpoint. And I think we had initially described that effort is probably taking between 12 and 24 months. I think that's still the case. And I think -- but it's not -- it's also not a light switch moment. So you develop the integration incrementally over time. And I think as we enter fiscal '26 on July 1, I think we will be in an incrementally better position to offer an experience that delivers incremental value from an integration standpoint to clients and lean heavier throughout the course of '26 from a go-to-market perspective.

And how -- I mentioned the PEPY, but just think about the cadence of innovation in areas that you can push. So now that you have an office of the CFO present, do we see the organic innovation maybe lean a little bit more in that direction? Or is there more M&A to supplement that? How do we think about those opportunities?

Well, I think the initial focus is just on, hey, from an organic perspective, what are the things that we can do from an organic innovation perspective that will drive even higher client value for that product set. So I think that's the immediate focus over -- call it, the rest of '25 and into '26. But I think over time, I think if we -- if we can really prove out the value that we can add with that part of the suite, then I think it becomes a natural point to look around and see what other -- what other points of value you might add in the office of the CFO.

And how do you think about the go-to-market aspect in terms of like sales teams for existing versus new? Is everybody going to have that in the basket? Or how does that work?

Yes. I mean I think when you think about a 12- to 24-month integration, that would not only include product, but that would be go-to-market approach as well. So we would be working through what that would look like for that time frame. I think if you think back to some of the other acquisitions we've made historically, BeneFLEX being a great example, where that is a product that is in the toolkit of our sales team, but there is a center of excellence or an overlay rep that has an expertise not only in that product, but trends across that industry, we'd be an expert that would be brought in during the sales cycle to be able to get that over the finish line. So still working through what that would look like, but that would be potentially one avenue that we could go down when you think about how you integrate the Airbase products and, in the go-to-market approach.

I want to hit on GenAI, and then I'll open it up to the audience. But how are you guys thinking about utilizing it internally? Have you seen any efficiencies there? And then as we're thinking about client adoption on the GenAI side, like where do you think we'll see that first?

Yes. I mean I think -- so yes, to the first part and that sort of spills into the second part as well. I mean I think one of the points of focus from an internal perspective has been giving our employees the same access to take our service team as an example. So it's building automation and AI -- leveraging AI from an automation perspective to give those teams access to data faster, creating a better experience for clients in terms of surfacing answers to the questions that we know they're going to ask at a certain point in time, surfacing those proactively in the application set. And I think that is what is driving client value initially, and that's also, I think, providing a likewise easier and better experience for our service teams, which also flows through into a better client experience. So I think early days for sure, but that's a real-time example of what we have been able to do in the product leveraging AI. I think the other parts that you just look at more broadly is looking across the application set and looking at ways to use AI to be predictive and proactive and automate workflows. So it's all about looking at what a stream of workflows looks like and saying, "Hey, that normally takes 10 steps, but you make the same decision every time on these 5. Can we automate that to provide a much more seamless and efficient workflow that might surface an exception versus requiring 10 decisions across whatever that workflow is." I think there's almost limitless examples across an application set as large as ours where you can add real efficiency to -- real efficiency and a much better client experience over time.

And do you think that drives incremental PEPY expansion? Or is it just -- how does it all unfold?

Yes, I think -- the way I would think about it at least as we sit today, it's probably less about necessarily a separate SKU in a certain area, and it's more about, hey, can you provide a higher degree of differentiation over time? Does that allow you to potentially take more price over time, maybe, but I think it's more about a better client experience that allows you to differentiate and create more client value that you might choose to try and monetize in aggregate over time versus, hey there's an AI or a non-AI set of SKUs.

Anything from the audience?

Yes. [indiscernible] on the Airbase acquisition, I'm sure [indiscernible] that's after a lot of consideration before you guys enter into the space. If we look out 10, 20 years from now, would that office of the CFO in terms of product as a category and the revenue be comparable or even bigger than your core HR confidence?

20 years a long period of time, George.

I'm sure that you guys look [indiscernible].

And for those on the webcast, the question was on how do we think about what is the long-term opportunity in the office of the CFO or how does that ramp? Or even if you can think about this, is there any TAM data that you can share as you guys look at any way to think about what that could look like longer term?

Yes. I mean I think we believe that it's a significant expansion of TAM and that there is, in fact, a significant opportunity there. And I guess part of what I would anchor to is if you look at the average deal size today for payroll and HCM suite in our business, it's in the 25,000, 30,000 territory. And if you would look at the average spend for the Airbase suite on a stand-alone basis, that was in that same ZIP code, it was in the 25,000, 30,000 type territory. And so I think our ability to attach that type of product to new sales and sell back into our 40,000 client base. That's a real opportunity. I think where you start to work through that is can you create enough value to expand that to make it relevant to everybody in the, call it, 40,000 base of clients and I think that's the effort that we're going through right now. So I think it can be a really substantial part of our business over a longer period of time. We're just in the very, very earliest stages of what that could be. I think we wouldn't have -- that was our belief as we looked at that as an acquisition potential. And our view was that it could be really meaningful to us over time.

And just a reminder on size, scale, margin impact, what has that been so far?

Yes. So I would think of it as Airbase representing roughly 1% of revenue this fiscal year. And then from an adjusted EBITDA or profitability standpoint, a headwind of about 100 basis points in fiscal '25. Now when you think about the pull through all of that has been embedded in guidance today and I think specifically when you think about the profitability impact. Organically, we have effectively offset the entire headwind of Airbase when you look at the updated guidance for this year. So we continue to drive really strong profitability increases organically. And I think you've got to hear where you're absorbing a fairly sizable acquisition from our standpoint. But I think our view is when you look into '26, the expectation to be able to continue to drive leverage on a combined basis going forward.

Yes, I was going to ask you, like how do you think about that balance of growth versus profitability going forward?

Yes, I think it's a balance for sure. Certainly, our bias is to drive revenue growth. And -- if you think about the results so far this fiscal year, we've talked about a really strong selling season for our sales force. You've seen that flow through to some pretty significant increases in guidance. Obviously, a lot of that falls to the bottom line as well. So we've been able to increase adjusted EBIT as well. So I think our view is when you think about over whether that is fiscal '26 or beyond, how do you drive durable revenue growth, increased both adjusted EBITDA margins and free cash flow. And then when you think about capital allocation being able to return capital to shareholders through some level of consistent share repurchase program.

And maybe I know there's a lot of debate on interest rates. Can you just remind us like what are you guys thinking in terms of the interest rate impact on the outlook?

Yes. So we obviously give a fair amount of guidance in detail in each quarter. We have expected in our guidance today, a cut -- 25 basis point cut in May. So we'll see if that plays out here in the fourth fiscal quarter. But from a core operating standpoint, we manage the business ex float. And we do that both as rates have gone up over the last several years, and you've seen us drive operating leverage in the business ex float. And then obviously, when you have higher rates, that has a tangible benefit on margins as well. And then I think in a flat rate environment or an environment where rates are down, we'll continue to drive core operating leverage in the business. But that is really the way that we planned the business. We haven't made short-term investments or over hired or done a natural things that rates have gone up. And I think we're now in a spot where we can still drive leverage across the business regardless of the rate environment.

All right. I think we'll stop it there. Toby, Ryan, thanks guys.

Thank you.

Thank you.