Paylocity Holding Corp (PCTY) 2015 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Paylocity Holding Corporation first quarter 2015 fiscal year results. At this time all participants are in a listen-only mode. Later, we'll have a question-and-answer session and instructions will follow at that time.

(Operator Instructions)

As a reminder this conference is being recorded. I would now like to turn the conference over to Peter McGrail, Chief Financial Officer. Sir, you may begin.

Good afternoon, and welcome to Paylocity's earnings results call for the first quarter of 2015, which ended on September 30, 2014. I'm Peter McGrail, CFO. And joining me on the call today is Steve Beauchamp, Chief Executive Officer of Paylocity. Today we will be discussing the results announced in our press release issued after the market closed. A webcast replay of this call will be available on our website under the Investor Relations tab.

Before beginning, we must caution you that today's remarks in this discussion, including statements made during the question-and-answer session, contain forward-looking statements. These statements are subject to numerous important factors, risks and uncertainties, which could cause actual results to differ from the results implied by these or other forward-looking statements. Also, these statements are based solely on the present information and are subject to risks and uncertainties that can cause actual results to differ materially from those projected in the forward-looking statements.

For additional information, please refer to our filings with the Securities and Exchange Commission for the risk factors contained therein and other disclosures. We do not undertake any duty to update any forward-looking statements.

Also, during the course of today's call we will refer to both GAAP and certain non-GAAP financial measures. We believe that non-GAAP measures are more representative of how we internally measure the business and there is a reconciliation schedule detailing these results currently available in our press release, which is located on our website at www.Paylocity.com under the Investor Relations tab and filed with the Securities and Exchange Commission. The non-revenue financial measures we will discuss today are non-GAAP unless we state the measures as GAAP. With that, let me turn the call over to Steve.

Thank you, Peter. Thanks to all of you for joining us today. Peter will review our financial results in detail, but let me share a few highlights from our first quarter.

Our first quarter was again healthy across all of our key metrics as demand for our cloud-base unified payroll in human capital management solutions continues to grow. Total revenue was up 39% year-over-year while reoccurring revenue grew 40%. Adjusted recurring gross margin increased to 69% for the quarter, up from 65% the same period last fiscal. The majority of the adjusted gross margin expansion was driven from the purchase of one of our resellers completed last quarter.

Recurring revenue represented 95% of total revenue this quarter, up from 94% a year ago. Revenue retention continues to exceed 92%, which is best in class for a company targeting mid-sized firms. We also recently hosted our annual client conference in October with nearly 600 users, up from approximately 450 users last year. Adjusted EBITDA was slightly better than break-even for the quarter and reflected our increased spending on sales and marketing and research and development.

We increased our sales and marketing spend by 58% year-over-year as we believe the mid-market is in the very early innings of a multi-year transition to SaaS-based payroll and human capital management solutions. Our sales organization had another very good quarter as our new sales hires begin to ramp up productivity heading into our fall selling season.

As mentioned on our last conference call, we are incrementally investing in marketing initiatives to further develop our referral network of 401(k) advisors, insurance brokers, third-party administrators and HR consultants that recommend our solution and provide our sales force with highly qualified referrals. These marketing initiatives include events, seminars and the development of broker-specific content on topics such as healthcare reform which add value to our partners and raise Paylocity's brand awareness in this important channel.

I am very pleased with the impact these marketing efforts are having as we continue to add new partners while at the same time generate additional leads from existing partners. Sales and marketing expense was 26% of total revenue for the quarter, up from 23% for the same period last fiscal year. We are also pleased to see that 35% of our first quarter revenue came from new customers, versus 34% for the same period in the prior year. Underscoring the fact that we are still focussed on adding new clients to our platform versus selling back into the client base.

We increased our investment and implementation resources by 36% year-over-year to ensure we can continue to deliver a smooth transition for these new clients. We are focused on recruiting experienced payroll and HR professionals in implementation. Many of our new hires on this team occurred a little later in the quarter than anticipated. However, we are now in very good shape heading into the busiest time of our fiscal year.

Trailing 12 month revenue retention continues to exceed 92% as we are focused on delivering our clients industry-leading software backed by great service. We had the opportunity to interact with almost 600 users at our annual clients conference in October. Many of the users I spoke with mentioned the importance of the relationship they have developed with the dedicated account manager as one of the key drivers of their satisfaction. In our experience, unlike enterprise clients, mid-market clients can have limited resources, and as a result, rely more significantly on their interactions with their dedicated account manager. It is the combination of meeting and exceeding this service expectation along with leading technology that has allowed us to consistently achieve best in class revenue retention in excess of 92%.

During the user conference I also had the opportunity to outline our commitment to research and development and review several of our product initiatives focused on addressing key macro trends in social, mobile and analytics. For example, our mobile first approach will deliver a new employee portal with an updated user experience in our November quarterly release. We will also be adding additional web time functionality to our already very feature rich mobile app where employees can view and manage schedules, punch in time, request vacation, and as of November, manage their time sheets.

This November's release also includes the first release of our new analytics tool providing interactive dashboards and insights on key workforce metrics for our clients. There is also a significant level of excitement at the conference for our new on-boarding module. We highlighted the on-boarding module as a great example of our mobile-first design allowing clients to automate previously manual tasks. We're gaining traction with this new product as onboarding is quickly approaching the 100-client milestone.

We believe strongly that our unified human capital management platform, purpose-built for mid-sized clients, is a key differentiator versus traditional payroll providers; and therefore, we will continue to aggressively invest in our cloud-based software. Research and development was 14.2% of our revenue for the quarter when you combine capitalized software with R&D expense, up from 13.3% for the same period last year.

In summary, we are very pleased with the first quarter results and feel like we are off to a very good start to our first full fiscal year as a public Company. With that, let me turn it over to Peter.

Thanks, Steve. Let me walk through the results and provide a bit of color as well as review some of the key aspects of our financial model.

Revenue. Total revenue was $31.1 million, which represents a 39% increase from the same period in the prior year. As you may recall, our revenues have two major components, recurring and non-recurring. Our recurring revenue has historically represented about 94% of our overall revenues and is separated into two categories, recurring fees attributable to our cloud-based payroll and HCM software solutions and interest income on funds held for clients.

For the first quarter our total recurring revenue of $29.5 million was up 40% from the year ago quarter and represented 95% of our total revenue. Recurring fees were up 41% in the quarter, the same percentage as the year ago quarter. Interest revenue was up modestly, 3% year-over-year as declining rates were offset by balance increases. Our non-recurring revenues are comprised of implementation services and other. It primarily consists of implementation fees charged to new clients for professional services provided to implement and configure our payroll and HCM solutions.

Implementation services and other revenue was $1.6 million for the quarter, up 26% from the year ago quarter. Within our implementation services and other revenue category, payroll start-up revenue was particularly strong. And as Steve mentioned, we were very pleased with our sales results for the quarter.

Our agreements with clients do not have a specified term and are generally cancelable by the client on 60 days or less notice. Even without fixed-term agreements, our annual revenue retention rate, which is always calculated on a trailing 12-month basis has been consistently greater than 92% for several years and remains so in this quarter. As we've noted in the past, we believe this is best-in-class in our segment. This combination of high recurring revenue percentages and high retention rates provides significant visibility into our future operating results.

Gross margins. Like our revenues, we separate our cost of revenues into two different categories. Recurring revenue and implementation services and other. These two numbers are combined to form our overall costs and then to produce our overall gross profit margins. We refine our gross margins further by providing adjusted numbers.

We adjust for two items. First, we exclude stock-based compensation. Second, we exclude amortization expense associated with capitalized research and development costs. A reconciliation of GAAP to non-GAAP adjusted gross margins is provided in the press release we issued after the close today.

We believe these adjusted numbers provide the best and most reliable comparison to other SaaS companies. Adjusted gross profit in the first quarter was $16.9 million, representing a gross margin of 54.3%, as compared to $11.2 million, or 50.2%, in the first quarter of 2014. This improvement was primarily the result of the acquisition of one of our two resellers in May, as well as the timing of hiring new personnel in our implementation function, which Steve highlighted earlier, and in our customer service function.

We expect the year-over-year margin improvement to narrow as we move forward in the fiscal year as we quickly approach our targeted staffing levels. We view our adjusted recurring revenue gross margins as the best barometer for our overall long-term margin opportunity as we generate these margins on the vast majority of our revenues. Our adjusted gross profit on recurring revenues was $20.4 million or 69.1% in the first quarter, up from $13.7 million or 65% in the year ago quarter. Again, this improvement was primarily the result of the acquisition of one of our two resellers and the timing of hiring new personnel.

As we've discussed in the past, our adjusted gross margins on non-recurring revenue, specifically on implementation services, are negative. We view the negative margins on our implementation services as a great short-term investment. They only last three to six weeks, which then become a long-term high margins annuity. In regards to implementations, we charge what we believe are market rates and we'll continue this practice as we continue to gain market share.

Operating expenses. As noted in our last earnings call, we're incrementally increasing our investments in two key areas. First, we are focusing investment in research and development to maintain and extend our technological leadership.

Second, we are engaging in sales and marketing activities that have the potential for longer term impacts; including taking a higher profile at industry events and cultivating our relationships with our unique broker referral channel, both of which we did in the first quarter.

In order to understand our overall investment in research and development it is important to combine both what we expense and what we capitalize. On a combined non-GAAP basis, research and development investments were $4.4 million or 14.2% of revenue in the first quarter compared to $3 million or 13.3% of revenue in the year ago quarter. On a non-GAAP basis, sales and marketing expense increased to $8.2 million or 26.3% of revenue in the first quarter, compared to $5.2 million or 23.2% in the year ago quarter as we continue to expand our marketing efforts in fiscal year 2015 including adding additional marketing staff and expanding our broker-related marketing events.

On a non-GAAP basis, general and administrative costs were $6.2 million or 20% of revenue in the first quarter, compared to $3.7 million or 16.7% of revenue in the year ago quarter, when we were not yet a public Company.

Income loss. Our adjusted EBITDA, which is adjusted for stock-based compensation and the amortization of intangibles related to our reseller acquisition, was $0.4 million for the quarter versus $1.2 million for the year ago quarter. Non-GAAP net loss per share was negative $0.03 for the quarter based on $49.6 million diluted weighted average common shares outstanding.

Briefly covering our GAAP results. For the quarter, gross profit was $15.7 million, operating loss was negative $4.9 million and net loss was negative $4.9 million.

Cash. Like others in our industry, we do collect funds from our clients in advance of making payments to employees and taxing authorities. Our cash flows from investing and financing activities are influenced by the timing and amount of funds held for clients, which varies significantly from quarter to quarter. Funds held for clients are restricted solely for the repayment of client fund obligations.

In regard to the balance sheet, we ended the quarter with cash and cash equivalents of $72.8 million. From a cash flow perspective, we used $0.2 million in cash for operating activities in the quarter and spent $2.5 million on property, plant and equipment.

Finally, as we noted in the past, we experienced fluctuations in revenues and related costs on a seasonal basis. For example, in our third fiscal quarter our revenues and gross margins are positively impacted by our preparation of W-2 documents for our clients' employees. Our costs also traditionally increased during this same period because it has historically represented our most significant for new client acquisitions.

I'd now like to provide our financial guidance for the second quarter and updated guidance for the full-year fiscal 2015. Second quarter 2015. Total revenue is expected to be in the range of $31.3 million to $32.3 million.

Adjusted EBITDA is expected to be a loss in the range of negative $2.25 million to negative $1.25 million. Non-GAAP net loss is expected to be in the range of negative $4.5 million to negative $3.5 million or negative $0.09 to negative $0.07 per share based on 49.6 million basic weighted average common shares outstanding.

Fiscal year 2015. Total revenue is expected to be in the range of $141 million to $145 million. Adjusted EBITDA is expected to be in the range of $2 million to $4 million. Non-GAAP net loss is expected to be in the range of negative $6.5 million to negative $4.5 million or negative $0.13 to negative $0.09 per share based on 49.6 million basic weighted average common shares outstanding.

In summary, we are very pleased with our operational performance during the first quarter of fiscal year 2015. Operator, we are now ready to begin the Q&A session.

Thank you.

(Operator Instructions)

Our first question is from Justin Furby of William Blair & Company. You may begin.

Hey, guys, great quarter. I had a couple of questions.

I know the competitive landscape doesn't really change much in this industry. But I'm just curious if you think about, outside of the big service bureaus, if you look at the regional guys as a percentage of sort of the times that you're taking away business. How often does that -- remind us how often that comes up. Is that sort of three behind call it ADP, Paychex?

(multiple speakers)

Hey, Steve, how's it going? Sorry, go ahead.

Yes. No, I think first of all I would say the competitive environment has been pretty consistent so I would not note any specific changes in the environment as we look at the percentage of business we still get the majority of customers from ADP and Paychex. The regional and local guys would be roughly the third source after that and that has been the case for many years and is consistent in the quarter.

Okay. And what are those guys do [to the fee] to the pricing environment? I'm just curious.

It seems like they're pretty challenged and what do you typically see from them from a pricing perspective? Are they pretty aggressive?

Yes, I think we see that group of all the local and regional players across the country being, typically, the most aggressive from a pricing perspective. That is one point of differentiation.

The investment level that we're putting in our product is what we emphasize when we're competing against the local and regional players who typically, certainly never, have the same level of scale to be able invest into the product. It typically is a little bit more aggressive from a pricing perspective.

Okay. Maybe you covered on this. I apologize, I jumped a few minutes late onto the call. But the new guys that you brought on, the new cohort of sales reps, can you talk a little bit about how you're feeling about them, kind of early days as you move into kind of your important seasonal booking period?

Yes. Just to remind everybody, we typically hire a number of new sales people in the spring and early summer. It is our goal to try to go into our fiscal year at our kick-off meetings with as close to as full staffing as possible. We were able to do that this year, which we were very pleased with.

Some of these new reps are still fairly new. It does takes us a good six months before we start seeing them to ramp to a normalized level of volume. And so I think we'll give you a much better sense of how they're doing post-January and once we see January sales coming in. But so far so good from our perspective.

Great. Thanks very much, guys, I appreciate it.

Pat Walravens of JMP.

Great. Thank you. And let me echo the congratulations.

So I love the focus on customer satisfaction. And I wonder, Steve, as you're sort of exceeding our expectations on growth, relying a bit on service, do you need to slow your growth to make sure the customer experience doesn't suffer?

Well, I think-- How do you think about that? That's a good question.

Well, first I would point to the fact that we've had pretty consistent growth rates over time. So we've been doing this level of growth for many years, would be the first point.

We are very much focused on customer service, and we take that very seriously and it's actually a big key point differentiator. And if you look at the fact we've been able to exceed 92% revenue retention for many, many years consistently, I think we're doing a great job from a service perspective. It's something that is always a challenge in any growth environment. But we've got a great team focused on it and we get very good feedback from our customers from a overall satisfaction level.

Great. And, as I look at the midpoint of the guidance range, I think it's sort of 33%, down from 39%, if I'm doing my math right. Is that just conservatism or what points would you make there?

Yes, I think we're going into a very busy time of year for us from a sales perspective. So obviously January is a big start time, so we've got three quarters left. We only have one quarter behind us.

From our perspective we do have to sell and set up most of the customers in that same given quarter. So we do have very good visibility because of our high revenue retention, but keep in mind it's a high transaction environment. We're bringing on a lot of customers.

This is something where we look at where we are at the start of each quarter and then guidance in terms of where we think is a reasonable spot where we're going to end up. And if there is over performance, it will likely come from better than expected new sales.

Great. And then last one for me.

Generally payroll companies, even the non-SaaS ones, seem to be doing great this year. What would you attribute that to?

Yes, I think there's some macro trends going on in the marketplace from a compliance perspective. I do think you'd hear of all of the companies talk about ACA or healthcare reform has created complexity for many businesses to be able to handle. With 2015 on the horizon, I think there's a lot of businesses looking at their existing systems evaluating if they have the right tools to be able to manage that complexity going into 2015. We certainly have found that more companies are at least interested in having those conversations because of that complexity.

So I think everybody in this industry, as a whole, is certainly racing to be able to provide the best solution for that. We were one of the earliest companies with our healthcare module in the marketplace, and so we've been actively talking about healthcare reform in the market for well over a year.

Great. Thanks very much.

Terry Tillman of Raymond James.

Hey, guys, I'd like to keep the echoing of the congratulations and nice job on the quarter, as well.

I guess the first question, Steve, relates to, you know, the sales and marketing investments this year it sounds like it is more of a dual focus. Obviously it's feet on the street, but also more of this just broad marketing spend and brand recognition and brand development.

But on the sales coverage side, just to give us appreciation for just, you know, how much breadth you have and how much coverage. Are there still big holes across like the US, in terms of where you're still not having good sales representation? Or do you feel like you've gotten past the point of having any notable territorial holes?

That's a good question, Terry. I think from an overall sales coverage perspective, our strategy has been to hire the best people wherever we find them. I think the advantage of the model that we put in place is there is not a market in the country that we couldn't put a sales rep.

So we've been obviously in the Chicagoland area for the longest, being our roots from here. And we could absolutely add rep to this marketplace if we found the right talented rep.

At this point in time, we have at least seeded every single marketplace, every major marketplace, across the country. And we're now in the process as we add reps, which would happen in ernest next spring, we would then look to backfill additional reps in each of those markets. And there is certainly a lot of capacity sitting here right now to be able to add a significant number of reps over a, you know, years to come.

Well, building on the question though, in terms of the third party influencers, the 401(k), the brokers, the TPAs, et cetera. As you continue to expand the opportunity with them and these qualified leads; could we see increasingly maybe, you don't maybe need as many sales reps in each given year and these lead-generators can actually then create that much more productivity with the existing sales force you have, or is it not at that point yet?

Well, it's a great question. We do think that it is a strategic advantage having a channel providing us these qualified leads.

It is still certainly early in that cycle, but I think if you look at the history, we give you the number of reps that we have each year, and you can see that we are gaining productivity per rep. I would tell you that referral channel is a key factor in that equation but not the only factor. So we do think investing in this channel certainly will make us more scalable from a sales and marketing, go-to-market strategy, long-term.

My final question just relates to, and your 10-K that you had filed earlier in the year. It looked like you updated the economics in terms of, you know, if a customer was to buy the -- the total of your offerings, or everything on the price list, I think it's $230 per employee per year. I think that was up from prior disclosure of $200. What is entailed in that?

Is that simply just the two new products that you've introduced or have you increased some prices on some preexisting products? And then I'll jump back into the queue. Thank you.

Sure. Yes, we do look at the per employee, per year total of all of our products if we sold the customer everything. We made that change by looking at the new products that we introduced, actually most significantly being on-boarding. And that really drove kind of the large majority of that per employee, per year available product sales.

(Operator instructions)

Jim MacDonald of First Analysis.

Good afternoon, guys, good quarter.

Thank you.

Could you talk a little bit about the impact of channel leads? Has it been the same this quarter or any impact that's different?

Yes. No, so we have traditionally been able to generate, well traditionally meaning last year we generated over 25% of our new business from these channel leads. And, you know, we found a number that we're going to kind of give you every quarter but we certainly will update that on an annual basis.

I would tell you that we do feel like the marketing efforts that we've been making have really ingraining us those channels and we've really got good momentum. So certainly, without giving you a specific number, I tell you that we're very happy with the amount of business that we're getting from the channels.

Right. And your growth has been pretty consistent quarter-to-quarter, is there any reason going forward to think that, you know, it may be harder to keep growth up at high levels in one quarter seasonally versus another quarter?

I would say that, you know, we were able to have a nice beat this quarter. And I would say that was driven by over performance from a sales perspective and our ability to be able to continue to generate this level of growth requires our sales team to really executive. Obviously for us to on-board the clients and make sure they're satisfied and then retain them. From our perspective, we have to do that every single quarter.

The third fiscal quarter of the year is the biggest quarter from a new sales perspective. And so that's something that at this time of year we're ramping up volume and trying to make sure that we've got a great January of new sales. It's also the busiest quarter from our customers with W-2s and retention.

So if there was any cyclical nature at all to our business, then I would say that quarter from a new sales perspective, obviously from a year-end work, would be the quarter to focus on.

Great. And my final question, just any update on your New Jersey distributor and your thoughts there?

Yes, so, just to remind everybody we have one reseller left and they operate in the New Jersey marketplace, and so we do have the option to acquire that reseller. It is at our option.

We have not made any decisions, yet, in terms of the acquisition of that reseller. It's a pre-defined formula, and we certainly understand it. So as soon as we make final decisions on when and if we want to make that acquisition, then we would obviously make those announcements publicly.

Great. Thanks.

Scott Berg of Northland Capital Markets.

Hi, Steven, Peter, congrats on a good quarter. Couple questions.

Thanks, Scott.

First of all on the new products, on-boarding's obviously a new product. You have analytics coming up. Wanted to get your opinion on how we should view attach rates for those.

I know it's early but, kind of in general, how are you thinking that those get sold with the current product suite going forward? Is this a significant opportunity near-term, or is this something that you think will take a little time to ramp properly?

I think if you look at some of the new products, I'll touch on a few of those, couple that you mentioned. First, on-boarding.

We are selling on-boarding as an add-on module to our new customers mostly focused on the new customers that we're bringing on. Once again we don't have anybody really going back into the client base unless they're requesting it at the moment. And we've had very good traction within our new client base with on-boarding.

And I do think that over time we can get to pretty reasonable penetrate rates. It is also something that we'll look at bundling and packaging with various solutions over time to be able to continue to drive that higher.

The other new product that you mentioned is analytics. And analytics we don't look at today as really a revenue opportunity. It's really a differentiator in the marketplace.

Our release in November is going to allow our customers to easily see kind of key insights into their workforce for things like employee turnover, as an example. And then they'll be able to drill down into the data and see what's driving it. And so we think that's going to be a big differentiator and moves it away from traditional reports to an interactive dashboard.

And then the other from a new product perspective that I would mention, is we talked about launching web benefits. And web benefits is really at an earlier stage than on-boarding.

We're going to get our first clients up and running on the platform this month. It's not going to have a material impact this fiscal, but as we move into next fiscal, and you think of the enrollment cycle next fall, we're going to be in much better shape that that's going be a revenue driver for us next fiscal year. That's how we look at, kind of, the existing, most recent new products.

Sounds great. Then a follow-up question on that vein, is how do you look at pricing or margin profile of those products? Should we consider them to be the same incremental benefit to your per employee, per year model.

And then from a margin perspective, my assumption is they probably carry higher incremental gross margins than what your model currently shows for recurring revenues. Or, I guess, is my perspective on that slightly incorrect?

I think that generally is the right perspective payroll. The nature of payroll requires a significant amount of work from an implementation perspective. There's the balancing of the year-to-date, bringing all the data over.

So I think that would always be the product -- and every single customer has payroll. There's no question that is going to carry a little bit more service for our customers than some of the others.

So I think that's generally a correct assumption, but we do still require implementation resource for these other modules. They still require a level of servicing. It's generally a little less than payroll and, therefore, a little higher margin.

Great. That's all I have. I'll jump in the queue. Thank you.

Thank you.

Kash Rangan of Merrill Lynch.

Hi, guys. Thanks for taking my questions and apologies if this question has already been asked.

I know that you do not really have a dedicated sales effort to upsell some of your modules back in the install base, any changes on that front? More broadly, can you talk about what kind of fixes are you getting with attach rate for some of the new modules on top of the new business? Thank you.

Sure, thanks, Kash. Yes, as I mentioned, we certainly don't have a dedicated sales force calling back into the customers with some of the newer modules or maybe even other modules we've had many years at the moment. It does happen at times where a customer lets us know that they're interested in a product and we're able to handle that.

I think at this point, as we look at this fiscal year, certainly, we are focused on land. We want to add as many customers to the platform as possible. We think that's a much bigger challenge than potentially expanding the product and solution set that they each have.

At this point in time we're still focused on that. There may come a time either, because we're getting more feedback from our existing customers or because we're adding a little less customers to our platform that will make that shift. But that's not in the foreseeable future at the moment.

Got it. Thanks so much.

Thank you. I'm showing no further questions at this time. I'd like to turn the conference over to Steve Beauchamp for closing remarks.

I'd like to take the opportunity for thank everyone for your interest in Paylocity, and I hope everyone has a great evening.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day.