PAYLOCITY HOLDING CORPORATION The statements included herein that are not based solely on historical facts are "forward looking statements." Such forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties. Our actual results could differ materially from those anticipated by us in these forward-looking statements as a result of various factors, including items discussed below and impacts from the novel coronavirus disease (COVID-19) as discussed in "Item 1A. Risk Factors" of our Annual Report on Form 10-K for the fiscal year endedJune 30, 2022 filed with theSEC onAugust 5, 2022 . Overview We are a leading cloud-based provider of human capital management, or HCM, and payroll software solutions that deliver a comprehensive platform for the modern workforce. Our HCM and payroll platform offers an intuitive, easy-to-use product suite that helps businesses attract and retain talent, build culture and connection with their employees, and streamline and automate HR and payroll processes. Effective management of human capital is a core function in all organizations and requires a significant commitment of resources. Our cloud-based software solutions, combined with our unified database architecture, are highly flexible and configurable and feature a modern, intuitive user experience. Our platform offers automated data integration with hundreds of third-party partner systems, such as 401(k), benefits and insurance provider systems. We plan to continue to invest in research and development efforts that will allow us to offer a broader selection of products to new and existing clients focused on experiences that solve our clients' challenges. We believe there is a significant opportunity to grow our business by increasing our number of clients and we intend to invest in our business to achieve this purpose. We market and sell our solutions through our direct sales force. We have increased our sales and marketing expenses as we have added sales representatives and related sales and marketing personnel. We intend to continue to grow our sales and marketing organization across new and existing geographic territories. In addition to growing our number of clients, we intend to grow our revenue over the long term by increasing the number of solutions that clients purchase from us. To do so, we must continue to enhance and grow the number of solutions we offer to advance our platform. We also believe that delivering a positive service experience is an essential element of our ability to sell our solutions and retain our clients. We supplement our comprehensive software solutions with an integrated implementation and client service organization, all of which are designed to meet the needs of our clients and prospects. We expect to continue to invest in and grow our implementation and client service organization as our client base grows. We will continue to invest across our entire organization as we continue to grow our business over the long term. These investments include increasing the number of personnel across all functional areas, along with improving our solutions and infrastructure to support our growth. The timing and amount of these investments vary based on the rate at which we add new clients and personnel and scale our application development and other activities. Many of these investments will occur in advance of experiencing any direct benefit from them, which will make it difficult to determine if we are effectively allocating our resources. We expect these investments to increase our costs on an absolute basis, but as we grow our number of clients and our related revenues, we anticipate that we will gain economies of scale and increased operating leverage. As a result, we expect our gross and operating margins will improve over the long term.
Key Metrics
We regularly review a number of metrics, including the following key metrics, to evaluate our business, measure our performance, identify trends affecting our business, formulate financial projections and make strategic decisions.
Revenue Growth
Our recurring revenue model and high annual revenue retention rates provide significant visibility into our future operating results and cash flow from operations. This visibility enables us to better manage and invest in our business. Total revenues increased from$181.7 million for the three months endedSeptember 30, 2021 to$253.3 million for the three months endedSeptember 30, 2022 , representing a 39% year-over-year increase. The increase in year-over-year revenue growth was driven by the strong performance by our sales team and also increases in client workforce levels and 19
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growth in interest income on funds held for clients attributable to rising interest rates and higher average daily balances for funds held for clients due to new clients and increases in client workforce levels as compared to the prior fiscal year. Our revenue growth in future periods may be impacted by fluctuations in client employee counts, potential increases in client losses, a changing interest rate environment, uncertainties around market and economic conditions including inflation risk, among other factors.
Adjusted Gross Profit and Adjusted EBITDA
We disclose Adjusted Gross Profit and Adjusted EBITDA because we use them to evaluate our performance, and we believe Adjusted Gross Profit and Adjusted EBITDA assist in the comparison of our performance across reporting periods by excluding certain items that we do not believe are indicative of our core operating performance. We believe these metrics are used in the financial community, and we present them to enhance investors' understanding of our operating performance and cash flows. Adjusted Gross Profit and Adjusted EBITDA are not measurements of financial performance under generally accepted accounting principles inthe United States ("GAAP"), and you should not consider Adjusted Gross Profit as an alternative to gross profit or Adjusted EBITDA as an alternative to net income or cash provided by operating activities, in each case as determined in accordance with GAAP. In addition, our definition of Adjusted Gross Profit and Adjusted EBITDA may be different than the definition utilized for similarly-titled measures used by other companies. We define Adjusted Gross Profit as gross profit before amortization of capitalized internal-use software costs, amortization of certain acquired intangibles, stock-based compensation expense and employer payroll taxes related to stock releases and option exercises, and other items as defined below. We define Adjusted EBITDA as net income before interest expense, income tax expense, depreciation and amortization expense, stock-based compensation expense and employer payroll taxes related to stock releases and option exercises and other items as defined below. The table below sets forth our Adjusted Gross Profit and Adjusted EBITDA for the periods presented. Three Months Ended September 30, 2021 2022 (in thousands) Adjusted Gross Profit$ 128,115 $ 182,697 Adjusted EBITDA 46,124 66,623 Three Months Ended September 30, 2021 2022
(in thousands) Reconciliation from Gross Profit to Adjusted Gross Profit Gross profit
$ 118,448 $ 168,737 Amortization of capitalized internal-use software costs 6,128 7,042 Amortization of certain acquired intangibles - 1,854
Stock-based compensation expense and employer payroll taxes related to stock releases and option exercises
3,527 5,045
Other items (1) 12 19
Adjusted Gross Profit $ 128,115 $ 182,697
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Three Months Ended
September 30,
2021 2022
(in thousands)
Reconciliation from Net income to Adjusted EBITDA
Net income $ 30,932 $ 30,352
Interest expense 108 187
Income tax benefit (20,797) (23,426)
Depreciation and amortization expense 11,322 14,267
EBITDA 21,565 21,380
Stock-based compensation expense and employer payroll taxes related to stock releases and option exercises
23,756 44,978 Other items (2) 803 265 Adjusted EBITDA$ 46,124 $ 66,623
(1)Represents nonrecurring acquisition-related costs. (2)Represents nonrecurring costs including acquisition and other transaction-related costs.
Basis of Presentation Revenues Recurring and other revenue We derive the majority of our revenues from recurring fees attributable to our cloud-based HCM and payroll software solutions. Recurring fees for each client generally include a base fee in addition to a fee based on the number of client employees and the number of products a client uses. We also charge fees attributable to our preparation of W-2 documents and annual required filings on behalf of our clients. We charge implementation fees for professional services provided to implement our HCM and payroll solutions. Implementations of our payroll solutions typically require one to eight weeks, depending on the size and complexity of each client, at which point the new client's payroll is first processed using our solution. We implement additional HCM products as requested by clients and leverage the data within our payroll solution to accelerate our implementation processes. Our average client size has continued to be over 100 employees. The number of client employees on our platform and the mix of products purchased by a client as well as the timing of services provided with respect to those client employees can vary each period. As such, the number of client employees on our system is not a good indicator of our financial results in any given period. Recurring and other revenue accounted for substantially all of our total revenues during the three months endedSeptember 30, 2021 and 97% of our total revenues for the three months endedSeptember 30, 2022 . While the majority of our agreements with clients are generally cancellable by the client on 60 days' notice or less, we also have term agreements, which are generally two years in length. Our agreements do not include general rights of return and do not provide clients with the right to take possession of the software supporting the services being provided. We recognize recurring fees in the period in which services are provided and the related performance obligations have been satisfied. We defer implementation fees related to our proprietary products over a period generally up to 24 months.
Interest Income on Funds Held for Clients
We earn interest income on funds held for clients. We collect funds for employee
payroll payments and related taxes in advance of remittance to employees and
taxing authorities. Prior to remittance to employees and taxing authorities, we
earn interest on these funds through demand deposit accounts with financial
institutions with which we have automated clearing house, or ACH, arrangements.
We also earn interest by investing a portion of funds held for clients in highly
liquid, investment-grade marketable securities.
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Cost of Revenues
Cost of revenues includes costs to provide our HCM and payroll solutions which primarily consists of employee-related expenses, including wages, stock-based compensation, bonuses and benefits, relating to the provision of ongoing client support and implementation activities, payroll tax filing, distribution of printed checks and other materials as well as delivery costs, computing costs, amortization of certain acquired intangibles and bank fees associated with client fund transfers. Costs related to recurring support are generally expensed as incurred. Implementation costs related to our proprietary products are capitalized and amortized over a period of 7 years. Our cost of revenues is expected to increase in absolute dollars for the foreseeable future as we increase our client base. However, we expect to realize cost efficiencies over the long term as our business scales, resulting in improved operating leverage and increased margins. We also capitalize a portion of our internal-use software costs, which are then amortized as Cost of revenues. We amortized$6.1 million and$7.0 million of capitalized internal-use software costs during the three months endedSeptember 30, 2021 and 2022, respectively.
Operating Expenses
Sales and Marketing
Sales and marketing expenses consist primarily of employee-related expenses for our direct sales and marketing staff, including wages, commissions, stock-based compensation, bonuses, benefits, marketing expenses and other related costs. Our sales personnel earn commissions and bonuses for attainment of certain performance criteria based on new sales throughout the fiscal year. We capitalize certain selling and commission costs related to new contracts or purchases of additional services by our existing clients and amortize them over a period of 7 years.
We will seek to grow our number of clients for the foreseeable future, and therefore our sales and marketing expense is expected to continue to increase in absolute dollars as we grow our sales organization and expand our marketing activities.
Research and Development
Research and development expenses consist primarily of employee-related expenses for our research and development and product management teams, including wages, stock-based compensation, bonuses and benefits. Additional expenses include costs related to the development, maintenance, quality assurance and testing of new technologies and ongoing refinement of our existing solutions. Research and development expenses, other than internal-use software costs qualifying for capitalization, are expensed as incurred. We capitalize a portion of our development costs related to internal-use software. The timing of our capitalized development projects may affect the amount of development costs expensed in any given period. The table below sets forth the amounts of capitalized and expensed research and development expenses for the three months endedSeptember 30, 2021 and 2022. Three Months EndedSeptember 30, 2021 2022 (in thousands)
Capitalized portion of research and development
23,076 40,093
Total research and development $ 32,905 $ 51,843
We expect to grow our research and development efforts as we continue to broaden
our product offerings and extend our technological leadership by investing in
the development of new technologies and introducing them to new and existing
clients. We expect research and development expenses to continue to increase in
absolute dollars but to vary as a percentage of total revenue on a
period-to-period basis.
General and Administrative
General and administrative expenses consist primarily of employee-related costs,
including wages, stock-based compensation, bonuses and benefits for our finance
and accounting, legal, information systems, human resources and other
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administrative departments. Additional expenses include consulting and professional fees, occupancy costs, insurance and other corporate expenses. We expect our general and administrative expenses to continue to increase in absolute dollars as our company continues to grow.
Other Income (Expense)
Other income (expense) generally consists of interest income related to interest earned on our cash and cash equivalents, net of losses on disposals of property and equipment and interest expense related to our revolving credit facility.
Results of Operations
The following table sets forth our statements of operations data for each of the
periods indicated.
Three Months Ended
September 30,
2021 2022
(in thousands)
Consolidated Statements of Operations Data:
Revenues:
Recurring and other revenue $ 180,824 $ 245,406
Interest income on funds held for clients 873 7,874
Total revenues 181,697 253,280
Cost of revenues 63,249 84,543
Gross profit 118,448 168,737
Operating expenses:
Sales and marketing 49,885 71,063
Research and development 23,076 40,093
General and administrative 35,235 50,492
Total operating expenses 108,196 161,648
Operating income 10,252 7,089
Other expense (117) (163)
Income before income taxes 10,135 6,926
Income tax benefit (20,797) (23,426)
Net income $ 30,932 $ 30,352
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The following table sets forth our statements of operations data as a percentage of total revenues for each of the periods indicated.
Three Months Ended
September 30,
2021 2022
Consolidated Statements of Operations Data: Revenues: Recurring and other revenue 100 % 97
%
Interest income on funds held for clients 0 % 3 % Total revenues 100 % 100 % Cost of revenues 35 % 33 % Gross profit 65 % 67 % Operating expenses: Sales and marketing 27 % 28 % Research and development 13 % 16 % General and administrative 19 % 20 % Total operating expenses 59 % 64 % Operating income 6 % 3 % Other expense 0 % 0 % Income before income taxes 6 % 3 % Income tax benefit (11) % (9) % Net income 17 % 12 %
Comparison of Three Months Ended
Revenues
($ in thousands)
Three Months Ended
September 30, Change
2021 2022 $ %
Recurring and other revenue $ 180,824 $ 245,406 $ 64,582 36 %
Percentage of total revenues 100 % 97 %
Interest income on funds held for clients $ 873 $ 7,874$ 7,001 802 % Percentage of total revenues 0 % 3
%
Recurring and Other Revenue
Recurring and other revenue for the three months endedSeptember 30, 2022 increased by$64.6 million , or 36%, to$245.4 million from$180.8 million for three months endedSeptember 30, 2021 . Recurring and other revenue increased primarily as a result of incremental revenues from new and existing clients due to the strong performance by our sales team and also increases in client workforce levels as compared to the prior fiscal year.
Interest Income on Funds Held for Clients
Interest income on funds held for clients for the three months endedSeptember 30, 2022 increased by$7.0 million , or 802%, to$7.9 million from$0.9 million for the three months endedSeptember 30, 2021 . Interest income on funds held for clients increased primarily due to higher interest rates and higher average daily balances for funds held due to the addition of new clients to our client base and also increases in client workforce levels as compared to the prior fiscal year. 24
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Cost of Revenues
($ in thousands)
Three Months Ended
September 30, Change
2021 2022 $ %
Cost of revenues $ 63,249 $ 84,543 $ 21,294 34 %
Percentage of total revenues 35 % 33 %
Gross margin 65 % 67 %
Cost of Revenues
Cost of revenues for the three months ended September 30, 2022 increased by
$21.3 million , or 34%, to $84.5 million from $63.2 million for the three months
ended September 30, 2021 . Cost of revenues increased primarily as a result of
the continued growth of our business, in particular, $11.5 million in additional
employee-related costs resulting from additional personnel necessary to provide
services to new and existing clients, $5.6 million in additional delivery and
other processing costs and $1.9 million in amortization of certain acquired
intangible assets.
Operating Expenses
($ in thousands)
Sales and Marketing
Three Months Ended
September 30, Change
2021 2022 $ %
Sales and marketing $ 49,885 $ 71,063 $ 21,178 42 %
Percentage of total revenues 27 % 28 %
Sales and marketing expenses for the three months ended September 30, 2022
increased by $21.2 million , or 42%, to $71.1 million from $49.9 million for the
three months ended September 30, 2021 . The increase in sales and marketing
expense was primarily due to $13.4 million of additional employee-related costs,
including those incurred to expand our sales team. The increase was also driven
by $4.4 million of additional stock-based compensation costs associated with our
equity incentive plan and $2.7 million in additional marketing lead generation
costs.
Research and Development
Three Months Ended
September 30, Change
2021 2022 $ %
Research and development $ 23,076 $ 40,093 $ 17,017 74 %
Percentage of total revenues 13 % 16 %
Research and development expenses for the three months ended September 30, 2022
increased by $17.0 million , or 74%, to $40.1 million from $23.1 million for the
three months ended September 30, 2021 . The increase in research and development
expenses was primarily due to $11.3 million of additional employee-related costs
related to additional development personnel and $5.1 million of additional
stock-based compensation costs associated with our equity incentive plan.
General and Administrative
Three Months Ended
September 30, Change
2021 2022 $ %
General and administrative $ 35,235 $ 50,492 $ 15,257 43 %
Percentage of total revenues 19 % 20 %
General and administrative expenses for the three months ended September 30,
2022 increased by $15.3 million , or 43%, to $50.5 million from $35.2 million for
the three months ended September 30, 2021 . The increase in general and
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administrative expense was primarily due to
Other Expense
Three Months Ended
September 30, Change
2021 2022 $ %
Other expense $ (117) $ (163) $ (46) 40 %
Percentage of total revenues 0 % 0 %
Other expense did not materially change for the three months ended
Income Taxes
Our effective tax rate was (205.2)% and (338.2)% for the three months endedSeptember 30, 2021 and 2022, respectively. Our effective tax rate for the three months endedSeptember 30, 2021 was lower than the federal statutory rate of 21% primarily due to excess tax benefits from employee stock-based compensation and state and local income taxes, partially offset by an increase to the valuation allowance. Our effective tax rate for the three months endedSeptember 30, 2022 was lower than the federal statutory rate of 21% primarily due to excess tax benefits from employee stock-based compensation, state and local income taxes, and a decrease to the valuation allowance.
Quarterly Trends and Seasonality
Our overall operating results fluctuate from quarter to quarter as a result of a variety of factors, some of which are outside of our control. Our historical results should not be considered a reliable indicator of our future results of operations. We experience fluctuations in revenues and related costs on a seasonal basis, which are primarily seen in our fiscal third quarter, which ends onMarch 31 of each year. Specifically, our recurring revenue is positively impacted in our fiscal third quarter as a result of our preparation of W-2 documents for our clients' employees in advance of tax filing requirements. The seasonal fluctuations in revenues also positively impact gross profits during our fiscal third quarter. Our historical results for our fiscal third quarter should not be considered a reliable indicator of our future results of operations. Our interest income earned on funds held for clients is also positively impacted during our fiscal third quarter as a result of our increased collection of funds held for clients. Certain payroll taxes are primarily collected during our fiscal third quarter and subsequently remitted.
Critical Accounting Policies and Estimates
Our management's discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenue and expenses. In accordance with GAAP, we base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. Actual results may differ from our estimates under different assumptions or conditions and, to the extent that there are differences between our estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected. Accounting estimates used in the preparation of these consolidated financial statements change as new events occur, as more experience is acquired, as additional information is obtained and as the operating environment changes. Our critical accounting policies and use of estimates are disclosed in our audited consolidated financial statements for the year endedJune 30, 2022 included in our Annual Report on Form 10-K filed with theSEC onAugust 5, 2022 .
Liquidity and Capital Resources
Our primary liquidity needs are related to the funding of general business requirements, including working capital requirements, research and development, and capital expenditures. As ofSeptember 30, 2022 , our principal source of liquidity was$65.5 million of cash and cash equivalents. InAugust 2022 , we amended the credit agreement entered inJuly 2019 to increase the borrowing capacity under our revolving credit facility to$550.0 million , which may be increased up to 26
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$825.0 million . No amounts were drawn on the revolving credit facility as ofSeptember 30, 2022 . Refer to Note 8 of the Notes to the Unaudited Consolidated Financial Statements for additional detail on the amended credit agreement. We may invest portions of our excess cash and cash equivalents in highly liquid, investment-grade marketable securities. These investments may consist of commercial paper, corporate debt issuances, asset-backed debt securities, certificates of deposit,U.S. treasury securities,U.S. government agency securities and other securities with credit quality ratings of A-1 or higher. As ofSeptember 30, 2022 , we did not have any corporate investments. In order to grow our business, we intend to increase our personnel and related expenses and to make significant investments in our platform, data centers and general infrastructure. The timing and amount of these investments will vary based on our financial condition, the rate at which we add new clients and new personnel and the scale of our module development, data centers and other activities. Many of these investments will occur in advance of experiencing any direct benefit from them, which could negatively impact our liquidity and cash flows during any particular period and may make it difficult to determine if we are effectively allocating our resources. However, we expect to fund our operations, capital expenditures, acquisitions and other investments principally with cash flows from operations, and to the extent that our liquidity needs exceed our cash from operations, we would look to our cash on hand or utilize the borrowing capacity under our credit facility to satisfy those needs. Funds held for clients and client fund obligations will vary substantially from period to period as a result of the timing of payroll and tax obligations due. Our payroll processing activities involve the movement of significant funds from accounts of employers to employees and relevant taxing authorities. Though we debit a client's account prior to any disbursement on its behalf, there is a delay between our payment of amounts due to employees and taxing and other regulatory authorities and when the incoming funds from the client to cover these amounts payable actually clear into our operating accounts. We currently have agreements with eleven majorU.S. banks to execute ACH and wire transfers to support our client payroll and tax services. We believe we have sufficient capacity under these ACH arrangements to handle all transaction volumes for the foreseeable future. We primarily collect fees for our services via ACH transactions at the same time we debit the client's account for payroll and tax obligations and thus are able to reduce collectability and accounts receivable risks. We believe our current cash and cash equivalents, future cash flow from operations, and access to our credit facility will be sufficient to meet our ongoing working capital, capital expenditure and other liquidity requirements for at least the next 12 months, and thereafter, for the foreseeable future.
The following table sets forth data regarding cash flows for the periods indicated:
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