I spent the afternoon doing some research on Paylocity, and so far I like what I see.
Paylocity (PCTY) is a cloud-based mid-market human resources software company. Their offerings include the basic core HR offerings; employee data, payroll, benefits administration as well as workforce management tools, such as talent and skills management, time and attendance, workforce planning, labor scheduling and budgeting.
The company recently added a number of third party administrator (TPA) products, such as health savings accounts, health reimbursement accounts, and flexible spending accounts, providing users with a single unified access point for payroll, HR, and benefits administration. Their offerings include mobile and web access, allowing users to see transaction details and account balances while also having the ability to submit claims, all from the integrated employee portal.
PCTY has 34% insider ownership. EPS this year are up 466%, and QoQ up over 1200%. Their Gross Margin > 63%, and their annual sales growth is over 37% over the past 5 years. Market Cap is nearly $4.5 Billion, approximately 9.4 times TTM revenue, on $417.7 million in sales and $53.2M in income. The company is debt free, and has a high PE of over 87, and forward PE near 52.
In G2 Crowd Grid reporting, the company scores high marks in several key areas, and compares favorably with the big ones such as ADP, Ceridian, Workday, and PayChex. Here is the link if anyone is interested in looking at the rankings: https://www.g2crowd.com/categories/benefits-administration
Motley Fool did a brief video spread on Paylocity in April last year. Here is a link to it: https://www.fool.com/premium/coverage/investing/2018/04/26/t…
The company reported Q2FY19 earnings on February 6th. These are a few of my takeaways from their earnings report.
Q2FY2019 Earnings Highlights
- Revenue was $107.2M, up 26% YoY
- Recurring revenue was $104.7M, up 26% YoY
- 98% of revenue is recurring
- Total cash and equivalent was $104.9M
- Cash flow from operations was $27M, up from $26M
For the third quarter the company expects total revenue in the range of $135.0 million to $136.0 million, approx. 22% growth from Q3FY18. Adjusted EBITDA is expected to be in the range of $52.0 million to $53.0 million (approx. 38-39%).
For FY2019 total revenue is expected in the range of $459.0 million to $460.0 million, approx. 23% growth from the $372.1M in FY2018. Adjusted EBITDA is expected to be in the range of $129.0 million to $130.0 million (approx. 28%).
Conference Call Highlights
Paylocity stated they are seeing improved penetration and success with their newer modules from last year, specifically compensation and surveys. But in-terms of market penetration, with 17,000 clients, Paylocity believes their penetration is still very low in terms of total addressable market with over 600,000 potential clients, stating they think there is a huge opportunity still ahead of them.
The company also reported they are seeing mobile adoption grow significantly faster than their online portal across employees and managers, and they are interpreting this as people are using much more of their HCM products, which they regard as a key indicator of greater adoption. This seems to be a key metric driving the industry as a whole because higher employee interaction increases the stickiness of the product, and suggests greater penetration of their products into key operations of their clients.
In January they added TPA solutions to the product portfolio, which has increased the total per employee per year opportunity from $320 to $360 when a client buys all their available modules. That is 80% greater from the $200 per employee per year in March 2014 when the company held their IPO.
The company was not expecting their TPA offerings to have a big impact this year, because it wasn’t ready in time for the January 1st enrollment period. But they anticipate building some volume throughout the year and then being in a good position to boost sales next fall. The key, they believe, is the ease-of-use of being able to get everything on a mobile phone or through their online portal, where users can now also get their balances and submit claims. So far early adopters are reporting good feedback.
Paylocity ranked high on multiple G2 Crowd Grid reports during the quarter, including placing number one in satisfaction in six different category reports; overall and mid-market HR management suite, mid-market payroll, mid-market core HR, and overall and mid-market benefit administration. I verified this and provided a link above. The company was also recognized in December as Best Place to Work by Glassdoor for the third straight year, and reportedly has > 92% employee retention.
Financial Observations
Q2 total recurring revenue was up 26.1% from Q2FY18, with recurring fees up 23.4% and interest income on client funds up 150.4%, which primarily reflects the result of balance increases and increased average interest rates. The company also receives some income from securities they offer, but I have not dug into that yet.
Adjusted recurring gross profit was 75.3%, and adjusted total gross profit was 69.8% during the quarter. Non-GAAP R&D expenses were 14.7% of revenue in Q2, and 34.5% greater in actual dollars spent on R&D year-over-year. Non-GAAP sales and marketing expenses were 22.9% of revenue in Q2. Non-GAAP G&A costs were 15.7% of revenue, down from 16.4% in Q2FY18, so the company is having some success in containing expenses.
Adjusted EBITDA was $26.1 million, 24.3% of revenue for the quarter. This was $2.1 million higher than the midpoint of their forecast. Gross profit was $69.1 million, operating income was $7 million, and net income was $5.7 million. They ended Q2 with cash and equivalents of $104.9 million, and generated $27 million in cash from operations, compared to $26 million in Q2FY18.
The company has managed mid-20s revenue growth over the last eight quarters, and continues to work towards it’s stated long-term adjusted EBITDA margin target of 30% to 35% of revenue.
My Thoughts
Paylocity has been extremely volatile in the past six months, a bit more so than the it’s competitors in the HR & Payroll software vertical, with a 52 week share price range of $43.72 to $88.47.
Despite their roller coaster price chart, Paylocity ticks a number of boxes. They are cloud based, with 98% recurring revenue, and they have a very sticky product. Although the online HR software market may be somewhat crowded, Paylocity differentiates themselves from the crowd by being Mobile First, and they seem to be enjoying an impressive growth streak in a vertical with a huge TAM.
If you have been watching this market vertical lately, then you probably know that Ultimate Software (ULTI) with $940 million in annual revenue (2017) was just acquired last week by a private equity firm for $11 billion (32% over their volume-weighted average share price).
Can Paylocity grow as big as ULTI, and how quickly? The company has grown sales by 38% annually and EPS by over 38% annually over the past five years. If we assume an annual growth rate of 20% they should get to over $900 million in revenue in about 5 years. At 25% growth they get there in 4 years. I think with their newer more modern technology platform, PCTY is capable of over 25% annual growth, and may even reach $1 billion in revenue in about 4 years, assuming we don’t experience an economic recession during that time.
The grand daddy in this vertical is Automatic Data Processing (ADP), which has a cap of > $65 billion, on annual sales of $13.8 billion, and income of $1.86 billion. Their gross margin is 49%, PE ratio is > 35, FPE > 24.8, and their PEG ratio is 2.1. Runner up to ADP is Paychex (PAYX) with a market cap of $27 billion, income of $866M, on annual sales of $3.5 billion. PAYX has a PE ratio > 31.6, FPE > 24, and PEG of 3.35.
Perhaps a more comparable competitor for Paylocity might be Paycom (PAYC), which is no stranger to this forum. Paycom currently has a cap of $10.2 billion, on annual sales of $566M, and income of $139M, with a gross margin of 84%. PAYC has a PE ratio of 78, FPE of 45.5% and PEG ratio of 3.6.
PCTY has a market cap of $4.4 billion, on annual sales of $418M, income of $53.2M and gross margin of 63.8%. PCTY’s PE ratio is 87.5, and FPE is 51.8, with a PEG of 2.98. PCTY’s operating and profit margins are a lot lower than PAYC’s, but the company has been investing significantly in R&D and it is growing EPS faster than PAYC. PCTY’s EPS growth was 466% this year, and 1,223% QoQ, versus PAYC’s 11.9% this year, and -34.6% QoQ . Both are growing sales at over 35%, with a slight edge to PAYC, but PCTY handily beats PAYC in cash and free cash flow generation.
Of course Paycom is no slouch, they are strong competitors. I anticipate both PAYC and PCTY will nibble away chunks of market share from ADP and PAYX, so I believe both will continue to grow and succeed. The key question is which one will have the highest return? I give the edge to PCTY based on their record of earnings growth since going public four years ago.
I welcome feedback and thoughts.
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Invest wisely my friends
CMFSoloFool - Ticker Guide / Share Holder
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