Paylocity Holding Corporation

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

Paylocity Holding Corporation is a cloud-based provider of human capital management (HCM) and payroll software solutions, primarily catering to small- and medium-sized businesses.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Paylocity’s core offering is its cloud-based HCM and payroll software platform, which provides services like payroll processing, benefits management, time and attendance tracking, talent management, and human resources functions. The platform is designed to automate and streamline various aspects of HR and payroll, making it easier for SMBs to manage their workforces.

Revenue Distribution:

  • Paylocity generates revenue primarily through recurring subscription fees for its software platform. In addition to those recurring revenues, a small portion is from implementing the software and related professional services.
  • The company generates revenue in all 50 states in the U.S.

Trends in the Industry:

  • The HCM and payroll software market is highly competitive and fragmented.
  • The ongoing digital transformation is a major tailwind for growth.
  • Companies are increasingly adopting cloud-based solutions as a result of a growing preference for automation.
  • Demand for more robust HR analytics is increasing.
  • The industry is seeing more competition with larger vendors moving into the SMB space.

Competitive Landscape:

  • The industry is intensely competitive, including large players like ADP, Paychex, and Workday.
  • Paylocity distinguishes itself by focusing on the SMB market and has specialized features that cater to the needs of smaller businesses.
  • It also competes with other specialized companies that also focus on the SMB market and focus on similar cloud-based solutions.

What Makes Paylocity Different:

  • Focuses on the SMB market with a strong track record and established brand.
  • Offers a comprehensive, cloud-based platform specifically designed for smaller businesses.
  • High customer retention rate due to switching costs.
  • Maintains a strong client support team.
  • Provides embedded analytics and insights tools to help improve decision-making.
  • Provides a large variety of additional services and functions to accommodate its clients needs.
  • Focus on continuous innovation and platform development.

Financials Overview

Paylocity’s financial performance has generally been strong, characterized by consistent revenue growth and high profit margins.

  • Revenue Growth: The company has shown a trend of steady year-over-year revenue growth, signaling healthy demand for its services.

    • For the three months ended December 31st, 2023, total revenue came at $317.4 million, while the year before it was $281.9 million. This shows 12.6% yoy growth.
      • Recurring fees revenue came at $311 million.
      • Implementation services revenue came at $6.2 million.
    • For the year ended June 30th, 2023, total revenue came at $926.1 million, while the year before it was $765.6 million. This shows 21% year over year growth.
      • Recurring fees came at $898.6 million and implementation services/other came at $27.6 million.
    • Management has stated that for 2024, the company is expecting $1.31 to $1.32 billion in revenue.
  • Profitability:

    • Gross profit margins were at 70.2% (for 3 months ending December 31, 2023) and 70.9% (for year ending June 30, 2023) reflecting higher pricing power and efficient cost structure.

    • Adjusted EBITDA margin remained at 38.5% (for 3 months ending December 31, 2023) and 36.8% (for year ending June 30, 2023) indicating that the company has the ability to generate profits from its business.

  • Net income, however, was quite low in 2023, due to a large loss stemming from the extinguishment of debt. Net income came at only $22 million for the year ending in June 30th 2023. However, when adjusted, net income was $170.3 million, highlighting the profitability of their operations.

  • Cash Flow:
    • The company’s free cash flow is improving. For the three months ending December 31, 2023, free cash flow came at $26 million, with an average daily balance of client funds of $2.475 billion.

  • For the year ending June 30, 2023, free cash flow came at $229 million * Management has stated that it expects full year 2024 free cash flow to be in the range of $250-$270 million.

  • Balance Sheet:
    • The company’s balance sheet is relatively healthy, with a solid cash position at $335 million.
    • Total debt (including operating leases), is valued at $1.138 billion, which is significant, but the company is able to generate sufficient cash to cover this amount.
    • The book value of intangible assets is high, as the company has been aggressively acquiring other companies.

Moat Rating: 3/5

Paylocity has a narrow economic moat based on its switching costs and scale-based advantages within its core SMB customer base.

  • Switching Costs: A significant portion of Paylocity’s moat is derived from the high switching costs it creates for its customers. Once a small or medium-sized business integrates Paylocity’s platform into its operations, switching to another provider is costly and time-consuming, including the time spent on learning a new system, retraining employees, and migrating financial data. Customers are also very unlikely to risk moving their data to another company.
  • Scale-Based Advantages: Having a larger customer base provides better pricing with suppliers, creates a large network of contacts for its employees to use, and allows for reinvesting in technology and R&D, resulting in better product and technology offerings, all of which increases the company’s competitiveness and moat.
  • However, there is significant competition in the market, including established players that can try to steal market share.

Risks to the Moat and Business Resilience

  • Technological Disruption: New or innovative cloud based HR management solutions that offer better performance and/or cheaper prices could challenge Paylocity’s position in the market and erode the moat.

  • Competition: Paylocity faces competition from well established players such as ADP, Paychex, and Workday, especially for larger SMBs. This competition could make it difficult for Paylocity to maintain profitability, and market share.

  • Cybersecurity: Security breaches can have devastating impacts on the company’s clients and reputation. There are many cybersecurity breaches that have affected companies providing software services.
  • Economic Slowdowns: In a time of recession, the customer base may contract and companies might be hesitant to spend on HR software and more inclined to reduce employee counts.
  • Acquisition Risks: Management has taken to aggressive acquisitions in an attempt to grow their company. If these acquisitions are not well integrated and managed or do not generate additional synergy, the company might see its economic moat or growth potential deteriorate.

Despite these risks, Paylocity’s strong customer relationships and steady subscription-based business model lend resilience to the business. Management has stated that while they may not be resistant to all economic conditions, the demand for HCM and payroll solutions is relatively inelastic.

Understandability: 3/5

Paylocity’s business model is relatively straightforward. It offers a cloud-based subscription service to SMBs. The industry in which they operate is relatively complex and is prone to disruption. The financials and reporting are understandable but can get complex. Therefore we grade the business 3/5 in its understandability.

Balance Sheet Health: 4/5

  • Paylocity’s balance sheet is generally strong.
  • Current assets are 2.2 billion, with total assets at $4.7 billion, while total liabilities stand at $3.25 billion.
  • The company had $335 million in cash on hand as of December 31, 2023.
  • Debt is relatively high, however the company is able to generate sufficient FCF to be able to handle and continue expanding.
  • The company is capable of handling it’s current operational liabilities with assets and positive cash flow.

Recent Concerns, Controversies and Management’s Response

  • Management noted during the earnings calls that they are seeing lower-than-expected new bookings, especially with small to mid-sized customers. Management noted that this is a short term headwind that does not reflect any changes in competitive pressures, and does not have any long-term impacts on their projected revenue.
  • Management has also mentioned that higher interest rates, and increased costs of capital may affect long-term strategic decisions and their operations.
  • Management highlighted that they have a great pipeline for potential customers and they are still confident in their growth and profitability targets.
  • Management has expressed some concern over the current business slowdown and is adjusting their guidance accordingly.

Conclusion

Paylocity is a company with a good business model with some competitive advantages that help it earn attractive returns. Though it is in an increasingly competitive industry, management seems to be doing well and it has a strong focus on innovation and expansion. It has had a strong record of consistent revenue growth and profitability. However, because of the volatility associated with the stock market and the fact that companies with limited technological moats are more prone to disruption, caution must be taken before investing in this stock.