Tailored SaaS Offering for $8 billion Payroll, HCM Market; Niche Positioning Strengthens Competitive Advantage in $8 Billion Market

The stock had a successful IPO offering. The stock is trading at $26.01.

Paylocity Holding Corp. (PCTY) went public on March 19th. The IPO price was $17. Through the IPO, Paylocity plans to sell 7,045,000 shares while selling shareholders plan to sell 1,670,000 shares, with a 15% overallotment options that gives underwriters – Deutsche Bank, BofA Merrill Lynch, William Blair, JMP Securities, Raymond James and Needham & Co. – the option to purchase an additional 750,000 shares from the company and 250,500 shares from selling shareholders.

The company expects to raise gross proceeds of $100 million (at $15; not counting overallotment) and plans to use proceeds to repay outstanding debt (just about $1.3 million), grow sales and product features and potentially acquire one of the company’s resellers down the road.

The company has adjusted net tangible value of about $1.54 per share so new shareholders will suffer substantial dilution. Post IPO, existing shareholders will control about 84.4% of outstanding shares assuming full exercise of overallotment.

The company does not plan on paying dividends.

Paylocity is a cloud-based provider of payroll and human capital management (HCM) software-as-a-service (SaaS) focused on small- to medium-sized organizations with between 20 and 1,000 employees.


Paylocity’s cloud-based solutions offer increased employee engagement with access from anywhere and any device; an intuitive user interface that reduces the need for training; easily configurable templates and checklists; and easy data integration for fewer errors, better accuracy, time savings and improved productivity that reduces processing time from hours to seconds.

The company has over 6,850 clients (over 100 employees per client on average) and is based in Arlington Heights, Illinois. Paylocity has about 740 employees, mostly IT professionals, and has consistently been awarded “Best Place to Work”.

Paylocity revenues are growing robustly, up 40% annually to about $77 million in FY13 and to about $46 million projected for the first half of 2014.

The company’s client base has grown at a 25% CAGR over the past two years with a highly diversified client base across a broad swathe of industries, and a platform that scales easily as a client’s needs grow.

Paylocity has a recurring and predictable revenue model with high client retention (more than 92% over the past three years) and a land-and-grow strategy that typically increases average revenue and margin per client over time.

In FY13, 94% of the company’s revenue was recurring, with just 6% from implementation and other services. And its recurring revenues too have grown 40% over the past year to about $44 million for the first-half of 2014.

Paylocity serves a large market that is currently underserved, which translates into a significant revenue opportunity with a multi-tenant SaaS platform, a differentiated go-to-market strategy that leverages open API integration with the existing ecosystem of third-party providers, a rapidly growing and highly diversified client base and a financial model that offers high growth, strong visibility and operating leverage from scale.

In 2014, Paylocity’s target market – medium-sized U.S. companies – is expected to spend about $8 billion on payroll and HCM software and services. This market includes about 40 million employees, and is based on an average spend of $200 per employee annually.

With Paylocity, medium-sized companies do not need to hire staff focused on payroll requirement and regulations (which are forever changing), or tracking how over 10,000 state and local tax codes apply to or benefit their business. Moreover, with the Affordable Care Act, companies face expanded needs for compliance that Paylocity’s solution can automate – thereby saving big money for clients while reducing corporate risk or penalties tied to non-compliance.

Unified Software Suite

Paylocity’s comprehensive suite of solutions includes four modules – web pay (for payroll, tax filing and direct deposit); web benefits (an employee self-service portal for payroll and HR); perform (for employee performance management, rewards and recognition); and web time (for employee time and schedule management).

Paylocity is a true multi-tenant SaaS application with an organically developed common code base that is purpose built for rules and workflow that apply to medium-sized organizations. The code base easily integrates with third-party systems through open application-program interfaces (APIs) and is easy to operate and maintain, with a short learning curve. Paylocity’s platform integrates with over 200 third parties and includes well-known firms in the insurance, 401(k) and third-party space such as Aetna, Well Point, Cigna, Prudential, Merrill Lynch, Wage Works and Unum.

 

The program also offers integrated real-time (on demand) analytics and dashboards so users can visually see information and deep-dive into numbers if they want to, with an intuitive user-interface.

Paylocity’s tight integration with the payroll and HCM ecosystem drives revenue growth through strong referrals. In 2013, fully 25% of the company’s new clients were from referrals, and this underscores customer and partner satisfaction with the company’s products, solutions and professionals.

Go-To-Market Strategy

The company derives revenues through a direct sales force with experienced sales representatives that target specific geographies. In addition, Paylocity generates sales leads through focused marketing programs and referrals from its extensive network.

Because of its low cost SaaS model, Paylocity also has a short sales cycle with deals typically closing within 60 days of the first meeting. The SaaS approach also enables quick remote customization and integration, and clients are typically trained and up-and-running in three to six weeks.

Paylocity meets the unique needs of medium-sized organizations and competes against solutions that are home-grown or overly complex to serve the needs of larger scale implementation.

Company Strategy

Paylocity expects to strengthen sales and market leadership by growing its sales force across U.S. geographies, expanding its product offerings through investments in software development (such as a new healthcare module that models the impact of Obamacare on businesses), increasing average revenue per client through a land-and-expand strategy, and further strengthening its referral network.

Risks

Paylocity is an early-stage public company with limited operating history that going up against giants in the payroll and HR software space, and may not be able to grow sales effectively or achieve targeted margin and profitability goals.

Strong Management Team

Paylocity has a solid management team that has a good history of working together. The company is led by President and CEO Steve Beauchamp who came to the company after senior positions at payroll giant ADP and Advantage Payroll Services. Peter McGrail, also from Advantage Payroll Services, serves as CFO. In addition, the company has sales, marketing, product development, IT and operations executives with deep expertise in the payroll and HCM field.

Operating Model Provides Attractive Leverage

Over the past three years, Paylocity has steadily increased adjusted total gross margin – from 51% to 53% – and increased adjusted gross margin from recurring revenues from 62% to 65% as the company benefits from higher margins in the second-year of client deployment.


Over the long-term, Paylocity plans to increase total adjusted gross margin from 53% to 65% – 70% by increasing higher-margin recurring revenue, through economies of scale and through reseller acquisitions. The company plans to spend 10% to 15% on R&D, 20% to 25% on sales and marketing, and 10% to 15% on G&A expenses. As a result, adjusted EBITDA should grow from about 8% to 20% – 25% of revenue over the next few years.

Consolidated Financials – Solid Revenue Growth, Profits Missing

The table above shows a nice ramp-up in recurring and services’ revenues, to $77.3 million for the year ended June 30, 2013, with rising gross profit to $37.7 million, and barely positive GAAP operating income. In FY13, Paylocity had a net loss of $2.3 million, and a net loss of $3.1 million for the six months ended 12/31/2014.

However, on an adjusted basis, the company reported EBITDA of $6.3 million in FY13, with lower 1H14 results that were impacted by IPO related expenses.

Adjusted for the IPO, the company expects to have cash of about $69 million (will likely be about 15% higher with overallotment), working capital of about $62 million, zero debt and stockholders’ equity of $75.5 million (well below its IPO market capitalization).

Summary

Paylocity is well positioned in its niche but faces stiff competition from other enterprise software providers such as Workday, SAP, Oracle, ADP and Paychex, and HCM providers such as Cornerstone OnDemand. However, the $8 billion opportunity is clear and real, and robust execution should drive revenues higher. Over the long-term, if Paylocity succeeds in becoming a niche leader, it could be a prime acquisition target.

March 23 thoughts: I like the stock and business model. I would prefer a $20 – $22 entry price. I may, personally, sell some bull put spreads to either make income or own $PCTY shares at an attractive price. Options will be offered in 3-4 weeks. At present levels, the stock is too rich for me. Todd 03.23.14

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