Welcome to Paylocity Holding Corporation Fourth Quarter 2019 Fiscal Year Results Conference Call. At this time, all participants are in a listen-only mode. Later there will be a question-and-answer session and instructions will follow at that time. As a reminder, this conference call is being recorded. I would now like to turn the conference over to Ryan Glenn, Vice President of FP&A and Investor Relations. Sir, you may begin.

Good afternoon, and welcome to Paylocity's earnings results call for the fourth quarter and fiscal year 2019, which ended on June 30, 2019. I'm Ryan Glenn, Vice President of FP&A and Investor Relations, and joining me on the call today is Steve Beauchamp, CEO of Paylocity and Toby Williams, CFO of Paylocity.

Thank you, Ryan, and thanks to all of you for joining us on our fourth quarter and fiscal 2019 year-end earnings call. We completed fiscal 2019 with recurring and total revenue growth of 25.7%. Total revenue growth for the fourth quarter was 25.4% which exceeded our guidance and was driven by another strong quarter of new sales. We were very pleased with the consistency of our revenue growth this fiscal year with Q4 marking our tenth straight quarter of total revenue growth in the mid 20s. Adjusted EBITDA for the fourth quarter was $29.9 million which exceeded the midpoint of our guidance by $2.1 million. For fiscal 2019, we were pleased with our ability to make investments to drive growth in both sales and marketing and Research and Development while also making progress towards our profitability goals. Adjusted EBITDA for fiscal 2019 was 28.7%, an increase of 50 basis points from our initial fiscal 2019 guidance as we work towards our revised adjusted EBITDA margin target of 30% to 35% of revenue.

Thanks, Steve. Total revenue for the fourth quarter was $120.4 million which is a 25.4% increase from the same period in the prior year. Total revenue for the fiscal year was $467.6 million up 25.7% from last fiscal year. And as Steve mentioned, Q4 marked our tenth straight quarter with total revenue growth in the mid 20s. For the fourth quarter our total recurring revenue was up 25.5% from the same period last year with recurring fees up 23.3% and interest income on client funds up 92.2% primarily as a result of balance increases, increased average interest rates and because we continue to invest a portion of client funds. For the year, our total recurring revenue was up 25.7% and interest income on client funds was up 118.6%. For the fourth quarter our adjusted gross profit was 71.2% and for the fiscal year it was 71.9% as we continue to focus on consistent revenue growth while also driving scale in our business model. We continue to make significant investments in Research and Development and to understand our overall investment in R&D it is important to combine both what we expense and what we capitalize. On a combined non-GAAP basis, total Research and Development investments were 14.6% of revenue in the fourth quarter compared to 14.1% in the year ago quarter. Full-year total Research and Development investments were 13.8% of revenue compared to 13.2% in fiscal 2018. On a dollar basis our investment in total Research and Development increased by 31.3% in fiscal 2019 when compared to fiscal 2018. On a non-GAAP basis sales and marketing expenses were 24.7% of revenue in the fourth quarter and 22.4% for the fiscal year. On a non-GAAP basis G&A costs were 15.3% of revenue in the fourth quarter as compared to 17% of revenue in the same period last year. Full-year G&A costs were 14.8% of revenue as compared to 15.5% of revenue in fiscal 2018 and we are pleased to have entered our long term G&A target range of 10% to 15% of revenue in fiscal 2019. Our adjusted EBITDA was $29.9 million or 24.8% of revenue for the quarter as we exceeded the midpoint of our guidance by $2.1 million. Our adjusted EBITDA for the year was $134 million or 28.7% of total revenue and we were pleased to continue to make progress towards our adjusted EBITDA target of 30% to 35% of revenue. As Steve mentioned, in the fourth quarter we completed the move of our remaining Chicago land employees to our corporate headquarters in Schaumburg. In connection with our move, we accelerated depreciation on certain property and equipment that will not be used in the new facility and have taken certain lease exit costs in the quarter related to our old headquarters.

Thank you. Our first question comes from Scott Berg with Needham. Your line is open.

Hi Steve and Toby. Congrats on the great quarter and thanks for taking my questions here. So Steve, I'd like to start off with the new LMS product today. I like the micro learning aspect because that’s certainly a popular today. But as you reach the 400 target, how should we think in the next $100 PEPY target that you discussed more maybe heavy in analytics or are there other things that maybe you're looking at today?

Yes. Sure Scott. So yes, we are really pleased with the feedback we've gotten in the LMS product and the good start that we've gotten actually with our customers and our sales force is pretty excited about having that product in their bag. I think from a product perspective I would look at each of the categories, think of time and labor, benefits, talent management and really core HR all having product opportunities that we think we may be able to pull as we drive towards that $500 PEPY. So we don't like to get into specifics in terms of what that next module might be. But, we are actively working on additional modules that we think will both create differentiation and will be demanded by our customers.

Got it, helpful and then a question for you Toby, you mentioned, you’ve attained your 15% to 20% free cash flow target or at least your prior target. How should we think about the model leverage going forward now that you're in that range? Now that you're at the top end of that or busting to see that today, but do you have a maybe a time frame or a revenue goal in mind that you can maybe getting that 20% to 25% range or even better?

Yes. I think step one was getting into the range. I think we feel pretty good about the progress we made going from just under 13% to just over the 16% in the course of fiscal 2019. So I think we feel pretty good about that but as you pointed out, we've still got a good bid ahead of us between where we are today in the top of the range and I think it was a big step up this year, I think same as probably how we would have talked about EBITDA. I think, we will continue to drive margin including in free cash flow maybe smaller increments, but I think we're happy to be in the range and we've still got plenty of runway to continue to drive leverage. So feel good about the progress in fiscal 2019.

Very helpful. I'm going to slide one quick one in for you Steve. The success in the strategic segment seems to be better than your expectations. Do you start to invest a little bit more quickly in that segment relative your expectations for maybe six to nine months ago?

Yes. I think we're off to a good start in our emerging market. it still is relatively small when you compare to our overall business and I think you got to remember if you think about a 1,000 emerging market clients they might be of roughly a couple thousand in revenue, maybe a little bit more than that. So that's only a couple million in revenue. So I think you see the strength in the unit growth this year, but it's still not that material. It's still an early stage investment. We will increase the level of investment overtime, but we think about it in a gradual fashion rather than some sort of step up.

Great, thanks guys.

Thank you our next question comes from Terry Tillman with SunTrust. Your line is open.

Yes, this is actually Nick on for Terry. So I guess just stepping back for a second, we just wanted to ask how newer product adoption has evolved over the years, so things like time to ramp or a ton of monetization has changed over the years? And then, if you could just give an idea of what you see as a good attach rate for these add-on modules like 20% or 30% adoption that'd be great? Thank you.

Sure. I think our philosophy has been, first of all, we interact with our customers a lot. We try to get feedback in terms of what they're looking for. We'll build a brand new module and product based off that feedback. We'll get it out to customers, a small subset of customers. We will garner feedback from them and then we'll iterate to the point that we're ready to launch it to the sales force just like we did with LMS. I would say from a longer-term perspective, we like to think of products getting certainly 10% to 20% penetration across our client base. We believe that's kind of the minimum range that we need to have to be able to kind of justify the investment in terms of R&D investment to get a product to launch. And if I were to highlight anything I think over the last year or even the last couple years, the talent management category has probably been one of our fastest growing categories and it's also the place that we've added most product and so I think LMS is going to be another great addition to our talent portfolio.

Great, thank you.

Thank you. Our next question comes from Brian Peterson with Raymond James. Your line is open.

Hi guys and I’ll echo my congratulations on the solid quarter. So Steve, obviously you've had a lot of success with the emerging markets. I'm curious, typically we've seen about a 120 employees for customer I think that's been the average. Any help on where that figure stands today?

Yes. So I think we're in a similar range. I don't think we gave the exact number and I think we talk about greater than 100 in our filings that's still very consistent. I think as we have success with an emerging market there's some possibility that might come down a little bit. They are kind of customers available to us there and we are definitely seeing more product demand in that market and we are adding customers both with our core sales force and our smaller emerging team. So I think if we continue to have that success you might see that come down just a little bit, but currently it hasn't changed enough worth updating.

Got it. And then just maybe on the learning management offering, I am curious if you look across your customer base, any sense for what they are using today and maybe how many if customers actually really don't have anything that they are actually using from a real technology perspective? Thanks guys.

Yes. Sure. I think in our target market I would say most of our customers that we brought on so far were going to be their first Learning Management System. This is clearly exception to that and we do have some people that have converting, but I would say the large majority of our customers were going to be the first Learning Management System and we think the way we build the product from both an ease of use and feature functionality and really terms of trying to have an easy way to share videos across the organization really appeals to that customer rate in our target market. But generally speaking to answer your question, we are largely going to be the first implementation of LMS for most of your customers.

Thank you. Our next question comes from Samad Samana with Jeffries. Your line is open.

Hi, good afternoon and thanks for taking my questions. Steve, I think first on for you, on-demand pay is something that several of the payroll software companies have been talking about. I am just curious if you could help us understand if maybe the economics of how on-demand pay works for Paylocity and should we think about it as a firm play per month type of opportunity or you actually making money on moving those funds as well? Maybe just a little bit of color and how you see adaption of that going overtime and I have a follow-up question.

Sure. So what I would say is, we are leveraging the fact that we move a lot of money for our customers already and obviously paying their employees is a key part of our value proposition and so on-demand pay allows employees to be able to draw from the pay that they have already earned on earlier basis and we are leveraging kind of our ACH capabilities to be able to do that which we can do relatively efficiently. I think we left ourselves open to how the industry is going to go from an on-demand perspective. So we wouldn't call it out as a big revenue driver today and it's a really a benefit that the employers are going to offer and it's one that's going to drive meaningful PEPM, but it's something that we think helps differentiate us and really appeals to that modern worker who is entering the work force. So think about it more today as a differentiator and if there is an opportunity for us to monetize it overtime, it's something we can certainly take advantage of.

Great and then, Toby maybe a question for you. As I think about rates they have come down dramatically so far this year and I think they are going to start to be a little bit of just given where the treasuries are. I am just curious how we should think about interest income or interest revenue for fiscal 2020, given that it's such high margin revenue and how we should think about maybe like that trend in the context of the actual balance probably growing since your customer growth is growing as well.

Yes. So, I think those are the right points. I think if you look at the average daily balance increases over last year and historically you would see that trend with closer to client growth and I think that's probably the rate expectation to have in fiscal '20. And then from a rate perspective, I think you've probably characterize the rate environment and I think our we've seen the recent rate move and I think well many of us are contemplating another one in the course of the fiscal 01. I think that's how we thought about the guidance from a fiscal '20 perspective.

Great. Thanks for taking my questions, guys, and great quarter.

Thanks.

Our next question comes from Mark Marcon with Baird. Your line is open.

Let me add my congratulations. Just wondering, with regards to the salesforce buildout, I know you're not really talking that much about the merging this small business sector but how from a management teams perspective are you thinking about some of the metrics that you would evaluate in terms of how quickly that should expand or philosophically how should we think about it?

Sure. So, I think we built up a series of metrics for our core salesforce over many years that we look at and it certainly really all revolves around new annual recurring revenue that the sales team can drive to the organization. And so, that would be no different when we look at the emerging market opportunity. Obviously, there would be more units involved and less average revenue per customer. And those folks are generally a little bit earlier in their career that be bring on, so there's a cost equation that we look at as well. We definitely think it's a very profitable space and it's something that we can manage the cost of client acquisition efficiently. But those are the things that we're looking at internally; what does those quarters look like; what is the cost to be able to drive that new recurring revenue. As you mentioned, we're still early in the process, we're also investing in channels which are going to be an important part of that emerging market opportunity as well as our digital presence which is another way to be able to drive that. So, there's really multiple factors than purely the salesforce and I think we're happy with the results so far albeit at an early stage.

That's great. And then, to go back to the on-demand payroll, what's the reception been like with the clients that you piloted it with and what kind of take up rates in terms of the usage?

Yes. So, we're just launching that now. So, we got a series of early adopters that we garner feedback from. What I would say is our customers with maybe a large number of hourly workers particularly one where they may have seasonality or they have a little bit of turnover involved in that and where that workforce might be on the younger end of the spectrum is where we've seen that really resonate well where people have needs that they may that come up. Once in a while and they can access part of that earned pay as really being valuable is really the feedback that we've gotten from our customers. We've also received feedback that it's just super easy to use. You literally logon to your mobile app, you see how much you've actually earned. We actually calculate what the value is of what you've earned with real time calculation capabilities. And then you can withdraw up to some sort of maximum amount of that. And so, the simplicity is probably the biggest point of feedback that we've heard.

That's great, thank you.

Thank you. Our next question comes from Nandan Amladi with Guggenheim Partners. Your line is open.

Hi. Thanks for taking my question. So, on the LMS system, what is your content sourcing strategy for content that you don’t build, I know you talked about building micro learning and also making available the platform for your customers to build their own content. But how about other types of content that you might be able to source from people who build content for living?

Yes, good question. So, I think we have three-pronged approach towards content. So, first we want to be able to build maybe the core compliance content that we know pretty much all of our customers are going to need. So, I think we've talked about in the past sexual harassment training and certain stage where that's mandated. That content we're going to build, we're going to deploy as part of our LMS platform and our customers can use that imbedded in the platform. I think the second part of the content strategy is allowing our customers to be able to use video capabilities to do these kind of short micro learning training videos that can then be shared across the organization. We use that our capability ourselves a lot and we've really enjoyed the benefit of being able to share knowledge seamlessly across the organization. And then, the third part of the strategy is our client can purchase content and then upload purchased content and then be able to distribute through our LMS. So, we give the choice of all three options for our customers.

Thank you.

Thank you. Our next question comes from Corey Greendale with First Analysis. Your line is open.

Hey, good afternoon. And congratulations on the good year! So, I have a question I think related to the emerging market. If you look at your client growth and revenue per client growth in fiscal '19, I think your client growth was the best in spanning in multiple years even better than the ACA benefit year. But your revenue per client growth was lower than it has been. I would have thought the emerging market was responsible for both of those dynamics but can you just dig into that?

Sure. Yes, I think the idea of getting more of our clients in that under 50 segment is really the key driver of why you got higher client growth and lower percentage growth in average revenue per customers; so it's really just the size mix. Now, that’s happening because our core salesforce does tells clients in that segment and we've seen more demand for our products. And then on top of that we've added this emerging market investment, that's also had some success. And so, it's really simply the result of a mix shift, we're really happy with the penetration rates that were driving both our products that we release several years ago as well as our newest products, so we're certainly still seeing that lift. But you are absolutely correct that it's the success in that under 50 marketplace that's driving the higher client growth.

And fair to say you see a similar split in fiscal '20 assuming you succeed a much higher growth in clients than in revenue per client?

I think if we continue to be successful in the under 50 market and emerging market investments continue to grow that the client growth would be higher than that ARPU growth on a go-forward basis that would be correct.

Great. Thanks, very much.

Thank you. Our next question comes from Adam Borg with Stifel. Your line is open.

Great and thanks for taking the question. Just as we think about the broker channel, are there any processes or steps that you're taking for fiscal '20 to kind of help ensure the greater 25% range that's helped delivered in recent years, thanks.

Sure. Yes, so the broker channel continues to be an important part of our go-to market strategy. Last year, we were pretty happy to once again deliver more than 25% of our new business revenue from brokers. We take it literally as we grow the salesforce meaningfully and so we're growing the salesforce by 23%. So, we need to be able to both deep in the relationship with existing brokers as well add new brokers to our network. And so, we have a number of initiatives to be able to do that. I would think of those as incremental based off the feedback that we're getting from our brokers, no big changes in the strategy. We think our value proposition resonates really well at that broker channel. And we think we're in a good position to be able to do so but that will remain a key part of our go-to market strategy going forward.

Great. And just maybe as a follow-up, you talked about some good experience and good success down in the emerging channel and had to continue to build experience down there. Is there any discernable change in either buying behavior or a sales cycle, obviously you talked about the good adoption of some of your add-on products? But anything around the sales cycles or just find that even more broader, thanks.

Yes. So, I think focusing on the smaller end of our target markets has certainly helped us optimize some of the experiences for our customers. And so, we have the ability to onboard a smaller customer rather than weeks and days. And we certainly have used last fiscal year to kind of perfect some processes around that. We've also made sure that we've been able to also deliver them the service experience that they're look for as well. So, I'll call small tweaks to kind of our implementation process and ongoing service process. And then lastly, I think we also learned last year that it does require a little bit more investment in channels as well as some digital presence online for that market. There is just a ton of businesses down in that segment and so we think we can leverage both of things at a greater level over time. And that's why I go back to the idea that emerging market will be a gradual expansion over time that we think is just a very interesting opportunity for Paylocity.

Great, thanks again.

Thank you. Our next question comes from Shankar Subramaniam with Bank of America. Your line is open.

Hi, thanks for taking the question. Just on that emerging market, you have just already said that the needs of customers we get is come from either Greenfield opportunities and are other peers. Can you characterize who are you getting the wins from, is it more of the legacy or the more Greenfield?

I would say we're still early, so we'll see how this develops over time but I think that the traditional peer outsources are probably the primary method that we see in emerging market in terms of displacing them. You do have a little bit more business activity as you might imagine in that segment. The channels are a little bit different, so you see things like CPA channels being certainly more prevalent in the emerging market than maybe midmarket. But I wouldn’t say it's significantly different than outside of the new business, it's not that significantly different from where we get our midmarket customers from.

Got it. And then, could you on the benefit side, is it how much is the contribution from BeneFLEX in fiscal '19 and what should we how should we think about the contribution in fiscal '20?

Sure. So, if you remember we acquired BeneFLEX really last spring, not this past spring but the one prior. And I think we called out the fact that we needed some time to build that own product over top of that. And we would then be in a position where a lot of those TPA buying decision happened in the fall. So, we're really trying to ramp our products so that we can kind of hit this fall selling season. So, we did not characterize BeneFLEX is having a meaningful impact last fiscal year and I wouldn’t change that. I think that actually played out. We got our product ready, it's available in the market, we've got great experience from our users and so we're going to be able to ramp-up a little bit more volume with our new product in the TPA space going into this fall.

Got it. Thank you, guys.

Thank you. And I'm showing no further questions at this time. I’ll like to turn the call back over to Steve Beauchamp for closing remarks.

Great. Well, I'd like to just take a brief moment to thank all of you for your interest on the call but also take some time to be able to thank our more than 3000 employees for all their time, energy, and dedication over this last fiscal year. Everyone have a great night!

Ladies and gentlemen, this concludes today's conference. Thanks for joining and everyone have a wonderful day.