Ladies and gentlemen, thank you for standing by, and welcome to Paylocity Holding Corporation’s Fourth Quarter 2020 Fiscal Year Earnings Results Conference Call. It is now my pleasure to introduce Vice President of FP&A and Investor Relations, Ryan Glenn.

Good afternoon, and welcome to Paylocity’s earnings results call for the fourth quarter and fiscal year 2020, which ended on June 30, 2020. 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 2020 earnings call. Before discussing our results, I want to first provide an update on the evolving situation around COVID-19 and its impact to our business. Our number one priority has remained ensuring the safety and health of our employees, while also providing world-class service to our more than 24,000 clients. All of our business functions have remained fully operational throughout the pandemic with no disruption to clients. I continue to be impressed by the dedication of our more than 3,600 employees as they have transitioned to nearly 100% remote working environment while helping our clients through these challenging times.

Thanks, Steve. Total revenue for the fourth quarter was $130.6 million, an increase of 8.5% and with recurring and other revenues up 12.7% from the same period last year. As Steve noted, our sales team had a solid quarter in the face of a challenging environment, and we were pleased to come in $4.6 million above the midpoint of our revenue guidance despite the anticipated COVID-19-related and interest rate-related headwinds. For the year, recurring and other revenues were up 22%, and total revenue was up 20%. For the fourth quarter, our adjusted gross profit was 70.1% and for the year, it was 72.1%. 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 R&D investments were 16.3% of revenue in the fourth quarter compared to 14.6% in the year ago quarter. Full year total research and development investments were 14.3% of revenue compared to 13.8% in fiscal 2019. On a dollar basis, our year-over-year investment in total R&D increased by 24.4% in fiscal 2020 when compared to fiscal 2019. We continue to believe our investment in R&D provide us with valuable product differentiation and the ability to drive future growth. On a non-GAAP basis, sales and marketing expenses were 22.9% of revenue in the fourth quarter and 23.3% for fiscal 2020.

Our first question comes from the line of Scott Berg with Needham & Company.

Congrats on the good quarter. I guess a couple for me. Steve, let’s start with sales in the quarter, I guess, kind of versus our expectations. Curious to know how they trended relative to maybe the same conversation 90 days ago in what your thoughts going into the quarter were. And then secondly, the comments on -- you started more ARR in the quarter versus the fourth quarter of 2019. Is that a function of sales actually occurring -- that occurred in the quarter or sales that may be partially a function of that started in the third quarter?

Sure, Scott. So I think as we entered the pandemic, we had significant momentum in sales. I think as mentioned in the prepared script, we’re up 40% year-over-year going into the pandemic and so we were pretty happy to be able to kind of start more than we had last year. There’s two facets to that: one is, how much you sell in the quarter and then, obviously, what you might already have submitted on the docket. But remember, we did have a bunch of delays in submits, and we called that out last quarter. And so when you combine the fact that there were some delays, but the sales force was still submitting new business. The fact that we were able to actually start more business than last year was really kind of a combination of both. And then I think the other thing I would tell you is momentum kind of built throughout the quarter. And so as we look at July, we had a great selling month in July. And so we are very much approaching those pre-COVID sales levels as we move past the fiscal year and into July.

Excellent. And then from a follow-up question. I think my Minnesota math tells me your -- the revenue level of the company is about 6x the size as what it was in 2014 when you went public. Yet partners still generate about 25% of your net new business, which I think is super impressive 6 years later. But how long do you think that’s sustainable kind of in those levels? I know you’ve been talking about the last couple of years even after the ACA bump that 25% is kind of the right level to think about. But as we go forward the next two or three years, can we still be in that 25%, maybe 20% range?

Yes. So I’m really pleased to be able to have more than 25% of our new business revenue come from partners. There are thousands and thousands of potential partners. When you really think the relationships we have are between our individual sales reps and those individual brokers. So it’s not just the firms, but it’s the individual brokers that provide those leads to our sales reps. And so we see an opportunity to be able to get deeper relationships with our existing partners as well as the opportunity to be able to add new partners. And we’ve made investment over the last couple of years, both in product as well as some channel marketing opportunities that we think it remains really a -- really core part of our go-to-market on a go-forward basis. And so I’m not sure if you fast forward another six years, whether it can still be 25% or more of our business, but we feel pretty confident in the near future that it will be as important as it has been in the past.

And our next question comes from the line of Mark Marcon with Baird.

Congrats on the strong performance in the quarter. Wondering just with regards to bookings specifically within this quarter, how did that compare relative to a year ago? I know we were trending really strongly prior to the quarter, but how did it come in?

Well, we definitely try to drive our business based off starts. This is very much how we’ve kind of run the equation. And so when you think about starts, you’ve got bookings that happened a little bit at the end of last quarter, but the reality is a lot of our sales happen in that same quarter. And so we weren’t on the same toward pace we were on that 40% prior to the pandemic. But we saw a little bit of a lull as we entered April, and then we saw things build back up from a sales perspective throughout the end of the quarter. To the point where we look at July, and that’s one of the best months we’ve ever had. And so I think that’s the way to kind of think about it is certainly a little bit of headwind early in the quarter, building throughout the rest of the quarter to a point where we feel really good about where we sit today after looking at July.

Great. And then can you talk a little bit about the impact on revenue in terms of the reduction in terms of the employees per client? How much of a reduction did you see in terms of the number of employees per client? And is there any way to quantify what the revenue headwind was during the quarter because of that relative to the prior quarter?

Yes. So if you look at pre-pandemic, recurring revenue and other was near 25% growth over the last several quarters before we entered the pandemic. And so if you were to take into account the workforce reduction that we saw in the platform, if we didn’t have that reduction in the workforce, we would have been at a very similar rate. So I think that gives you the opportunity to kind of fill in the math in terms of what the impact of the pandemic was in the quarter.

Great. And then can you talk a little bit about bridging -- what goes into the assumption with regards to revenue and EBITDA here for the upcoming first quarter? What areas are you going to spend more? Or are there going to gross margin contractions? Or how should we think about that?

Yes. So first on revenue, I think the way to think about it is we saw, as Toby mentioned, employees declined rather quickly in April, and then it started to build back up, but very, very slowly. And so right now, what we’re seeing in July is fairly flat employment levels and that’s kind of the assumption that we put into our revenue model. We assume that we would continue to gain momentum in sales, as I had mentioned, with July being very strong. So that’s another key part of the assumption in the model. And then from an expense perspective, as we entered the pandemic, out of an abundance of caution, we did halt a bunch of our hiring and some of our programs and we did get a fair amount of kind of onetime benefit associated with that. But as we saw our momentum building throughout the quarter, we started getting back into investment mode and hiring mode. And so that is certainly thought through in terms of our EBITDA number for the first quarter. Our view is, we need to continue to invest for the long term. We’ve got a huge opportunity in front of us. And this pandemic is going to last a while, but it isn’t going to last forever, and we want to come out of the other side of it with momentum.

If I could squeeze one more in. 30% to 35% adjusted EBITDA margins when we get back to normal. Does that include interest rates being back to normal? And what would that -- what in your mind is that?

Yes. So I mean, obviously, this was a tough kind of interest rate environment. We had absorbed several interest rate declines. And if you go through the first three quarters of the year, we were well on pace to meet or exceed our 28% adjusted EBITDA from the year prior. And so I don’t think we need a big tailwind in interest rates to hit the bottom end of that 30% to 35% range. We could still hit that in a low interest rate environment. It might take us a little bit longer than it would have had prior, but we definitely think that’s achievable.

And our next question comes from the line of Terry Tillman with Truist.

This is David Unger filling in for Terry Tillman tonight. I guess, broadly speaking, guys like over the last five months, what’s been the biggest differentiator for you when it comes to winning replacement deals? And based on your observations, which product areas in your suite are most critical to both perspective and existing customers right now?

Sure. So I think if you take a step back and you think about our product strategy, it really revolves around being the most modern platform available to our customers. And a lot of the features that we have designed and we’ve added to the platform, really appeal to a modern worker. And as everyone has had to transition to work from home or flexible work arrangements or really changing the way they’re running their business, it becomes a very opportune time to be able to look at, how are you training employees, how are you onboarding employees, how are you doing your performance management process. And so I think that has really resonated and allowed us to continue with the sales momentum that we had pre-COVID. We’ve also added, and as I said in the prepared remarks, a lot to our product in terms of features specific to COVID, but also features that we think are going to be really important on a go-forward basis. So the idea of communicating via video has become very commonplace within our customer set and so we’re excited about that acquisition and the ability to be able to integrate that into our portfolio. So we saw huge increases in LMS. We saw increases in surveys, we saw increases in community products as all ways for employers to connect with employees as they are working in virtual environments or in different ways than they ever have before, and we think those will be helpful on a go-forward basis.

And then I think just to kind of expand on the prior question in regards to expenses from the previous analyst. When you think about the balancing active managing expenses versus growth, which area of OpEx do you feel you have the most leverage in order to kind of pull that lever and focus on growth in the near term to win deals?

Yes. I think a lot of our expenses fall into people-oriented expenses, right, whether it’s them building products, selling customers or servicing our customers. And so we’ve always had an approach towards investing in R&D for the long term and investing in sales and marketing for the long term. And where we’ve historically gotten more leverage is out of gross margin. A lot of our HCM products naturally carry a higher margin and then over G&A. And so I think as we enter this kind of next phase of the pandemic, we want to go back to our roots of investing in sales and marketing for growth. And investing in R&D, while at the same time, finding ways to be able to create leverage in G&A and gross margin. Now some of that leverage might take a little while to come back because it requires people to come back to work and get those workforce reduction numbers to positive territory, but that’s really the approach we’re going to take on a go-forward basis.

Got it. And then just one quick one. You mentioned the retention rate is 90%. Is that the end of the period? Or that was the average for the year? I just want to get that right.

So we give the annual retention number each year at the end of our fiscal year. So 92% -- greater than 92% revenue retention, which is a very consistent number for us is for the entire 12-month period.

And our next question comes from the line of Brian Peterson with Raymond James.

Hope you’re all doing well. I’m actually just going to ask one question, if you can believe it or not. But -- so it sounds like the linearity improved throughout the quarter. It sounds like July was pretty strong. I’m just curious, is there any commonality in terms of the new business you’re adding in terms of size or, hey, attach rates to certain products, what you’re ripping out? I’m just curious because, obviously, things have changed, obviously, in the macro. So as we think about things improving into June and July, anything you can share on what drove that’s right?

Sure. Yes. So I think, overall, what I would say is the makeup of the customers that we are onboarding throughout the quarter really hadn’t changed that much. We definitely saw a little bit of delays in decisions. And at times, people would delay their implementation for obvious reasons as their business is being disrupted. But we didn’t really lose a lot of opportunities. Sometimes, it just took us a little bit longer to get them across the finish line. So we still saw unit strength throughout the quarter. So small business is still moving on board with us. And then larger organizations, we saw also moving. So I wouldn’t characterize any difference in terms of industry or market segment. Obviously, you would expect a little less activity in places like hospitality, but the thing that you got to remember is we’ve only got nearly 25,000 clients, a little over 24,000 in a market with over 600,000 businesses that we can go after. So I think the sales force was pretty acute at focusing on customers that probably are less disrupted and then really continue to build that activity on momentum that we saw increase throughout the quarter and then really start to get back very, very close to those pre-COVID levels in July.

And our next question comes from the line of Alex Zukin with RBC Capital Markets.

I wanted to ask a little bit about what you saw in terms of the competitive environment. Has this -- has the pandemic given you an ability to actually take market share and mind share versus your competitors? And I’ve got a quick follow-up about -- on more numbers based question.

Okay. Sure. We’ve been really marching down this path of making sure that we’ve got a complete single HCM solution that’s really easy to use, saves our customers' time and it works for small customers as well as larger customers at the top end of our market. And so what we found is many of these features, whether it is a more modern way to do performance management, onboarding your employees seamlessly, interacting with them with our community product or learning management, it started to really increase in what we saw demand really pre-pandemic. And what I would say is, that is absolutely accelerated in the pandemic. Some of these newer solutions we’re really resonating, and customers and prospects are really realizing that they need to modernize the way they’re interacting with their employees. So yes, we feel like we had a good strategy ahead of time, and it will really serve us well as we start to see recovery in the economy.

Perfect. And then if I look at the quarter, you had a really nice beat. The guidance is $1 million shy of consensus for Q1. But then when you talk about the assumption for flat employment levels, sequentially, I think I understood that right, versus what you’re seeing kind of in the month of improvement to some extent in the month of July, is there something about your guidance posture this quarter that’s different or similar to last quarter with respect to conservatism or decreased visibility? Or -- and maybe also just comment, obviously, you didn’t give a full year guide, your peers didn’t either. But how are you thinking about that? And what level -- remind us what level of visibility you typically have at this point to the full year?

Sure. So let’s be clear, we saw a pretty dramatic reduction in number of employees on the platform in early April. And we saw it come off of that bottom at a very small rate. So we are nowhere near pre-pandemic levels in terms of the number of employees on our platform. And so as we move into next quarter, what we’re saying is we’re not expecting any further improvement to that already lower number. If you were able to take us back to pre-pandemic levels, this past quarter that we just finished, we would have been in the mid-20s, just like we were in the last few quarters. And so as you kind of roll that through to next quarter, that’s probably one of the biggest differences between where we’re guiding to and where the run rate we were on prior. It’s really in that workforce reduction that we’re seeing.

Our next question comes from the line of Samad Samana with Jefferies.

Glad to hear you guys are all doing well and performed well in the quarter. If I could maybe just ask on the sales, the sales rep head count, that being up 14% year-over-year. I’m just curious, especially given the strong new bookings trends in June, all things considered, and then July being a record year, how should we think about that? It’s been growing in the low 20s before fiscal 2020. So just maybe why the slowdown in sales rep hires?

Yes. So a couple of things I would say. So first of all, the first three quarters, we were up 40% year-over-year, and a lot of that was driven by head count, but a significant portion was driven by productivity. So we had some really good productivity trends. As we went into our planning process for the next fiscal year, much of which happened even pre-pandemic, we felt like we could continue that trend with increased productivity, which at the end of the day, we think is obviously more efficient and a great way to be able to grow the business. As we went into the pandemic, we hadn’t completed, obviously, all of our hiring. We slowed down for a period of time, and we rebooted that towards the end of the quarter. And I think at the end of the day, we felt pretty good about being able to get to that 14%, 15% kind of number based off that. And we still see an opportunity from a productivity perspective as the economy starts to recover to kind of get back to that same run rate we were on pre-pandemic. So that was the thought process that went into getting to 14% increase in head count.

Got you. And then I know you guys kind of asked and answered on the pace for control side. But I guess how do we reconcile what we see in national employment numbers and kind of the -- I don’t dare not say V-shape, but the kind of deep plunge and then some improvement month-to-month from April to May, May to June, in your base. I guess I’m just -- we’re just trying to better understand how we can use maybe publicly available data to track that trend or what’s the difference between the Paylocity customer base versus kind of the broader employment end market?

Yes. I’m not so sure there is a big difference between the broader employment. We’re looking at data in very, very real time, right? So I can look at week-by-week punch information for hourly workers and see how that’s kind of trending. So from a forecasting perspective, we have the advantage of looking at things in very real time. But if you think of the increase of the unemployment rate and the number of people applying for unemployment and you start to think about where it was before and assume that we get that impact in a more real-time fashion in our platform, it does actually correlate kind of fairly well. And if you think of what we’re saying right now is we think that there was a little bit of a recovery fairly minor, that kind of tie to what you’re seeing nationally in terms of the reports, but things have kind of flattened, and that’s what we’ve assumed in our guidance. So I think those can generally be a decent indicator. They’re just -- they’re lagging.

And our next question comes from the line of Daniel Jester with Citi.

So I appreciate the updates on the products on community and LMS. I didn’t hear anything though about your on-demand pay product. So could you give us an update about how that’s looking in this environment?

Yes. So I would say the trend pre-COVID continues. I wouldn’t say that, that would be a product that I would call out that accelerated due to COVID, but it has grown throughout the quarter. And so we’ve seen more customers add on-demand pay as an option for their employees. It is still, what I would say, relatively small in terms of percentage of our total customers and growing. But we saw a lot more demand for things like community and LMS and surveys than we did for on-demand pay due to COVID.

Got you. And then I just want to be clear on the last call, you did talk about implementation kind of pushouts. Are you still seeing that from new business booked or we pass that? And can you remind us, historically, what percentage of your bookings go live within a couple of quarters of signing up a deal?

Yes. So first of all, if you think of the time for a typical customer, it’s three to six weeks from the time that our sales rep will get a yes and submit that order to us before they start. So it’s a relatively quick time frame. Most of our bookings happen certainly within that 6-week time frame. Once in a while, you get a little bit of a larger client that takes longer. And candidly, on the small end of the market, we can get customers up and running in a couple of weeks. So it’s a pretty quick cycle. What I would say is, as we look at the data kind of in July post the quarter, we are definitely starting to see things get back to normal, both in terms of our sales activity, but also in terms of clients going live. If you really take a step back and think about it, a client might have signed up at the start of the pandemic didn’t know what was going to happen to their business. There’s a fair amount of uncertainty. But clients that we’re signing up in May and June that are starting in July, they kind of know the environment. They understand the impact to their business. And so you get less disruption in terms of those start dates, and that’s what we saw play through with people generally starting on time in July.

Our next question comes from the line of Siti Panigrahi with Mizuho.

So your Q4 revenue came in at the high end of your guidance, but adjusted EBITDA was much higher than you guided. But for September quarter, EBITDA guidance is basically below consensus. So I’m wondering if there are any expense item you saw shifted from Q4 to Q1. Because I saw your R&D and sales and marketing were down sequentially. So I’m wondering is there any kind of expenses that shifted or anything else that’s driving that kind of sequential down.

Sure. I’ll let Toby take that question.

Sure. Siti, I mean, I think you hit it. So as Steve was describing earlier, in the end of March and then April time frame when we were in the midst -- of the beginning of the pandemic and its impacts, we paused spending across many areas of the business. So you had things like significant pause in T&E, which lasted the quarter. But as Steve said, you had a pause on hiring as well. So think about that as April and into May as we really got our feet under us and understood what the environment was going to look like. I mean there’s a lot of uncertainty. And so we pushed pause on a lot of hiring across the business that would have typically been taking place. And then as you get to the -- into the May and then in June time frame, as we got towards the end of the quarter, we started to refocus on the normal cadence of investments. And I wouldn’t say we’re sort of all the way back on that point. But you started to see hiring coming back, and as Steve was also saying in the growth driving areas. So think about that as go-to-market and R&D. Our goal is to come out of this, managing prudently all the way through it from a spend perspective. But when we come out of this, we want to be regaining the same momentum that we came in with. So I think you saw -- you did see a shift in terms of spend in Q4, where it would have been paused in sort of the earlier part and started to gradually come back. And then as we’re coming into Q1, you have those levels and that cadence continuing.

That’s great. And then I just wanted to understand the key drivers for your clients now switching their payroll HR vendors. So some of these new sales booking you talked about, it’s better than last year now. So how all these discussions started pre-COVID? Have those guys started talking about replacing their payroll pre-COVID? And I just want to understand the new leads like post -- after April, what are the trends you saw new clients thinking about now switching their payroll vendors?

Yes. So what I would say is we saw from a sales perspective, definitely, the market get a little bit of uncertainty in early April and early part of the quarter. But as we moved through the quarter and clients and prospects started to understand what is this going to mean for their business, we started to see activity levels continue to increase. And a lot of the value proposition remains the same, which is ultimately, we’re going to give you a really easy-to-use platform. It’s going to save you time, which efficiency is really important all the time, particularly in this type of environment. But we’re also going to give you ways to connect with employees that you might not have ever used before. And that’s the part of the equation that we think has become even more important and certainly was a contributor to the strong July sales. What I would tell you is the strong July sales commentary was really all done after the pandemic started. So that wasn’t necessarily a backlog of activity that then just came through in July. Those are all conversations that we started during the pandemic and closed post April. So we feel good that our message resonates.

Okay. And then last quick question. In terms of the trends you talked about, your clients hiring back. You guys tracked about like those who applied PPP loans, did you see something that clients told you maybe let people go, furloughed in the beginning, but they hired back after they got the PPP loan. Any kind of trends, can you talk about that?

So I think at the most macro level, the trend was people were absolutely furloughing employees, letting people go, reducing their workforce in early April. And then towards the end of April, we started to see off of the bottom, people started to hire some of those people back. And some of that was, I’m sure, due to PPP loans and others might have just been due to as businesses started to reopen or figured out a different business model in some cases. And we saw that increase throughout the rest of the quarter were at a fairly slow rate to the point where, as we entered July and you saw this spike in a lot of different parts of the country, we’ve now seen that flat line again. So we’re nowhere near the pre-COVID levels of employment, but it did hit the bottom in April. It moved up a little bit and now has kind of flat lined. And I think PPP loans plays part in that equation. But the PPP loan doesn’t have a sudden cliff where all of a sudden, you see it because it depends how long you’re going to be able to work through that. It depends if you’re going to be able to get forgiveness for the loan. And remember, legislation came out later that extended that, so you could use up to 24 weeks for that. So I think we’ve probably seen some of the impact of the PPP loan, and we may have others that have gotten the loan later in the cycle and still may have access to some of those dollars to be able to maintain higher levels of employment. But I think if you net all of that out, that’s the impact that we saw.

Our next question comes from the line of Arvind Ramnani with Piper.

Congrats on a good quarter. I just had a couple of quick questions here. So are you seeing any clients, particularly clients that have challenging operations ask for pricing discounts?

Yes. So I think our pricing is very fair. So let’s start with that. And so if customers get a reduction in their workforce, they automatically end up paying us less that way. And so I think because of that, we see less conversations around pricing. And so I would say we had some of that, but it was relatively small, not really a big enough number worth calling out, and we try to work with any of those customers where we have those conversations, but it was not a factor in the quarter.

Great. Great. And this -- I mean, clearly, kind of this -- business has some challenges, and you guys are executing quite well. But I’m try to sort of understand some of the underlying pressure from client sign-ups. Are some of the clients basically kind of essentially who are with some of the legacy HCM players frustrated with essentially those legacy players? And actually, accelerating the kind of move to Paylocity or is it more of a situation where these kind of clients are just facing core business issues and they’re distracted and churn has actually slowed?

Well, so I think what we’ve seen as the sales force has kind of regained momentum and really had a strong July is that we’re getting clients from the same usual places we used to. So the traditional payroll providers, the in-house methods, the small regional players, we’ve been able to compete with all of those. And our message hasn’t changed a lot. I think what’s become a little bit more important is the fact that customers are looking for different ways to connect with employees because employees are spending more time working from home. There is much more transparency required in terms of what shifts you’re scheduled for and how you might be able to exchange that and manage that. Things like a testing to not necessarily having a temperature as you come into the office. And so they are looking for new features, probably at an accelerated rate than maybe what we saw pre-COVID. But the concepts are the same. They’re really trying to find ways to save themselves time and connect with employees and so we feel pretty good about the value proposition that we offered pre-COVID. But if anything, it’s even a little bit stronger post-COVID because of the need to really have a more modern platform.

Yes. Yes. So I mean, that’s interesting. So if you look out like kind of post-COVID or whatever the kind of health care crisis kind of subsides, do you anticipate kind of growth rates being better than what they were in the pre-COVID environment because of the explanation you just gave?

Yes. I would say, if you look at last quarter, if it wasn’t for the reduction in number of employees on our platform that we experienced, we would have been at very similar growth rates prior. So in that mid-20s, just like we had been in the last several quarters. And so we’ve got pretty good momentum from a sales perspective. So assuming we can get back to those kind of workforce reduction levels, yes, we are really confident in terms of getting back to those growth rates. And obviously, you start to comp some quarters a year later that have been tougher quarters. And so yes, there’s potential for that to bounce around a little bit as we get -- but as we get to a more normal environment, we’ve always focused on 20%-plus growth. The market opportunity is big enough in front of us. We’re investing in the right things. The team is executing. So from a long-term perspective, we think we get back to that long-term model of 20%-plus growth.

I will now turn the call back over to CEO, Steve Beauchamp, for closing remarks.

Yes, I’d like to just wrap up by thanking all of you for your interest in Paylocity. And once again, reiterating a big thank you to the 3,600-plus employees that we’ve had that have just done a tremendous job for us over the last four months and building momentum as we move forward. Thank you, everybody, and have a great night.

Ladies and gentlemen, this concludes today’s conference call. Thank you for participating, and you may now disconnect.