Paylocity Q2 2025 Earnings Call Transcript

Quartr
Provided by Quartr
February 6, 2025

There are 17 speakers on the call.

Operator

Please be advised that today's conference is being recorded.

Operator

I would now like to hand the conference over to your speaker, Mr. Ryan Glenn, Chief Financial Officer. Please go ahead.

Speaker 1

Good afternoon, and welcome to Paylocity's earnings results call for the second quarter of fiscal twenty twenty five, which ended on 12/31/2024. I'm Ryan Glenn, Chief Financial Officer. And joining me on the call today are Steve Beauchamp, Executive Chairman and Toby Williams, President and CEO of Paylocity. Today, we will be discussing the results announced in our press release issued after the market closed. A webcast replay of this call will be available for the next forty five days on our website under the Investor Relations tab.

Speaker 1

Before beginning, we must caution you that today's remarks, including statements made during the question and answer session, contain forward looking statements. These statements are subject to numerous important factors, risks and uncertainties, which could cause actual results to differ from the results implied by these or other forward looking statements. Also, these statements are based solely on the present information and are subject to risks and uncertainties that can cause actual results to differ materially from those projected in the forward looking statements. For additional information, please refer to our filings with the Securities and Exchange Commission for the risk factors contained therein and other disclosures. We do not undertake any duty to update any forward looking statements.

Speaker 1

Also, during the course of today's call, we will refer to certain non GAAP financial measures. We believe that non GAAP measures are more representative of how we internally measure the business, and there is a reconciliation schedule detailing these results currently available in our press release, which is located on our website at palosity.com under the Investor Relations tab and filed with the Securities and Exchange Commission. Please note that we are unable to reconcile any forward looking non GAAP financial measure to the directly comparable GAAP financial measure because information which is needed to complete a reconciliation is unavailable at this time without unreasonable effort. In regard to our upcoming conference schedule, I will be attending the Wolf Software Conference, Toby and I will be attending the Raymond James Institutional Investors Conference and Toby will be attending the Stifel Technology one on one Conference. Please let me know if you'd like to schedule time with us at any of these events.

Speaker 1

With that, let me pass the call over to Steve.

Speaker 2

Thank you, Ryan, and thanks to all of you for joining us on our second quarter fiscal twenty twenty five earnings call. Our strong results continued in Q2 with recurring and other revenue growth of 17% as our differentiated value proposition of providing the most modern software in the industry continues to resonate in the marketplace. Total revenue grew 16% over Q2 of last year. Our sustained multi year investment in R and D has resulted in strong product differentiation and significant expansion of our product suite, which has helped drive durable revenue growth and expanded average revenue per client. The recent launch of Benefit Decision Support and our expansion into the office of the CFO with our integrated headcount planning product has increased our max PEPY from $550 to $600 achieving the target we set in August 2023.

Speaker 2

And this does not yet include any airbase products. We also remain confident in our ability to drive further product expansion and further expansion of our average revenue per client across new and existing clients with new HCM and office of the CFO products over time. Additionally, our new AI assistant chatbot is now generally available to all Paylocity client admins and we are pleased with early levels of adoption. Since launching in October, we have seen a 30% increase in utilization and key features such as natural language search capabilities, which are available in our reporting product, have driven an over 20% reduction in time required for our users to find reports. We are encouraged by the benefits our AI related investments are driving for our clients and excited to continue adding additional AI enabled functionality and key use cases over time.

Speaker 2

Our ongoing commitment to product innovation continues to be recognized by third parties as Paylocity was recently awarded the TrustRadius Buyer's Choice Award and named overall leader in 10 HCM product categories in G2's Winter twenty twenty five grid reports.

Speaker 3

I would now like to pass the call to Toby to provide further color on the quarter. Thanks, Steve. As Steve highlighted, the momentum seen in Q1 continued into the second quarter, resulting in solid selling season performance and increased revenue and profitability guidance for fiscal twenty twenty five. Our results are driven by strong sales and operational execution, continued product differentiation and a more stable macroeconomic environment. We also continue to be pleased by our ability to add talented sales reps and solution consultants and our ongoing investments in training and development across our sales team helped contribute to another quarter of strong go to market execution, including continued traction upmarket.

Speaker 3

Additionally, we are pleased to see another quarter of strong performance across the broker referral network, which once again delivered more than 25% of our new business in Q2. The sustained success of our broker channel is driven by our modern platform, marketplace ecosystem, third party integration and API capabilities and because we do not compete against our broker partners by selling insurance products. We remain committed to investing in and supporting the broker channel going forward with a goal of continuing to deliver real value and true partnership and support to our referring brokers and clients. Overall, we are pleased with Q2 results and believe we are well positioned heading into the back half of the fiscal year, which is reflected in our increased guidance for fiscal twenty twenty five. While still in the very early days, we're pleased with the reception of the Airbase acquisition from both existing and prospective clients, and we will continue driving the integration process across our teams and our platform.

Speaker 3

From our early conversations, the value proposition of having a single platform through which all payroll and non payroll related spend can be managed with a robust set of integrations with key third party systems is resonating with decision makers across our target market. We are also pleased with the ability to collaborate with mutual clients to drive a combined roadmap that delivers incremental value to businesses across our target market. Finally,

Speaker 4

this time

Speaker 3

of year is a very busy time for all of our teams as they work closely with clients on year end processing of payrolls, W-2s, 1095s and annual tax form filings to federal, state and local agencies and on the implementation of new clients. I want to thank all of our employees for their hard work and dedication to our clients during this very busy time of year. The strong culture at Paylocity also continues to be recognized externally as we recently were named to Forbes list of America's Most Trusted Companies and Fortune's list in twenty twenty four Best Workplaces in Technology, in addition to being recognized as one of America's Greatest Places for Diversity by Newsweek for the second consecutive year. I would now like to pass the call to Ryan to review the financial results in detail and provide our increased fiscal twenty twenty five guidance.

Speaker 1

Thanks, Toby. Q2 recurring and other revenue was $347,700,000 an increase of 17% with total revenue of $377,000,000 and up 16% from the same period last year. Our strong Q2 results were primarily driven by another solid quarter for our sales team, allowing us to come in $8,000,000 above the top end of our revenue guidance and resulting in a raise to our fiscal year guidance by more than our beat for the second consecutive quarter. Our adjusted gross profit was 73.8% for Q2 versus 72.7% in Q2 of last fiscal, representing 110 basis points of leverage as we continue to focus on scaling our operational costs, while maintaining industry leading service levels. We continue to invest in research and development and to understand our overall investment in R and D, it is important to combine both what we expense and what we capitalize.

Speaker 1

On a dollar basis, our year over year investment in total R and D increased by 16.2% when compared to the second quarter of fiscal twenty twenty four, and we remain focused on making investments in R and D throughout fiscal twenty twenty five as we continue to build out the Paylocity platform to serve the needs of the modern workforce. In regards to our go to market activities, on a non GAAP basis, sales and marketing expenses were 21.7% of revenue in the second quarter and on a non GAAP basis, G and A expenses were 9.8% of revenue in the second quarter and we remain focused on consistently leveraging our G and A expenses on an annual basis. Our adjusted EBITDA for the second quarter was $126,200,000 or 33.5% margin and exceeded the midpoint of our guidance by $8,200,000 dollars Excluding the impact of interest income on funds held for clients, adjusted EBITDA was $96,900,000 also exceeding our guidance for Q2. Briefly covering our GAAP results. For Q2, gross profit was $252,400,000 Operating income was $46,600,000 and net income was $37,500,000 In regard to the balance sheet, we ended the quarter with cash and cash equivalents of $482,400,000 and $325,000,000 in debt outstanding related to the funding of the Airbase acquisition.

Speaker 1

In regard to client held funds and interest income, our average daily balance of client funds was approximately $2,800,000,000 in Q2. We are estimating the average daily balance will be approximately $3,200,000,000 in Q3 with an average annual yield of approximately three sixty basis points, representing approximately 29,000,000 of interest income in Q3. On a full year basis, we are estimating the average daily balance will be approximately $2,900,000,000 with an average annual yield of approximately three ninety basis points, representing approximately $113,000,000 of interest income. In regard to interest rates, our guidance reflects all fed cuts to date with an additional 25 basis point rate cut assumed in May. Additionally, given the confidence we have in our business and our strong cash flows, we continue to utilize our share repurchase program with 8,600,000 or approximately 40,000 shares of common stock repurchased in Q2 at an average price of $197.9 per share.

Speaker 1

As a reminder, we have approximately $341,000,000 remaining under our share repurchase program and anticipate continuing to execute against the program over the remainder of the year. Finally, I'd like to provide our financial guidance for Q3 and full fiscal '20 '20 '5. Note that as a result of strong selling season and continued momentum across our sales team, we are increasing our fiscal twenty twenty five recurring and other revenue guidance by $15,500,000 and our total revenue guidance by $20,500,000 at the midpoint, which includes the full impact of our guidance beat in Q2 and a further increase in back half fiscal twenty twenty five revenue guidance. Additionally, we continue to realize success driving increased profitability across our business, resulting in increased adjusted EBITDA guidance, which includes the full impact of our guidance beat in Q2 and increased profitability expectations for fiscal twenty twenty five. With that said, for the third quarter of fiscal twenty twenty five, recurring and other revenue is expected to be in the range of $410,000,000 to $415,000,000 or approximately 12% to 13% growth over third quarter fiscal twenty twenty four recurring revenue.

Speaker 1

And total revenue is expected to be in the range of $439,000,000 to $444,000,000 or approximately 10% growth over third quarter fiscal twenty twenty four total revenue. Adjusted EBITDA is expected to be in the range of $171,000,000 to $175,000,000 and adjusted EBITDA excluding interest income on funds held for clients is expected to be in the range of $142,000,000 to $146,000,000 dollars And for fiscal year twenty twenty five, we are increasing all aspects of our guidance as follows: recurring and other revenue guidance is now expected to be in the range of $1,445,000,000 to $1,455,000,000 or approximately 13% growth over fiscal twenty twenty four recurring and other revenue. Total revenue guidance is expected to be in the range of $1,558,000,000 to $1,568,000,000 or approximately 11% growth over fiscal twenty twenty four. Adjusted EBITDA is expected to be in the range of $542,000,000 to $550,000,000 and adjusted EBITDA excluding interest income on funds held for clients is expected to be in the range of $429,000,000 to $437,000,000 In conclusion, we are pleased with our Q2 results and the momentum we have across our sales and operations team as we exit our busiest time of the year. Operator, we are now ready for questions.

Operator

Thank

Speaker 5

And our first question will come from

Operator

the line of Brad Reback with Stifel. Your line is open.

Speaker 6

Great. Thanks very much. Not sure who it's for, but with the M and A in the market and Paycor getting taken out, they clearly had a big broker channel. They're now going to be competing with those brokers. Do you see that as an opportunity to accelerate your broker go to market?

Speaker 3

Hey Brad, it's Toby. I mean, I think if you look at what's made it successful over time with the broker channel, it's been the investments that we've made to build those relationships to provide meaningful technology to them visibility into their business. It's being able to provide integrations that matter. And ultimately, I mean, we don't compete with a broker channel with the sale of insurance products. And so I think those are the things that have made us successful and helped us build meaningful relationships with that channel.

Speaker 3

And I think that's what we want to be able to do as we look forward. And I think if there's any disruption that comes from a deal like that, that's where we want to be positioned to be able to to provide those types of relationships with brokers that are successful.

Speaker 6

And just a quick follow-up on that, Toby. As you build broker relationships, does it typically take months, quarters or longer to get them productive?

Speaker 3

Well, I think a lot of the relationships that we have have been built over time with our sales force in the field. And I think when those relationships exist, they tend to be productive. It doesn't take years to get them to be productive. It's all about our ability to build those relationships, make the connection and then being able to communicate the value that I just ran through. And when we can do that, we can usually make those productive in the near term.

Speaker 2

I think the other thing I would

Speaker 7

mention, Brad, just to add to that is,

Speaker 2

yes, no problem, is oftentimes the broker relationships are not necessarily exclusive, meaning, they might refer to Paylocity, they might refer to somebody else, they may in different circumstances use multiple providers. We obviously want to be that premier provider in each of these relationships. And so if there happens to be less competition in the market and less options available, then I think to Toby's point, we feel like we are really well positioned, since we've been doing that really from the very start of Paylocity with a great reputation in the market to take advantage of that.

Speaker 6

Excellent. Thanks very much.

Operator

Thank you. One moment for our next question.

Speaker 5

And that will come from

Operator

the line of Scott Berg with Needham. Your line is open.

Speaker 8

Hi, everyone. Nice quarter. Thanks for taking my questions. Steve and Toby, I guess as I track your prescriptive remarks maybe this quarter and last quarter, I get a sense that you have maybe a renewed sense of optimism in the business. It sounds like you're able to call payrolls properly and it seems like deal flow is kind of stabilizing.

Speaker 8

Is that the right way to view some of your comments that you made here today or is that maybe something I'm making up in my head, I guess?

Speaker 3

Well, I mean, I think you I think we would hope that you would hear a lot of consistency in our approach. So I mean, I think we have always been optimistic about our ability to continue to grow and serve clients well. And as we're just talking about delivering value to the broker channel. And so I think that's been a pretty consistent approach from a strategy perspective and approach to the growth algorithm. And I think you continue to hear that today.

Speaker 3

And I think the Steve and I both have I think tried to communicate that over time and I think that still holds true.

Speaker 8

Understood. And now that we're through your obviously busy selling season in the fall and we're into calendar Q1. How do you think about sales hiring this year during calendar 'twenty five as you start to think about 'twenty six? I know not all your plans are certainly made for next fiscal year, but when you think about sales capacity, hiring, does it change much from how you viewed last year? So I know this is typically when you start to hire or at least into the spring for the busy selling season.

Speaker 8

Thanks.

Speaker 3

Yes, I think so if you go back to really the hiring season and coming into this fiscal year, we had come in growing sales headcount by around 8%. And what we talked about at the time was that we would that would be our starting point and the focus was really on driving productivity across our go to market teams. And that if we saw a market change in the macro, I mean, we still would have room to be able to continue to invest throughout the course of the year if leaning in made sense. And I think as we sit here coming through the first half, I think we performed well in selling season. We feel good about the momentum that our go to market teams have had and feel like it's been a more stable environment than we would have seen last year.

Speaker 3

And so I think we feel good about the investments that we made coming into the year and still remain optimistic about our ability to be a destination for talent, particularly in go to market in the industry. And I think when those opportunities present themselves, we're ready.

Speaker 9

Excellent. Nice quarter again. Thanks for taking my questions.

Speaker 10

Thanks, Scott.

Operator

Thank you. One moment for our next question.

Speaker 5

And that will

Operator

come from the line of Samad Samana with Jefferies. Your line is open.

Speaker 7

Hey guys, thanks for taking my questions and good to see you on quarter. Just one note for my good friend Scott. Dumbledore said it could be happening inside your head, but doesn't mean it shouldn't be real on Earth either. So just remember that Scott. So Toby and Steve, for you guys, I want to ask about Airbase.

Speaker 7

And I know you're talking about the early impression that you're getting from customers that it's been well received. I guess, can you maybe just help us understand what for the customers that you've sold it to since the acquisition, have you seen them buy it upfront along with the rest of the suite? Or are you seeing them engage in the conversation and put it as something down the road? Maybe just help us understand what that level of receptivity has been and how that's manifested in the numbers?

Speaker 2

Sure. So obviously, all understanding that this is still very early in integration, number one. Number two, airbase is still a relatively small revenue stream when you look at our overall business. But having said that, we are pleased with the early indications in both scenarios. First, interactions with our sales team that are bringing clients on board upfront.

Speaker 2

We're seeing some activity there where customers are interested in having that conversation about how air based product solutions can help them as they look at modernizing their HCM suite. So some good examples there. And then at the same time, as we go back to our existing customers and we talk to them about this acquisition and how we might be able to help them, we're also seeing some interest. That's all being done as we're working on the product integration, which we think will only increase the value proposition over time. So I think we're happy early on with both the team that we brought over with Airbase and the early reception from the both our customers and prospects in the market.

Speaker 7

Great. And then Ryan, maybe a follow-up for you. Any can you give us an idea of what the contribution from Airbase was in the quarter? And just as I think about the upward revision to the guidance, that's a really positive outcome. And how much of an influence did Airbase have on that or was that all for the core business?

Speaker 1

Yes, I would think of the contribution from Airbase being consistent with how we sized it last quarter, which is roughly 1% of revenue or so this fiscal year. So to Steve's point, I think that that business is performing as expected and relative to the overall businesses is fairly small. So when you think about both the results in Q2 and the larger guidance raised in the back half of the year, I would view that as really driven by core Paylocity over performance.

Speaker 7

Excellent. Thanks guys and congrats on a great quarter. Thanks.

Operator

Thank you. One moment for our next question.

Speaker 5

And that will come from

Operator

the line of Mark Marcon with Robert W. Baird. Your line is open.

Speaker 11

Hey, good afternoon. Thanks for taking my questions. And let me add my congratulations. Great quarter. Wondering if you can talk a little bit about what you're seeing just in terms of the differences between the mid market relative to the upper end of your target market.

Speaker 11

In the past, you had talked about longer decision cycles in the upper end. Are you seeing any change in tone? And what are you seeing in terms of receptivity or areas of strength in any areas that are more or less competitive?

Speaker 3

Yes, Mark, it's Toby. I think if you go back to this time last year, we were talking about the fact that we had seen longer sales cycles, particularly in the upper end of the market. And part of that was due to more, I think, cycles through with decision makers and seeing more demos, etcetera, things like that. And I think as we came through the third quarter and then through the fourth quarter of last year, we also started to see a little bit more stability in the market. And I think as we came into this year, that's really how we set the year up.

Speaker 3

I think that's what we saw through Q1 and I would say stable through Q2. I don't think we saw any significant change in the dynamics in the market, but we did feel like it was more stable. And I think coming through selling season, really proud of how our teams executed. I think they carry some momentum from Q1 into Q2. And I think it was a strong execution quarter for the teams in selling season.

Speaker 11

That's great. And then it sounds like both the benefits decision support and headcount planning are off to a good start. Can you give us a little bit more of a feel in terms of the level of receptivity? How much are you getting in terms of new sales, who is that appealing to, particularly in terms of headcount planning, which goes into the office of the CFO, anything there would be helpful?

Speaker 2

Yes. So I think we're definitely happy with the start for headcount planning. As you mentioned, it is the first product in that office of the CFO category and being able to deliver that to oftentimes both new customers, many of those who are starting in January and probably haven't fully taken advantage of headcount planning yet, but also back to the base and getting some of our existing customers. That's probably where we've gotten even more of the feedback from existing customers. As they're going through an annual cycle, going through their planning cycle, they were able to use that tool to do better headcount planning than they would have oftentimes been doing in spreadsheets and manually.

Speaker 2

So off to a good start. I think as you know, Mark, we always try to target these new products, get them into the 10% to 20% penetration range over time, get them off to a good start. And I would say that that's certainly the case with both these products. I think the benefit decision support has a little bit of cyclical nature to it. Benefit enrollment happens throughout the year, but it is a little bit more concentrated into the fall.

Speaker 2

So we were able to get some great feedback from customers that use that tool in the fall. And we think we've got momentum as new customers are coming on and they plan on using our benefit enrollment tool both throughout the year, but again this fall that it's going to deliver a much better experience for employees and also has some real nice value to brokers.

Speaker 11

Excellent. Great job.

Operator

Thank you. One moment for our next question. And that will come from the line of Brian Peterson with Raymond James. Your line is open.

Speaker 12

Jessica on for Brian. I have a quick question. So you're saying that your PPEY has reached your target of $600 and you've reached this goal. What is a high level thought on how you're now recalibrating, rethinking about a new target going forward?

Speaker 2

Sure. I'll take that. So, yes, we're really proud of being able to reach that goal back in 2014 at IPO. We've tripled the amount of product that we've been able to sell. And so we also see big opportunity for us to be able to do that.

Speaker 2

The PEPM model is certainly one that works very well when you think of HCM products. As we move into the office of the CFO, some of those might not be that same pricing model. However, I don't think that changes the mix of new units and ARPU over time. So you'll see us continue to focus on that average revenue per customer growth, which might be priced a little bit different depending on the product category, but it's the same model that we've really kind of operated. And so we'll have to give some thought in terms of how we discuss that on a go forward basis.

Speaker 2

But as I mentioned earlier, we're still very early innings into the Airbase acquisition. And so I would expect more color over time, but no change in focus. Continue to drive more new products back to the existing customers and new customers continue to drive both units as well as ARPU as the formula for growth.

Speaker 12

Thanks. And then also speaking about Airbase a little bit, I know it's early days still this integration, but I was a little bit curious as you're thinking about next twelve to eighteen months of integration path, how are you balancing the prioritization of integrating Airbase versus continuing driving these new product launches and continuing driving the penetration with existing products?

Speaker 2

Yes, I would say at our current scale, roughly 1,500,000,000 in revenue, we've consistently continued to invest a similar percentage back into R and D. That has been part of our belief that the product differentiation is what's really driving the performance over time. And so we will balance the investments both in terms of enhancements and features to our customers with existing products, new HCM products, innovation capabilities with things like AI and then at the same time make investments into new categories. I think we've had a pretty good history of being able to do that and have been first to market in many of those categories. And so we feel like we're well positioned to be able to do that.

Speaker 2

Oftentimes and most of the time that's organic. In some cases, we've made some strategic acquisitions where we think it's a great fit. We spend the time to integrate that product, so the customer experience mirrors something that we would build. And we've got to continue to balance our portfolio of investments from an R and D perspective, but certainly increased size and scale allows us to do that.

Speaker 12

Got it. Thank you.

Operator

Thank you. One moment for our next question.

Speaker 5

And that will come from

Operator

the line of Daniel Jester with BMO Capital Markets. Your line is open.

Speaker 9

Great. Good evening, everyone. Thank you for taking my question. Ryan, great outcome on the EBITDA line. If I look at the free cash flow of the business, it doesn't look as expansive on a year over year basis.

Speaker 9

My guess is that Airbase is kind of muddying the waters a little bit there. So can you help us think about the conversion of EBITDA to free cash flow for the rest of the year? If there's any puts and takes we should be considering as we're working through our model?

Speaker 1

Sure. Yes. Obviously, we don't guide to free cash flow specifically and certainly quarter to quarter that number moves around with timing of spend. So nothing that I would call out that would be concerning or one time to your point. There's obviously a headwind this fiscal year relative to the Airbase acquisition with which we've characterized as roughly 100 basis point headwind for adjusted EBITDA.

Speaker 1

I think the headwind to free cash flow is pretty similar. So when you think where we are today on a TTM basis, free cash flow roughly 21% margin, We do have the headwind over the balance of this fiscal year. I think we will end up somewhere north of 20% this year. That's not formal guidance. But I think when you look at where this goes going forward into 2026 and beyond, we expect to be able to continue to drive leverage going forward, but wouldn't have any specific concerns relative to Q2, just some timing of when some of the cash flows hit within the year.

Speaker 9

Okay, that's great. Thank you. And then, you said in the past, Airbase is certainly going to be something that you're going to try to push back into your current customer base. It sounds like headcount planning is also something that your current customers are very interested in. As you think about sales investments going forward, do you think about changing the mix between sort of hunters and gatherers in your sales organization?

Speaker 9

And what could potentially that look like if it were to emerge? Thank you.

Speaker 3

Hey, Dan, it's Toby. I mean, yes, we've called this out over time and we have invested in both. So I think going back to '20, probably 2015, '20 '16 timeframes started to invest in a team to sell back into the customer base and that's grown over the course of time since then. I think the mix has continually shifted in terms of higher percentage of growth in that team that's selling back into the base relative to the field. But I think to Steve's comments a few minutes ago, the focus has absolutely been from a go to market spend standpoint to focus on new units.

Speaker 3

That's a really important part of the growth algorithm, while also focusing on our ability to and investing in our ability to go back to the client base as our product set has expanded now to $600 in PEPY. So that's certainly been both have been important and that's some color on the mix.

Speaker 7

Great. Appreciate it. Thank you.

Speaker 9

Sure.

Operator

Thank you. One moment for our next question.

Speaker 5

And that will come from

Operator

the line of Patrick Walravens with Citizens. Your line is open.

Speaker 9

Great. This is Austin Cole on for Pat Walravens. Appreciate you taking the questions. Nice results. Steve, more high level question here, but would love to get your just general thoughts on the Paychex Paycor deal.

Speaker 9

Why do you think Paychex wants to buy Paycor? How do you see this market evolving going forward?

Speaker 2

Yes. So certainly have no any inside information, but I think just from a macro perspective, there has been consolidation in this industry over time. It is businesses that can drive pretty high margin. So as you're able to do that, you can typically take some cost savings out. I think they called some of that out in their press release in terms of targeting some cost savings.

Speaker 2

I think Paycor has focused a little bit of a larger size customer than Paychex historically. So I think you put all that together and that's at least is the rationale that I would think about. And I think from our perspective, we're going to continue to do what we were doing before. It's really about innovating. We've fared very well against both those competitors.

Speaker 2

They're strong competitors for sure, but they're someone that we've had success with over time. And so we feel like if there is a change in their strategy, if there is any type of disruption, then that could be incrementally beneficial to us. Otherwise, we're going to continue to do what we do and deliver the most modern experience to our customers.

Speaker 9

Great. Appreciate that perspective. Thank you.

Operator

Thank you. One moment for our next question. And that will come from the line of Sidi Panagrahy with Mizuho. Your line is open.

Speaker 13

Thanks and congratulations on an excellent quarter. Going back to Airbase again, so is your plan now to run this as an independent group or even keep that product in the same form? Or are you planning to rebuild on the Velocity platform before you go to your Velocity customer base to cross sell this? Basically, my question, when should we start thinking about cross sell opportunity in our air base into velocity?

Speaker 2

Yes. So I think stepping back from a long term perspective, our goal will be to integrate those platforms over time, so that we're delivering a very unified and holistic experience where we will have all payroll dollars, payroll activity approvals, as well as all the spend management capabilities. That will certainly take some time. Having said that, our customers can still benefit from some of the integration that already exists and that we're going to be adding over time. And so we will continue to sell new customers.

Speaker 2

We will sell back to our customer base in such a way that will grow over time. And so as we go into next fiscal, I would say throughout next fiscal and throughout the back half of next fiscal, I would imagine we start to gain some momentum with the product integration. It'll be a multi year effort. But and the bigger opportunity from our perspective is really this that we'll continue to grow standalone revenue within Airbase, but the bigger opportunity is to cross sell. And to your point that in if you look at our history, that will take us twelve to eighteen months.

Speaker 2

This is a little bit larger acquisition, wouldn't surprise me if that's more than the twelve to twenty four months. But what I'm really happy about is even without all the benefit that we're going to be able to deliver from a truly integrated platform, we're still seeing good receptivity from both prospects as well as existing customers. So off to a really good start.

Speaker 13

That's great. And then, Ryan, a follow-up to your guidance. You had a pretty strong first half and if I look at your Q3 guidance, it implies that your Q4 recurring revenue will be probably 10% or below. Is there anything that we should think about or is it conservatism here?

Speaker 1

Yes, Sid, I'd probably characterize it, I think, a few different ways. If you step back and think about how we set up the initial guide for this fiscal year, I think we were really clear that we felt like we want to return to a beat and race cadence. And I think we viewed it as if we had strong execution across the sales team and from an operational standpoint, we'd be in a spot to be able to beat and raise. And we're halfway through the year. We've raised both quarters.

Speaker 1

We've raised both quarters by more than the beat. And I think within our guidance philosophy, our view is while we have raised pretty significantly, if we continue to see strong sales performance and you've heard from us here today relative to the momentum we feel like we have in that team that come May earnings call, we'd be in a spot to potentially raise again. I think maybe the one thing I would call out relative to Q2 versus Q3 is while the vast majority of the over performance we saw in Q2 was sales driven, we did see pull forward of call it, a handful of million dollars of recurring revenue that we would have typically expected to see in Q3. And that's really driven off of some client starts that came in a little bit earlier. So both new and some of the upsells we have to existing clients being able to get those in a couple of months earlier.

Speaker 1

Net positive, I think both from our perspective as well as clients that get the product in the hands of clients earlier, the implementation process is smooth and for us it's all recurring revenue. So we did see that slight pull forward between Q2 and Q3. But when you think about the guide both third quarter and in the fourth quarter, again, we feel like if we perform well, we should be able to be able to beat raise over the balance of the year.

Speaker 13

Thank you.

Operator

Thank you. One moment for our next question.

Speaker 5

And that will come from

Operator

the line of Raimo Lenschow with Barclays. Your line is open.

Speaker 14

Hey, thank you and congrats from me as well. Two quick questions. First, have you like can we talk a little bit about the labor market? Obviously, remember last year was actually it was almost a year before where we had issues on new hiring, etcetera. Have you seen any change, especially if you look at the small business index post election, that's kind of going up every week.

Speaker 14

Any improvements there? What are you seeing there in that market? And I had one follow on.

Speaker 1

Yes. I think broadly speaking, we've seen a really stable macro and I think that that's from a macro standpoint across the board. Within employees in the platform, as you know, we probably had a touch of conservatism or prudence into the guidance. We did not assume any increase. And I'd say there's probably modest upside to that in the first half of the fiscal year, not particularly material, but net and overall positive.

Speaker 1

I think relatively the guide in the back half of the year, we continue to take a prudent approach. So to the extent you see a little bit of upside there, that would potentially provide some modest upside to revenue in the back half of the year. But overall, it's been pretty stable, nothing I call out as particularly materially different versus expectations.

Speaker 14

Yes. Okay. And then can we talk a little bit about gross margins? Q2, obviously, saw a really strong improvement ex float. Can you talk a little bit about the drivers there and how we should think about that going forward?

Speaker 14

Thank you.

Speaker 1

Yes, absolutely. I mean, we've been pleased with the expanded gross margins we had really last year, but certainly the first half of this fiscal year as well. So I think Q1 was a strong quarter. And I think for us, it's continuing to balance investments across our operational team to make sure we are driving that industry leading service levels. But at the same time, we're working hard to make sure we're prioritizing spend, making sure that we're driving efficiencies and automation.

Speaker 1

I think we've been able to balance that where we feel really good about where we are from a retention and implementation standpoint. But at the same time, we're able to take advantage of our size, our scale and the fact that we're investing across people, process and technology to be able to drive some pretty healthy margin leverage while not having to sacrifice on the service side.

Speaker 14

Perfect. Thank you. Okay. Very helpful.

Operator

Thank you. And one moment for our next question.

Speaker 4

And that will come from the

Operator

line of Jared Levine with TD Cowen. Your line is open.

Speaker 13

Thank you. Can you discuss

Speaker 9

the level of client interest in your Gen AI functionality and thoughts on your ability to monetize in the future?

Speaker 2

Yes, sure. As we mentioned in the prepared remarks, we were pretty happy with the launch of our internal chatbot that our customers are using. So probably gives the ability to really create a better experience overall. And so we're seeing some pretty nice increases. We still want them be there for them when they call us and email us or interact with them, but it gives them really quick answers and maybe built in advice over time.

Speaker 2

And so that's been really strong. We've got a number of other use cases that uses generative capability, things like writing announcements to all of your employees or job descriptions. We've got some things in rewards and recognition and performance. And so our approach overall is really to embed the AI capabilities to really make everyday processes even better for our customers. So sometimes that means faster, sometimes that means higher quality, sometimes it means it's just much easier for them to be able to get their jobs done.

Speaker 2

And we have a number of modules that we think we continue to enhance to do that. We think that's the bigger opportunity, both great service experience and differentiation embedded into the product. From a longer term perspective, we'll certainly keep our eye out for monetization opportunities, but from a near term, it's really client satisfaction, efficiency and differentiation.

Speaker 9

Great. And then in terms of retention, can you provide some color on your January retention performance, just given the significance of that for the year and how that compared to year on year relative to historical levels?

Speaker 3

Yes. I mean, as you

Speaker 4

know Jared, it's Toby. As you

Speaker 3

know, this is a really important time of year for us with all the volumes that our teams handle going into December and then through January from both a service standpoint and from an implementation standpoint. And I would say similar to the remarks I made earlier about our success in the selling season, really proud of the efforts of our teams both in service and implementation going through and serving our clients really successfully in December and January. So obviously, we'll kind of flush out how Q3 comes together. But I think sitting here today at the February, really happy with that, really proud of our teams and all the effort they put in to serve our clients in the busiest time of year.

Speaker 9

Great. Thank you.

Operator

Thank you. One moment for our next question.

Speaker 4

And that will come from the

Operator

line of Terry Tillman with Chua Securities. Your line is open.

Speaker 9

Yes. Hey, good afternoon. Congrats for

Speaker 2

me on the quarter. I'm running out

Speaker 9

of questions asked. I mean, they're relegated to Super Bowl picks or maybe an upmarket traction question. So I'll go for the latter, so it doesn't get into a sensitive topic on picks. As it relates to the upmarket traction, I think that was in the prepared remarks. Maybe you could just share a little bit more about, are you seeing any evolution on attach rate of other products beyond core and payroll?

Speaker 9

And what are you getting in terms of some early signals on their propensity to buy these office of CFO products maybe versus more of smaller mid market or smaller customers? Thank you.

Speaker 2

Yes. So I think the first part of the question, we are definitely seeing continued increases in attach rates. I would describe them as gradual increases in attach rates as we bring on some of the customers in the upper end of our market. And I would probably credit much of that to better execution on our things that we could do, training, staffing, different roles that support the sales organization. I think we've executed well on all those things and we saw the benefit of that through selling season.

Speaker 2

And I think you saw that with the guidance raise. I think that's probably the bigger element. We've seen product continue to perform well upmarket and continue to gradually increase attach rates. I think the second part of your question, one of the things we really liked about Airbase was the customer overlap. So the average size customer that they had was very much similar to our average size customer.

Speaker 2

So more than 100 employees, but their average size customer wasn't 10,000 employees or in the enterprise space. So we think it's a nice product market fit. And therefore, you see us having the strategy of taking that product, getting feedback from customers, using that voice of the customer to continually enhance capabilities. And as we enhance the capabilities, just like we have in HCM, you'll start to continue to expand that target market and it'll appeal to maybe slightly larger clients over time. And so I think you'll see the best receptivity early on in the core part of our market where we have the bulk of our customers and the bulk of our revenue.

Speaker 2

So that's certainly the strategy and it'll certainly take us time to be able to execute upmarket, but we do think that that opportunity exists.

Speaker 9

That's helpful. Thank you.

Operator

Thank you. One moment for our next question.

Speaker 5

And that will come from the

Operator

line of Steve Enders with Citi. Your line is open.

Speaker 10

Okay, great. Thanks for taking the questions here. I guess maybe just to start, I think based on the commentary around seeing strong sales momentum and macro maybe stabilizing to improving a bit. I guess maybe how is that potentially manifesting and kind of what you're seeing either in sales cycles or top of funnel or the number of number of ad vales that you're seeing just would be helping a little bit more, I guess, detail around some of those things?

Speaker 3

Hey, Steve, it's Toby. I mean, I guess I would say that I wouldn't call out any significant movement in any of those things. I would more characterize it as we came into this fiscal year after some after the overhang that we all saw across enterprise software and in our industry from a macro perspective throughout the first three quarters our first three quarters of last fiscal year, we started to see that stabilize in Q4. And I think that's how we talk to you all about the setup coming into the fiscal year for Q1. And I think that's what we saw materialize in Q1 as well was just a level of stability in the demand environment that we hadn't seen during most of the prior year.

Speaker 3

And I think that really continued into Q2. And I think that put our go to market and sales teams in a really good position to talk to prospects about our value prop. And I talked earlier about the momentum that we saw in that and just really proud of their execution in the quarter.

Speaker 10

Okay, perfect. No, that's great to hear.

Speaker 4

And then I guess just on maybe some

Speaker 10

of the 2Q versus 3Q dynamics, I appreciate calling out some of those earlier starts here hitting in 2Q, but anything else that we should kind of keep in mind for seasonality or maybe going through filing season, how should we be thinking about some of the impacts from that perspective between the quarters?

Speaker 1

Yes, yes, good question. I think that has largely tracked consistent with expectations. Maybe the one thing I'd call out relative to form filings is that typically grows a touch less than recurring revenue, grows more consistent with client growth or employee on the platform growth. So I think it's coming in consistent with expectations. Obviously, we're able to raise the fiscal year pretty significantly.

Speaker 1

But that's probably one when you look at the core recurring revenue versus form filings that would be a touch of a headwind into the third quarter. And then I think the other thing I'd mentioned would just be the contribution from Airbase doesn't have the same seasonal impact as our business. So from a growth standpoint within year over year, you would see airbase year over year have a little bit of a less impact to growth in Q3 versus Q2 or Q4 because you don't have that same seasonal bump that the core Paylocity business does. Outside of that, there's really nothing I'd call out as material.

Speaker 10

Okay, perfect. Thanks for the questions.

Operator

Thank you. One moment for our next question. And that will come from the line of Jason Celino with KeyBanc. Your line is open.

Speaker 15

Hey, thanks for taking my questions. Just a couple of quick ones. I don't want to get too ahead of my skis here, but on paper, it looks like the 2Q recurring revenues accelerated. But if we strip out Airbase, then we strip out a little bit of that pull forward, would Q2 have really just been more similar to the 14% growth you saw in Q1 or did you see any little bit of acceleration there?

Speaker 1

No, I think that's a fair characterization. I think when you control for those two items, I think it would be spot on or almost very close to what the Q1 recurring revenue growth would be. Okay.

Speaker 15

And then the pull forward of those clients from Q3 to Q2, you said it was start related. Was it election related possibly? I'm just trying to understand why something

Speaker 2

would be earlier?

Speaker 1

No, not election related at all. I think when you think about the momentum we've talked about from the sales organization really in Q4 of last year and the first half of this fiscal year, really strong bookings momentum and those clients get slotted into a start period and to the extent we're able to pull them earlier, it would really that type of scenario versus anything tied to the election. And again, right, you've got to characterize this, not particularly material on a $375,000,000 quarter. We're talking about a handful of $1,000,000 of impact, but it would really be those touch earlier starts versus anything election related.

Speaker 15

Okay, perfect. Thanks.

Operator

And one moment for our next question.

Speaker 5

And that will come from

Operator

the line of Alex Zukin with Wolfe Research. Your line is open.

Speaker 9

Hey guys, thanks for taking my question. A lot of might have been asked, but maybe just on workforce levels, I think some of your peers called out impacts from holidays and weather. Just curious kind of what you're seeing out there, what you saw and what you're seeing out there and how you're thinking about that for the rest of the year? And then I've got a quick follow-up.

Speaker 1

Yes, Alex, this is Ryan. Nothing that we would call out relative to weather or holidays that would have any material impact to that. I think as I mentioned earlier, probably a touch better than expectations in the second quarter. We've had a pretty prudent approach to workforce levels, the balance of this fiscal year. So net net a positive, wouldn't call it out as particularly meaningful to results.

Speaker 1

And I think guidance within the back half of the fiscal year continues to have a level of prudence around workforce levels.

Speaker 9

Perfect. And then maybe just on the competitive side, we continue to hear about some well capitalized, call it, private competitors, specifically down market. Have you seen any kind of do you see those guys more often, any change in win rates, any kind of ARPC pressure or just anything to call out in general?

Speaker 3

I don't excuse me, it's Toby. I don't think there's anything material we would call out. I mean, I think the commentary that we would generally provide is this has always been a really competitive space and continues to be today. And I don't think we've seen any material shift in the mix of competitors in any given deal. But certainly, no doubt it's competitive out there.

Speaker 3

And I think going back to some of Steve's earlier comments, I mean, our view has been that we want to be able to provide the most modern platform in the industry to our clients and prospects and with the broadest and deepest solution set. And I think we're really well positioned to do that today and I think that remains the strategy.

Speaker 9

Perfect. Well guys, it seems like it's working.

Operator

And one moment for our next question. That will come from the line of Jake Roberge with William Blair. Your line is open.

Speaker 3

Yes. Thanks for taking

Speaker 16

the questions and congrats on the results. Just wanted to follow-up on the go to market front. Sounds like you're looking to add more reps in the back half of the year, just given the strong selling season. I know it's early days with Airbase, but as you move more into the office of

Speaker 1

the CFO, does the profile

Speaker 16

of seller you're looking for change at all there?

Speaker 2

I think we'll evolve the go to market motion for the airbase model. So don't want to give you the impression that we have that all figured out. However, we do have a lot of experience in terms of selling back to the customer base for a variety of products. And so we're going to leverage that experience to be able to do something similar. So that ends up putting less of the burden on that front end seller and allows us to have more specialized knowledge and more of an inside team type of model.

Speaker 2

So that is likely the motion that we certainly start with. And therefore that allows us to continue to hire HCM experienced reps, driving productivity over time, while being able to leverage some level of office of the CFO experience to be able to help them when they are able to generate interest in the prospects, more likely the model than changing our hiring profile.

Speaker 16

Okay. That's helpful. And then great to hear the productivity gains with the new AI assistant. I know it's not being sold as a separate SKU today. But now that we're shifting more into kind of the AgenTek AI season, is that something you're looking to also add to your platform?

Speaker 16

And could that potentially be an unlock for monetization on the AI front?

Speaker 2

Sure. Yes. So the interesting thing about our clients business and what they use us for is there is a lot of workflows, there's a lot of approvals. If you a lot of things start with an employee, they go to a manager, they have to be routed across the organization based off certain rules, they get approved. And so there are opportunities to be able to provide AI use cases that are really automating these experiences and or really maybe shortening the experience by leveraging the historical data that we have to be able to provide insights, skip some of the steps, do some of the work on behalf of our customers.

Speaker 2

I think we're in the early innings of that. And so, we definitely feel like that is an opportunity over time, whether that gets translated into pure monetization, better, more modern software that allows us some pricing power or just differentiation, we think it's the right area of investment.

Speaker 16

Sounds great. Congrats again on the solid results.

Operator

Thank you. One moment for our next question. And that will come from the line of Arvind Ramnani with Piper Sandler. Your line is open.

Speaker 4

Hi. Thanks for taking my question. You've certainly been talking about Gen AI and some of the investments you've made and some of the benefits over the last few quarters. The question I have is, has it started to kind of show up in terms of like improved win rates or in terms of kind of like ability to charge folks more or better margins like where is sort of the Gen II basically showing up in terms of your financials? And then the second thing is, with some of these announcements made from kind of DeepSeek kind of last week, does it change anything or does it matter to you at all?

Speaker 2

Yes. So, I don't think it changes anything in terms of how bullish we are on being able to create unique experiences leveraging whether it's machine learning algorithms, whether it's generative AI models or other types of agentic use cases. I think those are all opportunities for us. And I think the easy answer is, oh, all of a sudden we have something that we're going to monetize and we can clearly talk about it, but I don't think that's really the way it's going to necessarily work. That may

Speaker 4

happen over time, but I

Speaker 2

think the bigger opportunity is us to leverage AI to continue to drive a better client experience, to increase margins over time, to be able to create more differentiation so that we continue to grow recurring revenue and add units. Those are all so I think AI has to be embedded throughout the organization and be in all parts of the business driving productivity, driving efficiency, driving client experience. And if we do that, that really helps us really deliver the vision of being the most modern platform in the industry is by embedding AI across the organization. And that's the approach that we're taking versus maybe being focused on some AI module that we would try to singularly monetize.

Speaker 4

Okay. Yes, that's helpful. And I also had a broader level question. You had this kind of elevated growth rates, obviously, in the last few years and then velocity, but also others in the industry, particularly kind of the cloud players have kind of growth rates have taken kind of a step back. And I'm just trying to figure out, is it because of some of the legacy players getting more competitive or kind of saturation of market?

Speaker 4

And what I'm really trying to get to is like, do we ever get back to those kind of well above 20% growth rates either for you or for your peers in the industry?

Speaker 3

Yes. I think you've got to look back over time a little bit just to there's been the ups and downs that have gone along with COVID. And certainly no doubt, the cloud players that you referenced are all much bigger today than they would have been pre COVID. At the same time, I think from a strategy perspective, our consistent strategy has been to been the deliverer of the most modern platform in the industry. We think we were doing that today.

Speaker 3

It's what's helping us win. It's what's helping us be the highest growth player out there. And I think that will continue to be the focus as we look forward. And I think everything that we're doing today, whether it's with respect to Airbase or the development of the new modules that we've released and talked about and or whether it's some of the AI investments that we've made that Steve just walked through, I think those are all the elements that go into being able to provide the most modern platform out there and ultimately beat the competition.

Speaker 11

And the only thing

Speaker 2

I would add, Toby, is at the same time, we've really been focused on delivering value from a shareholder perspective in terms of improved EBITDA and free cash flow, as Ryan mentioned. And so it's really it's really about growth as our number one priority, but very close second behind that is making sure that we're delivering both top line and bottom line improvements and we feel very comfortable being able to execute that strategy on an ongoing basis.

Speaker 4

Perfect. And congrats on a good print and looking forward to more of these as the year progresses.

Operator

Thank you. I'm showing no further questions in the queue at this time. I would now like to turn the call back over to management for any closing remarks.

Speaker 3

Thank you very much. I'd just like to say thank you to everyone for your interest in Paylocity. Thanks for joining the call and a special thank you to all of our employees for making it a great quarter and taking great care of our clients. Thanks everybody and have a good night.

Operator

Thank you all for participating. This concludes today's program. You may now disconnect.

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Earnings Conference Call
Paylocity Q2 2025
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