Payroll and human resources software provider, Paylocity (NASDAQ:PCTY) reported Q4 FY2022 results beating Wall St's expectations, with revenue up 36.7% year on year to $228.9 million. On top of that, guidance for next quarter's revenue was surprisingly good, being $239.3 million at the midpoint, 5.99% above what analysts were expecting. Paylocity made a GAAP profit of $15.1 million, improving on its profit of $11.8 million, in the same quarter last year.
Paylocity (PCTY) Q4 FY2022 Highlights:
- Revenue: $228.9 million vs analyst estimates of $217.9 million (5.04% beat)
- EPS (non-GAAP): $0.80 vs analyst estimates of $0.53 (50.5% beat)
- Revenue guidance for Q1 2023 is $239.3 million at the midpoint, above analyst estimates of $225.7 million
- Management's revenue guidance for upcoming financial year 2023 is $1.08 billion at the midpoint, beating analyst estimates by 5.45% and predicting 27.7% growth (vs 34.1% in FY2022)
- Free cash flow of $38.7 million, down 40.7% from previous quarter
- Gross Margin (GAAP): 66.1%, up from 64.7% same quarter last year
Founded by payroll software veteran Steve Sarowitz in 1997, Paylocity (NASDAQ:PCTY) is a provider of payroll and human resources software for small and medium-sized enterprises.
Managing payroll may seem like an easy thing to do from the outside, but it is actually one of the most difficult administrative functions of a company. There are tax compliance issues, employees are eligible for different benefits based on contract type, local and national laws, and even a small mistake can ruin the whole process.
Using Paylocity software, organizations can schedule interviews with job candidates, manage employee attendance, learning, payroll, and benefits. Paylocity also integrates with other software platforms to help employees with tasks such as compliance, tax and insurance management.
The company developed its software for small businesses in search of intuitive and affordable HR solutions, as enterprise HR software is often too expensive and too complex to use for smaller businesses and their employees.
HR software benefits from dual trends around costs savings and ease of use. First is the SaaS-ification of businesses, large and small, who much prefer the flexibility of cloud-based, web-browser delivered software paid for on a subscription basis than the hassle and expense of purchasing and managing on-premise enterprise software. Second is the consumerization of business software, whereby multiple standalone processes like payroll processing and compliance are aggregated into a single, easy to use platforms.
The major competitors in the mid-market for HCM software include ADP (NASDAQ:ADP) and Paychex (NASDAQ:PAYX).
As you can see below, Paylocity's revenue growth has been very strong over the last year, growing from quarterly revenue of $167.4 million, to $228.9 million.
And unsurprisingly, this was another great quarter for Paylocity with revenue up 36.7% year on year. But the revenue actually decreased by $17 million in Q4, compared to $49.9 million increase in Q3 2022. However, Paylocity's sales do seem to have a seasonal pattern to them, and since management is guiding for revenue to rebound in the coming quarter we wouldn't be too concerned.
Guidance for the next quarter indicates Paylocity is expecting revenue to grow 31.7% year on year to $239.3 million, in line with the 33.8% year-over-year increase in revenue the company had recorded in the same quarter last year. For the upcoming financial year management expects revenue to be $1.08 billion at the midpoint, growing 27.7% compared to 34.1% increase in FY2022.
What makes the software as a service business so attractive is that once the software is developed, it typically shouldn't cost much to provide it as an ongoing service to customers. Paylocity's gross profit margin, an important metric measuring how much money there is left after paying for servers, licenses, technical support and other necessary running expenses was at 66.1% in Q4.
That means that for every $1 in revenue the company had $0.66 left to spend on developing new products, marketing & sales and the general administrative overhead. This would be considered a low gross margin for a SaaS company and it has dropped significantly from the previous quarter, which is probably the opposite of what shareholders would like it to do.
Cash Is King
If you follow StockStory for a while, you know that we put an emphasis on cash flow. Why, you ask? We believe that in the end cash is king, as you can't use accounting profits to pay the bills. Paylocity's free cash flow came in at $38.7 million in Q4, up 25.4% year on year.
Paylocity has generated $102.4 million in free cash flow over the last twelve months, a solid 12% of revenues. This strong FCF margin is a result of Paylocity asset lite business model and provides it plenty of cash to invest in the business.
Key Takeaways from Paylocity's Q4 Results
With a market capitalization of $12.4 billion, more than $139.7 million in cash and with free cash flow over the last twelve months being positive, the company is in a very strong position to invest in growth.
We were impressed by the very optimistic revenue guidance Paylocity provided for the next quarter. And we were also glad that the revenue guidance for the rest of the year exceeded expectations and free cash flow came in strong. On the other hand, it was less good to see the pretty significant deterioration in gross margin. Overall, we think this was still a really good quarter, that should leave shareholders feeling very positive. The company is up 5.09% on the results and currently trades at $238 per share.
Is Now The Time?
Paylocity may have had a good quarter, but investors should also consider its valuation and business qualities, when assessing the investment opportunity. Although we have other favorites, we understand the arguments that Paylocity is not a bad business. We would expect growth rates to moderate from here, but its revenue growth has been strong, over the last two years. And while its gross margins show its business model is much less lucrative than the best software businesses, the good news is its very efficient customer acquisition hints at the potential for strong profitability.
Paylocity's price to sales ratio based on the next twelve months is 12.4x, suggesting that the market is expecting more moderate growth, relative to the hottest tech stocks. There are things to like about Paylocity and there's no doubt it is a bit of a market darling, at least for some. But we are wondering whether there might be better opportunities elsewhere right now.
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