Paylocity (NASDAQ:PCTY) Posts Better-Than-Expected Sales In Q3, Gross Margin Improves

Full Report / May 04, 2023
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Payroll and human resources software provider, Paylocity (NASDAQ:PCTY) beat analyst expectations in Q3 FY2023 quarter, with revenue up 38.2% year on year to $339.9 million. The company expects that next quarter's revenue would be around $301.2 million, which is the midpoint of the guidance range. That was roughly in line with analyst expectations. Paylocity made a GAAP profit of $57.6 million, improving on its profit of $34.8 million, in the same quarter last year.

Paylocity (PCTY) Q3 FY2023 Highlights:

  • Revenue: $339.9 million vs analyst estimates of $333.1 million (2.03% beat)
  • EPS (non-GAAP): $1.74 vs analyst estimates of $1.53 (13.5% beat)
  • Revenue guidance for Q4 2023 is $301.2 million at the midpoint, roughly in line with what analysts were expecting
  • Free cash flow of $123 million, up 108% from previous quarter
  • Gross Margin (GAAP): 71.8%, up from 69.3% 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).

Sales Growth

As you can see below, Paylocity's revenue growth has been very strong over the last two years, growing from quarterly revenue of $186.1 million in Q3 FY2021, to $339.9 million.

Paylocity Total Revenue

And unsurprisingly, this was another great quarter for Paylocity with revenue up 38.2% year on year. On top of that, revenue increased $66.8 million quarter on quarter, a very strong improvement on the $19.7 million increase in Q2 2023, and a sign of acceleration of growth.

Guidance for the next quarter indicates Paylocity is expecting revenue to grow 31.6% year on year to $301.2 million, slowing down from the 36.7% year-over-year increase in revenue the company had recorded in the same quarter last year. Ahead of the earnings results the analysts covering the company were estimating sales to grow 23.7% over the next twelve months.


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 71.8% in Q3.

Paylocity Gross Margin (GAAP)

That means that for every $1 in revenue the company had $0.72 left to spend on developing new products, marketing & sales and the general administrative overhead. Significantly up from the last quarter, this is around the lower average of what we typically see in SaaS businesses. Gross margin has a major impact on a company’s ability to invest in developing new products and sales & marketing, which may ultimately determine the winner in a competitive market so it is important to track.

Cash Is King

If you have followed 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 $123 million in Q3, up 66.9% year on year.

Paylocity Free Cash Flow

Paylocity has generated $232.1 million in free cash flow over the last twelve months, an impressive 21.2% of revenues. This extremely high FCF margin is a result of Paylocity asset lite business model and strong competitive positioning, and provides it the option to return capital to shareholders while still having plenty of cash to invest in the business.

Key Takeaways from Paylocity's Q3 Results

Sporting a market capitalization of $10.4 billion, more than $233.7 million in cash and with positive free cash flow over the last twelve months, we're confident that Paylocity has the resources it needs to pursue a high growth business strategy.

We were very impressed by the strong improvements in Paylocity’s free cash flow this quarter. And we were also excited to see that it outperformed analysts' revenue expectations. Overall, this quarter's results seemed pretty positive and shareholders can feel optimistic. But the market was likely expecting more and the company is down 3.08% on the results and currently trades at $178 per share.

Is Now The Time?

When considering Paylocity, investors should take into account its valuation and business qualities, as well as what happened in the latest quarter. We think Paylocity is a solid 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, and its bountiful generation of free cash flow empowers it to invest in growth initiatives.

The market is certainly expecting long term growth from Paylocity given its price to sales ratio based on the next twelve months is 7.7x. There are definitely things to like about Paylocity and looking at the tech landscape right now, it seems that it doesn't trade at an unreasonable price point.

The Wall St analysts covering the company had a one year price target of $264 per share right before these results, implying that they saw upside in buying Paylocity even in the short term.

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