Paylocity Holding Corp (PCTY) FY 2023 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The statements included herein that are not based solely on historical facts are “forward looking statements.” Such forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties. Our actual results could differ materially from those anticipated by us in these forward-looking statements as a result of various factors, including those discussed below and under Part I, Item 1A. “Risk Factors.”
The following discussion of our financial condition and results of operations covers fiscal 2023 and 2022 items and year-over-year comparisons between fiscal 2023 and 2022. Discussion of fiscal 2021 items and year-over-year comparisons between fiscal 2022 and 2021 that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended June 30, 2022 that was filed with the SEC on August 5, 2022.
Overview
We are a leading cloud-based provider of human capital management, or HCM, and payroll software solutions that deliver a comprehensive platform for the modern workforce. Our HCM and payroll platform offers an intuitive, easy-to-use product suite that helps businesses attract and retain talent, build culture and connection with their employees, and streamline and automate HR and payroll processes.
28
Table of Contents
Effective management of human capital is a core function in all organizations and requires a significant commitment of resources. Our cloud-based software solutions, combined with our unified database architecture, are highly flexible and configurable and feature a modern, intuitive user experience. Our platform offers automated data integration with hundreds of third-party partner systems, such as 401(k), benefits and insurance provider systems. We plan to continue to invest in research and development efforts that will allow us to offer a broader selection of products to new and existing clients focused on experiences that solve our clients’ challenges.
We believe there is a significant opportunity to grow our business by increasing our number of clients, and we intend to invest in our business to achieve this purpose. We market and sell our solutions through our direct sales force. We have increased our sales and marketing expenses as we have added sales representatives and related sales and marketing personnel. We intend to continue to grow our sales and marketing organization across new and existing geographic territories. In addition to growing our number of clients, we intend to grow our revenue over the long term by increasing the number of solutions that clients purchase from us. To do so, we must continue to enhance and grow the number of solutions we offer to advance our platform.
We also believe that delivering a positive service experience is an essential element of our ability to sell our solutions and retain our clients. We supplement our comprehensive software solutions with an integrated implementation and client service organization, all of which are designed to meet the needs of our clients and sales prospects. We expect to continue to invest in and grow our implementation and client service organization as our client base grows.
We will continue to invest across our entire organization as we continue to grow our business over the long term. These investments include increasing the number of personnel across all functional areas, along with improving our solutions and infrastructure to support our growth. The timing and amount of these investments vary based on the rate at which we add new clients and personnel and scale our application development and other activities. Many of these investments will occur in advance of experiencing any direct benefit from them, which will make it difficult to determine if we are effectively allocating our resources. We expect these investments to increase our costs on an absolute basis, but as we grow our number of clients and our related revenues, we anticipate that we will gain economies of scale and increased operating leverage. As a result, we expect our gross and operating margins will improve over the long term.
Paylocity Holding Corporation is a Delaware corporation, which was formed in November 2013. Our business operations are conducted by our wholly owned subsidiaries.
Key Metrics
We regularly review a number of metrics, including the following key metrics, to evaluate our business, measure our performance, identify trends affecting our business, formulate financial projections and make strategic decisions.
Revenue Growth
Our recurring revenue model and high annual revenue retention rates provide significant visibility into our future operating results and cash flow from operations. This visibility enables us to better manage and invest in our business. Total revenues increased from $635.6 million in fiscal 2021 to $852.7 million in fiscal 2022, representing a 34% year-over-year increase. Total revenues increased from $852.7 million in fiscal 2022 to $1,174.6 million in fiscal 2023, representing a 38% year-over-year increase. During fiscal 2023, total revenue growth was driven by the strong performance by our sales team, continued annual revenue retention in excess of 92%, increases in client workforce levels and growth in interest income on funds held for clients attributable to rising interest rates and higher average daily balances for funds held for clients due to the addition of new clients and increases in client workforce levels as compared to the prior fiscal year. Our revenue growth in future periods may be impacted by fluctuations in client employee counts, potential increases in client losses, a changing interest rate environment, uncertainties around market and economic conditions including inflation risk, among other factors.
29
Table of Contents
Client Count Growth
We believe there is a significant opportunity to grow our business by increasing our number of clients. Excluding clients acquired through acquisitions, we have increased the number of clients using our HCM and payroll software solutions from approximately 28,750 as of June 30, 2021 to approximately 36,200 as of June 30, 2023, representing a compound annual growth rate of approximately 12%. The table below sets forth the total number of clients using our HCM and payroll software solutions for the periods indicated, excluding clients acquired through acquisitions, rounded to the nearest fifty.
| June 30, | |||||||
|---|---|---|---|---|---|---|---|
| 2021 | 2022 | 2023 | |||||
| Client Count | 28,750 | 33,300 | 36,200 |
The rate at which we add clients is highly variable period-to-period and highly seasonal as many clients switch solutions during the first calendar quarter of each year. Although many clients have multiple divisions, segments or locations, we only count such clients once for these purposes.
Annual Revenue Retention Rate
Our annual revenue retention rate has been in excess of 92% during each of the past three fiscal years. We calculate our annual revenue retention rate as our total revenue for the preceding 12 months, less the annualized value of revenue lost during the preceding 12 months, divided by our total revenue for the preceding 12 months. We calculate the annualized value of revenue lost by summing the recurring fees paid by lost clients over the previous twelve months prior to their termination if they have been a client for a minimum of twelve months. For those lost clients who became clients within the last twelve months, we sum the recurring fees for the period that they have been a client and then annualize the amount. We exclude interest income on funds held for clients from the revenue retention calculation. We believe that our annual revenue retention rate is an important metric to measure overall client satisfaction and the general quality of our product and service offerings.
Adjusted Gross Profit and Adjusted EBITDA
We use Adjusted Gross Profit and Adjusted EBITDA to evaluate our operating results. We prepare Adjusted Gross Profit and Adjusted EBITDA to eliminate the impact of items we do not consider indicative of our ongoing operating performance. However, Adjusted Gross Profit and Adjusted EBITDA are not measurements of financial performance under generally accepted accounting principles in the United States, or GAAP, and these metrics may not be comparable to similarly titled measures of other companies.
We define Adjusted Gross Profit as gross profit before amortization of capitalized internal-use software costs and certain acquired intangibles and stock-based compensation expense and employer payroll taxes related to stock releases and option exercises. We define Adjusted EBITDA as net income before interest expense, income tax expense (benefit), depreciation and amortization expense, stock-based compensation expense and employer payroll taxes related to stock releases and option exercises, and other items as defined below.
We disclose Adjusted Gross Profit and Adjusted EBITDA, which are non-GAAP measures, because we believe these metrics assist investors and analysts in comparing our performance across reporting periods on a consistent basis by excluding items that we do not believe are indicative of our core operating performance. We believe these metrics are commonly used in the financial community to aid in comparisons of similar companies, and we present them to enhance investors’ understanding of our operating performance and cash flows.
Adjusted Gross Profit and Adjusted EBITDA have limitations as analytical tools. Some of these limitations include the following:
•Adjusted EBITDA does not reflect our ongoing or future requirements for capital expenditures;
•Adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs;
•Adjusted EBITDA does not reflect our income tax expense or the cash requirement to pay our taxes;
30
Table of Contents
•Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future, and Adjusted EBITDA does not reflect any cash requirements for such replacements; and
•Other companies in our industry may calculate Adjusted Gross Profit and Adjusted EBITDA differently than we do, limiting their usefulness as a comparative measure.
Additionally, stock-based compensation will continue to be an element of our overall compensation strategy, although we exclude it from Adjusted Gross Profit and Adjusted EBITDA as an expense when evaluating our ongoing operating performance for a particular period.
Because of these limitations, you should not consider Adjusted Gross Profit as an alternative to gross profit or Adjusted EBITDA as an alternative to net income or net cash provided by operating activities, in each case as determined in accordance with GAAP. We compensate for these limitations by relying primarily on our GAAP results, and we use Adjusted Gross Profit and Adjusted EBITDA only as supplemental information.
Directly comparable GAAP measures to Adjusted Gross Profit and Adjusted EBITDA are gross profit and net income, respectively. We reconcile Adjusted Gross Profit and Adjusted EBITDA as follows:
| Year Ended June 30, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2021 | 2022 | 2023 | ||||||
| (in thousands) | ||||||||
| Reconciliation from Gross Profit to Adjusted Gross Profit | ||||||||
| Gross profit | $ | 416,329 | $ | 565,649 | $ | 807,559 | ||
| Amortization of capitalized internal-use software costs | 23,227 | 25,267 | 31,440 | |||||
| Amortization of certain acquired intangibles | — | 1,853 | 7,414 | |||||
| Stock-based compensation expense and employer payroll taxes related to stock releases and option exercises | 8,348 | 12,610 | 18,446 | |||||
| Other items (1) | — | 121 | 19 | |||||
| Adjusted Gross Profit | $ | 447,904 | $ | 605,500 | $ | 864,878 |
| Year Ended June 30, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2021 | 2022 | 2023 | ||||||
| (in thousands) | ||||||||
| Reconciliation from Net income to Adjusted EBITDA | ||||||||
| Net income | $ | 70,819 | $ | 90,777 | $ | 140,822 | ||
| Interest expense | 1,002 | 498 | 752 | |||||
| Income tax expense (benefit) | (13,715) | (7,180) | 17,792 | |||||
| Depreciation and amortization expense | 42,972 | 50,218 | 60,866 | |||||
| EBITDA | 101,078 | 134,313 | 220,232 | |||||
| Stock-based compensation expense and employer payroll taxes related to stock releases and option exercises | 67,059 | 101,109 | 154,505 | |||||
| Other items (2) | 1,891 | 2,378 | 446 | |||||
| Adjusted EBITDA | $ | 170,028 | $ | 237,800 | $ | 375,183 |
(1) Represents acquisition-related costs.
(2) Represents acquisition and other nonrecurring transaction-related costs and lease exit activity.
31
Table of Contents
Basis of Presentation
Revenues
Recurring and Other Revenue
We derive the majority of our revenues from recurring fees attributable to our cloud-based HCM and payroll software solutions. Recurring fees for each client generally include a base fee in addition to a fee based on the number of client employees and the number of products a client uses. We also charge fees attributable to our preparation of W-2 documents and annual required filings on behalf of our clients. We charge implementation fees for professional services provided to implement our HCM and payroll solutions. Implementations of our payroll solutions typically require one to eight weeks, depending on the size and complexity of each client, at which point the new client’s payroll is first processed using our solution. We implement additional HCM products as requested by clients and leverage the data within our payroll solution to accelerate our implementation processes. Our average client size has continued to be over 140 employees.
While the majority of our agreements with clients are generally cancellable by the client on 60 days’ notice or less, we also have entered into term agreements, which are generally two years in length. Our agreements do not include general rights of return and do not provide clients with the right to take possession of the software supporting the services being provided. We recognize recurring fees in the period in which services are provided and the related performance obligations have been satisfied. We defer implementation fees related to our proprietary products over a period generally up to 24 months. Recurring and other revenue accounted for approximately 99%, 99% and 93% of our total revenues during the years ended June 30, 2021, 2022 and 2023, respectively.
Interest Income on Funds Held for Clients
We earn interest income on funds held for clients. We collect funds for employee payroll payments and related taxes in advance of remittance to employees and taxing authorities. Prior to remittance to employees and taxing authorities, we earn interest on these funds through demand deposit accounts with financial institutions with which we have automated clearing house, or ACH, arrangements. We also earn interest by investing a portion of funds held for clients in highly liquid, investment-grade marketable securities.
Cost of Revenues
Cost of revenues includes costs to provide our payroll and other HCM solutions which primarily consists of employee-related expenses, including wages, stock-based compensation, bonuses and benefits, relating to the provision of ongoing client support and implementation activities, payroll tax filing, distribution of printed checks and other materials as well as delivery costs, computing costs, amortization of certain acquired intangibles and bank fees associated with client fund transfers. Costs related to recurring support are generally expensed as incurred. Implementation costs related to our proprietary products are capitalized and amortized over a period of 7 years. Our cost of revenues is expected to increase in absolute dollars for the foreseeable future as we increase our client base. However, we expect to realize cost efficiencies over the long term as our business scales, resulting in improved operating leverage and increased margins.
We also capitalize a portion of our internal-use software costs, which are then primarily amortized as Cost of revenues. We amortized $23.2 million, $25.3 million and $31.4 million of capitalized internal-use software costs in fiscal 2021, 2022 and 2023, respectively.
Operating Expenses
Sales and Marketing
Sales and marketing expenses consist primarily of employee-related expenses for our direct sales and marketing staff, including wages, commissions, stock-based compensation, bonuses, benefits, marketing expenses and other related costs. Our sales personnel earn commissions and bonuses for attainment of certain performance criteria based upon new sales throughout the fiscal year. We capitalize certain selling and commission costs related to new contracts or purchases of additional services by our existing clients and amortize them over a period of 7 years.
32
Table of Contents
We will seek to grow our number of clients for the foreseeable future and therefore our sales and marketing expense is expected to continue to increase in absolute dollars as we grow our sales organization and expand our marketing activities.
Research and Development
Research and development expenses consist primarily of employee-related expenses for our research and development and product management staff, including wages, stock-based compensation, bonuses and benefits. Additional expenses include costs related to the development, maintenance, quality assurance and testing of new technologies and ongoing refinement of our existing solutions. Research and development expenses, other than internal-use software costs qualifying for capitalization, are expensed as incurred.
We capitalize a portion of our development costs related to internal-use software. The timing of our capitalized development projects may affect the amount of development costs expensed in any given period. The table below sets forth the amounts of capitalized and expensed research and development expenses for each of fiscal 2021, 2022 and 2023.
| Year Ended June 30, | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2022 | 2023 | ||||||||
| (in thousands) | ||||||||||
| Capitalized portion of research and development | $ | 31,744 | $ | 42,234 | $ | 55,582 | ||||
| Expensed portion of research and development | 76,707 | 102,908 | 163,994 | |||||||
| Total research and development | $ | 108,451 | $ | 145,142 | $ | 219,576 |
We expect to grow our research and development efforts as we continue to broaden our product offerings and extend our technological leadership by investing in the development of new technologies and introducing them to new and existing clients. We expect research and development expenses to continue to increase in absolute dollars but to vary as a percentage of total revenue on a period-to-period basis.
General and Administrative
General and administrative expenses consist primarily of employee-related costs, including wages, stock-based compensation, bonuses and benefits for our finance and accounting, legal, information systems, human resources and other administrative departments. Additional expenses include consulting and professional fees, occupancy costs, insurance and other corporate expenses. We expect our general and administrative expenses to continue to increase in absolute dollars as our company continues to grow.
Other Income (Expense)
Other income (expense) generally consists of interest income related to interest earned on our cash and cash equivalents and, if any, corporate investments, net of losses on disposals of property and equipment and interest expense related to our revolving credit facility.
33
Table of Contents
Results of Operations
The following table sets forth our statements of operations data for each of the periods indicated.
| Year Ended June 30, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2021 | 2022 | 2023 | ||||||
| (in thousands) | ||||||||
| Consolidated Statements of Operations Data: | ||||||||
| Revenues: | ||||||||
| Recurring and other revenue | $ | 631,725 | $ | 847,694 | $ | 1,098,036 | ||
| Interest income on funds held for clients | 3,902 | 4,957 | 76,562 | |||||
| Total revenues | 635,627 | 852,651 | 1,174,598 | |||||
| Cost of revenues | 219,298 | 287,002 | 367,039 | |||||
| Gross profit | 416,329 | 565,649 | 807,559 | |||||
| Operating expenses: | ||||||||
| Sales and marketing | 161,808 | 214,455 | 296,716 | |||||
| Research and development | 76,707 | 102,908 | 163,994 | |||||
| General and administrative | 119,771 | 163,692 | 191,823 | |||||
| Total operating expenses | 358,286 | 481,055 | 652,533 | |||||
| Operating income | 58,043 | 84,594 | 155,026 | |||||
| Other income (expense) | (939) | (997) | 3,588 | |||||
| Income before income taxes | 57,104 | 83,597 | 158,614 | |||||
| Income tax expense (benefit) | (13,715) | (7,180) | 17,792 | |||||
| Net income | $ | 70,819 | $ | 90,777 | $ | 140,822 |
The following table sets forth our statements of operations data as a percentage of total revenue for each of the periods indicated.
| Year Ended June 30, | ||||||
|---|---|---|---|---|---|---|
| 2021 | 2022 | 2023 | ||||
| Consolidated Statements of Operations Data: | ||||||
| Revenues: | ||||||
| Recurring and other revenue | 99% | 99% | 93% | |||
| Interest income on funds held for clients | 1% | 1% | 7% | |||
| Total revenues | 100% | 100% | 100% | |||
| Cost of revenues | 35% | 34% | 31% | |||
| Gross profit | 65% | 66% | 69% | |||
| Operating expenses: | ||||||
| Sales and marketing | 25% | 25% | 25% | |||
| Research and development | 12% | 12% | 14% | |||
| General and administrative | 19% | 19% | 16% | |||
| Total operating expenses | 56% | 56% | 55% | |||
| Operating income | 9% | 10% | 14% | |||
| Other income (expense) | 0% | 0% | 0% | |||
| Income before income taxes | 9% | 10% | 14% | |||
| Income tax expense (benefit) | (2)% | (1)% | 2 | % | ||
| Net income | 11% | 11% | 12% |
34
Table of Contents
Comparison of Fiscal Years Ended June 30, 2021, 2022 and 2023
Revenues
($ in thousands)
| Year Ended June 30, | Change from 2021 to 2022 | Change from 2022 to 2023 | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2022 | 2023 | $ | % | $ | % | ||||||||||||
| Recurring and other revenue | $ | 631,725 | $ | 847,694 | $ | 1,098,036 | $ | 215,969 | 34% | $ | 250,342 | 30% | ||||||
| Percentage of total revenues | 99 | % | 99 | % | 93 | % | ||||||||||||
| Interest income on funds held for clients | $ | 3,902 | $ | 4,957 | $ | 76,562 | $ | 1,055 | 27% | $ | 71,605 | 1,445% | ||||||
| Percentage of total revenues | 1 | % | 1 | % | 7 | % |
Recurring and Other Revenue
Recurring and other revenue for the year ended June 30, 2023 increased by $250.3 million, or 30%, to $1,098.0 million from $847.7 million for the year ended June 30, 2022. Recurring and other revenue increased primarily as a result of incremental revenues from new and existing clients due to the strong performance by our sales team, continued annual revenue retention in excess of 92% and also increases in client workforce levels as compared to the prior fiscal year. Excluding clients acquired through acquisitions, the number of clients using our HCM and payroll software solutions at June 30, 2023 increased by 9% to approximately 36,200 from approximately 33,300 at June 30, 2022.
Interest Income on Funds Held for Clients
Interest income on funds held for clients for the year ended June 30, 2023 increased by $71.6 million, or 1,445%, to $76.6 million from $5.0 million for the year ended June 30, 2022. Interest income on funds held for clients increased primarily due to higher interest rates and higher average daily balances for funds held due to the addition of new clients to our client base and also increases in client workforce levels as compared to the prior fiscal year.
Cost of Revenues
($ in thousands)
| Year Ended June 30, | Change from 2021 to 2022 | Change from 2022 to 2023 | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2022 | 2023 | $ | % | $ | % | ||||||||||||
| Cost of revenues | $ | 219,298 | $ | 287,002 | $ | 367,039 | $ | 67,704 | 31% | $ | 80,037 | 28% | ||||||
| Percentage of total revenues | 35% | 34% | 31% | |||||||||||||||
| Gross profit margin | 65% | 66% | 69% |
Cost of revenues for the year ended June 30, 2023 increased by $80.0 million, or 28%, to $367.0 million from $287.0 million for the year ended June 30, 2022. Cost of revenues increased primarily as a result of the continued growth of our business, in particular, $44.6 million in additional employee-related costs resulting from additional personnel necessary to provide services to new and existing clients, $18.3 million in delivery and other processing-related fees and $5.5 million of additional stock-based compensation costs associated with our equity incentive plan. Gross profit margin increased from 66% for the year ended June 30, 2022 to 69% for the year ended June 30, 2023, which was primarily driven by total revenue growth and improved operating leverage.
35
Table of Contents
Operating Expenses
($ in thousands)
Sales and Marketing
| Year Ended June 30, | Change from 2021 to 2022 | Change from 2022 to 2023 | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2022 | 2023 | $ | % | $ | % | ||||||||||||
| Sales and marketing | $ | 161,808 | $ | 214,455 | $ | 296,716 | $ | 52,647 | 33% | $ | 82,261 | 38% | ||||||
| Percentage of total revenues | 25% | 25% | 25% |
Sales and marketing expenses for the year ended June 30, 2023 increased by $82.3 million, or 38%, to $296.7 million from $214.5 million for the year ended June 30, 2022. The increase in sales and marketing expense was primarily due to $53.9 million of additional employee-related costs, including those incurred to expand our sales team. The increase was also driven by $15.1 million of additional stock-based compensation costs associated with our equity incentive plan and $8.1 million in additional marketing lead generation costs.
Research and Development
| Year Ended June 30, | Change from 2021 to 2022 | Change from 2022 to 2023 | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2022 | 2023 | $ | % | $ | % | ||||||||||||
| Research and development | $ | 76,707 | $ | 102,908 | $ | 163,994 | $ | 26,201 | 34% | $ | 61,086 | 59% | ||||||
| Percentage of total revenues | 12% | 12% | 14% |
Research and development expenses for the year ended June 30, 2023 increased by $61.1 million, or 59%, to $164.0 million from $102.9 million for the year ended June 30, 2022. The increase in research and development expenses was primarily due to $47.4 million of additional employee-related costs related to additional development personnel and $17.8 million of additional stock-based compensation costs associated with our equity incentive plan, partially offset by $9.1 million in higher period-over-period capitalized internal-use software costs.
General and Administrative
| Year Ended June 30, | Change from 2021 to 2022 | Change from 2022 to 2023 | ||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2022 | 2023 | $ | % | $ | % | ||||||||||||
| General and administrative | $ | 119,771 | $ | 163,692 | $ | 191,823 | $ | 43,921 | 37% | $ | 28,131 | 17% | ||||||
| Percentage of total revenues | 19% | 19% | 16% |
General and administrative expenses for the year ended June 30, 2023 increased by $28.1 million, or 17%, to $191.8 million from $163.7 million for the year ended June 30, 2022. The increase in general and administrative expenses was primarily due to $12.8 million of additional stock-based compensation costs associated with our equity incentive plan and $12.3 million in additional employee-related costs.
Other Income (Expense)
Other income (expense) for the year ended June 30, 2023 increased by $4.6 million as compared to the year ended June 30, 2022. The change in other income (expense) was primarily due to higher interest income earned on our cash and cash equivalents as a result of higher interest rates.
Income Tax Expense (Benefit)
Our effective tax rates were (8.6)% and 11.2% for the years ended June 30, 2022 and 2023, respectively. Our effective tax rates for the years ended June 30, 2022 and 2023 were lower than the federal statutory rate of 21% primarily due to benefits from stock-based compensation and research and development tax credits generated.
36
Table of Contents
See Note 14 of the Notes to Consolidated Financial Statements included in Part II, Item 8: “Financial Statements and Supplementary Data” of this Annual Report on Form 10-K for further details on the components of income tax and a reconciliation of the U.S. federal statutory rate to the effective tax rate.
Critical Accounting Policies and Significant Judgments and Estimates
In preparing our financial statements and accounting for the underlying transactions and balances in accordance with GAAP, we apply various accounting policies that require our management to make estimates, judgments and assumptions that affect the amounts reported in our financial statements. We consider the policies discussed below critical to understanding our financial statements, as their application places the most significant demands on management’s judgment. Management bases its estimates, judgments and assumptions on historical experience, current economic and industry conditions and on various other factors deemed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Because the use of estimates is an integral part of the financial reporting process, actual results could differ, and such differences could be material.
Revenue Recognition
We apply Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers (“Topic 606”), whereby we recognize revenue when we transfer control of goods or services to our customers in an amount that reflects the consideration to which we expect to be entitled to for those goods or services.
We derive our revenue from contracts with clients predominantly from recurring and non-recurring service fees. Recurring fees are derived from payroll and HR related services including time and attendance, HR and talent management and benefits enrollment and administration services. Payroll services are delivered on a weekly, biweekly, semi-monthly, or monthly basis depending upon the payroll frequency of the client and on an annual basis if a client selects W-2 preparation and processing services. HR related services are typically delivered on a monthly basis.
The majority of our recurring fees are satisfied over time as services are provided. The performance obligations related to payroll services are satisfied upon the processing of a client’s payroll with the fee charged and collected based on a per employee per payroll frequency fee. The performance obligations related to time and attendance services and HR related services are satisfied over time each month with the fee charged and collected based on a per employee per month fee. For subscription-based fees which can include payroll, time and attendance and HR related services, we recognize the applicable recurring fees over time each month with the fee charged and collected based on a per employee per month fee. We believe that the total fees charged to our clients is indicative of the standalone selling price as these fees are within the range of prices typically charged for our services to our clients. Even though our subscription-based services include multiple performance obligations, we do not believe it is meaningful to determine the standalone selling price for each service separately since these services are delivered and related revenue recognized within the same period.
We have certain optional performance obligations that are satisfied at a point in time including the sales of time clocks and W-2 preparation services.
Non-recurring service fees consist mainly of nonrefundable implementation fees, which involve setting up the client in, and loading data into, our cloud-based modules. These implementation activities are considered set-up activities. We have determined that the nonrefundable upfront fees provide certain clients with a material right to renew the contract. Implementation fees are deferred and amortized generally over a period up to 24 months.
Capitalized Internal-Use Software Costs
We apply ASC 350-40, Intangibles—Goodwill and Other—Internal-Use Software, to the accounting for costs of internal-use software. Software development costs are capitalized when module development begins, it is probable that the project will be completed, and the software will be used as intended. Costs associated with preliminary project stage activities, training, maintenance and all other post implementation stage activities are expensed as incurred. We also capitalize certain costs related to specific upgrades and enhancements when it is probable the expenditures will result in significant additional functionality. The capitalization policy provides for the capitalization of certain payroll costs for employees who are directly associated with developing internal-use software as well as certain external direct costs. Capitalized employee costs are limited to the time directly spent on such projects.
37
Table of Contents
Internal-use software is amortized on a straight-line basis, generally over a two- to three-year period while certain projects that support our main processing activities are amortized over ten years. We evaluate the useful lives of these assets on an annual basis and test for impairment whenever events or changes in circumstances occur that could impact the recoverability of these assets. There was no impairment to capitalized internal-use software during the years ended June 30, 2021, 2022 or 2023. We capitalized $31.7 million, $42.2 million and $55.6 million of internal-use software costs for the years ended June 30, 2021, 2022 and 2023, respectively, including stock-based compensation costs of $2.6 million, $7.1 million and $11.9 million for the years ended June 30, 2021, 2022 and 2023, respectively. We amortized $23.2 million, $25.3 million and $31.4 million of capitalized internal-use software costs for the years ended June 30, 2021, 2022 and 2023, respectively.
Business Combinations
We include the results of businesses acquired in our consolidated financial statements from the date of acquisition. We allocate the purchase price consideration associated with our acquisitions to the fair values of assets acquired and liabilities assumed at their respective acquisition dates, with the excess recorded to goodwill. The purchase price allocations require us to make significant judgments and estimates in determining such fair values, particularly related to intangible assets. Such estimates used in valuation methodologies can include, but are not limited to, forecasted revenue growth rates and cost projections, expected time and costs to rebuild developed technology, and discount rates. These estimates are inherently uncertain and may be refined over the measurement period. Adjustments to the fair values of assets acquired and liabilities assumed may be recorded during the measurement period, which may be up to one year from the acquisition date, with the corresponding offset to goodwill.
Liquidity and Capital Resources
Our primary liquidity needs are related to the funding of general business requirements, including working capital requirements, research and development, and capital expenditures. As of June 30, 2023, our principal sources of liquidity were $288.8 million of cash and cash equivalents. In July 2019, we entered into a five-year revolving credit agreement, which we amended in August 2022. The amended credit agreement provides for a $550.0 million revolving credit facility which may be increased up to $825.0 million. No amounts were drawn on the revolving credit facility as of June 30, 2023. In the fourth quarter of fiscal 2020, we borrowed $100.0 million under the original credit facility, which we repaid in the third quarter of fiscal 2021. In the third quarter of fiscal 2022, we borrowed $50.0 million in connection with our acquisition of Cloudsnap, Inc., which we repaid within the same quarter. Refer to Note 12 of the Notes to the Consolidated Financial Statements included in Part II, Item 8: “Financial Statements and Supplementary Data” for additional details on the credit agreement and borrowing activity.
We may invest portions of our excess cash and cash equivalents in highly liquid, investment-grade marketable securities. These investments may consist of commercial paper, corporate debt issuances, asset-backed debt securities, certificates of deposit, U.S. treasury securities, U.S. government agency securities and other securities with credit quality ratings of A-1 or higher. As of June 30, 2023, we did not have any corporate investments classified as available-for-sale securities.
In order to grow our business, we intend to increase our personnel and related expenses and to make significant investments in our platform, data centers and general infrastructure. The timing and amount of these investments will vary based on our financial condition, the rate at which we add new clients and new personnel and the scale of our module development, data centers and other activities. Many of these investments will occur in advance of experiencing any direct benefit from them, which could negatively impact our liquidity and cash flows during any particular period and may make it difficult to determine if we are effectively allocating our resources. However, we expect to fund our operations, capital expenditures, acquisitions and other investments principally with cash flows from operations, and to the extent that our liquidity needs exceed our cash from operations, we would look to our cash on hand or utilize the borrowing capacity under our credit facility to satisfy those needs.
Funds held for clients and client fund obligations will vary substantially from period to period as a result of the timing of payroll and tax obligations due. Our payroll processing activities involve the movement of significant funds from accounts of employers to employees and relevant taxing authorities. Though we debit a client’s account prior to any disbursement on its behalf, there is a delay between our payment of amounts due to employees and taxing and other regulatory authorities and when the incoming funds from the client to cover these amounts payable actually clear into our operating accounts. We currently have agreements with various major U.S. banks to execute ACH and wire transfers to
38
Table of Contents
support our client payroll and tax services. We believe we have sufficient capacity under these ACH arrangements to handle all transaction volumes for the foreseeable future. We primarily collect fees for our services via ACH transactions at the same time we debit the client’s account for payroll and tax obligations and thus are able to reduce collectability and accounts receivable risks.
We believe our current cash and cash equivalents, future cash flow from operations, and access to our credit facility will be sufficient to meet our ongoing working capital, capital expenditure and other liquidity requirements for at least the next 12 months, and thereafter, for the foreseeable future.
Cash Flows
The following table sets forth data regarding cash flows for the periods indicated:
| Year Ended June 30, | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2022 | 2023 | ||||||||
| Net cash provided by operating activities | $ | 124,850 | $ | 155,053 | $ | 282,723 | ||||
| Cash flows from investing activities: | ||||||||||
| Purchases of available-for-sale securities and other | — | (433,962) | (598,895) | |||||||
| Proceeds from sales and maturities of available-for-sale securities | 101,467 | 116,848 | 446,751 | |||||||
| Capitalized internal-use software costs | (28,594) | (34,515) | (45,004) | |||||||
| Purchases of property and equipment | (9,461) | (18,069) | (21,910) | |||||||
| Acquisitions of businesses, net of cash acquired | (14,992) | (107,576) | — | |||||||
| Other investing activities | — | (2,500) | (1,104) | |||||||
| Net cash provided by (used in) investing activities | 48,420 | (479,774) | (220,162) | |||||||
| Cash flows from financing activities: | ||||||||||
| Net change in client fund obligations | 432,373 | 2,228,038 | (1,362,421) | |||||||
| Borrowings under credit facility | — | 50,000 | — | |||||||
| Repayment of credit facility | (100,000) | (50,000) | — | |||||||
| Proceeds from exercise of stock options | 146 | — | — | |||||||
| Proceeds from employee stock purchase plan | 12,214 | 14,103 | 16,916 | |||||||
| Taxes paid related to net share settlement of equity awards | (64,191) | (69,761) | (88,312) | |||||||
| Payment of debt issuance costs | (64) | (87) | (885) | |||||||
| Net cash provided by (used in) financing activities | 280,478 | 2,172,293 | (1,434,702) | |||||||
| Net change in cash, cash equivalents and funds held for clients' cash and cash equivalents | $ | 453,748 | $ | 1,847,572 | $ | (1,372,141) |
Operating Activities
Net cash provided by operating activities was $124.9 million, $155.1 million and $282.7 million for the years ended June 30, 2021, 2022 and 2023, respectively.
The change in net cash provided by operating activities from fiscal 2022 to fiscal 2023 was primarily due to improved operating results after adjusting for non-cash items including stock-based compensation expense, depreciation and amortization expense and deferred income tax expense (benefit), partially offset by net changes in operating assets and liabilities during the year ended June 30, 2023 as compared to the year ended June 30, 2022.
39
Table of Contents
Investing Activities
Net cash provided by (used in) investing activities was $48.4 million, $(479.8) million and $(220.2) million, for the years ended June 30, 2021, 2022 and 2023, respectively. Net cash provided by (used in) investing activities is significantly impacted by the timing of purchases and sales and maturities of investments as we may invest a portion of our excess cash and cash equivalents and funds held for clients in highly liquid, investment-grade marketable securities. The amount of funds held for clients invested will vary based on timing of client funds collected and payments due to client employees and taxing and other regulatory authorities.
The change in net cash provided by (used in) investing activities from fiscal 2022 to fiscal 2023 was primarily due to an increase in proceeds from sales and maturities of available-for-sale securities of $329.9 million and a decrease of $107.6 million in amounts paid for acquisitions, net of cash acquired, partially offset by $164.9 in additional purchases of available-for-sale securities during the year ended June 30, 2023 as compared to the year ended June 30, 2022.
Financing Activities
Net cash provided by (used in) financing activities was $280.5 million, $2,172.3 million and $(1,434.7) million for the years ended June 30, 2021, 2022 and 2023, respectively. The change in net cash provided by (used in) financing activities was primarily the decrease in client fund obligations of $3,590.5 million due to the timing of client funds collected and related remittance of those funds to client employees and taxing authorities during the year ended June 30, 2023 as compared to the year ended June 30, 2022.
Capital Expenditures
We expect to continue to invest in capital spending as we continue to grow our business and expand and enhance our operating facilities, data centers and technical infrastructure. Future capital requirements will depend on many factors, including our rate of sales growth. In the event that our sales growth or other factors do not meet our expectations, we may eliminate or curtail capital projects in order to mitigate the impact on our use of cash. Capital expenditures were $9.5 million, $18.1 million and $21.9 million for the years ended June 30, 2021, 2022 and 2023, respectively, exclusive of capitalized internal-use software costs of $28.6 million, $34.5 million, and $45.0 million for the same periods, respectively.
Contractual Obligations
Our principal commitments consist of $81.3 million in operating lease obligations, of which $10.1 million is due in the next twelve months. Refer to Note 13 of the Notes to the Consolidated Financial Statements included in Part II, Item 8: “Financial Statements and Supplementary Data” for additional details on our lease activity. We also have $59.0 million in purchase obligations, of which $32.2 million is due in the next twelve months.
New Accounting Pronouncements
Refer to Note 2 of the Notes to the Consolidated Financial Statements included in Part II, Item 8: “Financial Statements and Supplementary Data” for a discussion of recently issued accounting standards.