Paylocity Clocks Impressive Growth and Enjoys Robust Retention Despite Macro Headwinds 

Equity Analyst

Emma Williams

Paylocity's unified platform appeals to clients who prefer an all-in-one payroll and human capital management, or HCM, solution. Clients can customize through add-on modules, including talent management and benefits administration, alongside core payroll functionality, and integrate with over 400 third-party providers, including referral partners such as benefit brokers. A unique feature of Paylocity's platform is the complementary inclusion of communication and engagement tools, including social collaboration platform Community, and video, survey, and learning management tools. These features aim to drive higher employee engagement and satisfaction, benefiting the client as well as Paylocity by entrenching the software into the business. 

We expect Paylocity will continue to take market share through industry consolidation of the highly fragmented small-business payroll and HCM market, paired with rising demand for outsourced solutions amid an increasingly complex regulatory environment. Approximately 65% of the small-business market is serviced by regional providers or do it yourself solutions using software such as Intuit's Quickbooks or Microsoft Excel, creating meaningful scope for greater penetration

We anticipate Paylocity will be able to take greater share of wallet through increased uptake of modules. While Paylocity's average client size has remained stable at above 100 employees per client, average revenue per client has increased at a CAGR of 10% over the nine years to fiscal 2023 primarily due to greater module attachment rates. We expect Paylocity will continue to invest in software development and tuck in acquisitions to expand its portfolio of modules to meet changing client need. We forecast average revenue per client to increase at an annual average rate of 4% reflecting increased module uptake and minimal like-for-like price increases.

Business Strategy & Outlook

Paylocity has garnered a narrow economic moat underpinned by high customer switching costs. Paylocity also benefits from intangible assets including a referral network of primarily brokers and financial advisors who generate warm leads and a growing track record of performance. While dominant legacy providers ADP and Paychex have invested heavily over the past decade to remain competitive on functionality, Paylocity has capitalized on their shortfalls to capture share through the appeal of its nimble, unified, and user-friendly platform. Over the nine years to fiscal 2023, Paylocity's payroll and HCM client base grew at an average annual rate of 18% to about 36,300, relative to about 5% and 3% growth for ADP and Paychex, respectively. During the same period, revenue retention remained steady at around 92% despite fierce competitive pressures. While we expect Paylocity will need to maintain high levels of investment in software development and will face pricing pressure from an increasingly competitive operating environment, we are comfortable the company will be able to earn maintainable economic profits for at least the next 10 years. 

Paylocity holds a minority but fast-growing share of the United States small to midsize payroll and HCM market. We estimate 50% of its client base are in the highly fragmented 1 to 49 employees small business market, representing an estimated market share of less than 1%. This compares to the dominant providers Paychex and ADP who have an estimated small business market share of about 11% and 12%, respectively. We estimate the remaining share of clients are in the more concentrated 50-999 employees midsize market, representing an estimated market share of 7%. This compares with Paychex's and ADP's midsize market share of about 14% and 30%, respectively. Paylocity reports winning approximately 40% of their new business from ADP and Paychex, with the remainder from in house solutions, regional providers, new business formation and other competitors. 

As with payroll and HCM peers, Paylocity benefits from high customer switching costs. Payroll and HCM software is typically deeply embedded in a business' operations, making it a costly and time intensive process to switch providers. Alongside monetary costs, a business could face operational disruptions and inefficiencies including having to train employees on the new system, the integration of the new solution with other software, and the risk of losing data. Despite operating in a highly competitive environment, Paylocity’s revenue retention of around 92% implies an average client life span of about 12 years, assuming minimal price increases. We also estimate about half of Paylocity's client attrition is due to business failures in the small business market, meaning the remaining client life span is likely much greater. Over the long run, we expect Paylocity will continue to invest in software development and user experience to maintain customer satisfaction and high retention rates. Maintaining high customer retention rates allows Paylocity to earn a steady stream of recurring revenue at a low marginal cost. 

Paylocity offers a range of payroll and HCM solutions on its unified, cloud-based platform. The company has invested heavily to expand its portfolio of modules which includes talent and workforce management and benefits administration, alongside its core payroll solutions. Clients can customize their software through add-on modules and integrate to over 400 complementary third-party providers. A unique feature of Paylocity's platform is the inclusion of complimentary modern workforce solutions launched in fiscal 2020 which aim to drive employee engagement and higher client retention. These solutions include the social collaboration platform, Community, which in our view emulates Microsoft's Yammer, and video, survey and learning management capabilities. While we anticipate these features are not best of breed solutions, we expect they will appeal to smaller clients within Paylocity's target market who typically prefer all in one bundled software. We expect increased regulatory complexity and tight labor markets will underpin strong demand for HCM solutions and allow Paylocity to take greater share of wallet, driving higher realized PEPY growth. We also expect the same tailwinds will support a greater penetration of outsourced payroll and HCM solutions by small businesses, driving market share gains for Paylocity. 

We expect Paylocity's reputation for user friendly products, an established referral network and a track record of delivering reliable and compliant solutions over the past two decades is supporting their ability to win market share. Paylocity has established a powerful referral network of primarily benefit brokers and financial advisers who refer over 25% of new client revenue each year. Paylocity fosters this network by offering discounted services, data analytics and cross selling opportunities to network partners. While we expect legacy providers have stronger brand assets by virtue of their longer operating histories and larger scale, Paylocity is at an advantage to newer entrants who lack track records of performance. Payroll is a highly sensitive and mission critical operation for all businesses who place high value on reliability, accuracy, compliance and data security. We believe prospective clients will favor providers with a track record of performance given the potential ramifications for a business that fails to make payroll on time or accurately, is noncompliant with applicable laws or breaches data security could be severe.

Narrow

Economic Moat

Paylocity Hlds

Paylocity Holding Corp. engages in the development and provision of cloud-based software solutions. It offers cloud-based payroll, human capital management applications, time labor tracking, benefits administration, and talent management. The company was founded by Steve I. Sarowitz in 1997 and is headquartered in Schaumburg, IL.

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SCHAUMBURG, Ill., Dec. 01, 2023 (GLOBE NEWSWIRE) -- Paylocity (NASDAQ: PCTY), a leading provider of cloud-based HR and payroll software solutions, today announced the acquisition of TraceHQ.com, Inc. (“Trace”), an innovative solution for headcount planning, which helps organizations plan and manage their most important investment – their people.

Paylocity Announces Acquisition of Trace

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Paylocity Holding Corporation (NASDAQ:PCTY ) Q1 2024 Earnings Conference Call November 2, 2023 5:30 PM ET Company Participants Ryan Glenn - Chief Financial Officer Steve Beauchamp - Co-Chief Executive Officer Toby Williams - Co-Chief Executive Officer Conference Call Participants Scott Berg - Needham & Co. Brian Peterson - Raymond James Brad Reback - Stifel Bryan Bergin - TD Cowen Jared Levine - TD Cowen Mark Marcon - Baird Sheldon McMeans - Barclays Jason Celino - KeyBanc Capital Markets Alex Zukin - Wolfe Research Daniel Jester - BMO Capital Markets Adam Bergere - Bank of America Robert Simmons - D.A. Davidson Terry Tillman - Truist Pat Walravens - JMP Securities Operator Good day and welcome to the Paylocity Holding Corporation First Quarter 2024 Fiscal Year Results Conference Call.

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SCHAUMBURG, Ill., Oct. 09, 2023 (GLOBE NEWSWIRE) -- Paylocity (NASDAQ: PCTY), a leading provider of cloud-based HR and payroll software solutions, today announced the winners of its inaugural Elevate Awards, honoring forward-thinking HR teams that are solving business challenges through innovative use of technology.

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