PCTY - NASDAQ

Good day, and thank you for standing by. Welcome to Paylocity Holding Corporation's Second Quarter 2026 Financial Fiscal Year Results Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question and answer session. To ask a question during the session, you need to press star 11 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 11 again. Please be advised that this conference is being recorded. I would now like to hand the conference over to your speaker today, Ryan Glenn, Chief Financial Officer. Please go ahead.

Good afternoon, and welcome to Paylocity's earnings results call for the second quarter of fiscal 2026, which ended on December 31, 2025. I'm Ryan Glenn, Chief Financial Officer. 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. During the call today, we will use non-GAAP financial measures as defined in Regulation G. You can find the related reconciliations to GAAP in our press release, which is located on our website at paylocity.com under the Investor Relations tab. We will also make forward-looking statements. Actual events or results could differ materially from those projected in our forward-looking statements. Please refer to our press release and SEC filings, including our most recent 10-K, which contain important factors that could cause actual results to differ materially from the forward-looking statements. We do not undertake any duty to update any forward-looking statements. In regard to our upcoming conference schedule, we will be attending the Raymond James Annual Institutional Investors Conference and the Citizens Technology Conference. Let me know if you'd like to schedule time with us at either of these events. With that, let me turn the call over to Steve.

Thank you, Ryan, and thanks to all of you for joining us on our second quarter fiscal 2026 earnings call. Our strong results continued in Q2, with recurring and other revenue growth of 11% as our differentiated value proposition of providing the most modern software in the industry continues to resonate in the marketplace. Total revenue was $416.1 million, or 10% growth over Q2 of last year. Our multiyear investment in R&D and commitment to driving innovation continues to fuel our growth as the combination of HCM, finance, and IT in one single platform, all underpinned by our core employee record data, represents the broadest and deepest comprehensive offering in the marketplace. This dynamic continues to be highlighted by the growing adoption and utilization of products across our suite, including new HCM offerings such as reward and recognition. As the only provider with a native reward system that automates the taxation of rewards payments and allows for the cash redemption of rewards, reward and recognition continues to serve as a point of competitive differentiation in the market and a driver of improved employee engagement and efficiency for our clients. For example, during the calendar year-end, which is a popular time for companies to recognize employees, an existing client fully transitioned and automated their manual holiday reward program within our platform, successfully distributing gift cards to more than 750 employees located across multiple locations. Our expanded AI capabilities, which we have continued to embed across the platform, also contributed to our strong financial results and increased guidance, including the recent release of our policy and procedures agent, which enables clients to leverage their own internal documentation, such as employee handbooks and standard operating procedures, to provide employees with instant and accurate answers to questions around topics such as travel expense and sick leave policies. Additionally, we recently extended our AI assistant into HR rules and regulations, tapping into more than 200 IRS and Department of Labor knowledge sources to provide administrators with guidance on tax and labor regulations. Collectively, these new capabilities will help our clients simplify and automate employee support while also reducing risk and improving compliance outcomes. And we continue to see growing utilization of our AI capabilities, with the average monthly usage of our AI assistant increasing over 100% quarter over quarter. Our ongoing commitment to product innovation continues to be recognized by third parties as Paylocity was recently awarded the 2026 Buyer's Choice Award from Trust Radius, named a leader in 19 categories within the winter 2026 G2 Grid reports, and listed on Capterra's payroll shortlist. I would now like to pass the call to Toby to provide further color on the quarter.

Thanks, Steve. As Steve mentioned, the momentum seen in Q1 continued into the second quarter, contributing to a strong selling season performance and increased revenue and profitability guidance for fiscal 2026. Our results continue to be driven by the combination of strong sales, operational execution, and product differentiation, including the addition of new functionality to core products such as video candidate screening, self-service scheduling, and prescreening forms within our recruiting module. As a result of these new capabilities, we are helping our clients improve their hiring process, drive a higher degree of automation and efficiency within their business, and better stand out in an otherwise competitive hiring environment, as evidenced by an existing client with over 1,200 employees who has seen a roughly 50% reduction in their time to hire since adopting our new recruiting functionality. We also continue to be pleased with the consistency of our referral channel, which once again delivered more than 25% of our new business in Q2. The sustained success of our broker channel continues to be driven by our modern platform, 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, with the goal of continuing to deliver real value and true partnership and support to our referring brokers and their clients through enhanced capabilities such as our benefits guided setup. Through self-service and intuitive tooling, benefits guided setup allows brokers to directly build plans and rate structures and update rates on behalf of their clients directly within the Paylocity platform, enabling our partners to deliver a higher level of service to our mutual clients. We also saw another strong quarter of client retention, which helped contribute to our strong financial performance through fiscal 2026. As highlighted last quarter, in addition to embedding AI capabilities within our product suite, we are also investing in AI and broader automation efforts internally to help drive greater efficiency and productivity across our business. Specifically within the operations team, we continue to leverage AI to drive down client case volumes, automate client interactions and case routings, and perform sentiment analysis to flag urgent cases for faster response, and we remain committed to continuing to evaluate new opportunities to help deliver world-class service and partnership. Overall, we are pleased with our Q2 results and believe we are well-positioned heading into the back half of the year, as reflected in our increased guidance for fiscal 2026. Finally, this time 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. In addition to our market-leading financial performance, our strong culture at Paylocity continues to be recognized externally as we were recently recognized by Newsweek on America's Greatest Workplaces for Culture, Belonging, and Community 2026. I would now like to pass the call to Ryan to review the financial results in detail and provide our increased fiscal 2026 guidance.

Thanks, Toby. Q2 recurring and other revenue was $387 million, an increase of 11%, with total revenue of $416.1 million, up 10% from the same period last year. Our strong Q2 results were primarily driven by another solid quarter for our sales and operations team, allowing us to come in $8.1 million above the midpoint of our revenue guidance and allowing us to again raise our fiscal year guidance by more than our quarterly beat. Our adjusted gross profit was 74.4% for Q2, versus 73.8% in Q2 of last fiscal year, representing 60 basis points of leverage. Over the first six months of fiscal 2026, adjusted gross profit is up 80 basis points over the same period last year as we continue to focus on scaling our operational costs while maintaining industry-leading service levels. We continue to make significant investments in research and development, and to understand our overall investment in R&D, it is important to combine both what we expense and what we capitalize. On a dollar basis, our year-over-year investment in total R&D increased by 10% compared to 2025, and we remain focused on making investments in R&D throughout fiscal 2026 as we continue to build out the Paylocity platform to serve the needs of the modern workforce. In regard to our go-to-market activities, on a non-GAAP basis, sales and marketing expenses were 21.1% of revenue in the second quarter, and we remain focused on making investments in this area of the business in fiscal 2026 to drive continued growth. On a non-GAAP basis, G&A costs were 9% of revenue in the second quarter versus 9.8% in the same period last year, representing 80 basis points of leverage. Briefly covering our GAAP results for Q2, gross profit was $282.1 million, operating income was $70.4 million, and net income was $50.2 million. Our adjusted EBITDA for the second quarter was $142.7 million, or a 34.3% margin, and exceeded the top end of our guidance by $7.2 million, resulting in increased margin guidance for fiscal 2026. Excluding the impact of interest income on funds held for clients, adjusted EBITDA margin for Q2 was up 140 basis points over Q2 of last year, and we continue to be pleased with our ability to drive both durable recurring revenue growth and expanded profitability. We remain focused on driving leverage by improved operational scale and through improved efficiencies resulting from our ongoing investments in automation and AI across our business, which are helping us scale our team and providing the ability to focus on more strategic work. We're also pleased by our ability to drive expanded free cash flow through increased profitability and the benefits of recent tax legislation changes, including a 40% increase in cash provided by operating activities in the first six months of fiscal 2026, 26% growth in free cash flow over the last twelve months versus the comparative period, and a free cash flow margin of nearly 24% over the last twelve months as we execute against our recently increased financial targets. Additionally, given the confidence we have in our business and our strong cash flows, in Q2, we repurchased roughly 690,000 shares of our common stock at an average price of $144.86 per share, approximately $100 million in aggregate repurchases in the quarter. Fiscal year to date, we have repurchased over 1.8 million shares of common stock at an average price of $162.66 per share, approximately $300 million in aggregate repurchases, helping to drive our diluted shares outstanding down more than 2% as of the end of Q2. As a reminder, we have approximately $400 million remaining under our share repurchase program, which we anticipate continuing to opportunistically execute against going forward. In addition to our expectations for continued growth in adjusted EBITDA and free cash flow, the scale we are demonstrating in stock-based comp expense and the reduction in diluted shares outstanding will help drive continued expansion of earnings per share on an annual basis. Looking at the balance sheet, we ended the quarter with cash and cash equivalents of $162.5 million and $81.3 million in debt outstanding related to the funding of the Airbase acquisition. In regard to client-held funds and interest income, our average daily balance of client funds was approximately $3.2 billion in Q2. We're estimating the average daily balance will be approximately $3.7 billion in Q3, with an average annual yield of approximately 320 basis points, representing approximately $29.5 million of interest income in Q3. On a full-year basis, we are estimating the average daily balance will be approximately $3.3 billion with an average yield of approximately 340 basis points, representing approximately $112 million 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 each of March and April of this fiscal year. Finally, I'd like to provide our financial guidance for Q3 and full fiscal 2026. Note that as a result of continued momentum across both our sales and operations teams, we are increasing our fiscal 2026 recurring and other revenue guidance by $12.5 million and total revenue guidance by $14.5 million, which includes the full impact of our guidance being Q2 and a further increase in back half fiscal 2026 revenue guidance. Additionally, we continue to realize success driving increased profitability across our business, resulting in increased adjusted EBITDA guidance for fiscal 2026. With that said, for the third quarter of 2026, recurring and other revenue is expected to be in the range of $457.5 million to $462.5 million, or approximately 9% to 10% growth over Q3 2025 recurring and other revenue. Total revenue is expected to be in the range of $487 million to $492 million, or approximately 7% to 8% growth over third quarter fiscal 2025 total revenue. Adjusted EBITDA is expected to be in the range of $200 million to $204 million, and adjusted EBITDA excluding interest income on funds held for clients is expected to be in the range of $170.5 million to $174.5 million. For fiscal 2026, we are increasing all aspects of our guidance as follows: Recurring and other revenue guidance is now expected to be in the range of $1.62 billion to $1.63 billion, or approximately 10% to 11% growth over fiscal 2025 recurring and other revenue. Total revenue guidance is now expected to be in the range of $1.732 billion to $1.742 billion, or approximately 9% growth over fiscal 2025. Adjusted EBITDA is expected to be in the range of $622.5 million to $630.5 million, and adjusted EBITDA excluding interest income on funds held for clients is expected to be in the range of $510.5 million to $518.5 million. In conclusion, we are pleased with our Q2 results and the momentum we have across our sales and operations teams as we execute the busiest time of the year. The strong results we are seeing across HCM, finance, and IT solutions, combined with continuing to drive competitive differentiation and our AI strategy, give us confidence in our ability to drive sustainable, durable revenue growth and improve leverage across the business to achieve our updated long-term financial targets over the coming years. Operator, we're now ready for questions.

If your question has been answered and you wish to remove yourself from the queue, please press star 11 again. We'll pause for a moment while we compile our Q&A roster. Our first question comes from Daniel Jester with BMO Capital Markets. Your line is open.

I guess we'll start with the selling environment. I think the commentary was that it was pretty strong. I guess maybe double-click on that if you could, please. Maybe compare and contrast how you exited this year compared to last. And any pockets of strength or weaknesses you'd call out? Thanks.

Hey, Dan. Yeah. I'll start off. I mean, I think overall, I would characterize the selling season as strong this year. I think the go-to-market team performed really well, excuse me, across sales and marketing in our channel teams. And I think we saw a very stable demand environment. So I think similar commentary on the demand environment from last quarter carried through to this quarter. And I think our performance from a sales perspective through selling season was strong, and I think that's a good part of what allowed us to turn in the really strong results we did from a revenue growth and profitability perspective. And I think that's a lot of what carried into the raise of guidance for the rest of the year. I think on a relative basis to last year, to the other part of your question, I would characterize it as consistent and stable. And I think the performance of the team was really strong. So I think we were overall pretty happy with it.

Great. Thanks. And then maybe just a follow-up on maybe sort of a bit of an obligatory AI question. You know, I think you've commented a lot about how Paylocity is building tools and integrating AI into the platform. I guess, how are you seeing your customers engage with AI, and are you seeing any trends about maybe building some of this functionality business themselves? Appreciate the context, guys. Thank you much.

Yeah. I think I'll grab that one, Steve, here. What I would say is we have really been focused on embedding AI across the suite. You know, our value proposition is being the most modern platform. As we embed AI, the two use cases that we called out in the script, you know, policies and procedures, and allowing clients to be able to upload their own docs and answer employees' questions is certainly one of the big use cases that we've seen. We've seen a lot of interactions with our AI assistant with how do I do something? How do I accomplish this? Asking for data in the application. And so I think from our perspective, we will continue to build templated agents for our customers to be able to use. We'll give them some flexibility so that they can customize those for their use cases. And what we're seeing is really improved ease of use from our customer feedback. We're seeing more engagement in the platform, some more utilization. And then finally, it's really saving our customers time.

Great. Thank you so much.

One moment for our next question. Our next question comes from Brad Reback with Stifel. Your line is open.

Great. Steve, so on that last point, saving your customers' time, that's great. Can you talk about how you're translating that into revenue for Paylocity?

Yeah. So I think, as you know, Brad, one of the things about being in payroll and HR is we have the data in terms of being the system of record. So we know in real time when anything happens, whether somebody's getting a new job, new supervisor, new hires, terms, and many times, our customers then want to use those triggering events via our APIs and marketplace to be able to connect to other systems. I think as the client experience becomes more developed, we will see more, and we've already started seeing significantly more usage of our APIs tying our data to other really key workflows within an organization. That's number one. Number two is we're seeing people put more data and drive more utilization of our platform. So from a monetization perspective, it has an opportunity for us to sell more of our modules back to our clients. We're seeing more value. And they're able to customize more of that experience so that it's purpose-built to really deliver on their individual use cases. So I think from a client perspective, it's less about us driving them away from the personal interaction that we have. As you also know, our clients call us very frequently. They're looking for advice. You know, that relationship is really part of our strong retention, so we don't want to walk away from that. But we really want to be able to drive an easier-to-use experience and drive more utilization. When we do that, we get larger upsell. On top of the opportunity in marketplace and APIs. That's really where we see the near-term opportunity.

And on that upsell and the retention, is it still too early to have good metrics around new customers with high AI engagement spending 10 or 15% more than peers or retaining two or three points better?

I think it's a little early. I think you gotta go back to our average-sized customer, which is about 150 employees. And so this does happen on a gradual basis. And we have, though, seen in the past as we've really increased the number of modules that the customers who are using more of our modules typically have a stronger retention, typically are more satisfied, and we see AI as another tool to be able to drive that same outcome.

Awesome. Thank you very much.

One moment for our next question. Our next question comes from Terry Tillman with Truist Securities. Your line is open.

Yes. Hey, good afternoon. Nice job on the quarter. I've decided to abstain from asking an AI question. I was gonna ask two questions on kind of evolving products, which I'm very intrigued by. First, just an update on Airbase and just your play in the office of CFO and finance. And then secondly, I also wanted to ask what's developing and what you can share around your ability to help in the area of IT operations? Thank you.

Hey, Terry. It's Toby. I'll start and then, Steve, obviously, jump in. I mean, I think first on the Airbase update and all things in Paylocity for Finance, I think we continue to be pleased with the momentum we have there. We closed that acquisition last October, so we're just over a year or so into it. And I think we're really pleased with what we've seen so far. We delivered version one of the integrated product set in July, and I think that was an important factor from a differentiation standpoint as we came through selling season. So all across the spend management suite now is Paylocity for Finance. I think we are continuing to see lift there. We're continuing to get positive feedback from a client and prospect standpoint, and we're seeing, I think, a positive path as it relates to the attach and penetration and adoption and usage of those solutions. And then I would say we're in early days as it relates to all things IT-oriented, but I think we continue to see positive progress there from an attach standpoint and from a use case perspective there. And that's another one where, you know, I think you see Steve's comment in relation to the last question was very focused on our ability as the system of record to leverage the data that we have in our system to create automation against some really common use cases, whether that's onboarding or offboarding or system access or device management. I mean, I think all those things are triggered off of changes in the data that we see from a status perspective with respect to employees. And, you know, we continue to see a significant opportunity there to help create value for our clients from that product area.

That's great. Maybe just a quick follow-up on the cash flow, which was well above what we were looking for. Was there, and this maybe this is for Ryan, but anything timing there that may not reoccur in the second half of the year? Just anything more you can share on just the strong outperformance and comparing it to the second half?

Yeah. Hey, Terry. This is Ryan. No. I think, yeah, obviously, you can see cash flow movement quarter to quarter. But when we look at it on an LTM basis, we're at nearly 24% free cash flow margin, up 26%. So we continue to execute against the same playbook that we've had for a number of years, which is driving leverage both in gross margin and G&A. And then continue to invest both in R&D and in sales and marketing to drive future growth. So nothing that I would call out timing-wise. Obviously, there is some benefit from the recent tax legislation changes, but we are seeing a strong majority of that leverage and free cash flow coming from natural scale across the business.

Okay. Thanks.

One moment for our next question. Our next question comes from Mark Marcon with Robert W. Baird. Your line is open.

Good afternoon and thanks for taking my question. Wondering if you could talk just a little bit more about the selling environment. Obviously, the stocks have all gotten hit based on concerns around the impact of AI. Can you just talk a little bit about, like, from your client's perspective, the average client size is 150. I imagine they're not thinking anything close to about using, you know, any sort of new tools. But are you seeing any sort of hesitation in terms of slowing down either at the core part of the market or even at the enterprise side? And how would you judge your Salesforce productivity, you know, given some of the noise that's out there?

Yeah. So I think there's a few questions in that, Mark. I guess I would summarize it closer to where I started, which was selling season was strong. I think the team performed really well. I think we continue to be on a fairly consistent pace from a client growth perspective as we sit here halfway through the year, pretty consistent with last year. You know, and I think our ability to perform with the level of revenue growth that we showed in Q2 and our ability to raise the remainder of the year comes from the strong performance that we saw from new sales in the first half of the year. And I think the confidence that we have in our ability to perform across all segments throughout quarters three and four. And so I think, you know, you're right with an average client size around 150 employees, and Steve mentioned this a minute ago, I mean, I think we've seen just a relative level of stability in our client base, in the demand environment, in our team's ability to sell and bring on new units, and, you know, I think absent all of the concern around AI or any of that conversation, particularly in the last forty-eight hours. I mean, I think what we see is the continued really strong execution from both a sales and ops perspective as we've come through selling season performing really well. Driving, you know, 11 plus percent recurring revenue growth in the quarter. And I think performing really well from a retention perspective as well. I mean, our ops team performed very well in the context of getting through year-end and getting through January. So, I mean, overall, absent any other noise in the market, I think we sit here halfway through the year having put in a really strong performance in Q1 and Q2 with a lot of confidence around our ability to be successful in Q3 and Q4.

I would just add one thing, Mark, just add one thing to that is, and I know you've been in this industry a long time, there's a lot more conversation from prospects around our service levels, our ability to meet those customer needs, and not necessarily replace all the interaction from an AI perspective. Certainly, when we automate things for them, they love that. When we make it easier for them, that's great. And they want to make sure that, you know, we're really pursuing the right modern technology. But our service organization, as Toby called out, is a big reason why it was a driver. So unlike other software spaces, we've got a pretty big moat around the service component of what we do, whether that's implementation or ongoing service or taxes. And that is actually a much bigger conversation still today with prospects than AI, which is a conversation and is a growing conversation, but still a smaller part of the overall value proposition.

That's great. And then I was wondering if we could flip the AI in terms of advantages. And wondering if you can just talk a little bit about, like, how much more efficient I know it's early days, you know, Claude just came out a little while ago. But if we think about, like, when we think about your R&D efforts, are there any early thoughts there? And then in addition to that, with all the fears around AI, you know, are from a capital allocation perspective, are there some opportunities for M&A in terms of valuations becoming more reasonable that you're starting to explore to a greater degree? Thank you.

Yeah. On the first part, Mark, I mean, I guess I hear that from you as a question just around the efficiencies that we're able to drive in the business from the use of automation or AI. In areas like engineering. And we've talked about this a little bit before, but I guess I would start by saying, you know, going back to Ryan's comments with free cash flow up 26%, I mean, what you're seeing across the business is our ability to drive a level of continued productivity and efficiency increases across the business, and you see it show up in the free cash flow. And that comes from, you know, all kinds of different places. One of them is driving automation across the business, and part of that is utilizing AI in areas like engineering. But we're also using that from a broader operations perspective to help create a better, faster, more engaged client experience that is still driven by our service team. And so I think you know, that's part of the story that you're seeing play out. As it relates to our profitability increases in both adjusted EBITDA and free cash flow. So I think that's a significant part of the story.

And M&A?

Yeah. From a capital allocation standpoint, I mean, I think we have always been focused on looking for areas in M&A that would be able to drive our product roadmap faster, further, speed time to market with critical solutions that we think are really strategic. And I think that, you know, that opportunity continues to exist. We continue to focus on it. But I think our threshold for what makes sense for us has not changed. I mean, I think you see valuations sort of ebb and flow in any given quarter from a target perspective. But I think our threshold for being able to find solutions that make sense for our platform that will add value to clients and that we tightly integrate, those are still the things that we're focused on. And if we can find things that will add value and that will speed our time to market, then those are the things that we'll continue to be interested in.

Great. Thank you.

One moment for our next question. Our next question comes from Sitikantha Panigrahi with Mizuho. Your line is open.

Great. Thanks for taking my question. I just wanted to ask about employment levels. First, what did you see this quarter, I mean, in the December quarter? Employment levels, and what's baked into your guidance?

Hey, Citi. It's Ryan. Good to hear from you. A lot of stability in employment levels, very similar to what we called out in the overall demand environment. So we continue to see year-over-year workforce levels up modestly in Q2. Spot on to what we saw in the first quarter. So continue to watch and see those numbers on a weekly basis, but have seen a lot of stability and no real change. And that extends into January as well. We continue to have an assumption in the back half of the year of flat employment levels year over year, which would be a slight degradation from what we've seen in the first half of the year.

Okay. That's great. And then, at a broader high-level question on employment, we keep hearing from, you know, people around saying that how AI is going to disrupt in terms of employment. More layoffs coming. How do you what what's your view on that? How exposed or not exposed is Paylocity?

Well, I think just to give you a couple of thoughts. I mean, I think, you know, we don't have any specific vertical concentration. And I don't think we have any particular exposure given any concern that anybody might have about a particular vertical being disrupted. And I then go back to, you know, Ryan's commentary that he just shared around us seeing things be relatively stable, you know, despite any of the commentary that's out in the market. I mean, we've seen stability, and I think if you go back to the commentary most recently from any of the large providers, you'll hear the same thing. So, I mean, I think what we see in real-time is stability across the employees in the platform in our business, and I think that's what you hear from others as well.

Great. Thanks for the color.

One moment for our next question. Our next question comes from Scott Berg with Needham and Company. Your line is open.

Hi, everyone. Nice quarter, and thanks for taking my questions. I have two non-AI questions. I hope you're ready for them. The first one, I guess, is any commentary on win rates since you've had Paylocity for finance and asset management, IT asset management out in the market? I heard someone in the ecosystem tell me, you know, that they're seeing some at least chatter around it, that people have some interest in it and just don't know. And early, obviously, but didn't know if you're seeing any, you know, changes to your win rates based on having the availability of those modules.

Well, I think we've been going back to my prior comments. I mean, I think throughout the first half of the fiscal year, we've been really happy with how we performed overall from a go-to-market standpoint. I think we've seen a relative level of consistency in win rates. I do think, though, that there's a few things in the market, Scott, that are helping. It's just sometimes difficult to have perfect attribution as to, you know, what exactly those things are contributing and how much, but I think they're all positive. So, you know, I think the differentiation that we're able to create through things like Paylocity for finance, I think that is in the helpful column. And I also think it from an incremental ARPU standpoint. I would say the same thing with respect to our IT solutions. I think it's helpful from a differentiation perspective. Also helpful for ARPU. In pretty early days for each of those. And then I think the other thing that we've seen momentum on is our relationship with brokers, which has always been strong, but I think we continue to see momentum with the broker channel. And so I think all of those things are positive in addition to just the overall value prop of the platform. And the execution from our teams, I think, was really strong in the quarter. So there's a lot of positive there against a fairly stable demand environment. It's tough sometimes to create perfect attribution on those things. But I think that's the overall picture.

Fair enough. Thanks, Toby. I guess from a follow-up perspective, now that we've kind of seen what the impact of the tax law changes were on the business in the last quarter, which I assume had some maybe catch-up for the year a little bit, was there any debate or any conversation around maybe taking some of those cash flows and trying to invest that in other aspects of the business versus just, you know, harvesting them? I know it's accounting treatment and timing and etcetera, but you guys already generate plenty of cash, so my guess is, you know, probably there wasn't a lot of thought there. But I didn't know if there's anything that you thought of that you could maybe, you know, spend on that would be worthwhile in the short term.

Yeah. I mean, I think, you know, just echoing Ryan's commentary with free cash flow being up 26%. I mean, I think we're really happy with how we've been performing in driving that type of free cash flow leverage. I don't think, though, that that is coming at the expense of the things that we think we can and should invest in across the business to create better client experiences and to drive future growth. So, you know, I think we're really happy with what we've been able to both drive down into free cash flow, but while also investing in the things that we need to and want to and think that there's great opportunity around the course of the full year. And I think that includes, you know, a lot of things we talk about, new product development focus in our product and tech teams, a lot of things within the existing core of the solution. So I think overall, you know, pretty excited about the investments that we're making across the business not coming at the expense of also driving free cash flow.

Excellent. Thanks for taking my questions.

Yep.

One moment for our next question. Our next question comes from Samad Samana with Jefferies. Your line is open.

Hi, good evening, and thanks for taking my questions. I guess one that I wanted to ask about is if you think about customers in a more muted hiring environment, presumably, they're hiring less and or there's less people to hire. What are they focused on? Like, where are they either redirecting within the HR tech budget and or are they redirecting that HR tech budget somewhere else? And then I have a follow-up question.

Yeah. I mean, I think we've seen going back to Ryan's commentary. I think we've seen a relative level of stability across the market from an employees on the platform perspective. And I think the clients that we're serving today and that we're talking to from a prospect perspective are focused on, again, going back to the fact that we have an average client size around 150 employees, they find significant value in a single vendor providing a broad swath of solutions on the platform. And echoing some of Steve's comments earlier, they derive a lot of value by the actual service that we're offering, particularly as we come through this time of year. So December is certainly a high point from a client service interaction perspective. And you have a huge amount of volume coming through the system in January with new business coming out of the platform. So I think I don't think there's a significant shift in terms of the value prop that clients in the core of our market are looking for. They're looking for a partner they can trust. They're looking for breadth of solution and a platform that will serve their needs and is purpose-built for their use cases. And I think we're continuing to deliver all of those things and focused on driving a level of automation and productivity and efficiency and usability to them that I think they value more and more by the day. So I think that's probably how I would characterize the overall state of engagement with clients.

Understood. And maybe just for follow-up in a different direction. Just as I think about the pricing environment, we've seen, you know, with different software vendors either raising prices, especially over the last couple of years. I know price increases are just a normal course of business, but how are you seeing customer reaction on renewal to either increases and or reduction of discounts? Any change in behavior versus prior renewal cycles, and anything that we can extrapolate from that?

No. I don't think we've seen any change there whatsoever. I mean, it's been very, very stable from that perspective. Although, we typically look at price in the springtime as we did last spring and as we will again this spring, and from the time that we would have looked at it last spring, I don't think we've seen any meaningful change.

Great. Appreciate the time as always.

Thank you.

One moment for our next question. Our next question comes from Brian Peterson with Raymond James. Your line is open.

Hi. Thanks for taking the question. This is John Messina on for Brian. Maybe a follow-up to Terry Tillman's question earlier. As you look to deepen the penetration of finance and IT over time, what are the key execution milestones we should look for over the next eighteen to twenty-four months to measure success there? And how are sales cycles for those products either landing or expanding versus the traditional HCM modules? And then I have a quick follow-up.

Yeah. I think so taking that apart, I mean, I think when we're talking about the addition of those solutions to new clients that are coming out of the platform, the sales cycles are right in line with what we would have typically seen from our average client size. I mean, that could be in the, you know, thirty to forty-five day window for the heart of our market, and go-live times in the, you know, four to six-week time frame or something in that

It was just on measuring success from the outside there on the penetration rate of those products across the base.

Yeah. I mean, I think from a what we've always described as targets for new clients or new products being launched is if you can get into that 10 to 20% penetration rate over a, you know, three, four, five-year period of time, and I don't think it's any different from those. I think we're on track to get to those milestones with each one of those products or product areas. And so I think we're really pleased with the traction that we're seeing in the path that we're on. And I think what you see play out overall over time is our ability to continue to win new deals and continue to grow our client base in a fairly consistent fashion year to year while also continuing to drive ARPU. So I think those are overall the results that we've been really targeted on.

Okay. Thanks. That really helpful color there. And then with the announced consolidation in the industry, just can you share any impact the consolidation is having on pipeline, win rates, or go-to-market efficiency? The execution seems really good. Just trying to get at what extent you're maybe benefiting as competitors are navigating that M&A activity. Thanks.

Yeah. I mean, again, some of the attribution is challenging probably, but I think overall, the execution, you know, I appreciate your comment. Yeah. I think the execution has been very good across both our sales and ops teams in particular. And I think, you know, we see momentum in the business coming through selling season. And, you know, I think January, the same thing. I mean, we saw momentum with new deals coming out of the platform. So, you know, overall, I think the business has executed well. I think our go-to-market and ops teams have executed well. And, you know, I think overall, that's what we're really focused on to the extent that there's disruption in the market because of, you know, one company or another going through an M&A transaction. And yeah, I think we stand ready to perform for our clients and perform for the prospects that we're bringing on the platform. And I think if we can maintain that focus, if the case that others lose theirs, we'll be well-positioned to take advantage of that. So, you know, overall, just happy with the level of focus and the execution that we had in the quarter and year to date.

Thank you.

One moment for our next question. Our next question comes from Jared Levine with TD Cowen. Your line is open.

Hello. Thanks. To start here, can you talk about Airbase upsell progress year to date versus expectations and your expectations for the second half of the year here?

Yeah. I think they're right on pace with our expectations. Both through the first half of the fiscal year and from what we can see for the back half. So, I mean, just commented on that a few minutes ago. I think overall, pretty happy with the progress that we've made. Yep. The one of the integrated solution was launched in July, so not all that long ago, but I think we're pretty pleased with what we've seen. And believe that overall, I mean, it's a story that helps with differentiation, believe that that's a meaningful area of differentiation for prospects that we're pitching. And I think it's been part of the reason that we've had such a successful first half of the fiscal year.

Got it. And then, Ryan, for follow-up here, in terms of the adjusted EBITDA guide, you didn't pass through all the 2Q beat here. Anything to call out in terms of timing? Because I think there was a similar dynamic with 1Q. There was some timing call out in terms of not passing through all the beat with the prior print, but just with this print, what would you call out here?

Yeah. I mean, I think, you know, as we set up the year on the August earnings call, I think the context we provided is if you look back to the last twenty-four months specific to adjusted EBITDA, we have driven several hundred basis points of leverage. Definitely ahead of where we would have expected to be and have been really happy with those results. And as we guided in August and have now updated in November, and here in February, we have increased margin each quarter. But the bias, I think, is to continue to drive some reinvestment back into the business. So you're seeing us reinvest some of those dollars back into R&D, back into sales and marketing because as you've heard on the call, we feel really good about the progress in each of those teams, and we want to reinvest in upside that will drive continued growth in the back half of this year and on to '27. So I think that's the context and that is how we're operating this year. Obviously, you are seeing outsized performance from a free cash flow standpoint as we've talked about. So that is not something that we have historically guided to, but when you think about free cash flow specifically in the updated target of 25% to 30% free cash flow margin against a TTM number of 24%. We are quickly moving to the high end of the prior range and not too far away from the updated range. So continue to believe, like, we have the ability to balance reinvestment but also continue to take margins up on a multiyear basis.

Great. Thank you.

One moment for our next question. Our next question comes from Raimo Lenschow with Barclays. Your line is open.

Hi. This is Sheldon McMeans on for Raimo. Thanks for taking the question, and I just have one here. The perceived AI risk in the market has been brought up times on the call, and as you mentioned, things are relatively stable for you. However, we're seeing announcements from AI companies that are moving software stock significantly. And to that point, can you speak a little bit more to some of the specific ideas on why AI advancements are not as big of a risk for your company compared to what, you know, maybe some of the recent price action may suggest? And you talked about the moat on your service org and, you know, are there a couple of other areas you could point out to? For example, the banking relationships and payment rails are not you can't vibe code something like that. Payroll companies need a certain scale on the from a balance sheet perspective on the float side or that simply, you know, just throwing a bunch of expensive GPUs at a payroll run just isn't efficient and doesn't make sense. And, yeah, as I mentioned, you touched upon this already, but I think we need some more handholding here. Thank you.

Sure. So I think you hit some of the points. I think let me start with I think AI can certainly improve our client experience in a number of ways, make the software easier to navigate, make the data more accessible, provide additional use cases, where we have an opportunity to be able to expand our footprint and drive ARPU. All those things, I think, are opportunities in front of us. I think on the concept that some company is going to quickly kind of build a replacement product, there's challenges to that. And so you mentioned one. Is a lot of interaction with the customer. And so they call us. We email interaction. There's projects that we do on their behalf. Implementation is largely a handheld process where we lose money on implementation, right, to be able to bring the customer on board, which is well worth it when we think of how long we retain them for. So the service is absolutely an element. The other thing is there we interface with thousands of agencies on the back end. From a tax filing perspective. So local agencies, state, federal agencies, those formats change. The rules change. You're constantly changing your engine. Those are all deterministic calculations. They're not something that you can do and be probably right, and they require a fair amount of investment in testing. And so another example of where AI, at least today, is really not necessarily suited to be able to solve that problem most efficiently. And then you even got into a little bit of the capital structure behind it. To do that, you know, with an AI model and to be able to make the capital investments, it's much easier to be able to have deterministic algorithms to get you to that answer. And so as we think of this in a layered approach, the service capability that we have, the fact that, you know, we've got the data from a system of record perspective that allows us to continually expand our use cases, AI making those even better. And then the fact that we're moving, you know, billions of dollars through banks and to thousands of tax agencies across the country. We believe all are natural moats that, you know, we have and certainly many of our competitors have. And, again, I'll just end with, we see AI as a big opportunity. We certainly see an opportunity to be able to drive utilization, make our products easier to use, even integrate broader use cases into other applications. And so we're excited about that opportunity. And we certainly understand the nature of the question, but I think there's more complexity behind the scenes than in our business.

Very clear. Thank you.

One moment for our next question. Our next question comes from Patrick Walravens with Citizens. Your line is open.

This is Austin Cole on for Pat. A lot of questions here have been asked. I want to ask two on the new offerings in HCM, maybe, rewards and recognitions, and some of the other offerings there. What was kind of the upsell motion, how has that performed recently? And what's the opportunity around some of those new offerings?

Yeah. I think Toby summarized it, I think, best. If you look at our historical formula and average revenue per customer growth versus unit growth, you know, those have moved a little bit year by year. But we've been fairly consistent on a year-over-year basis where unit growth is. And so you can see we're getting broader product adoption across the board that's really driving that incremental difference in terms of, you know, our unit growth versus our overall revenue growth. And I would not call out a singular product. I think to be able to move the needle at our size and scale, you know, our goal, you know, we want to get to 10 or 20% penetration for early products, things like reward and recognition. Then we want to move that to 30-40%. And then you've got products in our portfolio where we're seeing 70-80% adoption. And for those products, we think about what's the opportunity to be able to potentially add, you know, plus offerings or get more value from product enhancements that allow us to be able to continue to increase that average revenue per customer from those modules. So we see a ton of opportunity within the HCM category. Those continue to be probably because they're generally bigger and been around longer, the bigger driver today. And then you've got earlier in that product portfolio, things like IT and finance. Still being relatively small, but off to a really good start. And so I think we're really happy with seeing our product strategy resonate in the market and see the adoption across our client base.

Great. And then just as a quick follow-up, there was a comment made about the AI assistant monthly usage increasing 100% quarter over quarter. How should we think about that metric and maybe how it compares to your guys' expectations and that going forward and as a catalyst for some of that upsell as well?

Yeah. So, you know, our strategy is to continue to embed AI across the suite, really adding additional use cases, increasing flexibility, and making the assistant, you know, more powerful over time. So, certainly, part of that utilization is the features that we've added. We talked about, you know, the policies and procedures. We talked about third-party content with the best department of labor, IRS, or state websites. And really helping our clients not only answer their questions but in many cases, save them time by answering a bunch of their employee questions. And so that's been really positive. We see an opportunity to continue investing in AI, adding additional use cases, and really driving agents' experiences that are going to really embed multistep processes into single clicks that's going to be able to drive insights and anticipate what their next steps are going to be. All of which is part of our goal, which is to be able to save our customers time so that they can, you know, really spend time with people, versus spend time on administrative tasks. And so, we're really, really happy with where we are, how that's really resonated with our customers, and we would anticipate that, you know, that single kind of text box interaction that you see in AI assistant is going to allow customers to do an increasing number of things over time.

Great. Thank you.

One moment for our next question. Our next question comes from Jason Celino with KeyBanc Capital Markets. Your line is open.

Great. Thanks for taking my questions. This is

No. We haven't seen that at all. I think we've seen a huge amount of consistency from a go-to-market standpoint. And new business being brought in during selling season and really happy with the performance that we've seen there. And I wouldn't call out any difference that we've seen from that standpoint.

Okay. Great. Good to hear. And secondly, I believe last year, second quarter, you noted seeing a little bit of pull forward. Did that dynamic reoccur this quarter? Is there anything that might have pushed or pulled out of the quarter?

No. I don't think we saw anything this quarter. And what we mentioned last year was extraordinarily small, which we noted at the time.

Great. Appreciate it. Thank you.

One moment for our next question. Our next question comes from Steve Enders with Citi. Your line is open.

Alright. Great. Thanks for taking the questions here. I guess just to start, sounds like you had a good strong selling season. I guess, are you seeing kind of in the forward pipeline? And maybe how are kind of the new appointment requests or kind of the other forward-leading indicators kind of looking for pipeline development?

Yeah. I think they've been really stable. So, I mean, I think, you know, going back to prior comments, I mean, really, really happy with the team's execution from a go-to-market sales perspective in Q1, and through selling season. I think we've seen the demand environment maintain as stable. And, you know, there's nothing that I would really call out in terms of changes there. And I think that's also so I think that that is a big part of what allowed us to overperform relative to expectations for both Q2 and the first half. And I think that's also what gives us the confidence to carry that through from a raise perspective on the year. And, you know, I think to your question on activity and pipelining, I mean, I think that's that that is all our confidence in that carrying forward from selling season is also what gives us the ability to take the year up. So I think we feel pretty good in that respect.

Okay. Great. And then, just on the broker channel side of it, I guess, have you seen kind of any changes in terms of the, you know, the number of opportunities or maybe the share of opportunities that you've been able to capture within that channel? And then how do the new solutions and capabilities that you're releasing here to the broker side impact how you're thinking about that kind of go-forward opportunity and, I guess, how it could change the number of opportunities coming from the brokers?

Yeah. I mean, I think we've always had a great relationship from a broker standpoint with that channel. It's consistently been more than 25% of our new business referred from that channel, and that continued through the course of I think we've had the first half of the year and through selling season in Q2. Just, you know, directionally, I think we've had great momentum over the last year with the brokers in particular, and I think there's been some disruption from a market perspective with certain other competitors that have played in that space before. But I think we've taken we've gotten the benefit of some of that. I think we have great momentum. And, you know, I think part of that is our execution and focus and value-added delivery to that channel, and part of that is also focused there from a product perspective. So benefit guided setup is a product that we've launched, and I think that that is certainly one that accrues to the benefit of brokers being able to give more help and service to their clients. So I think we continue to focus on that channel in every respect, whether it's from a go-to-market standpoint, from a service standpoint, being able to partner with them and service their clients, and from a product perspective, launching new products that are not just useful to clients, but also helpful to the brokers.

Okay. Awesome. Thanks for taking the questions here.

Yep.

One moment for our next question. Our next question comes from Matt Van Vliet with Cantor. Your line is open.

Yes, good afternoon. Thanks for taking the question. Just looking towards the rest of the year and even into fiscal 2027, curious where you feel you are from a sales capacity and overall market coverage, especially with the addition of Paylocity for finance and IT there and kind of how you think you can continue to meet the demand in the market?

Yeah. I think overall, we feel pretty good about our coverage. I mean, I think as we've said for probably the last eighteen months or so, we've been really focused on making sure that we have that we have adequate coverage across the opportunity set, but also that we're continuing to focus on driving productivity across those teams. And I think we're really happy with what we've seen so far this fiscal year from a sales productivity standpoint. And I think that's, you know, also a big part of what helped us perform well in Q2 and through selling season, and that's also a big part of, I think, what gives us confidence to take the year up for, you know, quarters three and four as we're looking ahead. I feel pretty good with where we sit today in terms of go-to-market investment and the productivity that we're seeing from those teams.

And then a quick follow-up on the broker channel. You've obviously seen better momentum there and you highlighted some disruption from competitors. But in terms of resource allocation, you know, is there still more to be done in terms of total broker coverage, or is it now just, you know, kind of leaning into those that have greater, I guess, success of selling through Paylocity and how you do that, you know, kind of how you leverage that relationship there. And within that, have win rates gone up at all given some of that disruption in the market?

Well, I think from an execution standpoint, it's all of the above. I mean, it's always been an important part of our selling motion. It's and it's an important part of the selling motion in the field with our reps. And building those relationships at the ground level, also managing them from a corporate perspective. But a lot of that work is in a lot of the partnership and a lot of that success is driven in the field with and through our reps. And I think it is just it is continuing to drive that focus from an execution standpoint. It's continuing to invest in the things that the brokers find the most value in. That's in part the relationship in the field. That is in part the service that we provide to our mutual clients, and the clients they refer to us. And it's in part being a good partner to them as clients go through implementation and service. And it's continuing to also drive the delivery of a platform and a solution set, including new product launches like benefit guided setup that add value to them and give them the ability to add more value to their clients. So it is it's all of the above.

Alright. Great. Thank you.

One moment for our next question. Our next question comes from Jacob Smith with Guggenheim Securities. Your line is open.

Hey, thanks for taking my question. Retention has been consistently around 92% over the past couple of years. As you look at the elements from cross-selling Paylocity for finance, expanding IT offerings, getting greater AI adoption across the platform, how do you see that retention rate evolving over the next two years? Is there a structural reason it should move higher as customers become more embedded across HCM finance and IT, or are there any offsetting factors we should be mindful of? And maybe related to that too, are you seeing any early evidence that customers who adopt multiple modules have different churn characteristics than single product customers? Thanks.

Yeah. Our retention rate has been north of 92% for over a decade. And I think, you know, we are very, very happy with being able to maintain that level of client retention. You know, huge shout out to our operations and service teams that work really hard to maintain those relationships with our clients and partner with them. And particularly coming through this time of year when December, January is the biggest two months that we have for client engagement and client interaction. So I think overall, our belief has been and has played out that the more value that you can add to clients, whether that's through the adoption of a broader part of the platform, and coupled with our service model and our service teams, you know, that's the recipe for success. And I think that's a large part of the reason we've been able to maintain those retention rates for such a long period of time. And I think that's, you know, that is a reflection of the value that's added from an overall platform and service perspective. So, you know, really pleased with our ability to maintain those levels over a long period of time.

Great. Thanks.

And I'm not showing any further questions at this time. I turn the call back to management for any further remarks.

Well, thank you very much. I really appreciate everybody joining the call and your interest in Paylocity. And I want to send a special shout out to all of our teams and all of our employees helping our clients through year-end and onboarding in January. Great job. Very much appreciate all the effort, and I hope everybody has a great night. Thank you.