Paycom Software Inc (PAYC) — Q3 2015 Earnings Call Transcript

Thank you, and good afternoon. Before we get started, I would like to note that certain statements made during this conference call that are not historical facts, including those regarding our future plans, objectives and expected performance are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements represent our outlook only as of the date of this conference call. While we believe any forward-looking statements we have made are reasonable, actual results could differ materially because of statements are based on our current expectations and are subject to risks and uncertainties. These risks and uncertainties are discussed in our Annual Report on Form 10-K that was filed with the Securities and Exchange Commission on February 26, 2015, and as maybe supplemented by subsequent Form 10-Q filings. You should refer to these factors when relying on such forward-looking information. We do not undertake and expressly disclaim any obligation to update or alter our forward-looking statements, whether as a result of new information, future events or otherwise except as required by applicable law. Also, during the course of today’s call, we will refer to certain non-GAAP financial measures. A reconciliation schedule showing GAAP versus non-GAAP results is included in the press release that we issued after the close of the market today, which is available on our website at investors.paycom.com. I will now turn the call over to Chad Richison, Paycom’s President and Chief Executive Officer.

Thanks, Craig, and thank you to everyone joining us on today’s call. As with our prior quarters, I’ll provide some high-level comments regarding our performance and perspective on the marketplace and also share some examples of customer wins we achieved during the third quarter of 2015. Craig will then provide a deeper look at our financials and finally we will open up the line for questions. So let’s get started. As you may have read in our press release earlier today, Paycom enjoyed continued momentum in the third quarter of 2015. Our revenue for the third quarter of 2015 was $55.3 million, representing growth of 51% compared to the comparable prior year period. Annualized new recurring revenue or ANRR was $31.8 million, representing growth of 113% over the third quarter of 2014. We believe this robust performance was due to the ongoing market embrace of our powerful yet easy-to-use cloud-based solution as well as our top-notch sales organization that continues to mature and hit its stride. Let me spend a few minutes providing some insight into our view of the market for human capital management software. From our perspective, there remains substantial potential for improvement in how companies recruit, manage and serve their employees. As we speak with prospective customers, we routinely encounter companies that have substandard solutions in place, and as a result are not fully leveraging their valuable talent asset. Many are deploying multiple systems that have been pieced together over years; in these situations we typically find multiple login requirements for employees as well as a difficult user interface. This leads to low employee usage of the system, which in turn contributes to already unreliable data for HR managers and few, if any, actionable insights for C-suite. The other paradigm we often encounter is companies that have invested in what they believe to be a sophisticated hi-tech system, only to find that due to its complexity only a very small number of employees are capable of using it. These companies often suffer from the exact same issues this companies deploying multiple systems face: namely low employee usage and the resulting low-quality data that precludes action and improvement. The Paycom solution is easy to use but also very powerful due to its single database architecture. This combination provides the benefit of very clean data that can produce actionable insights. Additionally, it gives us the ability to continually refine and improve our existing solution, as well as consistently launch new applications that continue to enhance our appeal in the marketplace. To this point we’ve continued to evolve our solution, growing our R&D spending well over 100% in the third quarter. Examples of these enhancements include our pre-hire checklist, which allows our clients to streamline the employee onboarding process and get their new hires quickly up to speed. Instead of filling out I-9s, W-4s and enrolling in benefits during their new employee orientation, new hires can hit the ground running and make an impact on day one. Another example is our newly added customizable personnel action form. This new piece of functionality empowers our clients to create actionable forms that can be completely customized based on position or departmental needs. For instance, with our customizable personnel forms, managers can notify departments of specific changes that may need to be made, such as granting employee access to different systems or restricted work areas. We believe this new component is more efficient and easier to use than anything currently available. We also delivered two new features, geo-fencing and geo-tracking, to our current clients who utilize our time and attendance module. Geo-fencing is providing clients the ability to set geographical boundaries where their employees are authorized to be when using Paycom’s web time clock on smartphones, tablets or other electronic devices to clock in and out. Our geo-tracking technology enables our clients to track employees' geographical location when they clocked in and out. The coordinates we collect can then be entered and viewed on Google’s display map. Together, these applications empower employers to help mitigate time theft, a problem many organizations face. These are examples of how our ongoing development improves our clients’ user experience. While simple in nature, the positive client feedback we’ve received regarding these enhancements continues to motivate us to provide the best possible solution in the market. As I mentioned earlier, we believe that the single database foundation of our solution makes it easier for us to develop and launch these other enhancements, which contribute to our continued growth and success. However, our solution is not the only area that we continue to improve. I’m pleased to report that our sales organization is performing extremely well. As I mentioned on past calls, we continue to see our sales team selling more at the upper end of our market. Additionally, our newer offices continue to mature and we are excited with their progress and development, all of which are reflected in our excellent results. With that, I’d like to provide some quick examples of notable client wins in the third quarter. We were pleased to bring on the Board, one of the largest golf management companies in the world, despite an existing competitive provider landscape. This company operates more than 90 premier private resort and public golf courses throughout the U.S. and employs over 5,500 individuals. The client was previously using outdated disparate systems for each of its HR and payroll processes. They appreciate the fact that Paycom allows them to streamline their workflows and eliminate the manual tasks they had to do with their previous providers. Another organization that utilized our services in the third quarter was a large early chartered educator with over 120 private pre-schools and elementary schools across the country. With nearly 3,300 employees, this business chose Paycom due to our ability to significantly improve their HCM operations, allowing them to empower their employees to pursue their mission of serving their students. One challenge this company faced with the previous provider involved a software upgrade during which the company lost access to all of their existing data and reports. In fact, with this incumbent provider, they experienced times when their system was completely offline, and they could not access the tools they needed to operate. Our solution has enabled this client to automate and standardize its payroll and HCM processes, with 24/7 access across all levels of the organization. To conclude, our momentum continued in the third quarter, and I’m very proud of our entire team, as our combined efforts are essential to our current and future success. I’ll now turn the call over to Craig for an update on our financials and our guidance.

Thanks, Chad. Before I review our third quarter results and also our outlook for the fourth quarter and fiscal year 2015, I would like to remind everyone that my comments related to certain financial measures will be on a non-GAAP basis. Adjusted EBITDA and non-GAAP net income are non-GAAP financial measures that exclude stock-based compensation and other non-recurring charges including transaction expenses relating to our initial public offering and our follow-on public offering. A reconciliation of our GAAP to non-GAAP results is included in our press release. Our sales momentum continued in the third quarter with total revenues of $55.3 million, representing year-over-year growth of 51% from the comparable prior-year period. Within total revenues, recurring revenue was $54.2 million for the third quarter of 2015, representing 98% of total revenue for the quarter and growing 51% from the comparable prior-year period. ANRR was $31.8 million for the third quarter of 2015 compared to $14.9 million in the same period last year, representing 113% growth. As a reminder, ANRR is an estimate based on the annualized amount for the first full month of already onboarded new recurring revenue. Total adjusted gross profit for the third quarter was $46.5 million, representing an adjusted gross margin of 84.1%. This compares to 82.4% in the third quarter of 2014. Turning to operating expenses, as a reminder, we pay commissions to our sales reps based solely on new sales at the time of the clients' first monthly billing cycle. This is a one-time commission that we recoup over the life of the client relationship. When we experienced strong sales performance in a quarter, but this quarter being a timely example, there is a potential for us to see increased expenses in that quarter depending on the timing of the client’s onboard process. For the third quarter, total adjusted administrative expenses were $38.3 million. This compares to $25.4 million in the third quarter of 2014. R&D expense increased to 110% from the comparable prior-year period. As Chad detailed, we continue to invest in our solution to maintain our competitive advantage. Adjusted EBITDA was $10.8 million or 19.5% of total revenue in the third quarter of 2015 compared to $6.6 million or 18% of total revenue in the third quarter of 2014. Adjusted EBITDA was impacted primarily from the overachievement in ANRR, which resulted in increased commission expense. Due to this overachievement, at the end of the third quarter, we had approximately twice as many sales representatives qualified for the highest commission level compared to the same period last year. Non-GAAP net income for the third quarter of 2015 was $4.7 million or $0.08 per diluted share based on approximately 58 million shares versus $2.7 million or $0.05 per diluted share based on approximately 53 million shares a year ago. Turning to the balance sheet, we ended the quarter with cash and cash equivalents of $48.5 million and debt of $26.1 million. As a reminder, this debt represents the financing on our corporate headquarters. With that, let me turn to guidance for the fourth quarter and for fiscal 2015. For the fourth quarter of 2015, we expect total revenue in the range of $59.5 million to $61.5 million, representing a growth rate over the comparable prior-year period of approximately 38% at the midpoint. We expect adjusted EBITDA for the fourth quarter in the range of $9 million to $11 million, representing an adjusted EBITDA margin of approximately 17% at the midpoint. For fiscal 2015, we are raising our revenue guidance from $210 million or $212 million up to a range of $219 million to $221 million or approximately 46% year-over-year growth at the midpoint. We expect adjusted EBITDA for fiscal 2015 in the range of $46.5 million to $48.5 million, representing an adjusted EBITDA margin of approximately 22% at the midpoint. In summary, we had an excellent third quarter and look forward to continued momentum through 2015. With that, we will open the line up for questions.

Thanks and congratulations on an amazing quarter. Chad, could you talk a little bit about the strength in ANRR, that sort of growth we’ve been looking for quite a while, and maybe just talk a little bit about, you mentioned already some of the drivers for the strength, have you hidden any true points, whereas some things in Q3 were specific to this quarter right now. Thank you.

Yes, with ANRR, thanks Raimo, we had significant growth this quarter. I mean, to remind everybody ANRR is the amount of processed, onboarded revenue for the full month of any given quarter. And so, that’s actually onboarded revenue, new business revenue annualized. We had several deals that came in at the top end of our range, I’ve highlighted a few of them on the call. We do have our offices starting to mature, and continuing to drive growth in those areas, and I mean, we’ve got a substantial number of salespeople that are really hitting record numbers these days. We built out a strategic organization to be able to produce these types of results. As far as how we hidden an inflection report or an inflection point, we made the comment earlier this year about ANRR and now we’ve seen it jump. And so, ANRR isn’t something we can necessarily forecast, as it is a metric itself that’s established after onboarded revenue.

Okay, and then one more question. On the reference customers that you mentioned but I know that they all sort of size temporarily sizable kind of more in the several thousands, now can you talk a little bit to what – just the in terms of customer base, that’s involved in terms of you moving slightly high up the market and who the competitors are if you kind of sort of deals coming through? Thank you.

Yes, we continue to stay focused on the market we serve, we have been pulled that market on a couple of occasions, more so now than in the past. I did highlight a few of the larger accounts; it is important to note that in any given quarter, we have accounts equal to those sizes. This is just that we’re having more salespeople selling more to the upper end of our target, we’re running into more of those clients. Then I also do believe that larger companies maybe over time, who have experienced some complications in patching together multiple systems are starting to embrace a single database architecture that has some ease of use. As far as the competitive landscape, it is substantially the same as what we’ve experienced in the past.

Okay, thank you.

Thanks for taking my questions. I’ll echo those congratulations, these results are impressive. The ANRR was kind of staggering; I had to do a double take on that number. Just to build on Raimo’s questions about that growth and the strength in ANRR. Is anything changing with the speed of implementations that is allowing you to get that first month of revenue in from the clients?

No, I would say the speed of our implementation remains the same. We have put in processes to get better in implementation. So to the extent that there was a little bit of a speed-up, it may have a little bit to do with that. But I can’t point to any deal that started later or earlier due to that efficiency.

So another question that we’re probably going to get asked and I’m sure you were to – should we look at the ANRR growth this quarter as maybe a pull forward of some deals that you were expecting to close later or you expecting to implement a little bit later, because it’s just – yes, I mean it’s more than double what it was year-end and last quarter?

No, I mean we’ve really tended to unload the musket every quarter on these deals. We continue to do that; we don’t have a long drawn-out onboarding process as far as someone making a conversion from a competitor to us. That’s something we want to get them set up very quickly and efficiently and – that’s just what we do. I wouldn’t say that we pulled forward anything that was due to start later in the year or that anything necessarily pushed, anything out of the ordinary.

You always have those deals?

Okay, I’m sorry go ahead.

I’m sorry, you always going to have some of those, the push forward or back or whatever. But there wasn’t anything I can point to to say okay, well – this is the situation this quarter.

So we could see typical seasonality year-over-year and sequentially or year-over-year, let’s say from in Q4.

I’m trying to think through what you’re asking there. Ask that again?

I’m just trying to well – should we continue to think that the Q4 bookings or billings number should look similar to what we have previously modeled, were not for this aberrantly large Q3 ANRR number?

Well, we’re trying to sell as much as we can sell. And we don’t intend on letting up the gas. I mean, it took in our goal as not only a SaaS company in the payroll and HCM space, but also as a sales organization to onboard the most new business revenue onto our platform over any other that are in our industry.

Okay.

And I mean – this quarter, you had some very big companies. ADP increased their revenue about, I think it was $20 million, something like that. Ultimate increased their revenue about $8 million, and we’ve increased ours almost $6.5 million. That remains our goal and so I don’t know what’s going to happen next quarter. But what is true is our reps are out there, they’re doing their job and we’re going to be continuing to drive for those results.

Just one for Craig, on the ANRR growth, given how strong it’s been or it’s going to be regardless of what is put up in Q4. The delta on the next year’s revenue is pretty slight from the ANRR growth, the previous year and in fact this year it’s accelerated. Just want to – given where consensus is which is relatively low compared to what is probably possible for you to do in 2016. Could you give us any indication of where you’d like estimates to shake out for growth in 2016 without giving specific guidance?

No. As we’re looking to 2016, what we’ve done in the past is given 2016 guidance in the fourth quarter as we’re reporting fourth quarter results. And as Chad mentioned, we set up to be a growth organization and I feel good about our sales organization and kind of how they’re set up to do that for the rest of the year.

Okay. Thanks guys. Well done.

Thank you.

Hi, this is actually Albert Chi on for Mark. Congratulations on a great quarter; really impressive results. But I just want to dig a little bit deeper into the strength this past quarter. Are you seeing a big tailwind from ACA compliance and if so, are you able to quantify that for us? And secondly, do you think that next quarter there would be even greater sort of scramble towards year-end or do you think customers are mostly gotten reduction in a row for this quarter? Thanks.

I think customers are continuously interested in the ACA offering; I think it’s going to continue to be a popular topic, definitely through the first quarter of next year as companies move from implementing into actually having to submit the forms. And so I see that happening. As far as ACA, I mean ACA is one of the many products that we sell here, it’s not a metric that I want to give out on a continual basis. But what I will say is that of the $159 million in revenue we’ve done so far this year, less than $790,000 was done in ACA. So again, of our total revenue ACA at this point represents a smaller portion and again, I don’t see it being any more significant in the future than other products that we’ve brought to market underneath the same platform.

Okay, that’s helpful. Thanks.

Thank you. Hey, Chad and Craig, I sort of have a follow-up to some of the questions here on ANRR because we are all looking at this, and some companies have done pretty well this quarter, so that’s great. And this is actually sort of at the high end of that range, way at the high end. So when we look at, I’m going to go back to Mike’s question, was asking about seasonality. Because this quarter, ANRR was significantly up and post-difficult for the highest growth quarter from last year. Most people would look at it, as we did as the most difficult comp you have relative to last year. Can you put up the number there? I think it is maybe shocking or at least certainly very impressive? I’m curious, is there something in the third quarter, maybe that’s changing in your business? Were you seeing more seasonality here, or is it just everything seems to be clicking along? We all know you have a very disciplined sales process that appears to be working here. What are – does it sound like you’re selling some larger deals on average. Maybe if there’s anything you can quantify for us and you gave some examples, which is like just even percentage growth in those ASP or average seat size or number of seats, anything like that you can give us to help us quantify as we move forward?

Well, I mean I can’t tell you that the number of sales reps we have that are going to reach over $1 million in new business sales has continued to increase. As I think back a couple of years ago, the largest person to sell, the largest amount someone may have sold may have been $750,000, and now we have so many people that sell over a million. I think back to two or three years ago, the largest office sold $3 million, $3.5 million, and now we have offices that could do over $8 million in a year. Again, that’s accelerated from $6 million the previous year, and so what’s happening is that our sales reps that we hire, that we bring in here go through our program, go through our training, and then they come out, and several of them are extremely successful. Most of them are successful. That’s really what’s happening, we’ve strategically on purpose built the sales organization to be able to deliver results, we have a very good product for them to sell and those two things coupled together have produced the results we have this quarter. I cannot point to anything in the third quarter that’s significantly well, I mean anything at all really that has driven the new business that’s been brought on. I do think the fact that we do have an ACA product that we’re talking about it, that we’re onboarding companies as we’re out closing new business. I do think that’s a conversation starter but most of the business, again, most of the businesses that we have brought on, from July through September. But those conversations were being had before July. So, it’s something we had in our bag for a while.

Thanks and it’s like – would it be safe for us to be thinking a little bit differently perhaps? We used to think okay, you sign on, you open these new offices, you want it sort of a wash not much production, year two you get some production, after year three – and year three you start to think of in that mature offices but you just went through some numbers $8 million, $6 million, up from $6 million from some offices. That term mature office sounds like it sort of a misnomer. We shouldn’t really be thinking in that way, we should – that have sort of implies relative stagnation at a high level. It sounds like that’s interesting more out of those – those people as they continue to improve and as you expand your offering. Is that?

You’re correct, you’re correct. You should not be setting a limit on what a mature office can sell in any given year.

Thank you.

Thanks for taking my question. This is [indiscernible] for Brendan. To follow-up on your comments on ACA’s year-to-date impact on revenue. Can you maybe give more color on the impact of ACA and ANRR or wins in the quarter?

Well, it’s hard to say exactly how much ACA would have impacted any given win. I’m sure we did get business because someone looked at our ACA offering or maybe someone else wasn’t able to convert it to theirs. But again, most of the business that we’re having converted in July, many of those discussions were already taking place earlier in the year. I think we came out with our full service ACA offering earlier this summer, maybe. So it’s just really hard to point to that. Again, ACA is a part of our overall system; there’s definitely no one that came onto our software just to use ACA. And so, it’s the total value proposition that we deliver, which does include ACA, and whether or not those same companies would have come on without using our time and attendance or talent management or HR software pieces would have also been a question. It’s really hard to quantify exactly why customers choose to use us, if you want to point out any one very specific piece of software functionality. But, I definitely think it’s a door opener and it’s a conversation starter. But again, most of our competitors have an offering, I mean, it would be very rare, this late in a year, to be talking into a competitive situation where we are competing against someone that also doesn’t have some type of offering for ACA as we sit here in the third and fourth quarters of 2015.

Okay, thank you.

Great, thanks so much. So Chad, did you think about the strength of the business right now, does it change how you think about new office – the rate of new office openings in 2016?

No, I think we have a strategy for the offices we open and we have a certain focus on how and when we open up an office. It really has to do with personnel development; it is true that the more offices we have, the more opportunities for relo we have for current managers, as well as the more backfill strength we have as well. We’re focused on both continuing to grow our footprint as well as expanding our footprint in current geographies, and I don’t see that changing into 2016.

Great, thanks very much.

All right, thank you.

Hey, good afternoon and congratulations on a very nice quarter. A couple of quick things, just following up on the ACA point, and some others – we’ve heard some others that they expect it to be higher cost associated with getting clients ready for ACA. Do you expect any of that in Q4, going into the new year?

Yes, I mean there is definitely a push to move data into the system. I think to the extent there are higher costs on REN, it’s really the education aspect of the sale and working with the client to make sure that data is in and it’s being measured correctly. I don’t know that we can point to necessarily say that it’s going to impact our numbers significantly as costs are associated with this; Craig, I’ll let you expand on that. But I mean I can’t put if anything...

Not like that…

Yes, there is no third-party software that we’re buying or anything outside of it. So really, the cost would be labor related to the people we have right now, maybe providing some additional service to clients that are doing this for the first time. To some extent, clients are just finding their data and tracking it, maybe some things they haven’t tracked to the extent they should have. And convert that into the system and so I would say there is going to be some cost associated with that, but no more cost than would be associated with looking at someone’s talent management system or the software system or time and labor management or talent acquisition. There is a cost that we incur to servicing clients, and we do definitely report that. So I don’t see this being an additional cost item necessarily. No more stuff than anything else, the revenue – any revenue that’s achieved through that product once it starts building, I think will make up for that.

Okay, that’s helpful and I appreciate you’re showing that $790,000 number. Is that based on what your pricing is that a meaningful number to extrapolate far more because that number would be meaningfully higher in next year just based on kind of the forms and other things being initiated?

Yes. I mean, I gave that number to show kind of where we’re at in the process. I don’t see ACA, and that’s one thing that I don’t – I don’t want to get into ACA as we have so many other products that also have a lot of traction and revenue opportunities associated with them as well. Yes, I would say as we move into next year, as we continue to onboard more clients, especially as they become part of the Q1 forms filing side of this, you’re going to see ACA revenue increase; I just want to increase at a rate larger than some of our other items. I mean I don’t know. But you will definitely see it go up from $791,000.

Okay. And – sorry, go ahead.

Well, I just say again $790,000 is an annualized, is a year-to-date number.

Yes, I understand. And just one quick one on the Q4 guidance. If you look at where the ANRR number was in Q3 and kind of really impressive. I realized the math has been quite worth – if you take one quarter of that and added to where your revenue was this quarter, looks like the revenue guidance for Q4 is pretty conservative, like I put it under methodology, that exactly sounds. But directionally, can you just comment on that?

Some of the ANRR would have been already rolled into the Q3 numbers as well. So as Chad mentioned, those are clients that are already billing on the system. The Q4 guidance from that end, we feel good about that. The one thing to mention is, Q4 is a tough comp from last year. So, we got at the Q4 and the calendar as well.

Great, I’ll turn it over. Thank you.

Hey, thanks. Chad, at the timing of your IPO, I think we talked about, the approximate bookings and mix like 5% was coming from 2000 plus employee organizations. Is there any way you can update that metric, give us a sense of how that’s growing?

You know, I don’t have that information on me. And it would be, I mean, it’s not something I could comment right now, without having those numbers at hand. I do think that we are selling more at the top end of our range, I mean, if you draw on the line at 2,000 how many did we sell in the 1,900 to 1,700 range and how many we sold from 2,100 to 4,000? I know we’ve sold more, but we’ve also sold more in both of those ranges. Therefore, it would be hard for me to really at this point, you know, draw any percentage for now.

Okay, understood. And then help us think about kind of the cadence of new office openings, the past two years since live in Q1, they’ve been pretty consolidated. Do you think 2016 kind of falls at the similar pattern or could they be shrinkable throughout the year, how are you thinking about growth on that front?

With that we are very focused on the development of the personnel that actually relos; again to remind everybody the way we open up a new territory which might be a new geography or it could be more geography in a current territory. We take a current manager that’s established with us, we relocate them to a new geography. Then we backfill them with an up and coming sales manager, currently a sales rep who wants to lead. The more offices we have and more managers we have, the more people we have that we are able to relocate. We will continue to update that, again we do announce those openings after they’ve happened. I wouldn’t draw any line in the sand on exactly when we would have another office opening whether that’s early or late in the middle or consistently throughout next year. Those are decisions that we will continue to make in subsequent quarters.

Okay, understood. Thanks for the color.

All right, thanks again to everyone joining us for the call. As a quick note, we will be presenting at the Credit Suisse Annual Technology Conference in Scottsdale on December 1, and at the Barclays Global TMT Conference in San Francisco on December 8. I’ll look forward to meeting with some of you at these events and in the coming months. So thank you, all. Bye.