Paycom Software Inc (PAYC) — Q1 2017 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 the statements are based on our current expectations and are subject to risks and uncertainties. These risks and uncertainties are discussed in our filings with the Securities and Exchange Commission including our Annual Quarter report on Form 10-Q for the quarter ended December 31, 2016. You should refer to and consider these factors when relying on such forward-looking information. Any forward-looking statements speak only as of the date on which it is made and 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. I would like to welcome everyone to our first quarter 2017 earnings call. As with prior earnings calls, I will begin with some highlights of our results, provide some comments on the marketplace, and then conclude with some examples of notable client wins during the quarter. Craig will review our financials, and then we’ll open up the lines for a question and answer. We had a great start to the year and I’m pleased with our results. Revenue for the first quarter of 2017 was $119.5 million, representing growth of 33% over the comparable prior year period. This performance is especially impressive considering the very strong growth we achieved in the first quarter of 2016. Additionally, this is the first time our quarterly revenue has exceeded $100 million. This is a notable achievement for our company and I’d like to extend thanks and congratulations to our entire team for their dedication and energy in helping us reach this milestone. Craig will provide more detail on our financials in a few minutes, but I’ll quickly note that our strong revenue performance in the first quarter flowed through our bottom line, driving adjusted EBITDA of $47 million, representing 39% of revenue. These results underscore our profitable business model. Our strong results were driven by broad-based sales outperformance as well as strengthening our tax form filing business. We continue to see robust demand for our solution across a wide range of industries and regions. Our sales representatives are finding that our single database application which spans both payroll and human capital management or HCM continues to resonate with prospective clients. Companies are attracted to the significant ROI they can achieve by deploying our solution. With our intuitive user interface that can be easily navigated by every employee type, our comprehensive suite that covers employees from hire to retire, makes Paycom a compelling alternative for mid-market companies looking to replace disparate point solution providers. When you combine this broad HCM functionality with our sophisticated payroll offering, clients can have peace of mind knowing that Paycom is in their corner, handling crucial responsibilities such as accurate tax withholding and labor law compliance, and also helping to manage their vital talent. This support allows our clients to fully focus on their core objectives and run their business for growth and success. Now I’ll provide some examples of notable client wins from the first quarter. First, we signed a workforce solution company with over 6,500 employees. This client had been using another provider for payroll, several other HCM vendors, and even paper-based processes in certain areas. With Paycom, they were able to eliminate all these systems and create a single workflow for their employees. We were also able to assist them with compliance and substantially improve their reporting. Next, we signed a document management company with approximately 2,000 employees. This client had been using another payroll provider for payroll and several other HCM functions. They were drawn to our ability to improve their employee experience and create a linear system to manage employee workflow. This client also appreciated our ability to help them mitigate risk exposure as well as our extensive talent development capabilities. Finally, we brought on a hospitality company with over 6,700 employees. They decided to shift away from their former HCM provider and were evaluating several companies including Paycom. I’m pleased to say we won this client due to our single database platform and the ease of use of our system. Our one-to-one customer service model, as well as our commitment to a rapid implementation with a strong onsite presence, were also important to this client. Overall, we saw excellent sales traction this quarter and are optimistic for ongoing success this year and beyond. Additionally, we continue to expand our sales organization with our recently announced Milwaukee office. We are excited to bring the power of the Paycom solution to clients in the Milwaukee area. As with all of our newly launched sales teams, we selected an experienced sales manager from an established office to relocate to Milwaukee and lead our new team. This approach ensures that the Paycom culture and sales strategy remains intact as we expand. We intend to announce additional new offices throughout the year when the timing is appropriate for our business. To conclude, we kicked off 2017 with excellent results and I look forward to maintaining our momentum through the year. I’ll now turn the call over to Craig for an update on our financials and our guidance.

Thanks, Chad. Before I review our first quarter results and also our outlook for the second quarter and full year 2017, I would like to remind everyone that my comments related to certain financial measures will be on a non-GAAP basis. We use adjusted EBITDA and non-GAAP net income as supplemental measures to review and assess our performance and for planning purposes. Adjusted EBITDA is a non-GAAP financial measure that excludes non-cash stock-based compensation expense. Non-GAAP net income is a non-GAAP financial measure that also reflects adjustments for non-cash stock-based compensation expense which is further adjusted for the effective income taxes. Reconciliations of the GAAP to non-GAAP measures discussed today are included in the earnings press release issued earlier this afternoon. As Chad mentioned, we experienced a strong first quarter with total revenues of $119.5 million, representing year-over-year growth of 33% from a comparable prior year period. Our revenue performance was driven by a combination of excellent new business growth and also contributions from our forms filing business. Our forms business generates revenue every first quarter and consists of both tax forms and forms related to the Affordable Care Act that we file on behalf of our clients. As a reminder, this is our second year of ACA forms so the results we released today are really an apples-to-apples comparison against last year and we’re encouraged by our strong performance in light of the tough comps that we posted in the first quarter of 2016. Within total revenues, recurring revenue was $118 million for the first quarter of 2017, representing 99% of total revenues for the quarter and growing 33% from the comparable prior year period. Total adjusted gross profit for the first quarter was $103 million, representing an adjusted gross margin of 86%, reflecting our strong revenue performance. For the full year 2017, we continue to anticipate that our adjusted gross margin will be within a range of 82% to 84%. Total adjusted administrative expenses were $61 million for the quarter as compared to $48 million in the first quarter of 2016. Adjusted sales and marketing expense for the first quarter of 2017 was $36 million. Adjusted R&D was $7 million in the first quarter of 2017. We’ve made substantial progress in building out our R&D organization over the past several quarters. Going forward, we will continue to invest in R&D to maintain the competitiveness of our solution. For modeling purposes, we would expect adjusted R&D expense at a percentage of revenue to be consistent with the levels we saw in the third and fourth quarters of 2016. Adjusted EBITDA was $47 million or 39% of total revenue in the first quarter of 2017 compared to $33 million or 37% of total revenue in the first quarter of 2016. We expect higher expenses in the second quarter of 2017 in both sales and marketing and in our research and development spend. These anticipated increased expenses will be reflected in the guidance that I will provide in a few moments. Our GAAP net income for the first quarter was $26 million or $0.43 per diluted share based on approximately 58.5 million shares versus $19 million or $0.31 per diluted share based on approximately 58.4 million shares a year ago. Our effective income tax rate for the first quarter of 2017 was 33.5%. Non-GAAP net income for the first quarter of 2017 was $28 million or $0.47 per diluted share based on approximately 58.5 million shares versus $19.4 million or $0.33 per diluted share a year ago. For modeling purposes, we expect stock-based compensation to increase by approximately $4 million per quarter for 2017 due to our recent issuance of additional restricted shares under our long-term incentive plan. In the first quarter, our Board of Directors extended our initial $50 million stock repurchase plan and authorized the repurchase of an additional $50 million worth of common stock. We look forward to continuing to return cash to our stockholders opportunistically via these repurchases. Turning to the balance sheet, we ended the quarter with cash and cash equivalents of $93 million and total debt of $32 million. As a reminder, this debt represents financing of construction at our corporate headquarters. We recently completed construction of our new parking garage and opened it for use for our employees. Construction of our fourth building is proceeding and we look forward to creating additional space to accommodate our growth. Cash from operations was $40 million for the first quarter, reflecting our strong revenue performance and the profitability of our business model. The average daily balance of funds held on behalf of clients was approximately $840 million in the first quarter of 2017. Now let me turn to the guidance for the second quarter and full year for fiscal 2017. For the second quarter of 2017, we expect total revenues in the range of $94.5 million to $96.5 million, representing a growth rate over the comparable prior year period of approximately 29% at the midpoint of the range. We expect adjusted EBITDA for the second quarter in the range of $22 million to $24 million, representing an adjusted EBITDA margin of approximately 24% at the midpoint of the range. For fiscal 2017, we are raising our revenue guidance to a range of $426 million to $428 million, representing approximately 30% year-over-year growth at the midpoint of the range. We’re also increasing our full year 2017 adjusted EBITDA guidance to a range of $117 million to $119 million, representing an adjusted EBITDA margin of approximately 28% at the midpoint of the range. With that, we’ll open the line for questions.

Can you talk a little bit about sales compensation this new upcoming year? I remember last year you changed the level that junior salespersons had to get to move to senior, is there any change that you could think about as we move into the upcoming year? And then you’ve gone obviously deeper in the industry like in the prior quarters you talked about ACA and the changes and FLSA and the change, is there anything on the horizon that we should be aware of? Thank you.

Yes, Raimo. First on the sales compensation there have been no changes that we’ve made other than to announce what we did last year in which we changed the amount that someone needs to sell in order to hit the executive rep status, and we moved that up 500 at the time and so that stays consistent. As far as your second question as it relates to ACA or FLSA and what else we have out there, there are still a lot of movements in the ACA and we’re kind of waiting to see what happens with that, but there is a lot of legislation that we track on a continuing basis. We are still tracking ACA as well as FLSA and also H1B.

All right, thank you.

This is Alex Toone on for Michael, congrats on the quarter and thanks for taking our questions. Chad just wanted to touch on the sales offices timeline this year. Can you give us a little preview on these numbers of expecting reopening this year?

Yes, so we opened up Milwaukee so far this year. I did announce at least fourth quarter maybe third quarter of last year that we were very focused on improving the gap in between what we actually sell and what our total new business sales capacity is, we’re very focused on that, that said. We did open up Milwaukee and we do expect to announce more office openings this year and we’ll do that when it makes sales force.

Great, and could you comment on the sales office productivity on a per-rep basis this quarter, at both your existing and new sales offices and how they’ve been trending? Was it sort of inline or above your expectations?

Yes, I mean I think that our sales groups have been doing very well. I think that’s evident by the numbers that are reflected in the first quarter and so, we’re off to a very good start. We have continued to increase sales productivity, especially within the matured offices, and the strategies continue to work for us.

Great, and lastly, just one for Craig. I’m looking at your sort of adjusted EBITDA guide implied for Q2. I think it's still down year-over-year. I know you mentioned higher sales and marketing and R&D expenses, but are there any sort of other one-time expenses that we should be aware of?

Not, as it relates to Q2. No, we just call those two items out: the sales and marketing and R&D.

Thank you. I’d like to ask question Craig on the adjusted EBITDA guidance for quarter two. It’s a lower margin than it has been in the last couple of years in the second quarter, and you mentioned R&D and sales and marketing, but maybe you can just a little bit especially on the R&D side. What is it that you’re going to be investing incrementally, and what I looked at it too, when you give the guidance for the year it actually looks like you did increase the adjusted EBITDA for the year and you also, I think increased the margin a little bit too. So I assume we’re just going to see increased leverage going forward even though you have this upfront investment.

I mean, there’s definitely some timing to it, John. I would say sales and marketing, anytime we have increased sales and marketing corresponds to sales performance because as a reminder we do pay commissions in the month that a deal starts. Even though we may not have received full billing for that quarter, we do pay out full commissions. And I’ll also remind that, with this guidance that we put out there, we’re at 30% revenue growth and 20% adjusted EBITDA. If we were to go back and adjust for the pull forward that we experienced in 2015, which we are very open about, the $10 million in the ANRR pull forward and the associated commission rate on that, which we pegged at about $3.5 million to $3.6 million. Our adjusted EBITDA from last year, we’re actually guiding ahead of our adjusted EBITDA finish for all of last year, and so I do think there is some timing issue as it falls into the second quarter with our expectations for both sales and R&D, but as with our guidance would suggest we’re setting up for a strong growth year as well as some adjusted EBITDA expansion.

Okay, Chad, thank you for that clarification. And as far as on the R&D side though, increased R&D should we expect to see perhaps more modules on the, is that what we're talking about here?

Yes, I mean if you’re one of our clients, you’re definitely going to see more product coming out. I mean, we do continue to go deep into the current products as well as expand them. We do publish the software updates monthly as far as what we’re specifically working on, I mean like in the past. I mean we operate in a very competitive environment and we don’t want to provide a roadmap to our competitors as far as what we’re focusing on, but we also believe that our R&D efforts drove our top line results and we feel like this quarter was a good example of that.

Okay, great, and if I might, Chad on the office opening, I know you get that question a lot. I get a lot too. But I guess can you tell us about how long it takes for an office to sort of let it stride and become, I’ll say, full capacity because I don’t like the term mature. Is it about what it used to be a couple of years or is it taking a little longer or how’s that thing developing?

It is still 24 months for an office to reach, you say, capacity. We’ve been using the term mature but you’re right they continue to mature past that. That’s a must entry point to which they are fully staffed and maybe that’s a better term. But within 24-month period you would expect an office to be fully staffed. They can’t start off with the full staff with the way we bring people on and develop them. It takes time and so that is still the same timeline and that it takes 24 months.

Okay great and thanks for all the clarifications and really nice job. Thanks.

This is Trevor Upton for Brent. Thanks so much for taking our questions. Just another follow-up on the EBITDA guide. On sales and marketing, can you help us walk us through how much of that is kind of related to sales performance you’ve seen so far in the quarter versus increased marketing efforts or if there is something else driving that higher for Q2?

Well for Q2, I would say the largest impact that we have on our expense lines going to be sales commissions. When you look at the sales and marketing line that’s the most volatile piece of it and as a reminder, I mean on something that comes in that we might bill $10,000, in the last month of Q2 we might add corresponding three times that to get that business and so, that would probably be reflected in Q2 as well. And then we also, we’re continuing to hire in our R&D staff as well.

Okay, great. Thank you and then a quick one on the competitive landscape. One of our mid-market peers announced kind of they moved out market a little bit more aggressively. Just sort of high level, have you seen any change in the competitive environment or your win rates in the quarter? That’s all I have. Thanks.

Yes, we don’t talk about win rates, but what I will say is that the competitive landscape as we see it has remained substantially the same for a long period of time for us in the mid-market as far as the players that we see.

Good. Thank you.

Just two quick questions around the go-to-market strategy or I guess tactics. Craig, can you give us color on kind of what level of quota you have in terms of coverage of your internal bookings targets? And then I guess my second question relates to the office starts. I think in your 10-K, you alluded to a goal of 10 to 14 new offices over the course of ‘17 and ‘18 any changes to that plan or is that still feel like a pretty realistic expectation?

I’ll take the latter question. I might have to have you repeat the first one because I’m not so sure I tracked you on that. As far as the latter, we’re not making any changes to the goal that we established last year and what we would see in office openings over the same period of time. Your first question almost felt like it was, what’s our quota and how close are we to achieving it? Did it hit that?

It was more around kind of capacity, in other words quota to bookings targets. What level of achievement do you need to get to for you to hit kind of bookings targets that would then roll forward into ‘18 growth?

Yes, I mean it’s important for us to continue to bridge that gap and then the more we bridge the gap we would expect the new business sales capacity to grow as well as you have maturing offices that also impacts that. And so we’re very focused on catching that up and again I’ll just point to the first quarter numbers as well as our guidance. I feel like we’re having success in bridging that gap.

Yes, no doubt. Okay, thanks.

Can you talk a little bit about what you ended up seeing in terms of the impact from the filings in this quarter's results, just was it up materially relative to a year ago?

I mean, I would say the filings followed what we expected them to follow. It’s the number of employees you have at the end of the year that we’ve done or the number of clients and corresponded to the number of employees that we have done the ACA4, Advanced ACA service for the entire year and then the forms that we file in the first quarter, so I would say those were about what we had expected.

Okay, was there any uptick Chad in terms of the percentage of clients that were using you for the ACA this year relative to last year? Hello?

Thank you very much and congratulations from me as well. Two questions just on the margins as you talk about Q2. Chad, I think you said something about the timing of sales could impact the sales and marketing cost relative to revenue, and I wondered if you were trying to suggest, there was any different linearity in the second quarter, in your mind?

Yes, so it’s the timing of starts that impacts that; that’s the largest impact. So we sell those throughout the year and then when they start and after they’ve run a full month, then we commission those. We do actually recognize the commission within the first full month that a deal starts as well and so that’s the largest impact that we have on the sales and marketing line. As far as the volatility in that number, it’s the achievement of sales starts during that quarter.

Okay, so is there something implied in Q2 in terms of start dates or I guess what I’m really asking you is that?

No, we weren’t trying to imply anything in Q2 start dates.

Okay, and then related to this just on the full year margin guidance when I look at incremental margins, I think you’re still guiding to a lower incremental margin on a revenue dollar than we’ve seen in either of the last two years. And I just wondered if there was anything in particular that you thought might drive that this year in terms of investment areas or different revenue composition or anything else. Thank you.

Well, I don’t know if you’re talking about incremental from Q1 to Q2. I mean, are you talking about incremental margin, are you talking about from Q1 to Q2?

No, more about full year 2017 versus what we saw in terms of incremental margins full year 2016 and full year 2015.

No, Ross. It’s really nothing that we haven’t really already pointed to. The R&D on the full year, as we mentioned in the prepared remarks, are going to track closer to those levels that we’re in Q3 and Q4 and then also you know the sales and marketing, we would expect to hire as well.

Thank you very much. Congratulations.

Just starting one more question, I guess on the sort of sales of this. When you look at sort of the decision of opening in Milwaukee it seems like, and correct me if I’m wrong, but it seems like this is sort of your new region that you’re entering with that expansion. Is there any shift and focus towards going forward towards moving into new regions or versus expanding again into existing cities that you’re already active in?

No, I mean we do both. I believe over the last couple of years we’ve focused on Ohio that was a place that we really didn’t have an office and we have opened up both in Cleveland and Cincinnati over the two-year period of time, we did not have an office in Wisconsin. Wisconsin is a fairly large state, you have quite a few employers in that state and so we thought it was time to focus on Wisconsin as well as that’s what the Milwaukee move was.

Got it, and then just touching on sort of initial customer adoption. I think the last time you gave us an update in terms of adoption of modules at the point of sale, I think you were saying that new customers adopting roughly half of the available 26 modules. Any update to that number or any sort of increased progress there?

Yes, and so, you know from as new clients come on, we have stated that they do continue to adopt greater than half of the products that we have at the time, and that is still the case today and we haven’t updated that number to be more specific than that.

Got it, all right thanks congrats again on the quarter.

Got cut off last time.

Well, I’m sorry about that.

It’s okay, I didn’t hear. Whether or not the penetration of ACA was a little bit greater this time relative to last year?

It would have been consistent. Most every deal that we sell that we onboard that is eligible or required to track ACA takes our ACA module. I think it would be extremely rare to see someone that didn’t, and so of course in 2015 about the last two quarters or especially the very last quarter, we had a huge surge in those clients that very quickly onboarded onto our ACA module as well as those clients that started early. We mentioned $10 million go forward and the associated commissions associated with that into the fourth quarter of 2015. Then throughout 2016 as people onboarded onto our system as new clients, the ACA module they definitely adopted with that and we saw the same in 2017 thus far.

Great, and then can you just talk about the strength that you experienced this past quarter with regards to the areas that kind of outperformed in terms of your sales expectations? Were there any specific regions or verticals and anything that really stood out or is it just really broad-based?

I mean it was broad-based, we’re very focused on our message to both our clients and our prospective clients. I think we’ve gotten better at that and I think that continues to be reflected in our numbers.

Great, and then lastly, can you just talk about the strength that you mentioned or one of the reasons for selection would that last large client that you mentioned in your prepared remarks, specifically the aspects that ended up winning the deal for you and you mentioned having some onsite service, can you talk a little bit more about that?

I can’t with any great detail, not that I’m unwilling but I’m not as close to that very specific situation as far as the strong onsite presence. What I will explain, though, is in Paycom’s implementation process not only are our sales people held responsible for being onsite with the client, we also have a very strong transition group, which does a lot and not only helps clients onboard onto our systems but is also there to help train other clients as well as foster the usage at the employee level, the client employee level. So I would imagine all of that would have been good reasons for this client to choose us or one of the reasons for this client to choose us.

Terrific. Thank you.

So if you look at the upside in this quarter, was it all from the annual forms that were filed in the quarter or was there upside from the monthly recurring revenue as well? Can you quantify that?

No, I mean I would say we had a strong new business onboard in the first quarter and I think that’s reflected as you’ve gone throughout, as you see the numbers that we’ve adjusted when we look at our guidance for full year guidance. Our ACA forms did what we expected them to do, I mean our forms business does what we expect it to do. This was our second year to have the ACA forms business included again and so it made for a little bit tougher comp because last year was our first full ACA forms filing quarter for the year prior. And so but I just think it was a healthy quarter for us.

Got it, and do you still treat ACA-related forms as 5% of revenue or is there any change since last time?

Yes, we’ve not made any update to that and that approximate amount of 5% would still hold today.

All right, thank you to everyone for joining us for the call today. We appreciate the time and interest in Paycom. We look forward to meeting with you at the Jefferies Technology Group Investor Conference on May 9 in Miami as well as the JP Morgan Technology Media and Teleconference on May 23rd in Boston.