Paycom Software Inc (PAYC) — Q2 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 Report on Form 10-K 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 was 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. Welcome to everyone joining us on the call today. I’ll start with some comments on the quarter and our view into the industry, and then Craig will speak to our financials and guidance, then we’ll take some questions. Our second quarter results reflect ongoing momentum. Revenue for the second quarter of 2017 was $98.2 million, representing growth of 33% over the comparable prior year period. This performance is particularly impressive when you consider that we grew 51% in the comparable prior year quarter. We are proud of our first half results as we continue to post very healthy growth, even in the face of challenging prior year comps. As the guidance provided in our press release implies, we anticipate we will continue to deliver robust growth throughout the year, even as we will be lapping our first full year of ACA related revenue. HR leaders and executive management within every industry across the country are becoming increasingly aware of how to utilize technology-driven human capital management or HCM solutions to solve problems and gain efficiencies in their business. At the same time, workers are becoming more reliant upon technology and increasingly expect their employers to keep pace by offering powerful yet easy-to-use software for their HR needs. Executives are continuing to turn to advanced HCM functionality to gain a competitive advantage and also attract and retain talent. This trend is demonstrated by our growth. Additionally, we believe that Paycom is well-positioned to benefit from these trends. We believe our single database solution that allows employees to input and manage their own data is the best option for companies looking to streamline processes and realize the benefits of having their HCM functionality reside within a single database. We recently conducted a survey of HR professionals in conjunction with HR.com, that provides insight into how companies are utilizing HCM technology across their organizations. Our finding showed that approximately 87% of HR executives agreed that self-service technology is the most efficient way to provide employees with HR information. For companies with over 500 employees, this figure was 94%. Additionally, easy-to-use and single log-on capability were amongst the most important aspects of HCM technology. Even with this growing focus on HCM technology, our survey found that in nearly half of the organizations with self-service capabilities, HR departments still manually enter on average 38% of their employees’ data, indicating significant room for improvement. These survey results echo what we hear from our prospective clients. We believe that we’re still in the early stages of a multiyear secular trend of companies turning to HR technology to help them succeed and that Paycom is in a favorable position to benefit from this shift and achieve sustainable growth for many years to come. To support this growth, we continue to execute on our strategy to expand our sales organization. In June, we opened our Richmond office and in July, we announced our new office in Long Island. These offices along with our Milwaukee office, which launched in April, increased our total number of sales teams to 45. All of our newer offices are developing in line with our plans and we’re pleased with their progress. This more staggered cadence of office openings in 2017 is allowing us to focus more on developing our talent and minimize the disruption that occurs when we open new offices. At Paycom, growth is a key goal. With our market share still in the low single digits, we believe there remains a significant opportunity to win substantial new business, and we’re hyper-focused on achieving this goal. While we remain committed to growth, we’re also mindful of continuing to improve our profitability along the way. Our current full-year adjusted EBITDA guidance of $122.5 million to $124.5 million or 29% at the midpoint, exhibits continued improvement over the guidance we provided last quarter and also at the beginning of the year. This performance underscores our ability to both leverage our topline growth and also improve our own internal processes to drive efficiencies. Our profitable cash-generative business model also allows us to return capital to stockholders. During the second quarter, we repurchased approximately 460,000 shares as part of our $50 million share repurchase plan, including 235,000 shares in open market purchases. As a reminder, this is our second $50 million repurchase plan in the past 13 months as we completed our first $50 million share repurchase plan in December. Before I turn the call over to Craig for an update on our financials and guidance, I want to highlight our recent sponsorship of the Jim Thorpe Award which is presented annually to the defensive back in college football, and will be named the Paycom Jim Thorpe Award going forward. For those not familiar with Jim Thorpe, he was born and raised here in Oklahoma and was named the greatest athlete of the 20th century by ABC Sports. He played professional baseball, basketball, and football and also won Olympic gold in the decathlon and pentathlon. Jim Thorpe exhibited many of the qualities we value highly at Paycom such as grit, versatility, perseverance, and teamwork; and we’re proud to have the Paycom name associated with such a prestigious award. Now, I’ll let Craig comment on our financial performance for the quarter.

Thanks, Chad. Before I review our second quarter results and also our outlook for the third 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 the adjustment for non-cash stock-based compensation expense, which is further adjusted for the effective income taxes. Reconciliation 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 second quarter with total revenues of $98.2 million, representing year-over-year growth of 33% from the comparable prior year period. Our revenue was primarily driven by strong new business wins, and we are pleased with our performance in light of the tough comps from 2016. Within total revenues, recurring revenue was $96.4 million for the second quarter of 2017, representing 98% of total revenues for the quarter and growing 33% from the comparable prior year period. Total adjusted gross profit for the second quarter was $81.6 million, representing an adjusted gross margin of 83%. 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 $58.6 million for the quarter as compared to $43 million in the second quarter of 2016. Adjusted sales and marketing expense for the second quarter of 2017 was $32.5 million. Adjusted R&D was $7.5 million in the second quarter of 2017. We made substantial progress in building out our R&D organization over the past several quarters. We will continue to invest in R&D. We anticipate adjusted R&D expense in the third quarter of 2017 will increase by approximately 100 basis points as a percentage of revenue compared to the third quarter of 2016. Adjusted EBITDA was $27.8 million or 28% of total revenues in the second quarter of 2017 compared to $22.6 million or 31% of total revenues in the second quarter of 2016. Our GAAP net income for the second quarter was $14.2 million or $0.24 per diluted share, based on approximately 59 million shares versus $10.4 million or $0.18 per diluted share based on approximately 59 million shares a year ago. Our effective income tax rate for the second quarter year-to-date 2017 was 16.1%. Non-GAAP net income for the second quarter of 2017 was $15.2 million or $0.26 per diluted share based on approximately 59 million shares versus $12.4 million or $0.21 per diluted share a year ago. Absent vesting events of performance shares, we expect stock-based compensation to be approximately $7 million in both the third and fourth quarters of 2017. In the second quarter, we repurchased a total of approximately $30.2 million of stock under our $50 million share repurchase program including $15 million for share net downs as a result of stock awards vesting and $15.2 million in open market purchases. We look forward to continuing to return cash to our stockholders opportunistically via these open market purchases. For modeling purposes, we anticipate fully diluted shares outstanding will be approximately 59 million in the third quarter. Additionally, we expect our full year effective income tax rate to be approximately 22% to 24%. Turning to the balance sheet, we ended the quarter with cash and cash equivalents of $68.1 million and total debt of $34.6 million. As a reminder, this debt represents financing of construction at our corporate headquarters. Construction of our fourth building continues to go well and according to schedule. Cash from operations was $15.1 million for the second 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 $802 million in the second quarter of 2017, which increased approximately 27% compared to the prior year period. Now, let me turn to guidance for the third quarter and full year for fiscal 2017. For the third quarter of 2017, we expect total revenues in the range of $99 million to $101 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 third quarter in the range of $21 million to $23 million, representing an adjusted EBITDA margin of approximately 22% at the midpoint of the range. For fiscal 2017, we are raising our revenue guidance to a range of $429.5 million to $431.5 million or approximately 31% 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 $122.5 million to $124.5 million, representing an adjusted EBITDA margin of approximately 29% at the midpoint of the range. With that, we will open the line for questions.

Guys, this is Alex Hu on for Michael. Thank you for taking our questions, and congrats on the strong quarter. My first question is, given the new cadence on office openings with three announced year-to-date and more to come, can you comment on how the new staggered timeline has impacted your business thus far compared to prior years, whether it’s better sales productivity you’re seeing in existing offices, employee retention, higher quality sales hires, etc.?

So, our goal in opening the offices in a more staggered approach was to reduce the disruption that happens to those teams when we open a new office. Just as a reminder, we always open up an office with current sales managers who are ready and prepared to open up an office, and then we backfill them with sales reps who are ready to step into management from another office and then we backfill that sales rep with a new hire. In the past, this has been disruptive. By spreading out this disruption, we believe we’re still able to accomplish our goal in the outer years, because these offices take 24 months for them to reach maturity. We feel good about that and also it’s caused less disruption, which we believe is reflected in the numbers we’ve been able to onboard this quarter and in our future guidance.

And then, just from a sales capacity perspective. I understand that it takes about 24 months before an office is matured, but many offices do continue to ramp well past that. Just curious can you quantify or share the performance of some of the top offices currently? Specifically, how much new recurring revenue did, at point, typically, for let’s say the top five performing offices on average, just so that we could get a flavor on what could transpire for your newer offices?

Sure. I gave out this sales capacity number of $260 million, I believe, about this time last year. I’m not going to update that today. That number was given out when we had 42 offices, so you could somewhat average those 42 into the $260 million to assess our capacity. We’re continuing to eat away at that. I’m not ready to change that number yet. However, something I can share is that in the past 30 days, we’ve achieved our highest sales week that we’ve had here at Paycom, as far as new revenue that was recently sold. I’m proud of the group and what they’ve been able to accomplish in achieving this in a month that traditionally for our industry is not one of our strongest new business signing months, because it’s in the summer. But again, we had our highest week from both a sales perspective and we’re very proud of that accomplishment.

And just one last question for Craig. Looking at your R&D guide for Q3, it suggests to us that you’re continuing to invest heavily on the product side. Just curious, can you comment on some of the near-term initiatives working on specifically where are those investments going towards?

We haven’t discussed any specific items we’re working on until they’ve actually been released. One other thing I will mention is, we were the top trending app on the iOS Apple Store for our employee self-service app that we put out in early July. So, increased R&D made an impact on that app. We do continue to work on our other products. As you guys are aware, we have a very broad product set and the more clients you have using that, the more specs you get. We do want to continue to increase the value proposition for these clients. Our R&D spend is directed toward that and we expect to see that translate into revenue-generating products.

I have a question for Craig first and then a follow-up for Chad. Craig, congratulations on the strong results, both in revenue and profit. However, cash flow fell short of our expectations. It appears there were a few factors at play, notably a $20 million cash outflow in the accrued expenses category. Could you clarify what is occurring there and whether we should anticipate this to reverse, or if this quarter reflects the reversal of a prior benefit? Is this tied to the significant cash contribution for incentive compensation in this quarter?

In terms of the cash flow and what was going on in the quarter, some of that’s just timing quarter-to-quarter. We also had some tax payments that were made this quarter. We had a catch-up in the second quarter based on the first quarter’s results, so we had some additional tax payments as well, and we’ll see some benefits moving forward. You saw our tax rate for the second quarter decline some as well because of the deduction related to some of that stock compensation.

And then, Chad, great to hear the largest ever new sales week in the past month. I mean that is great to hear. And I’m just trying to think big picture and that helps, but when I look at this market and we’ve realized that a lot of your competitive wins are against what I’ll call the incumbent HRO vendors. It seems that part of those deals could also be, I guess Greenfield, so to speak. In other words, customers may be doing just payroll with the likes of ADP and then they come to Paycom, they realize, you know what, it’s easy to consume this other stuff too. Can you even roughly quantify how much of a new deal on average might be incremental functionality for the customer?

Yes. Our value proposition is an expanded value proposition past the competition. We would hope that any client that comes onto our offering having less from a competitor would experience greater usage and have a more robust product. We would expect that would be the case for new clients, but we’re also starting to see a change in the way companies use HCM technology. Historically, employees at 2,000-employee companies used more technology to buy coffee than when interacting with their HR departments, but that’s shifting. HR departments are becoming more strategic, leveraging technology and the tools provided to employees. I believe we’re still in the early innings of that shift happening.

Okay. Keep that attitude; it’s a dogfight. I appreciate it. Thank you.

Hey, guys. This is actually Albert Chi on for Mark. Great job in the quarter, Chad and Craig, and thanks for taking my question. Chad, on previous earnings calls, you normally highlight some of the larger, notable wins that you sign in the quarter. Can you talk about some of the trends that you might be seeing at the upper end? Are there any changes that you detected in the competitive environment?

Yes. No, thank you Albert. I appreciate your point. Historically, we provided a few examples of our larger wins after being a public company, mostly to provide proof points that our solution can scale and meet the needs of larger clients. We believe we’ve established that at this point. To answer your next question, we did have clients both above and below our stated range, and I believe that’s also reflected in the numbers. However, when I keep calling out specific companies and their industries, it’s easier for others to triangulate or reverse engineer the companies we’re talking about. Therefore, moving forward, we don’t really feel a need to share specific details other than to say that the client profile this quarter has been in line with what we've onboarded in previous quarters.

Just one more follow-up. I want to ask you about the acceleration of revenue growth in the quarter. Revenue or recurring revenue also accelerated. You mentioned that there are decisions made to increase sales productivity. Could you walk us through a little more about what those are and what drove the strength in the quarter?

I don’t want to get too specific on our sales metrics and strategies to drive productivity. I don’t necessarily want to telegraph that but, I will say our focus on reducing disruption as we open offices has been effective. Previously, we were opening all offices in one quarter, which was disruptive. By spreading out the openings, we’ve improved productivity and we’re proud of that and what’s happening in the sales group.

Wondering if you can talk a little bit about your internal efforts just in terms of what you’re seeing from a recruiting, training perspective, what are you seeing in terms of customer satisfaction metrics. How do you think that client retention trends over the next two to three years relative to historical levels?

Well, we update our client retention every year. We just updated it in February. It has remained unchanged at 91% for the last four or five years, so from that standpoint. As far as retention of our own staff, it’s probably been in line. We’ve made significant efforts on the sales side to continue to improve productivity, but we haven’t experienced any more attrition from our sales reps. We continue to focus on training and development for our staff and our clients, ensuring effective onboarding. We remain very focused on that.

Great. I was wondering if the success you’ve had is changing the profile or the types of people that are looking to join Paycom and if that’s having some impact. Also, could you discuss the capacity to implement new clients as you continue to grow rapidly? Are there any changes occurring from that perspective over the next few quarters?

I do believe it’s easier for us to find people now than it was three or four years ago, due to the profile and momentum we have. We look for and train the right people, and we’re fortunate to receive a lot of referrals from our current sales staff, which helps us attract top talent. As for onboarding clients, there’s no such thing as an easy client transition; every client has complexities. However, we do many transitions and get better at it constantly. We will keep improving our onboarding process, as ensuring our clients utilize the technology is key to their success.

Thanks, it’s actually Mark Belcarz on for David today. Just one more on the competitive landscape. Obviously, sales execution for you guys has been going well. But when you’re out there in new deals, is there anyone that you’re seeing more or less of maybe this quarter than you’ve seen in the past?

No, it’s been substantially the same.

And then, just quickly on the numbers, cash flow, it was brought up earlier, was also a little lower than what we had, and you called out the facilities build out. So, I was just wondering on CapEx, what can we expect in the back half of the year relative either to as a percent of revenue or relative to the first half? How should we think about that?

Our CapEx for the first and second quarter of this year has been very consistent on a dollar basis. We’re continuing to complete the construction of the fourth building, and we would expect those levels to be fairly similar on a dollar basis. As we get closer to the completion of the building, you would see CapEx increase a little. I mentioned earlier regarding tax payments dealt with the first quarter and prior year, which played a role in the cash flow you saw this quarter.

So, Chad, not to get too hung up on the point that you had a record week in July, that’s great, congratulations. Is there anything you would point to suggest, like in terms of process or something that’s actually going to be repeatable? Would you be disappointed if you don’t have another record set in August or September or do you think it’s more kind of a great week, but let’s not expect that’s going to happen again?

I can imagine a situation where we might not have additional record weeks as we continue on as a company. I think it was a timing anomaly. However, it’s important for us to continue to minimize disruptions and increase productivity. That has been our focus, and it appears to be yielding results.

Great. And then, just on the regulatory environment. Do you see the stop and start on ACA having any impact on your discussions with customers? Is it affecting conversations at all?

Our prospects must have an ACA option when choosing a company that already has one. For clients already using us, it's a nominal fee, and we assure them we'll do what's necessary to ensure compliance, regardless of changes to ACA. We haven’t seen an impact on our sales; any changes will be communicated in advance.

And then, one last quick one. Can you remind me, or if you haven't disclosed, can you tell us if we look at your revenue growth that roughly the split, how much of the growth is coming from the number of new customers and how much from a higher ARPU per customer?

We don’t break that out, but the overwhelming majority of our revenue growth comes from new client additions. Those new clients may add additional products as they come into the fold.

Hi. This is Ankit for Siti Panigrahi. Could you talk about your general investment plan in R&D and if you’re working on any new modules to drive higher interest?

We haven’t disclosed specifics about any new modules we’re working on or expanding current modules. We’re investing in R&D, and we’ve seen 80% to 100% growth in R&D each quarter over prior-year quarters. However, it’s necessary to monitor R&D as a percentage of revenue as we continue to grow, and we expect to stay on this trajectory.

Hi, guys. Thanks, this is Parthiv in for Abhey, congrats on the results. Can you comment on attainment during the quarter and how attainment relative to plan? Any directional color on quotas during the quarter would be very helpful.

We don’t really ever talk about what percent of quota our staff is. But I believe it was a good quarter for us. Sales group continues to increase their level of not only knowledge but production and activity. I’m very happy with what’s going on there as we sit today.

And for your current sales office base, how many of the close to 45 are either mid ramped or fully ramped? What’s your high-level commentary on where you expect to end up by the end of the year?

You’re going to have about 14 offices that are either close to maturity or have just hit maturity, leaving 9 to 10 still in the ramping phase. By the end of the year, we expect to have significant productivity from those offices.

Chad, building on the sales force question, how is the hiring environment out there right now?

I think it’s been a good hiring environment. If you’re looking for top talent, you need a good strategy to attract them. We go through several interviews to find the right people, and referrals from current sales staff help attract talent as well.

And one other unrelated question. Last week, ADP talked about better retention. Have you seen any impact in the field, or is there really no impact?

ADP is the 300-pound gorilla. We continue to gain the business that we seek and believe that momentum will continue.

I want to thank everyone for joining us on the call today. We appreciate your time and interest in Paycom. We look forward to meeting with investors at the Canaccord conference on August 9th in Boston and also on the road this quarter. Thank you all.