Paycom Software Inc (PAYC) — Q1 2019 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 may have made or make in this presentation 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 most recent annual report on Form 10-K. 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 they are 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, including adjusted EBITDA, non-GAAP net income, adjusted gross profit, adjusted gross margin and certain adjusted expenses. We use these non-GAAP financial measures to review and assess our performance and for planning purposes. 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'll now turn the call over to Chad Richison, Paycom's President and Chief Executive Officer.

Thanks Craig and thank you to everyone joining our call today. I'll begin my remarks by reviewing another strong performance during the first quarter. I'll then share some details around Paycom's groundbreaking direct data exchange and finish by discussing some other early 2019 highlights. Following that Craig will review our financials and then we will take questions. We kicked off another year with robust results that exceeded our guidance positioning us well to accomplish our performance objectives for 2019. Q revenue was approximately $200 million representing growth of 30% versus the comparable prior year period. Top-line growth percentage accelerated versus the pace in last year's first quarter. Our adjusted EBITDA of $103 million represents a 52% margin. Today, we're also raising our guidance for the full year and Craig will have more details in his remarks. Our performance this quarter was primarily a result of our strong software offering, focused sales efforts and the additional value we are bringing to the market with our concentrated employee usage strategy. Employee usage of Human Capital Management or HCM technology is the future of our industry. We believe having a comprehensive HCM system can lead to higher employee engagement, increased productivity, better job satisfaction and higher employee retention. Our single database HCM solution including our mobile app empowers our clients' employees to take ownership of their HR functions. During the quarter, we released our new direct data exchange for all Paycom clients. This is a highly differentiated enhancement to our overall software offering. It's a first-of-its-kind solution within the HCM industry that measures the efficiency of the data collection process. The direct data exchange does this by reporting all of the data changes made directly into the HR database by employees, as well as all of the duplicative data points typically input by other client representatives. Paycom firmly believes in an HCM system that empowers its employees to easily make and confirm changes to their own data, and to take full ownership of their personal information which produces the strongest ROI for the data collection process. Before the availability of the direct data exchanges, businesses had no way of truly knowing the level of inefficiencies hidden within their HCM processes and systems. Now they have the tool to effectively drive efficiencies into their HCM environment. Moving to other recent business highlights. In early April, we broke ground on our new Operations Center in Grapevine, Texas. It will be exciting to see the land transformed into what will soon be another beautiful Paycom facility. We expect this 14-acre campus will eventually house 1,000 jobs and should be completed in under two years. The Dallas-Fort Worth area features a great pool of talent to help foster our continued growth efforts. Turning to our sales initiatives. We are continuing to expand our sales organization through 2019 and beyond, and we will do so at a pace that is appropriate for our business and that we believe will allow us to effectively achieve the greatest revenue growth, which is and will remain a top priority for us. Finally, this April also marked our fifth anniversary of becoming a publicly traded company on the New York Stock Exchange. And I'm extremely pleased with all that the Paycom team has worked hard to achieve together during this past half decade. In addition to our exceptional growth and overall financial performance, we've been recognized numerous times for our positive workplace culture and dedication to client engagement. Since the beginning of 2014, we have released many compelling new products and software enhancements, nearly doubled the number of sales teams and significantly expanded the footprint of our corporate headquarters. Paycom is blessed to have assembled the most talented team in the industry, and I'm very grateful for their hard work and dedication; the best is yet to come. To conclude, I'm proud of our strong start to 2019 and look forward to continued success through this year and beyond. With that I'll turn the call over to Craig for a review of our financials and updated guidance.

Before I review our first quarter results of 2019 as well as discuss our outlook for the second quarter and full year 2019, I would like to remind everyone that my comments related to certain financial measures will be on a non-GAAP basis. As Chad mentioned, we were pleased with our first quarter results with total revenues of $199.9 million, representing growth of 30% over the prior year period. Our revenue growth continues to be primarily driven by new business wins. Within total revenues, recurring revenue was $196.9 million for the first quarter of 2019, representing 98% of total revenues for the quarter and growing 30% from the comparable prior year period. Total adjusted gross profit for the first quarter was $173.5 million, representing an adjusted gross margin of 87%. For the full year 2019, we anticipate that our adjusted gross margin will be within a range of 83% to 85%. Total adjusted administrative expenses were $80 million for the quarter as compared to $58.7 million in the first quarter of 2018. Adjusted sales and marketing expense for the first quarter of 2019 was $37.1 million as compared to $30.4 million in the first quarter of 2018. Adjusted R&D expense was $15.4 million in the first quarter of 2019 or 7.7% of total revenues. Total adjusted R&D costs including the capitalized portion were $21.1 million in the first quarter of 2019 compared to $13.1 million in the prior year period. Adjusted EBITDA was $103.3 million or 52% of total revenues in the first quarter of 2019 compared to $80.7 million or 52% of total revenues in the first quarter of 2018. Our GAAP net income for the first quarter was $47.3 million or $0.81 per diluted share based on approximately 58 million shares versus $41.2 million or $0.70 per diluted share based on approximately 59 million shares in the prior year period. Our effective income tax rate for the first quarter of 2019 was 23.9%. In the first quarter, our non-cash stock-based compensation increased by $7.6 million over the prior year period due to the issuance and subsequent vesting of restricted stock with market-based vesting conditions. For the second quarter, we anticipate non-cash stock-based compensation expense to be approximately $6 million to $7 million. The restricted stock vesting events in the first quarter had an impact on our first quarter tax rate lowering it approximately 400 basis points. Non-GAAP net income for the first quarter of 2019 was $69.3 million or $1.19 per diluted share based on approximately 58 million shares versus $55.8 million or $0.95 per diluted share in the prior year period. We anticipate fully diluted shares outstanding will be approximately 58 million shares in the second quarter of 2019. Since we initiated our repurchase program in 2019, Paycom has repurchased more than 3.5 million shares at an average share price of $79.56. Turning to the balance sheet, we ended the quarter with cash and cash equivalents of $91.3 million and total debt of $34 million. As a reminder, this debt represents a financing of expansion-related construction at our corporate headquarters. Cash from operations was $80.4 million for the first quarter reflecting our strong revenue performance and the profitability of the Paycom business model. The average daily balance of funds held on behalf of clients was approximately $1.2 billion in the first quarter of 2019. Now let me turn to guidance for the second quarter and full year for fiscal 2019. For the second quarter of 2019, we expect total revenues in the range of $162.5 million to $164.5 million representing a growth rate over the comparable prior year period of approximately 47% at the midpoint of the range. We expect adjusted EBITDA for the second quarter in the range of $62.5 million to $64.5 million, representing adjusted EBITDA margin of approximately 39% at the midpoint of the range. For fiscal 2019, we are increasing our revenue guidance to a range of $718 million to $720 million or approximately 27% year-over-year growth at the midpoint of the range. We're also increasing our full year 2019 adjusted EBITDA guidance to a range of $296 million to $298 million, representing an adjusted EBITDA margin of approximately 41% at the midpoint of the range. With that we will open the line for questions.

Hey, thanks and congrats on another great quarter. And Chad can I start with the direct data exchange? How do you see that in terms of how you're going to utilize that? Basically, it looks like a really nice tool for clients. Is that something that you think about using as a kind of in the sales process? Because you can kind of briefly show to clients how they are doing and how they could do better or is that something you're going to charge for? And then I had a follow-up question.

Yes. So think about the direct data exchange as almost like a health check of our system. I mean if you're driving a vehicle, you have a dashboard that tells you how your oil is and everything else, and that's what this is. It shows how our system is working and so the direct data exchange tracks the number of direct data changes made into the system by employees. It also tracks the changes that are duplicative or being made indirectly. And so our clients use this to help drive ROI for themselves, and we're having a lot of success with it. These usage numbers continue to ramp with this. And I believe that this type of strategy and the direct data exchange is really the death knell, if you will, to the indirect data collection process that exists right now in our industry.

Yes, makes sense, okay. And then if you look at R&D like you basically are kind of really outpacing a lot of your competitors with the R&D that you're doing there. Can you talk a little bit about some of the initiatives? I mean on these growing like quite a bit higher than sales and marketing and revenue, etc. What are the key things for you for this year?

Yes. Well, definitely a lot of the things that we're working on are being developed to support our strategy of employee usage. I believe that businesses that lack an employee usage strategy are going to find it hard to compete and even more difficult to attract and retain talent. Businesses in our industry that lack an employee usage strategy will find it hard to compete in our own industry. And so we're very much focused on this initiative. I've been talking about this for two years. We are now having clients on board and they are agreeing to a full employee usage strategy. And that means that all changes as it relates to employee data would be made by employees when relevant. Obviously, employees aren't going to change their own rate of pay, but most things are being changed by employees in our system. This is the way for the future and we're really using it to show as just an additional proof source to our clients of the ROI that can be driven when you use our system correctly. And that's really what we've been working on, getting our clients to use our system the correct way. And we're focused. As far as opportunities it presents for us in the future, once we have client employees all engaged in the system for each data point change, obviously that opens up additional opportunities of development for us. We've been focused on that as we have identified several opportunities that exist. It changes the model of the way our industry works. And so there's a lot of exciting things coming.

Hi, good afternoon. Thanks for taking my questions and congrats on a great quarter. Maybe first, Chad, you mentioned sales investments to prioritize growth. I was wondering if you can give us an idea as you think about those investments, is it more headcount at existing offices? Is it potentially opening new offices? Any potential color on how we should think about timing and the type of those sales investments?

Yes. So we're continuing to mature all of our offices, or even our mature offices continued to increase their capacity. Opening up new offices is part of our strategy. I mean there are several cities we are not in. There are cities that we are significantly under-penetrated with the current sales offices that we have. And we would look to add additional sales offices to those geographies as well. But we are also focused on what's the right pace for us. Again, we will be opening up sales offices here in 2019 and continuing that strategy to set us up for subsequent years.

Great and then maybe just one follow-up if I may. I think that in recent quarters the company has seen increased success with upmarket customers. And I was curious if maybe there are any comments around this quarter and anything notable that we should think about especially with some of your competitors going through some changes.

Sure. There is definitely a difference in how large companies and smaller companies utilize this type of technology. However, an employee at a five-person company or even at a company with 100 employees will have similar tasks that need automation as someone at a company with 5,000 employees. We have been focused on this aspect and continue to see strong client additions in the upper end of our market, which includes companies up to 5,000 employees. We are also onboarding clients that exceed our upper limit as our sales process has become easier and the return on investment is clearer with our strategies.

Hi. It's Bevin on for Brad. Thanks for taking my question and congrats on the great start to the year. Can you guys just provide us some insight into how your marketing campaigns are going relative to your expectations? What kind of ROI are you seeing and what changes have you made to your marketing programs relative to last year?

Yes. So last year we did, I would say double down on this initiative to help market our product toward a new end user. Since the beginning of time our end user has always been the HR Payroll operating manager and it still is today. They are the end user; however, with an employee engagement strategy you are able to add value to even what the end users are using with greater employee usage. And so you will have noticed that our marketing efforts about 18 months to 24 months ago really started shifting toward that employee user to help soften the beach for our clients that want more employee engagement, as they are now directing employee usage.

Got it, that's helpful. And then just one quick follow up. Can you just talk about some of the early insights you've been seeing or early feedback with the direct data exchange? And what are the key insights some of these C-level executives are saying?

Yes. Previously, there was uncertainty regarding how employees were utilizing the system. Some may have believed that employees were heavily engaged, while others thought the opposite. The Direct Data Exchange provides a direct measure of employee activity. We have observed clients increase their usage from 30% to as high as 90%. Our understanding of what constitutes good performance has evolved as we work to elevate all clients into the 90th percentile, with some reaching 100%. This represents a significant transformation in our industry regarding product usage. We are actively promoting this change, encouraging clients to adopt the correct usage of our products. Many clients still prefer traditional methods, where employees communicate via emails or phone calls, and the data is entered by client representatives instead of the employees themselves. It's not only about inputting data; it's also about retrieving accurate information. When employees have access to precise data, their productivity can increase significantly, benefiting both the individual employee and the overall client. We are committed to this focus, and the Direct Data Exchange product illustrates the performance of each organization's HCM implementation.

Hi, good afternoon. This is Matt Coss on behalf of Mark Murphy. If you look at the deals you closed in Q1, can you tell us what percentage of clients agreed to the full employee usage strategy? And I know you mentioned some uptick in retention last quarter, which was a great result of those efforts. Are there any other outcomes worth highlighting as a result of increased employee interaction with the database? I mean anecdotal or otherwise or any metrics you plan to share going forward on how kind of how your customers are benefiting?

Sure. Well, first on the percentage of those clients that have committed to a full employee usage strategy. I don't have the exact percentage, but I can tell you it was zero in the fourth quarter. And so the first quarter was really the first time we drove it from the sale side. We've been driving usage with our client base now for a couple of years. We then backed it all the way up to the sales process to gain sponsorship of this type of activity before the system is deployed. My personal opinion is I think it's difficult for companies to buy HCM products in this environment if they're not going to fully leverage it to the employee, because again employers use consumer-grade type technology everywhere else in their life. They're not emailing their bank asking them to add a payee or void a check. So I don't understand why we're doing it in our industry. And that's the shift, and so percentages, I don't know, but it's gone from zero to quite a bit. As far as the retention number, a little bit of a correction on that. That retention gain was for all of last year. We have not reported quarter one retention numbers, but I do believe as people use our product the way it is intended and they are generating greater ROI, that should have an impact on retention. I mean if you've bought our hammer and you've been using the claw side of that hammer to beat and pound in a nail, imagine if you turn it around the other way and use it correctly. And we're seeing that happen. It doesn't cost our clients anymore to use our product correctly. And when it happens, we're able to demonstrate a very strong ROI that's being realized by our client base. It's being generally accepted by all of the clients and prospects that we are engaging with.

Great, thanks very much. Chad, from a high level if customers, if employees at customers start using the service a lot more, will that have any impact on gross margin?

I do believe that the more someone uses our system, the more proficient they become in it, and so at some level it does allow, when you're both aligned to the same service results, it does allow for some additional capacity on the service side. We don't charge for using our product correctly. It doesn't cost any more, but you could have some areas that are somewhat ancillary to the direct billing items that could provide additional value to us at the margin.

Great and a quick follow-up for Craig. If we think about the increase in float balance coupled with a fairly significant increase in interest rates year-over-year. What type of tailwind has that afforded you on the top line? Thanks.

Well on the interest rate flow, we went from about $1 billion last year at this time to $1.2 billion quarter over same quarter last year. Those are our client funds. So we invest them just like we have in the past. There were some upticks in rates last year. As we looked at guidance this year, we're not anticipating any additional rate increases at this point.

Good afternoon, Chad and Craig. Congratulations on a great start to the year. I was wondering, first of all, just with regards to the big ramp that you're seeing. Can you talk a little bit about some of the big client implementations that you had? It looked like implementation revenue jumped pretty dramatically. And so I was just wondering if you could give a little bit of a feel for that. And how did those implementations go?

In terms of the implementation revenue, Mark, that's implementation and another so as we recognize implementation revenue, we actually recognize that over a 10-year period, so there's going to be some clock revenue in that number as well. It was a strong quarter for implementation.

Yes. It was a strong quarter for implementation and our implementations are still as they've been in the past as far as timelines and what have you. We are seeing greater usage prior to implementation as we continue to drive usage even prior to the full deployment go-live of the system.

Great and then the margin performance continues to be stellar. I'm wondering if you've thought about giving some new longer-term targets now that we've had 606 in place for a while.

We have not updated our long-term targets at this time. We are currently reviewing them and remain focused on being a high-growth company. This is the third consecutive quarter where our growth has accelerated compared to the same period last year. Our guidance remains consistent with what it was last year, but our numbers are showing improvement compared to the same time last year. We are concentrating on that and are mindful of our margins, striving to be efficient in all our efforts. However, our primary focus is on growth opportunities, as we believe there have been changes in our market. It's a new day, which is positive for all our clients and prospects looking to achieve greater efficiency through the deployment of this technology.

Can I just squeeze one more in this with regards to the strong growth that you're seeing? Can you characterize that in terms of like what percentages from new sales in terms of number of clients relative to our ARPU and then also what you're seeing in terms of internal client employee hiring and what sort of adds you're seeing there? How we should break it down?

Yes. I would say the mix has been consistent as it's been in the past. I can't call out that we have a greater amount as a percentage of up sales today than we've had in the past. Again, the largest upscale year as a percentage that we had was during the rollout of ACA. It's somewhat returned back to normal after that and it's been consistent with previous years as far as the mix between new client adds and up sales to current clients.

Good afternoon, Chad and Greg. Congrats on a great quarter. I guess, if you're looking at the solution set that you're providing to customers, we've seen broadly within the HCM market that HR case management is an area of strong demand among customers and particularly as you're moving up market and you look at this Direct Data Exchange solution, does the data you collect from those customers create a potential for you to develop more automation on the platform to offer those customers, and are you seeing any increased demands for that type of automation?

Yes. Well, definitely, as you identify and to some extent incentivize appropriate usage of the system, that becomes somewhat of a cadence or regular action for employees that become predictable, and at appropriate times you can automate certain functions that make sense. We're always a client that first looks at what the problem that exists today. We don't try to create a piece of technology and then go create a problem that needs to be fulfilled. And so, as we look at the problems that exist for our clients and the user buyers, we look to automate more of that. As this has been pushed out to the employee base, it's identifying greater opportunities for both our clients as well as for Paycom to be able to fulfill that through additional software development.

Hey. Thank you for letting me ask a question and congrats on the results. So I just have a question on the pain point, inefficiencies in the HCM usage in customers. Can you help elaborate on where the inefficiencies are? And maybe give some anecdotes on how the clients are using the system now and how this will change that process?

Yes. So I mean there are inefficiencies throughout the HCM system, right now, if you have employees that could be using multiple products, email and phone call, even to request time off, you could show up tomorrow and you've got 15 emails on people requesting time off, you've got to go and look at the schedule, decide if you've got enough coverage whether or not to approve that time off. I mean, that's one example versus in a complete full system that has both time and attendance scheduling and everything else. The employee can make that decision themselves at night without talking to HR based on the appropriate rules that have already been set up in the system, which we do on our end. So there are those examples, there's editing examples, making changes to benefit enrollment, expense management, mileage tracking, general HR and onward. Learning management is another piece. And so those are all initiatives that we continue to drive and make more efficient. Both clients and HR before this is their idea. HR has been trying to put this together. They've done it in many cases. I mean, I think HR departments and accounting departments and procurement and operating departments across the board have really looked to drive these strategies. I mean HR isn't in the middle of a data collection process because they want to be, they are in the middle of the data collection process out of necessity. Because if they hadn't been in the middle of the data collection process, in the past the data wouldn't have even had an opportunity to be correct. Well, it's not necessary for HR to be in the middle of that particular process anymore. When you remove them out of it, it helps for their own efficiencies because no one went to get a degree in this structure with the intent of doing a lot of data input. We are being able to show a lot of our ROI by increasing these efficiencies across the board.

Got it. That's helpful. Just one quick follow up. If you look at the markets they're participating now, the 2K to 5K and then below 2K, where would you think this had the most competitive advantage for you from new client list?

Everywhere. I don't see why anybody wouldn't use it to be honest with you. Just, it doesn't make sense anymore why somebody wouldn't deploy a full employee usage strategy. No reason why you wouldn't do it if you already were doing it, I guess. If you already had a full strategy going and it's working for you, but outside of that it's where everybody should be trying to get. I don't know that there's much ways you can get better at the software side; when you look at HR, I mean I see them becoming as they have more and more strategic over time as they look to go toward more revenue generating activities versus something that's primarily all cost. I mean you're great at data input, great, but it's not something that you necessarily have to do.

Yes. Hi. Thanks for taking my questions today. I too add my congratulations on the business performance. Chad, can you shed a light at all, just wanted to ask you a question on the mix of the bookings these days between say the upper mid-market and the mid-market. Is there any way of maybe parsing on what you're seeing at least from a percentage of those upper mid-market deals that are coming through the funnel? And then the follow-up question along with that is for Craig, how should we think about the long-term margin implications as that upper mid-market funnel becomes an increasingly bigger mix of the bookings? Thanks.

Yes. So I'll take the first question and let Craig do the latter. Our mix we've always sold at the upper end of our market. I mean I remember prior to IPO in 2014, I was talking about five companies at that time that had over 4,000 employees that we had sold the quarter before. And that was with a much smaller sales organization and a different product. I just want to point that out that we've always sold at the upper end of our market. It's really about those businesses that we market to. So I can't call out a different mix of clients today versus what we've done in the past other than to say we've always had success at the upper end of our markets. So now I'll let Craig talk about the other.

Yes. I would say regarding the margin, as Chad mentioned, we've consistently focused on the mid-market as well as the upper mid-market. So we are not planning to shift our focus away from the lower segment, which is between 50 and 2,000. Therefore, I don't expect significant changes in our margin. We've already had this client mix over time.

Got it. And then one follow-up question. Chad, just wanted to ask you how you're thinking about the hiring plans for this year? And if there are any changes to your original plan given the 1Q outperformance that the business delivered? Thanks.

No, we have not made any changes to our goals for hiring for this year. All right. Well, I want to thank everybody for joining us on the call today. Over the next few months, we'll be on the road meeting with investors at the following conferences. We'll be at the J.P. Morgan Technology, Media and Communications Conference on May 14th in Boston. We'll also be at the Baird Consumer Technology and Services Conferences on June 4th in New York. And finally, we will be at the Stifel Cross Sector Insight Conference on June 12th in Boston. We appreciate your continued interest in Paycom, and look forward to meeting many of you soon as we get on the road. Thank you, operator. You may disconnect.