Paycom Software Inc (PAYC) — Q3 2021 Earnings Call Transcript

Thank you and welcome to Paycom's third quarter 2021 earnings conference call. Certain statements made on this call that are not historical facts, including those related to 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 made on this call are reasonable, actual results may differ materially because the statements are based on our current expectations and subject to risks and uncertainties. These risks and uncertainties are discussed in our filings with the SEC, including our most recent annual report on Form 10-K and our most recent quarterly report on Form 10-Q. You should refer to and consider these factors when relying on such forward-looking information. Any forward-looking statement made speaks 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 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. The reconciliation schedule showing GAAP versus non-GAAP results is included in the press release that we issued after the close of the market today and 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.

Thank you, James, and thank you to everyone joining our call today. I will spend a few minutes on the highlights of our third quarter 2021 results and our progress on key initiatives. Following that, Craig will review our financials and our guidance and then we will take questions. We delivered very strong third quarter 2021 results with revenue of $256 million, representing robust year-over-year revenue growth of 30.4%, which was above the top end of our guidance range. We continue to see strong demand for our products across our target market, and we are having great success attracting new clients. We have reinvested and will continue to reinvest revenue upside into the business while still delivering attractive adjusted EBITDA margins. With these strong results, we are once again raising our full-year guidance, which Craig will discuss in more detail. Our innovative solutions continue to gain popularity and we're being recognized by industry organizations for their impact on the human capital management industry. In September, Paycom was once again awarded the 2021 top HR product honor at the HR Technology Conference for our newest innovation, Beti. This marks the third consecutive year for Paycom to receive such honors, which included the Direct Data Exchange in 2019, Manager on The Go in 2020, and now Beti in 2021. It is precisely the combination of these three industry firsts coupled with our comprehensive single database that is transforming the human capital management industry and turning employee usage and easy-to-use solutions into the key buying criteria for clients. Beti is a self-service payroll technology that allows employees to do their own payroll, and we're having great success in the market. As a reminder, with Beti, employees submit their own time worked, make their own benefit selections, schedule deductions, manage tax statuses, remit expenses, request time off, and do all the things that an employee does to calculate a check. Beti does the rest and works with the employee to ensure a perfect payroll for them prior to the payroll. Employees doing their own payroll is the only way payroll should be done. I am very pleased with the market response to Beti and I continue to expect all clients to eventually deploy Beti. Our advertising and marketing efforts continue to deliver strong demo leads that are fueling our revenue growth, and we will continue to spend aggressively in the coming quarters to further expand our market share in the large and expanding HCM total addressable market. Our advertising strategy is working and we are deliberately reinvesting revenue upside into advertising, marketing, and product innovation. You've heard me say consistently that we are willing to trade a point of margin for a point of growth, but we are unwilling to trade a point of margin for a point of stagnation. And that philosophy has served us well over the years, and you can see it in our results. On the sales front, we’re seeing success with both smaller and larger companies. I'm particularly pleased with the traction we're having in our recently expanded target market range of companies with up to 10,000 employees, where our messaging around ease-of-use and the employee self-service is resonating. Finally, it's great to see all the Paycom faces back in the office, even if behind masks. We have successfully transitioned nearly all employees back to our offices around the country and it is great to see we're getting our office culture back. While we accomplished extraordinary things working remotely, I believe we're even better together. Many of our new hires are experiencing for the first time the daily buzz and enthusiasm that makes Paycom a unique place to work. While our sales teams are still selling virtually, we're already seeing the benefits of everyone being safely back in the office, sharing best practices, and collaborating more closely. In summary, Q3 was a very strong quarter driven by record new client revenue. The investments we've made throughout 2020 and to date in 2021 have made Paycom more differentiated than ever, and we are seeing the benefits across the sales, service, and product organizations. As a reminder, we have approximately 5% market share of a growing total addressable market and a long runway ahead of us. I want to thank all of our hardworking and dedicated employees for their grit and commitment to success. With that, I'll turn the call over to Craig for a review of our financials and guidance.

Before I review our third quarter 2021 results and our outlook for the fourth quarter and full-year 2021, I would like to remind everyone that my comments related to certain financial measures will be on a non-GAAP basis. We're very pleased with our third quarter results with total revenues of $256.2 million, representing growth of 30.4% over the comparable prior-year period, driven primarily by strong new client revenue growth. Within total revenues, recurring revenue was $251.3 million for the third quarter of 2021, representing 98% of total revenues for the quarter and growing 30.4% from the comparable prior-year period. Total adjusted gross profit for the third quarter was $214.8 million, representing an adjusted gross margin of 83.8%. Third quarter margins were impacted by both our return to office and our aggressive hiring of the individuals needed to service our current and future growth. For 2021, we expect to deliver a very strong adjusted gross margin of approximately 85%. Adjusted total administrative expenses were $142.5 million for the third quarter as compared to $113.3 million in the third quarter of 2020. Adjusted sales and marketing expense for the third quarter of 2021 was $66.3 million, or 25.9% of revenues. Our marketing strategy continues to generate strong demo leads and we plan to continue to invest in advertising given the strong return on our investment we are seeing. As Chad suggested, growth remains a top priority and advertising is a productive lever that we have continued to deploy to drive revenue growth. Adjusted R&D expense was $29.3 million in the third quarter of 2021, or 11.4% of total revenues. Adjusted total R&D costs, including the capitalized portion, were $40.7 million in the third quarter of 2021, compared to $29.8 million in the prior-year period. Even in this tight labor market, we're having good success attracting and retaining talent. Adjusted EBITDA was $89.7 million in the third quarter of 2021, or 35% of total revenues, compared to $67.5 million in the third quarter of 2020, or 34.3% of total revenues. Our GAAP Net Income for the third quarter was $30.4 million, or $0.52 per diluted share, versus $27.5 million, or $0.47 per diluted share, in the prior-year period based on approximately 58 million shares in both periods. Non-GAAP Net Income for the third quarter of 2021 was $53.6 million, or $0.92 per diluted share, versus $40.6 million, or $0.70 per diluted share in the prior-year period. We expect non-cash stock-based compensation for the fourth quarter of 2021 to be approximately $22 million to $24 million. For the full year, we anticipate non-cash stock-based compensation will be approximately $98 million to $100 million. For 2021, we anticipate our full-year effective income tax rate to be 23% to 25% on a GAAP basis. On a non-GAAP basis, we anticipate our full-year effective income tax rate to be 25% to 27%. Turning to the balance sheet, we ended the third quarter of 2021 with cash and cash equivalents of $230.9 million and total debt of $29.6 million. Cash from operations was $83.2 million for the third 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 $1.6 billion in the third quarter of 2021. During the third quarter of 2021, we've repurchased approximately 61,000 shares for a total of roughly $29 million. Through September 30th of 2021, Paycom has repurchased nearly 4.3 million shares since 2016 for a total of approximately $484 million, and we currently have roughly $271 million remaining in our buyback program. Shifting to guidance, we are pleased to provide strong fourth quarter guidance that reflects the robust performance year-to-date and we are raising our full-year 2021 outlook as a result. Our Q4 and full-year guidance are as follows: For the fourth quarter of 2021, we expect total revenues in the range of $274.5 to $276.5 million, representing a growth rate over the comparable prior-year period of approximately 25% at the midpoint of the range. We expect adjusted EBITDA for the fourth quarter in the range of $103 to $105 million, representing an adjusted EBITDA margin of approximately 37.7% at the midpoint of the range. For fiscal 2021, we are raising our expected revenue range to $1.045 billion to $1.047 billion, up from $1.036 billion to $1.038 billion, or approximately 24% year-over-year growth at the midpoint of the range. We expect full-year adjusted EBITDA in the range of $413 to $415 million, representing an adjusted EBITDA margin of approximately 39.6% at the midpoint of the range. To conclude, we are very pleased with the performance in the quarter and how the full-year has been shaping up. Product differentiation, outstanding customer service, and our use of effective advertising and sales levers are all contributing to our strong results, and we have a long runway ahead of us to continue to deliver rapid growth for years to come. With that, we will open the line for questions.

Thank you, and congratulations on another quarter as the fastest growing HR company that I cover. I have two quick questions. First, Chad, can you discuss the customer momentum? Specifically, can you elaborate on the lending-related sites and the increase in modules from these new customers? Have there been any changes in terms of what people are purchasing and how Beti and others are influencing the scale of lending? Then I have a follow-up question.

Yeah, definitely. Well, Beti, for instance, is included on all accounts since July that we've sold. This doesn’t mean that we've converted all of them that we've sold since July, but Beti is included in that, meaning that it's sold as part of the package that we sell with that. Included in that are products that are, to be honest with you, our most popular products anyway. But I do believe Beti is making an impact on our ability to sell more products at the initial point-of-sale.

Yes. Okay. Perfect. And then if you think back to the pandemic, you did really well in new customers but your existing customers had a lower employee count, which obviously then hurts. Since now in September, a lot of the benefits fell away, like what are you seeing in terms of rehiring at the existing customer level? Could that be another driver for you as we think about the next year as well in terms of the revenue trajectory? Thank you.

Yeah, I'm going to take this as you're talking about the clients that we had at the time of the pandemic and the negative impact on them, which we've quantified in the past of that $1.8 to $2 million. We've talked about a couple of different quarters of seeing improvement in that specifically this last quarter. In the second quarter, we did see a little bit of improvement to the extent we did. It was around $100,000 a week. That trend has continued into the third quarter where I would say it was very similar to what it was in the second quarter as to that improvement of about $1 million to $1.5 million positive impact on the quarter from our pre-pandemic client base becoming a little bit healthier.

Good evening. Thank you for addressing my questions. Congratulations on your continued strong growth. Chad, I appreciate that you've highlighted your commitment to aggressive investment for growth. I'm wondering if, considering the investments you've made so far, there’s been a shift in how you're allocating those funds. As you mentioned the reopening, will there be a change in the distribution of dollars between advertising, sales headcount, and other areas like user conferences? How should we understand your investment approach in terms of dollar allocation as the world begins to reopen?

Sure. We're definitely focused on the marketing and advertising and I'm sure you guys have seen our assets out there working. We continue to drive that. We've also returned to the office, each of our offices as well as here in Oklahoma City. I was actually a week-and-a-half ago with all of our sales leaders in Aspen as we've done, really our first big meeting with one another since the pandemic. Something else that we're doing, we're having a lot of success hiring service individuals and training them up ahead of the revenue that we're bringing in, and so we had a lot of success hiring service individuals with the anticipation that our growth continues as it has and we will need them to service these accounts. And so those are the large areas. Obviously, marketing is more of a lever-type area and we spend that deliberately throughout the quarter to make sure that we're not leaving potential on the table and that we could turn into future sales.

Yeah. And Samad, I would also echo that. I mean, we're also having success on the R&D side. I mean, we're able to hire and bring those individuals in as well.

Great. Then maybe just a question on bookings linearity in the quarter. Maybe if you could just help us understand the overall strength of bookings in the third quarter and then how it trended throughout the quarter just given we've had varying use in software more broadly around trends evolving over the course of the quarter.

Yeah, and our bookings in the quarter remained strong throughout the third quarter. In fact, October, we just finished was our largest booking month ever. I know I say that quite often, but we would expect to have strong quarters in subsequent quarters and months for bookings. But bookings remain strong now. Deals are booked, and then they turn into revenue over time. Whether that's 13 weeks or 17 weeks is our focus for those, but yes, we had a lot of strong bookings come in in the third quarter. And as I mentioned, October was our largest booking month we've ever had in our company.

Great. Thanks again for taking my questions.

Thank you.

Great. Thanks very much. Chad, as you went back over the last 18 months and the efficiencies that you've been able to achieve across the organization, where would be one or two places where you generated the most, and where do you think it's most sustainable going forward?

That's a good question. I think that we've gained a lot of efficiencies through our own technology that we've developed to use internally. Some of that is based off of internal communication which had to strengthen in order to survive the work from home and the impacts of the virtual environment that we had to move to. I believe we're still gaining efficiencies through the sales model. As predominantly, most all of our sales are still done virtually, which allows for better training on our side and allows our managers specifically to set on more calls. I'm sure there's others, but I would call out those two for sure.

That's great. Thanks very much.

Thank you.

Good afternoon, Chad and Craig. Really strong sequential growth in this quarter and obviously called out the bookings. I was wondering if you could help put a little bit more color behind where you're seeing the bookings strength. Is it in newer markets for you relative to older markets, smaller clients versus larger clients? Obviously, the marketing is having a positive impact, but wondering if you're seeing any patterns that are discernible?

Not really. I would say it's more of the same for us; there's just more of it now. I would remind everyone that we did increase our inside sales group in the past. I talked about that, how we've grown that over the years. We now have teams there that we have. Of course, they're bringing in smaller deals with a little bit lower revenue associated with it, but I wouldn't really be able to call out that the mix is different than what we've had in the past. It's the same type of mix. We continue to go more up market, but we always have. But the mix is very similar.

Great. And can you give a little bit more color with regards to the impact of Beti, and then lastly, just a little bit more color regarding the impact of bringing people into the office in terms of the gross margin for this quarter and how we should think about gross margins going forward?

I will say the gross margin. I mean it will definitely be impacted some by their return to work. You definitely have some of that, but I would also say that we've had a lot of success hiring our service individuals as we get ready to get trained up for the revenue that we're bringing in, so there's been quite a bit of it there as well. From a Beti perspective, we started selling it to the group, to the masses in July. And since July, I think in July, I said that we had sold 1,000 somewhere in conversions; some had already started. As of today, we've sold nearly 4,000; again, some have already started and some are in conversions. So that product continues to be successful for us as it changes the way that employees do their payroll and really puts the control into their hands.

That's great. Thank you.

Thank you.

Hi, everyone. This is Michael Rackers on for Ryan. Thanks for taking my question, and congrats on the quarter. At HR Tech and some other industry work we've done this year, we've heard about a lot of new customer interest and vendor functionality in things like Daily Pay and Talent Intelligence, which seems to be more targeted to the customer segment that you are starting to target more moving up market. How do you think about product expansion and the larger customer segment that may or may not have some different module requirements?

We focus on larger clients, specifically companies with around 10,000 employees, and our largest client has approximately 20,000 employees. We believe our product meets their needs very effectively. While there may be enterprise-level businesses, I don't think there are enterprise-level employees. An employee can transition from a 300-person company to one with 50,000 employees, but their expectations for functionality remain the same. That's what we aim to deliver—appropriate tools for all employees, regardless of the company size. Whether you're using a shovel for a simple task or trying to dig a four-mile trench, having the right tools is crucial. We've ensured that employees, no matter where they work, have access to the right resources. Many tasks employees perform are similar, whether they are at a company with 300 or 5,000 employees. While larger companies may involve international tax issues and other complexities, we are confident in the value our product provides to employees in larger markets.

Right. Thank you so much.

Thank you.

Hey guys, this is actually Matt Diamond on behalf of Siti. Congrats, again on the results here. One thing I'm trying to figure out is the potential for sales office reopening. Chad, it sounds like everybody's enthusiastic to be back in the office, but it's undeniable the benefits that came from virtual selling over the last 18 months. How should we think about sales office openings in 2022?

Sure. We actually did. I didn't call it out in prepared remarks, but we actually did open up an office in this past quarter. We opened up a second Manhattan office there in New York City. As far as from sales, I think it's important to state that we are back in the office, but we're selling virtually from our office. The change there is we were selling virtually from our homes, now we're back in the office selling virtually from the office and so we have the collaboration, and it may just make more sense for us to be there.

Helpful. And with Beti, it sounds like there's a lot of positive momentum occurring in that module. Could you help us understand what percentage of Paycom's client base today is prepared to upgrade to Beti or you sold Beti? I know that there are some requirements that go into that module, but any color there would be helpful?

Well prepared from a product standpoint; I'm hoping all of them are, but prepared from a product standpoint, there would be some products that we would upsell to some of our clients that would enable them to get the full value and actually be able to use Beti. I haven't disclosed exactly what that is because that's a moving target as we continue to have success selling Beti both into the current client base as well as to all new clients that are brought on.

Understood. Thanks so much.

Thank you.

Hey guys, good afternoon. Thank you. I have a follow-up on Beti here. Just curious how the efforts are progressing on selling it back into that existing base. So, Chad, of those 4,000 or so sold clients, can you give us a sense on how many of those were in the existing base versus new?

Well, we're not splitting that out separately, but you could expect there to be a healthy mix of both with 4,000. So, you'd have a healthy mix of both. For current clients, it's one of those things where they're having success with our current products in the current environment, and we're going up to them asking them to change their internal processes again to start the process at the beginning versus at the end. We're having a lot of success with that, and as we get more and more proof sources of current clients that have shifted over to it and their employees are having great success, we're receiving both more client referrals as well as more prospect referrals, which is driving more results for us.

Okay. Fair. And then just on the challenge on the hiring front, any challenges at all in acquiring needed talent across the organization, whether that since sales or services?

Well, there's no doubt it's a tighter market. It really does depend on at what level we're talking about bringing people in and then also what departments. Some levels, we're actually receiving upgrades in talent due to the fact that I think our brand's much stronger than it's been in the past, and we're a destination location for employment. Some areas just like everyone else, it's a tight labor market and we're all fighting for talent. So it's really somewhat department-dependent as well as at what level of employee, whether it is a new front-line type position or a management-level position? But it's tight everywhere, but we're having a lot of success continuing to bring people in.

Okay. Thank you.

You got it.

Hey there, this is Alan on for Alex Zukin. It seems like there's a bit of an inflection with demand environment in the March and April timeframe. How are you thinking about the complete trends around both reopening along with the shortage of talent? Are these opposing forces or are they coming together to drive demand? Thanks.

I'll tell you from where we're at right now, and I've said this a little bit consistently, we needed stability in the market in order for us to enable our growth, so that our growth could actually be reflected as we brought businesses in. We needed some stability. We've had that. As far as it being a tight labor market, I do think there's some impact, obviously, and the larger we get, the larger the impact on our ability to have what I'm going to call same-store or current client growth and see that. We've never been a company that's been dependent upon that, nor have we really looked at that as any type of driver for us and probably still today wouldn't even have thought of it as a question, except for we did go through the pandemic and lost a significant amount in our client base. But from a macro standpoint of what we see amongst our client base, we see stability, and our growth is coming from our ability to add new clients onto our platform.

Great. Thank you. So, I was wondering, what are you seeing out there in the market from the competition? Is there anything unusual going on in terms of pricing, marketing, or anything that you've observed?

It's hard for me to hear you. I heard the question: What is going on? Is anything going on new with the competition? I can't say. I would say we've always been in an extremely competitive market. I think that's good for clients. The more competitive an industry is, the more innovation you see because the harder we're all trying. I can't say that I've seen anything new in the market from our clients, be it different types of technologies and/or techniques that are used. Clients have always sold against us with different pricing, discounting, and bring different people to accentuate their positives. The positive we insinuate is the fact that we drive significant return on investment for those, and a low-cost total ownership for those businesses that choose Paycom, and that's all experienced through employee usage in an easy-to-use product.

Okay, great. And then, are you seeing any change in the demand environment in terms of which modules are particularly picking up by clients in terms of, are there changes in what people really want to focus on, or is that really not a factor that presents more?

Yes, sure. I will tell you one thing that we are seeing, and I've said this in the past. We've always been really good at selling products, but sometimes not as good at getting clients to use the products that we've sold. What I would say is happening now, and it's really been happening, we came out with the Direct Data Exchange, we came out with Manager on The Go. We kept the data moving, we gave people visibility. When we came out with Beti and gave them another reason to go ahead and fully automate, we've continued to do that and we've seen great success around usage, which is really driving everything for us right now.

Great. Thank you.

Thank you.

Great, thanks for taking my question and congrats on your quarter. Chad, I was wondering if you could just dive into the up-market motion a bit. How has the pipeline here evolved since you formally opened up this opportunity and any sense of how the initial sales cycles and win rates are compared to the rest of your business? I know it’s kind of early days still.

I would say there haven’t been any significant changes. We have expanded the market because we are seeing success and have a strong pipeline as we continue to move up market. It’s pretty much the same as before, and I can’t point out many differences from what we’ve experienced in the past. We have just formalized our target market to companies with up to 10,000 employees, as we have been successful in the 5,000 to 10,000 range throughout this year.

Got it. Then on Beti, I know you're not breaking out the split between the 4,000 of new and existing. But maybe of those existing, any sense of how many of them have come back to the table to adopt additional modules that fully utilize the benefits of employee self-payroll?

Yes. I would say every client that's deployed Beti would have to have the full solution set that Beti requires to be able to even implement Beti. That would have happened up front. Again, I do want to state that most all of the products required or necessary to work with Beti are our most popular products. We've always been pretty good at selling the value to both the client and the employee for them taking that product and using it. So, Beti itself; it's incremental to our overall revenue, and it will prove very positive, but really where it's making the impact, it's driving an incredible amount of value for the client. It's a very nominal spin for them to add it. But the value multiple that they are receiving just by adding Beti really makes all the other products that we've already provided to them much more valuable with the stronger return, and it's very measurable for both them and the employee. One thing we are starting to receive a lot more of right now are employee referrals who have used Beti even at one Company; they go to another Company and we're continuing to have strong referrals from rank-and-file employees who have used our technology and now are at a different location for business.

That's great to hear. Congrats again.

Thank you.

All right. I want to thank everyone for joining us today on the call and a special thanks to our employees for helping to deliver another very strong quarter. I'd like to reiterate that I believe getting vaccinated saves lives. So, I hope that everyone who hasn't been vaccinated is able to get it so we can end this pandemic. On the investor outreach front, this quarter we will be participating in several virtual investor conferences, including the Stifel Growth Conference on November 11th, the Needham SaaS one-on-one conference on November 18th, and the Barclays Global TMT Conference on December 1st. We look forward to speaking with many of you very soon and appreciate your continued support of Paycom. Thank you, Operator, you may disconnect.