Paycom Software Inc (PAYC) — Q1 2023 Earnings Call Transcript

Thank you, and welcome to Paycom's earnings conference call for the first quarter 2023. 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. 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. 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 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. Chad?

Thanks, James. And thank you to everyone joining our call today. We delivered strong results in the first quarter and I'm very pleased with the progress we've made on a variety of initiatives. I'll start with highlights from the first quarter, then I'll discuss some of our plans for the remainder of the year. Following that, Craig will review our financials and our guidance and discuss our new dividend policy, then we will take questions. With that, let's get started. Our 2023 first quarter revenue of approximately $452 million came in very strong, up 28% year-over-year with strong recurring revenue growth from new clients. First quarter adjusted EBITDA also came in very strong at $221 million, representing an adjusted EBITDA margin of roughly 49%, up 70 basis points year-over-year. With our updated full-year 2023 guidance, we are well positioned to exceed our initial outlook for a solid Rule of 65. On the product front, BETI continues to be a key differentiator in the market with Employee Self Service Payroll continuing to drive strong client additions. The industry transformation to more efficient HCM and payroll processes is accelerating. And now with BETI, payroll processes can be automated to deliver perfect payroll. Using BETI, employees do their own payroll. Employee usage is a key differentiator and new clients are coming to Paycom for exactly that. With 95% of database interactions being completed by the employees of our clients, as measured by the DDX, we are changing the way employees engage with HCM solutions. Our product and go-to-market strategy are working. I just returned from our Annual President's Club Meeting with our top salespeople, and I couldn't be more excited about the tone of the conversations and enthusiasm for our product, especially around employee usage in BETI. We are having increasing success in the market with continued rapid growth at the upper end of our target market range. Large organizations benefit tremendously from simplifying their HCM and payroll needs with our single database solution. We have 5% of the TAM today, however, our TAM has increased now that we've laid the groundwork for our global platform, beginning with Global HCM, which further strengthens our value proposition with our largest clients. To sum up, we are executing well with a highly differentiated product and go-to-market strategy. Our addressable market opportunities continue to expand and we are pleased to enhance our long-term commitment to stockholder return with the initiation of the quarterly dividend program. I'd like to thank our employees for helping lay the foundation for another record-breaking year. With that I'll turn the call over to Craig for a review of our financials and guidance. Craig?

Before I review our first quarter results for 2023 and our outlook for the second quarter and full-year 2023, I would like to remind everyone that my comments related to certain financial measures will be on a non-GAAP basis. We delivered very strong results this quarter with revenue of $451.6 million, up 27.8% compared to the prior-year period. Our GAAP net income for the first quarter was $119.3 million, or $2.06 per diluted share, up 29.8% compared to the prior-year period based on approximately 58 million shares. Adjusted EBITDA was $220.5 million in the first quarter of 2023, or 48.8% of total revenues, compared to $170.1 million in the first quarter of 2022, or 48.1% of total revenues. Non-GAAP net income for the first quarter of 2023 was $142.7 million, or $2.46 per diluted share, up 28.9% from the prior-year period. Our revenue growth was driven by strong demand, new business wins and new product adoption. Within total revenues, recurring revenue was $444.4 million for the first quarter of 2023, representing 98.4% of total revenues for the quarter and growing 27.6% from the comparable prior-year period. Adjusted sales and marketing expense for the first quarter of 2023 was $98.1 million or 21.7% of revenues. We have been aggressively investing in marketing to drive strong demo leads that complement our outside sales model. Adjusted R&D expense was $37.4 million in the first quarter of 2023 or 8.3% of total revenues. Adjusted total R&D costs, including the capitalized portion, were $55.2 million in the first quarter of 2023, compared to $42.9 million in the prior-year period, reflecting continued investment in new products. For Q2 and full-year 2023, we anticipate our effective income tax rate to be approximately 28% on a GAAP basis, and approximately 26.5% on a non-GAAP basis. Turning to the balance sheet, we ended the quarter with a very strong balance sheet including cash and cash equivalents of $506 million and total debt of $29 million. Cash from operations was $146.1 million in the first quarter, representing an increase of 24.6%. The average daily balance of funds held on behalf of clients was approximately $2.4 billion in the first quarter of 2023, up approximately 10% year-over-year. Now let me turn to guidance. For fiscal 2023, we are raising our outlook and now expect revenue in the range of $1.713 billion to $1.715 billion or approximately 25% year-over-year growth at the midpoint of the range. We expect adjusted EBITDA in the range of $717 million to $719 million, representing an adjusted EBITDA margin of approximately 42% at the midpoint of the range. With these strong results and outlook, we are well positioned to exceed the Rule of 65. For the second quarter of 2023, we expect total revenues in the range of $397 million to $399 million, representing a growth rate over the comparable prior-year period of approximately 26% at the midpoint of the range. We expect adjusted EBITDA for the first quarter in the range of $152 million to $154 million, representing an adjusted EBITDA margin of approximately 38% at the midpoint of the range. Finally, after 25 years of rapidly growing Paycom into a highly profitable company, we're expanding our capital allocation strategy. On May 1, the Board of Directors approved a quarterly dividend program that we expect to initiate in mid-May. In 2023, we project Paycom would generate greater than $1.7 billion in revenues, over $700 million in adjusted EBITDA and strong operating cash flow, all of which continue to grow. We believe Paycom is in a unique position to return value to stockholders in the form of a dividend and still have the necessary resources to aggressively pursue growth opportunities. Since 2016, we returned a total of nearly $600 million to stockholders through stock buybacks and we have a $1.1 billion buyback authorization still in place. Today's dividend policy announcement reflects our confidence in the resilience of our long-term growth opportunity, the strength of our balance sheet and the profitability of our business model. We intend to pay a dividend at an annual rate of $1.50 per share with a first quarterly dividend of $37.5 per share payable in mid-June, subject to Board approval. 2023 is off to a great start, and we are in a strong financial and competitive position in a large and attractive addressable market. We have a long runway to continue to deliver rapid organic revenue growth, high profit margins and attractive cash flows. With that, we will open the line for questions, operator?

Thank you. Congrats on a strong quarter and dividend introduction. Two quick questions for me. First, on the global initiative, Chad, can you help us understand a little bit about how global or what's the extent of what you're trying to do here? Is this like helping existing customers that have subsidiaries? Is this like a whole sea change in strategy that you become more international? Just help us understand a little bit there and then I have one follow-up?

Sure, and so right now, Raimo, we have several clients who currently use our domestic software, and they use it internationally; they rigged the system a little bit so that they can store employees in other countries, and then oftentimes, they'll work with a third-party for payroll. So our current clients, they don't have to do this any longer because the Paycom system now does have a Global HCM product that'll work in 180 countries in 15 languages. And Global HCM for us is everything, minus the payroll side. And so, we've looked at integration opportunities, we've looked at working with third-parties and even potential acquisitions. But the fact is, everyone else does it the old way, and payroll and HR departments send data for processing. And we're not going to be putting any development into the old way. So for us, BETI is packing her bags, and we'll be going around the globe as we develop it out.

Yes, yes, okay, perfect. Okay. But does it mean that you want to become a global company with operations in other major countries? Or is this just more for U.S. domestic clients to give them more optionality and kind of work with them better?

Yes, absolutely. We'll be a global company. This is the first step. And that's moving our product into the different languages and getting the HCM side done. And now we're heavily focused on bringing BETI to the other countries, which will require us to have operations in certain countries in order to do that, in order to process in those countries.

Hi, good afternoon, and congrats on the good quarter. Chad, I had a whole list of questions. But then you said the word open to acquisitions, which I'm really thinking about. So I'm going to pivot in real time here and ask you between the dividend announcement and you mentioning the potential for M&A, which is something that hasn't historically been done, is M&A something that is just maybe going to be a part of the broader capital allocation strategy of how to use the company's cash going forward, or is that just limited to maybe the global side of it? Or would it be something you'd explore in other areas too?

Well, I mean, I don't want to say never, but it's been our process to develop internally and to develop things that way and grow that way. And so my comment earlier was more as we looked at building out the payroll side internationally, we did review multiple options for that. But at the end of the day, there's no shortcut to long-term success. So, at the end of the day, we're going to dance with what brung us, and we know how to develop software. We're already well on our way in getting things set up to be able to have BETI in all the other countries as well. So in answer to your question, I would say more no, Samad, I mean, if I was going to have to be direct with that. But we did do a dividend, and we still have a $1.1 billion buyback in place.

Great. And then maybe just a quick follow-up for Craig, just the numbers on the margin side were impressive as always. The sales and marketing dollars jumped a pretty good bit from 4Q to 1Q, more than you normally see. I was just curious, I know you mentioned marketing campaigns. Was there any acceleration or pull forward maybe in sales headcount addition, or anything else that we need to maybe be aware of there beyond just digital marketing? And how should we think about that maybe going forward?

No, I would just say it's pretty normal. I think last Q1 was slightly down. But yes, I mean, just kind of normal marketing spend and campaigns that what we talked about kind of from Q4 of 2022 to Q1 of 2023. Some of those pushed into this quarter.

Great. Thanks very much. Chad, do you have a pretty unique perspective on the economy across the country? Down market, up market, GEOs, verticals? Anything you're seeing specifically that gives you pause or optimism?

I wouldn't say one way or the other. I think it's somewhat easier to hire now compared to a year ago when the labor market was a bit tighter for us, particularly as the work-from-home trend was prominent while we returned to the office. On the tech side, we are successfully attracting top talent as many companies have reduced their workforce. We're focused on adding clients and haven't observed any significant negative trends within our client base. I've been trying to plan ahead with a focus on a portion of the total addressable market and some growth opportunities for us. My current priority is being a salesperson instead of an economist. Overall, we aren't noticing much in our numbers as we look ahead, but from a hiring perspective, which could reflect client conditions, it does seem somewhat easier, especially for technical roles.

Yes, Brad, and I would say on our client base, I mean, we have a very diversified client base. And that's both geographically and based on industry. So some of the things you're hearing out there, we're not overly exposed to those.

That's great. Thanks very much.

Thank you.

Hey, good afternoon, Chad, Craig, and James, and congratulations on the really strong results, and also the initiation of the dividend, which I think is a huge positive. With regards to what you ended up seeing during the selling season, and then extending into the first quarter. Could you give us a little bit of a sense for on the recurring revenue, if we strip out the float income, what you ended up seeing in terms of sales from new logos relative to upsells, relative to increases in employment within the existing base? And how you're thinking about the pipeline on a go-forward basis?

For us, it's really all about acquiring new logos. Changes in employment from our existing base have not significantly impacted us one way or the other, except for a period during COVID when we experienced notable fluctuations. Since then, things have stabilized, and we aren't seeing employee gains or losses that would affect us. We focus on new clients; we added over 3,000 clients to BETI in this first quarter, and that has been going well. I'm not sure if Craig has anything to add to that.

No, I would agree with Chad. I mean, it's primarily new logo wins, and that's what's driving the recurring revenue.

Hey, thanks guys for taking my questions. Chad, in the press release for Global HCM a few weeks ago, you mentioned that you've been working on the product for two years. Since it doesn't include BETI yet, why not just wait until you had developed it for some of those countries first, or maybe can you just talk about the timing on why move now?

Sure. Well, you're going to have to do first things first. We're going to have to have it, but as I mentioned with Raimo's very first question, we have a demand for Global HCM right now as we have clients that are storing client or employees that they have in other countries in our system right now. And somewhat rigging the system. So we have demand right now for HCM. You have to have first things first. I mean, with BETI, everything's connected; it's not like it's payroll only, you have to have time and attendance, you have to have expense management, you have to have paid time off. So you have to have these other products within the system to work; BETI, I wouldn't say that we're developing just payroll only, we're developing BETI, the BETI process internationally. We looked at kind of us to following what the competition does out there with international, and quite honestly, I think it was unimpressive for an ROI strategy that it produces for clients. Our clients now are used to using BETI and so I think they're going to expect that internationally, and I think that's how we win. So I would say it's the beginning foundation for what we're doing, but also we have demand for that product in and of itself right now.

Okay, yes, that's fair. You mentioned that some of your customers are already using your systems, but is there any way to determine how many of your customers have international employees or offices?

It's our larger clients; it would be our larger clients in many of those cases. So I'm not going to give out a specific number, but I mean the revenue opportunities there for them. And then of course, when you look at our just prospect base that's out there, over time, this will increase the size of companies that we prospect.

Hi, thanks for taking my question. I just wanted to ask about some of the churn kind of benefit you see from legacy players. And are you seeing any kind of change in sort of the competitive dynamics or sort of the win rates that you have historically seen from some of the legacy players?

Yes, I mean, I wouldn't call out anybody in particular; we're getting much stronger. When we released BETI in July of 2021, we first started selling it, and we've gotten a lot better at our value proposition and how we actually go to market with it. I think it took some learning; it was somewhat hard to teach an old dog new tricks, from our standpoint of our sales force. When we started selling BETI, we were all virtual sales. We've made a bunch of changes dramatically. I definitely think having a stronger value proposition as we've had with BETI, as well as us being face to face, is helping our close ratio out there. I would say it would be competitor agnostic. When we have a strategic buyer that takes the time to really try to achieve the return on investment that implementing any one of these products would promise to produce, we do very well.

Terrific, and certainly within the technology world, there's a lot of conversation with ChatGPT and AI. I just wanted to sort of get your perspective either sort of expected impact to Paycom specifically, but even to the HCM space. Do you think this is a space that's kind of susceptible to change or kind of some pressure from ChatGPT? Do you think it's not yet kind of relevant to your space or to your company?

No, I definitely think it'll be relevant. You can use AI for multiple things. There are areas that you can use it for that are better than others. There are front-end things you can use it for direct to the client, there are back-end things that you can use it for that a client may never see. When you're talking about AI, it has many uses, some of which are front-end and some back-end. I don't want to talk specifically about what exactly we're using it for already internally and what our opportunities would be into the future. But in answer to your question, yes, I do think that over time, AI is going to be a thing in our industry.

Great. Thanks for taking our questions, guys. The first one is on Chad, you mentioned hiring and maybe being able to kind of hoover up some of the tech talent that have been coming from some of the larger maybe tech layoffs. But it sounded like that was more on the developer or the R&D side. I was curious whether you've also been able to maybe pick up additional salespeople along the way as well.

I mentioned R&D because we often hire individuals with technology experience, such as coding. For our sales team, we usually seek candidates with less than two years of outside sales experience, although we do consider those changing careers and have specific educational requirements for that role. I wouldn’t say it has been particularly challenging for us to fill these positions. However, the sales hiring process has changed; in the past, if you were interviewing a salesperson, you only had a week or two to make a decision due to them receiving numerous offers. Nowadays, that urgency has decreased, allowing us more time during the interview process to hire salespeople. This aspect has shifted, but I emphasized technology because that’s where we are currently seeing opportunities.

Right. Okay. All right. Cool. That's great. One quick follow-up, just like on the mechanics of the BETI payroll rollout. So you're in 180 countries with Global HCM? But, like, do you roll out BETI one country at a time? Are we going to see like 180 press releases for all the different countries that block here, a block there? Just mechanically, how is that rollout going to work?

There's about 16 to 20 countries that represent about well over 80% of the opportunity. So, I would expect us to be rolling those out first as you look at it, but yes, I mean, over time we build things ourselves. I would expect us to continue to roll them out. But there are 16 to 20 countries that are going to be first.

Hey, guys, thanks for taking the question. Most of my questions have been asked, but I guess maybe on the topic of just pipeline and sales expansion efficiency, I guess, how do you think about office openings, territory expansion, through the rest of the year, maybe sales hiring, moving into the back half of this year to get ready for next year? Just any kind of commentary around that, particularly as it would relate or compare to last year? And then just a quick follow-up?

Yes, so that opening up offices continues to be a big part of our strategy. We've continued to open up offices. I think a year ago was it last year, maybe about 15 months ago, let's call it 14 or so, we opened up five offices from December through February. Those offices are maturing very well and continue to mature, and we will continue to open up offices. For us, our bottleneck on being able to open up offices is capacity of our management group being ready to do that. We have to both backfill for managers that may not be accomplishing their goals, as well as we have to expand. Over the course of 25 years, I think we've done that pretty well. But it is a part of our growth strategy, and we'll continue to open up offices when we're able.

Perfect. I have a financial question. Free cash flow was very strong in Q1, significantly exceeding our predictions. How should we view that trend as we move through the year? With steady adoption continuing to improve, last quarter you mentioned nearly 50% penetration for BETI. What is the target for this year, and how much more efficient is an additional BETI sale compared to traditional sales?

Yes, I mean we didn't guide to the adjusted gross margin. I mean, it's been very stable over the last few years, and adding 85% to 86%. I mean typically, if it gets too high, we may be a little bit behind on hiring. That's usually what would cause it to creep up some, and it fluctuates based on how our hiring trends are, because those were the individuals that are bringing on handling the new business that we're bringing on, and we have to hire them ahead of the revenue growth. And that way, they can be trained up and ready to capture those clients.

Yes, also on the margin front, I mean, we wouldn't call out that it would be accretive or diluted; it should follow the same profile fairly similar to what our current clients are doing. I mean, obviously, we'll have some R&D costs as it relates to building some of this out, but in terms of just the overall margins, it should be very similar.

Thank you for taking the questions. Craig, when I look at your first quarter sequential growth or fourth quarter in recurring revenue, it appears to be slightly lower compared to previous first quarters. I understand that the declining mix of tax wins revenue plays a role here, but do you have any additional insights on the narrative of go-lives or growth within the tax forms? How is that trending?

I would say, we call out the tax forms; I mean, obviously, they don't grow in quite the same rate as the rest of our revenue, but they become a smaller portion of our overall revenue. So I would say that that's kind of what we've seen on those tax forms filings. They don't have the same growth rate as the rest of our revenue.

Yes, set a little bit differently. Since 1998, when we started the company, we've only added one product to our year-end services. That was ACA; that's it in 25 years. Meanwhile, our monthly recurring revenue products, we've continued to add products that we charge on a monthly recurring basis for them. And so the monthly recurring is just growing at a rate much more so than our annual recurring. And over time, the annual recurring amount represents a smaller amount of a client's bill because of that.

Got it helpful. Just one follow-up on float revenue, and just your philosophy on reinvesting some of the upside here. Can you just remind us of your philosophy, and if anything has changed at all, given some of the announcements on kind of your global initiatives?

Yes, I mean, we're still investing in pretty short-term investments, very safe. We're looking at CDs, commercial paper, treasury notes, and then some overnight. So we're still very safe on our investments and fairly short-term. As we do global, we'll look at those opportunities as well.

Thank you for taking my question. Good afternoon, everyone. Perhaps you can approach global HCM differently. Considering some of the new products you’ve introduced in the past few years, such as BETI and TDX, these appear to potentially reach your entire customer base. We saw a relatively quick impact on your business from BETI. I'm trying to understand if global HCM will also affect a significant number of your customers. Is the opportunity with large customers substantial enough to make a difference this year, or should we view global HCM as a multi-year initiative that lays the groundwork rather than expecting immediate results like we did with BETI? I know that was a long question, but I hope I communicated my point clearly. Thank you.

Yes, I mean, we just came out with Global HCM. I do think it'll be somewhat accretive to our numbers this year, more so in subsequent years. It's a significant system. I think it'll allow us to continue to go further up, even just the Global HCM side increases our TAM by about 50%. It's available there. As we continue to add the payroll to it, I just think that puts us on a different playing field for us to continue to go up market as well as serve those clients of ours that currently have an international presence and might not be using our system the way they're going to be using it in the future.

Thank you, and congratulations on the impressive results. I have a sense of the answer, but I would like to understand the source of the upside and the adjustments made, particularly regarding the new logo for the quarter, and how that aligns with initial expectations.

Yes, new logos drive our growth. I'm not going to say you see, when interest rates go up, we've talked about how we're achieving roughly 80% of that as it moves. So obviously, that impacts us positively as well. But for us, what's always driven our revenue has been new logo ads.

And then if you think about the move internationally and up market? Does that impact the implementation strategy at all? In terms of upfront, you try to be very opportunistic, RAM modules, things like that? Is that the same strategy as you kind of scale the client base?

Yes, it's going to influence our implementation strategy as we expand into other countries. It will change implementation to some degree. A lot of that depends on where the client is located. Are they in Nebraska, Mexico, or the U.K.? Different time zones come into play, and sometimes people are awake while other times they are not. So, it definitely alters our implementation strategy as we go global.

Hey, thanks for taking the question. I was wondering, do you have customers who are now using Global HCM? And if so, what's been the early feedback?

We have some companies that are starting to pilot it, I think there's a couple. A lot of Global HCM is developed with current client feedback. From that perspective, just seeing what they're trying to accomplish, what they're using. And then just making a decision that we had just take our current systems and be able to put them to where they could be used in 180 countries and in 15 languages; so that we would expect more and more clients throughout this year to use the global HCM piece of Paycom.

Got it. And then on the dividends, how do you think about it? Just seemed like going forward. Would it be a percent of GAAP EPS or free cash flow or some other metric?

Now, I mean, right now, we're looking at it as a fixed amount, the $50 over the next year, or $37.5 a quarter. Right now, it's basically a 50% to about a 50% or 0.5% dividend yield based on our current share price. But we would look at it as that $50 and then adjust that as we see fit in the future.

I want to thank everyone for joining the call today. Our employees' efforts continue to put Paycom in a great position, and we're off to a great start in 2023. So thank you to the Paycom team. Over the next quarter, we'll be hosting meetings at five conferences beginning with the Needham Tech and Media Conference and the Moffett Nathanson Technology, Media and Telecom Conference, both of which will be held in New York. Following that, we'll be attending the JPMorgan TMT conference in Boston, and the Jefferies Software Conference in Newport Beach. We'll also be presenting at the Baird Global Consumer Technology and Services Conference in New York in early June. We look forward to catching up with many of you soon. And operator, you may disconnect. Thank you.