Paycom Software Inc (PAYC) — Q1 2024 Earnings Call Transcript

Thank you, and welcome to Paycom's earnings conference call for the first quarter of 2024. 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 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'll now turn the call over to Chad Richison, Paycom's Co-CEO and President. Chad?

Thanks, James, and thank you to everyone joining our call today. I'll kick off the call with a few highlights from the quarter, and then I'll turn it over to Chris to discuss client trends and recent awards. Craig will then review our financials and our guidance before taking questions. Our product vision centers around eliminating redundant HR work, eliminating cost and allowing users to recoup valuable time in their day to add value to their organizations. In addition to our single database, which simplifies the client experience and reduces integration costs, another key Paycom differentiator is that employees input and validate their data directly into our HCM solution. With Paycom, employees do their own payroll, fixing errors before they become problems. On our last call, we highlighted three key focus areas in 2024: solution automation, client ROI achievement and world-class service. Led by Beti, our solution automation initiatives continue to generate tremendous opportunities for our clients. We released more product enhancements in the first quarter than in the previous two quarters combined. We are leveraging AI and decisioning logic across our solution, adding more value and eliminating mundane, non-revenue generating activities for our clients. A recent new client told us that prior to implementing Beti, it would take over two days to process payroll. With Beti, they complete the process in only 90 minutes. We've also automated time-off decisioning, allowing managers across the country to focus on value-added activities. With GONE, our time-off product leverages decisioning logic to automatically approve, deny or warehouse time-off requests by employees. This is a better experience for employees and delivers both time savings and efficiencies for workforce management and scheduling. On the client ROI achievement front, our success with Beti results in increased client ROI and is resonating with more and more businesses in the marketplace. Our clients already receive industry-leading ROI, and we are focused on accelerating our product road map to drive even more value. Now with Beti, clients regularly tell us that their company runs much smoother when their employees do their own payroll, and I know this sentiment is shared across the client base of Beti users. We are changing the way payroll is done, and our clients are telling us we're right. On the world-class service front, we are meeting clients where they live to help identify and close any gaps they might be seeing between their respective total available ROI and where they stand today. We are strengthening our client relationships with service and value achievement, and I want to thank our employees for their incredible efforts on this front. It is working. Our go-to-market strategy continues to emphasize the differentiated nature of our offering and the significant benefits of doing your own payroll with Paycom. We are getting more leads, thanks to Beti, and we are seeing solid demand for our solution. At our recent sales incentive trip, we recognized our first sales rep to sell over $4 million in annual new business. It wasn't that long ago that we celebrated the first sales rep to sell $1 million in annual new business. We believe our unique value proposition separates us from the other disparate offerings in the market that require complex integrations and manual entry activities. We continue to make meaningful progress on the international front, as we build on the momentum we achieved in 2023 and early 2024, when we released our global HCM product and announced the launch of native payroll in Canada, Mexico and the United Kingdom. Today, we are pleased to announce that we have developed and are launching our native payroll solution in Ireland. In less than a year since we announced our international journey, we are already seeing U.S.-based companies with an international presence look to Paycom as a global provider. While still early, I'm pleased to see that all the work on our international strategy is paying off. In fact, we recently won a large international sports organization, thanks to our multi-country payroll and HCM offering. This client will process payroll with Beti in multiple countries, and this win represents another proof point for our international strategy. While this is a great win for Paycom, I want to be sure to note that we remain highly focused on our U.S. growth, as we still have only an estimated 5% of the total addressable market. To sum up, I'm pleased with the progress we are making on our strategic initiatives, and I look forward to building on the momentum we are seeing. With that, let me turn the call over to Chris.

Thanks, Chad. Our service and client relations group continue to work very closely together to drive value for our clients. Usage of our system continues to increase as more employees interact directly with their data. Our average DDX score continues to rise and is above 95% across our client base today. Our innovative technology and our client ROI achievement strategy are key drivers of satisfaction and bolster our world-class service model. In fact, we were very pleased to receive several awards that highlight the strength of our relationship with our clients. Most recently, we were recognized as the 2024 winner of the Excellence in Customer Service Award by Business Intelligence Group. It's gratifying to receive recognition from an organization for our hard work and dedicated focus on our clients. This award highlights businesses who are redefining service standards in their industry. This achievement showcases our ability to further drive client ROI while making a positive impact across our client base. We were also named one of the most trustworthy companies in America by Newsweek for the third consecutive year. These awards are a testament to our service model. I'm pleased to see that our relationships with our clients continue to get even stronger. Finally, we earned the Gallup Exceptional Workplace Award for the second consecutive year, and we're grateful to be recognized among global leaders in workplace culture.

Thanks, Chris. Before I review our first quarter 2024 results and our outlook for the second quarter and full year 2024, I would like to remind everyone that my comments related to certain financial measures will be on a non-GAAP basis. First quarter revenue of $500 million was up 11% over the comparable prior year period. Within total revenues, recurring revenue was $492 million for the first quarter of 2024, representing 98% of total revenues for the quarter and growing 11% from the comparable prior year period. We delivered strong net income and adjusted EBITDA in the first quarter of 2024 with GAAP net income of $247 million, or $4.37 per diluted share based on approximately 57 million shares. Included in our GAAP results is a one-time non-cash stock compensation benefit of $118 million related to the forfeiture of the 2020 CEO performance award. Non-GAAP net income for the first quarter was $147 million, or $2.59 per diluted share. First quarter adjusted EBITDA of nearly $230 million was better than expected, primarily due to higher revenue and expense discipline and represented a margin of 45.9% for the quarter. During the first quarter, we paid over $21 million in cash dividends. And earlier this week, the Board approved our next quarterly dividend of $0.375 per share payable in mid-June. We still have approximately $796 million remaining under our buyback authorization as of March 31, 2024. Adjusted R&D expense was $45 million in the first quarter of 2024, or 9% of total revenues. Adjusted total R&D costs, including the capitalized portion, were $71 million in the first quarter of 2024 compared to $55 million in the prior year period. We continue to invest in our long-term future growth in areas of automation, AI and international. Our tax rate for the first quarter of 2024 was 15% on a GAAP basis, reflecting the benefit of the forfeiture of the 2020 CEO performance award during the quarter. For Q2 and the full year 2024, we anticipate our effective income tax rates to be approximately 33% and 22%, respectively, on a GAAP basis. We estimate Q2 and full year 2024 non-GAAP effective tax rate to be 25%. Quarterly fluctuations in our effective tax rates are generally due to the timing of stock compensation vesting and related tax effects. For the remainder of 2024, we expect stock-based compensation expense to be approximately $33 million per quarter. Turning to the balance sheet. We ended the first quarter with a very strong balance sheet, including cash and cash equivalents of $371 million and no debt. The average daily balance of funds held on behalf of clients was approximately $2.6 billion in the first quarter of 2024, up 8% year-over-year. On the capital expenditure front, our fifth building in Oklahoma City is substantially complete and will be placed into service in the second quarter. While we continue to estimate total CapEx as a percent of revenues to be approximately 12% in 2024, we also expect that percentage to decline beginning in 2025. Now let me turn to guidance. For fiscal 2024, we are maintaining our revenue and adjusted EBITDA guidance ranges with revenue expected to be in the range of $1.860 billion to $1.885 billion, or approximately 11% year-over-year growth at the midpoint of the range. We expect adjusted EBITDA to be in the range of $720 million to $730 million, representing an adjusted EBITDA margin of approximately 39% at the midpoint of the range. We remain on track with the full year plan we put in place at the beginning of the year and are beginning to see positive responses from our strategic initiatives. For the second quarter of 2024, we expect total revenues in the range of $434 million to $438 million, representing a growth rate over the comparable prior year period of approximately 9% at the midpoint of the range. We expect adjusted EBITDA for the second quarter in the range of $151 million to $155 million, representing an adjusted EBITDA margin of approximately 35% at the midpoint of the range. We continue to focus our efforts on executing on our plan and building momentum. We have a differentiated product, an industry-leading value proposition and a solid foundation to build upon.

I have two quick questions. First, for Chad and Chris, can you explain the strategic initiatives you're discussing? Specifically, what are you doing in that regard, and how do those initiatives relate to market conditions, such as end demand and challenges from reduced hiring? It would be helpful to understand what's happening in the market compared to your situation. My second question is for Craig. Can you talk about the potential benefits you might experience from fewer rate cuts this year? Is this situation advantageous for you, and how does it fit into your overall model?

Sure. So I'll take the first one, Raimo. Our client value achievement strategy, or as you called it, the strategic initiatives that we're working on throughout the year really have to do with meeting clients where they live and making sure that they're achieving the full value of ROI that's available to them through the appropriate usage of our software. We've been focused on that. We did call that out on October 31, actually, when we reported, we did call out that we're going to be really focused on that. All of those initiatives are in efforts to continue to drive improvements in retention, and again, be able to set clients up to achieve full value because we do have additional products for many of these clients that can really help them out once they're utilizing the product correctly that we've already implemented. And I'm going to say that's in regard to our current client base. From a new client base perspective, we're focused on our sales initiatives, and those have been unchanged as we move throughout the year as far as what our focus is there.

Sure. And Raimo, on the rate cuts, I mean, obviously, that changes every day as to how many there might be, but it seems like there may be less than we had originally thought. So that is a benefit towards the end of the year. But the one thing we're also looking at is do we try to extend the duration of some of those funds? And when you do that, you're trading off some of those higher rates. Effectively, you're taking two or three rate cuts if you do that. So that's kind of what we're looking at strategically with those funds.

This is Mason Marion on for Samad. So looking at your guidance, can you kind of elaborate on what you're seeing from a churn new bookings perspective and how – and the assumptions that you have for those in your guidance?

You sound exactly like Samad. So churn, new bookings POB assumption. What is the – I'm trying to can you maybe – can you say that question again?

I'm just trying to better understand what you're factoring into your 2Q assumptions and maybe for the back half of the year around what you think from a new bookings perspective, from a churn perspective?

Yes, stability. I mean from a new bookings perspective, we are seeing improvement in that. Retention is something that we call out at the end of the year, but all of our initiatives that we're working through our client value achievement are set to have an impact on that, and we feel good about how that's working.

Chad, I was wondering if you could talk just a little bit about what you're seeing in terms of variance, in terms of sales performance across the various offices. You did mention that you've got one quota carrier that achieved over $4 million, and so that obviously seems very strong. But on the other hand, we've had a little bit of a deceleration with regards to the revenue growth rate. And so I'm just wondering, when you talk to your sales leaders, and you obviously made some changes there, what are they seeing out in the market? How much more difficult is it to get new sales? There have been some investors that have been asking about saturation in the mid-market. And I'm wondering what your perspective is with regards to that.

Yes. And so I guess, first, I would say, I mean, our best offices are going to have the best managers regardless of geography. I think there for a couple of years, Tulsa was #1, and it's a city of 400,000 people. We've been in that city for 22, 23 years. So your best office is going to have your best manager. From a saturation perspective, that's – no, there's no such thing as saturation in the mid-market. I mean you've had the same players for a long period of time. We're all very competitive in the market. We have about 5% of the total addressable market available to us. And so no, I wouldn't say it's from a saturation perspective. It comes from appropriate management, appropriate training and appropriate leadership. As we've gone through the year, we've gotten better and better and can call out that we are having accelerated sales if you look at the last two months of this year versus the first two months of this year from a bookings perspective. And that's not to say that the first two months were bad, it's just to say that we are getting better and better at how we move product.

That's great. And can you talk a little bit about what you're doing with regards to the internal sales group that typically does the upsells? How are you structuring commissions? Is there still a mandate that new clients have to have Beti? And where do you stand with the Beti penetration within the existing client base?

Yes. So there's no change with what the CRR groups have been doing. They've been making significant impacts for us and the client value achieving the strategy. Again, meeting clients where they are today, making sure they're receiving full value of using the system that they've already purchased before we move forward. Selling them additional products, they've done a good job with that. There's no change as far as what their focus is from that, but we are seeing the positive impacts from them.

This is Camden Levy sitting in for Brian Schwartz. My question is around sales capacity. How do you guys feel about the quota carrying like sales capacity of the business? And are there any plans to increase the number of sales offices in the second half of this year or early 2025? And then just additionally, thinking about just the pipeline momentum, is there anything you guys can provide qualitatively about how the pipeline is building in 2024? I know you guys had mentioned stability, but any other commentary regarding how that's building?

Yes. So first around sales capacity. Our sales capacity numbers, again, have gotten a lot more improved, I would say, over the last two or three months from that perspective. It would be too early to say exactly when we would be opening up additional offices because, as you know, we take a current manager that's successful, relocate them to a new territory to open up an office and then we backfill them with salespeople who are ready to be sales managers. How quick we are able to open up additional offices is really dependent upon that backfill bench and how we are doing there. We've continued to have success building that out, but also key for us is we have 55 sales teams right now and it's making sure that all of those are performing at top levels. That's a focus that we've had going throughout 2024. Commentary on pipeline. Pipelines are very strong.

Can you give us a sense how is the pre-employment services revenue trending for the year relative to your maybe expectations leading into the year? And remind us how correlated is that revenue stream to job switching versus any other factors that we should be considering there?

Our unemployment services are stable, and I would categorize them as such. They have remained stable and are somewhat influenced by the new clients we acquire as well as trends among current clients. If a company were to experience increased turnover, they would need to manage the new hire background checks as required. However, we haven't observed any significant changes in employee turnover leaving clients for other opportunities compared to the past. There was a time during COVID when turnover seemed to increase a bit more than normal, but currently, there is nothing significant to report regarding that product.

Got it. And then just a quick follow-up. The revenue guidance implies a little more of maybe a second half reacceleration in growth than what we were previously expecting. Can you just give us a sense of what gives you the confidence or visibility to that revenue growth reaccelerating in the second half?

Yes. So a lot of the initiatives that we had and we talked about last November and fourth quarter really were front-end loaded. And so that's really what we saw even going into the Q2 guide, is those were more front-end loaded and then we would expect once we get through some of those, we would see a reacceleration in the back half of the year.

Okay. Great. I guess maybe to dig into the guide a little bit more. It seems like sales performance has improved the past couple of months or at least better than first couple of months. And I guess with rate environments maybe staying in a little bit higher, I guess, would have expected maybe a little bit better of a guide here. So I guess, is there kind of like any change in assumptions? Or maybe help me kind of think through why the guide has been maintained versus maybe some of the green shoots that would impact that?

Our guidance for 2024 was provided for the first time on October 31 of last year. It includes various organic initiatives aimed at positioning us for 2025. We have remained committed to those plans and timelines. At the beginning of this year, we indicated that our results would be more weighted toward the latter part of the year due to client value strategies and the efforts of the CRRs and other teams. As we approach each quarter, we concentrate on actions that we believe will have the biggest positive effect on our clients, enabling them to achieve the best ROI. I have often mentioned that it's much easier to sell an additional product to a client once they are actually using it. We have put in place several strategies to ensure that clients can fully utilize our offerings and derive their value before we offer them more products or even invoice them after a sale. We want to ensure they are engaged with the product before we charge them. While these initiatives have postponed certain revenue opportunities, they are essential for our long-term success. It's critical for us to stay focused on meeting clients where they are in their journey with Paycom.

Okay. That's helpful. Maybe just to slip another one in here, I guess, maybe to ask it differently. Just I guess if we think about the guide today versus 90 days ago, like maybe how are some of the underlying assumptions different today than they were before?

They're not. They're not changed.

Great. I don't know if you said it on the call. If you did, I missed it. How much stock did you buy back in the quarter?

Yes. We didn't call it out on the call. It was a small amount, I think like $3 million.

$3 million. Okay, great. And then it seems like the margins really overperformed. Was that a function of maybe not being able to hire certain folks you wanted to or just better expense management? And how should we think about that, if possible, over the balance of the year?

I would say better expense management for the quarter. I mean we've given the full year adjusted EBITDA guidance. We'll continue to look throughout the model for efficiencies. I mean yes, right now, we're like 39% adjusted EBITDA margins. And so still best-in-class and looking at additional efficiencies.

It's Ryan Krieger on for Alex. So first one, just to touch on margins again. You kind of previously talked about leaving a little bit of room for potential incremental investment this year. So I'm just curious what are the top investment priorities that that optionality could be earmarked for? And then on customer cohorts, can you just give us a quick update on kind of the down-market attrition that you were seeing last quarter and how the upmarket cohorts are performing now?

Yes. We have been increasing our spending significantly in the research and development area, particularly with the recent launch in Ireland this quarter. This is a key focus for us. Additionally, we have some flexibility to make adjustments on the sales and marketing front.

From a customer attrition perspective, we mentioned last quarter the effect that our small business group, which we entered in 2020, had on our retention rate. We're not updating the retention rate today, but I want to emphasize that the small business segment accounts for about 3.5% of our total revenue. However, I don't think there have been any significant changes in how the small business impacts attrition, which tends to follow traditional patterns. Again, I'm referring specifically to the small business part of our revenue.

It's Phil on for Siti. I just wanted to ask, it sounds like you guys are heavily investing into the product to several enhancements. What are some key features that you're working on? And when can we maybe hear more about them?

Yes. So we did roll out GONE fourth quarter, and we continue to put people on that. From an automation perspective, I mean, we've got several things rolling out throughout this year. We don't disclose what we're developing and/or what we've done until it's actually out in the market. But we're having a lot of success in product and really around automation. That's very important, and I believe that's wins. I mean it's 2024. And to think that any company would buy or implement a system, whereby the payroll department inputs and imports data to do the payroll, I mean, it's crazy. I mean if a company wants to do that, they might as well drive to their office throwing money out the window and run every stoplight because they don't care about liability. I mean to me, it's all going to automation. That's what's important. That's how you do something, consistently the same way and actually achieve value. And so that's what we're doing over in product. I did call out on the call that we did put out more product this quarter than we had the two previous quarters combined, and we're just accelerating from there. So it is an exciting time to be in product because you're able to really utilize technology today to make an impact. I believe we've been at the forefront of that, and we're accelerating it.

My first question, how should we think about the sequential headwind to 2Q revenue growth from the annual form filings revenue recorded in 1Q?

There wouldn't be any headwinds there into Q2.

Not in the Q2...

There was a sequential decline, but I don't think the comparison to last year is particularly relevant.

There wouldn't be any headwinds there into Q2.

Obviously, it's factored into our outlook. And as far as the sequential drop, we'll see there. And then as we probably could comment on forms filings, we're in line with expectations.

Yes. But we have called out for the last seven, eight years that over time, the percent of the quarter that your forms filings would have, the percent of revenue that it would represent over time is going to be lower and lower because we've added additional products and additional services. But we really haven't added anything to our year-end forms filing. I mean it's been substantially the same service types. We added one thing to it in 2016, and that was the ACA form. But other than that, it's been the exact same services since 1998. And so it represented a larger percentage for us in revenue during the first quarter can go way back. Over time, that percentage has dropped, not because it's going down or we're charging less, but because of the other fees, services and additional products now that just represent a larger percentage of that revenue for the quarter.

Okay. And then as my follow-up, any reason why you cannot shift towards PEPM-based pricing for payroll? And is this something that you've considered or you anticipate considering in the future?

We don't comment on specific pricing initiatives in regard to competitive situations. All that's to say is we're looking to win every deal. And that's the mode that we're in right now. I know I have our sales organization listening to this call, and they know that. We're looking to win every deal. So that includes all the initiatives that would go into that. So I would just stop with that.

Great. This is Zane Meehan on for Jason Celino. I wanted to ask quickly about the competitive environment. Any notable changes you're seeing there? And maybe any particular strength or weakness you're seeing in any specific verticals or end markets?

I wouldn't say there's been a change in the competitive market; it's always been competitive. I've consistently mentioned that. There are definitely differing strategies in place, and I believe ours stands out in terms of automation and effectively utilizing our workforce to enhance ROI. Our employees are the ones most concerned about their paychecks and financial situations, including hours worked and health insurance, as it directly affects them. We have successfully leveraged that and shifted our focus accordingly. Although our messaging could have been better during this transition, I'm confident we've corrected our approach while assisting clients to adapt. From a market perspective, this is why companies are reaching out to us. They are evaluating how many back-end staff they can hire to manage these tasks effectively. We have the best process, and trust in it is growing as more companies adopt Beti. All clients who began using Beti since July 2021 have seen considerable success with that product and the associated suite of products. With the launch of GONE, it's noteworthy that managers spend an excessive amount of time handling PTO. Over 50% of PTO requests in the U.S. are approved after the time off is already taken and compensated, indicating poor management. Additionally, nineteen states mandate payout for unused PTO when an employee leaves. This represents just one area where there’s significant ROI potential for our clients. Therefore, it’s crucial to align with them based on their current needs and showcase this in our sales discussions. We have improved in this area as we refine our training programs and strategies for sales and lead generation.

And two for me. The first one, just, Chad, can you just maybe talk about the promotion of Amy Walker as the Head of Sales at the beginning of the quarter. Can you just elaborate on any changes to the go-to-market strategy that we should expect over the coming quarters or years?

Yes, we changed our go-to-market strategy. Amy was promoted to run outside sales in late November, and then she took over all of sales shortly after that. We started enhancing our go-to-market strategies, particularly for the outside sales group, which makes up the majority of our sales. She has had a significant impact on that group. We are seeing continued improvement week after week.

Got it. Craig, could you help quantify some of the challenges you are facing with revenue from your strategic initiatives, such as the reduced paper control due to fewer payroll runs through Beti or the impact of other clients' success measures that you mentioned today?

What we discussed was the decrease in payroll runs due to Beti. Beti is enhancing efficiency for clients by eliminating some of those runs, which ultimately benefits the client. Overall, this creates a more favorable process and situation for them. We mentioned that we are beginning to observe these changes, and most of the impact will be felt in the first half of this year. As we move into the latter half, we don't expect to see as significant an impact.

Great. Maybe to revisit the sort of innovation and R&D kind of theme that came up a couple of times. I guess when you look at your customer base today, where is the least automation in the workflows? Is there any sense of where there's like the easiest ROI for you to come in and offer some additional automation in the product?

There are so many places that we can go in our product and really automate full items that were multiple steps before. It again takes appropriate client configuration. It takes a client's ability to have a mind of change management because it is different than what they've done before. It takes some trust because you are giving up some level of control when you turn it over to AI, and you have to prove that out. There are certain ways that you can work with clients and help prove that out. So there are certain ways that you can work with clients and help prove that out. And so it's everywhere. I mean in answer to your question, it's everywhere. We've been working on that. I've been working over in product, and we've been having an exciting time doing it. The world's our oyster right now in regards to that. I believe we've always been the leader in what's new and innovation. We have opportunities to continue to accelerate that, especially now that we're all focused in the same model from a product development perspective.

All right. Well, thank you for joining our call today. I do want to acknowledge and celebrate our 10th anniversary as a publicly traded company. I want to thank all employees who have contributed to our success and set us up for the next decade of innovation and growth. Over the next couple of months, we'll be attending the Needham Conference in New York on May 14, the Jefferies Conference in Newport on May 29 and presenting at the Baird Conference in New York on June 6. We look forward to engaging with many of you again soon. Operator, you may end the call. Thank you all.