Paycom Software Inc (PAYC) — Q2 2024 Earnings Call Transcript

Thank you, and welcome to Paycom's earnings conference call for the second 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 the 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 will now turn the call over to Chad Richison, Paycom's CEO and President.

Thanks, James, and thank you to everyone joining our call today. I'll focus my comments on the progress we are making on our 2024 initiatives, and then I'll turn it over to Craig, who will review our financials and guidance before taking questions. This year, we remain focused on providing world-class service to our clients, solidifying client ROI achievement, and deepening our automation capabilities through product innovation. I'm very pleased with the progress we are making on these client-focused initiatives as they are resonating across our client base. As a result of our initiatives, our client usage metrics and our net promoter score are up and trending positively. Beyond that, I'm very pleased with our achievements on the product front. We continue to lead the industry in automation. Our clients consistently confirm this view. We continue to eclipse our functionality with even greater automation as we rapidly move towards full solution automation. The enhancements we made to our development processes at the end of 2023 enabled us to transform our solutions even faster. Year-to-date, we have more than doubled our development productivity rates and implemented functionality for our clients that eliminates redundant payroll and HR work through automation and employee usage. We are rapidly eclipsing the industry by delivering a fundamentally differentiated value proposition for our clients, which ultimately results in a better employee experience. We are focused on continuing to automate the most automated solution in the industry. Two examples of automation in our industry are Beti and GONE. Every month, millions of checks are processed directly by employees using Beti, delivering our clients measurable ROI through this truly unique solution. One example is an existing client who has been with us for six years. This is a 2,500 employee company that recently adopted Beti. Since allowing their employees to do their own payroll, they reduced their payroll team by half, going from a process that took roughly four days before Beti to merely hours with Beti. Beti continues to evolve and raise the bar as we add more functionality and connections to solve complex decisioning. And we are seeing increased inbound inquiries from prospective clients. GONE, the industry's first fully automated time-off solution was recently recognized as a global award winner for transforming the time-off process. It connects highly complex traditionally disparate solutions and leverages decisioning logic to automatically approve, deny, or warehouse employee time-off requests. Time-off decisions are a hassle for everyone within an organization unless you use GONE. Thanks to GONE, employees get immediate decisions and managers gain back time and increase scheduling visibility. HR and payroll no longer have to track down managers to verify and decision requests and GONE significantly reduces after-the-fact liabilities and related costs. The C-suite benefits from increased confidence in operations and resource management, driving improved productivity and reducing liability. We have a retail client with over 100 stores where each manager controlled time-off requests differently. The client enabled GONE and built unique rules per store to ensure each manager was in control of their appropriate coverage. Now these managers no longer need to take direct action on requests. And when the payroll team is prepping payroll, they've eliminated the need for all follow-ups. Their payroll manager stated, GONE took Beti to the next level. Since implementing GONE, this client has automated over 1,000 time-off decisions, bringing about hours of non-productive time. I'm very excited about GONE and its ability to streamline time-off requests for businesses across the globe. Through solution automation, we are helping our clients eliminate decision fatigue across the entire organization, from the C-Suite to HR and from managers to employees. This in turn creates better employee retention and engagement for all organizations. We are meeting the expectations of today's employees and once they've experienced Paycom, they don't want to go backward in technology. In fact, we are seeing more and more returning clients as both user buyers and employees are missing the automation that is lacking in disparate and antiquated competitor solutions they had deployed. At the end of the day, the best product will win, and we are furthering our product advantage. We continue to leverage AI across a wide variety of areas within our organization. We believe our AI approach toward full solution automation will continue to deliver even stronger ROI, value, and functionality for our clients. On the international front, we continue to make meaningful progress in the geographies that we rolled out in the last 12 months. Beti is now available for employees in Canada, Mexico, Ireland, and the UK. We continue to win new clients with domestic and foreign employees, thanks to our investments in our global HCM product and our native international payroll. On the sell-side, we are seeing strong momentum. Our new outside sales reps are winning more deals earlier than ever before, and we've sold significantly more units in 2024 than we did this same time last year. Just this month, we had our top sales week in company history. Sales is energized and last week we added our largest sales class of new reps placing 67 sales reps in the field across the country. I'm excited about the enthusiasm across our sales division heading into the back half of the year. To sum up, I'm pleased with the progress we are making with our product strategy and with our strategic initiatives. The investments we are making in 2024 and our focus on client value achievement are designed to deliver long-term value to our clients and their employees, which will in turn deliver value to Paycom and its stockholders. With that, let me turn it over to Craig.

Thanks, Chad. Before I review our second quarter 2024 results and our outlook for the third quarter and full year 2024, I'd like to say a few words about my future plans here at Paycom. I joined this incredible company nearly 19 years ago and had the privilege of shepherding the company from a few million dollars of revenue to one approaching $2 billion in revenues. It has been a career that has surpassed all of my dreams, and I want to thank Chad for bringing me in as a partner in this journey. As a new grandfather, it is time for me to prepare for my next chapter and I'm announcing my plan to retire from my role as CFO sometime in the next nine to 12 months. And after that, I expect to remain with Paycom in an advisory role. With that, let's dig into Q2 results by reminding everyone that my comments related to certain financial measures will be on a non-GAAP basis. Second quarter revenue of $438 million came in at the top end of our range and was up 9% over the comparable prior year period. Within total revenues, recurring revenue was $430 million for the second quarter of 2024, representing 98% of total revenues for the quarter and growing 9% from the comparable prior year period. GAAP net income in the quarter was $68 million, or $1.20 per diluted share based on approximately 56.8 million shares. Non-GAAP net income for the second quarter was $92 million, or $1.62 per diluted share. Second quarter adjusted EBITDA of nearly $160 million, or 36.5% margin, was better than expected, primarily due to expense discipline in the quarter. We continue to aggressively invest in areas of AI, automation, international expansion, and our value proposition for the client. Adjusted R&D expense was $55 million in the second quarter of 2024, or 14% of total revenues. Adjusted total R&D costs, including the capitalized portion, were $81 million in the second quarter of 2024 compared to $61 million in the prior year period. We are building more automation on the most automated platform in the industry, which should continue to distance us from the rest of the competition. For Q3 and full year 2024, we anticipate our effective income tax rates to be approximately 28% and 23%, respectively, on a GAAP basis. We estimate Q3 and full year 2024 non-GAAP effective tax rate to be 26%. For the remainder of 2024, we expect stock-based compensation expense to be approximately $30 million per quarter. Turning to the balance sheet, we ended the second quarter with a very strong balance sheet, including cash and cash equivalents of $346 million and no debt. The average daily balance of funds held on behalf of clients was approximately $2.4 billion in the second quarter of 2024, up 8% year-over-year. During the second quarter and into July, the valuation of our stock dropped below that of slower growth and lower margin peers. We opportunistically took advantage of the low stock price to repurchase approximately 790,000 shares between April 1 and July 31 for $120 million. Since July 1 of last year, we have repurchased approximately 2.3 million shares, representing approximately 4% of total shares outstanding. Nearly 2 million of that has been repurchased since November of last year. Earlier this week, we increased our buyback authorization to $1.5 billion and extended it for another two-year period. We will continue to be opportunistic buyers of our stock if and when we see dislocations in valuation relative to our peers. During the second quarter of 2024, 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-September. Now, let me turn to guidance. We continue to execute on several strategic initiatives and remain on plan to achieve the 10% growth and 39% adjusted EBITDA margin that we guided to at the beginning of this year. For fiscal 2024, now that we have more visibility into the remainder of the year, we are narrowing our revenue guidance range with revenue expected to be in the range of $1,860 million to $1,875 million or approximately 10% year-over-year growth at the midpoint of the range. We are raising our expected adjusted EBITDA range to $727 million to $737 million, representing an adjusted EBITDA margin of approximately 39% at the midpoint of the range. For the third quarter of 2024, we expect total revenues in the range of $444 million to $449 million, representing a growth rate over the comparable prior year period of approximately 10% at the midpoint of the range. We expect adjusted EBITDA for the third quarter in the range of $155 million to $159 million, representing an adjusted EBITDA margin of approximately 35% at the midpoint of the range. We have a strong balance sheet, strong free cash flow, and significant liquidity. We will continue to invest in areas that will bolster our competitive position and strengthen our client ROI through automation and the user experience. With that, we will open the line for questions.

Hey, thank you. And Craig, all the best. Well, I guess we still have a few quarters. My question is around Beti. Chad, in your prepared remarks, you talked about increased inbound inquiries. Can you talk a little bit about the perception that Beti now has in your installed base and I'm thinking about the whole installed base and how it's turning into a sales tool as the industry is understanding the benefit of that for its own business, but also for the employee base? Thank you.

Sure. And so new clients, and by the way, everybody does get a question and a follow-up. He didn't necessarily state that on the call, but Raimo, what's happening with new clients coming in, that's why they're coming in to use it. I mean, they're coming to Paycom to actually utilize Beti. I did talk about a client on the call who had been with us for six years. They have 2,500 employees, they implemented Beti and they were able to reduce their payroll department by half, and it went from a process that took roughly four days before Beti to mere hours with Beti. And so within our client base, we continue to meet clients where they are today as we work our client value achievement strategy to help them maximize the most ROI with where they are today. And then as far as new clients coming on, it's been no change. I did talk about on the call how we've had more unit sales this year than what we have in the past. And so our sales staff is doing really well in our go-to-market as well.

Okay, now that I'm allowed to follow up, may I ask one more question? You mentioned the record number of sales reps added this quarter. How do you view the hiring pace, particularly in sales? Considering what you're observing in your existing client base and the economy, how do you anticipate that will develop? Thank you and congratulations from me.

Yeah. So we're better staffed in sales than what we've been in probably five or six years. And what I mean by that is having all teams with the sales manager in it fully staffed and then just the number of staff that we have on each. And so, Amy Walker took over sales and had been with us for 14 years prior to that. She took over sales in April and since that time has really got them in a position, us in a position on the sell-side where we're strong from a staffing perspective and again, our sales tactics and techniques to be able to go out there and even sell more as we're differentiated in the industry.

All right. Thank you. And Craig, congrats on becoming a new grandfather, it's exciting news.

Thank you.

So maybe I'll start with you or for either one of you, but just as I think about the narrowing of the guidance outlook, what assumptions changed or what did you experience and what are you tweaking to get to that new narrow range? Is it a change in new business assumptions? Is it a change in CRR bookings retention? Just help us understand the mechanics of the change going forward, especially considering that 2Q came in a little bit better than you expected.

Yeah. I mean, as we came into the year, our plan had a wide range of initiatives and opportunities. And the high range had assumptions depending on some timing and the magnitude of some of those initiatives. So some of it was timing, and now that we have more visibility during the year and it's progressed, we're going to narrow that range.

Yeah. I mean, I would say that I've always felt like we've had the best sales organization. I think having the best products is part of that. We focus very hard on sales this year. We were very focused on it and what we wanted to accomplish with it. And being fully staffed does allow us to get to the opportunity to be able to open up offices, again, when it's right for us. Right now, we're really focused on unit growth and sales skills development. In the second quarter, we sold 24% more units than what we had sold second quarter of the previous year. That's just one data point since Amy has taken over. So that's helping. And being staffed really helps with that. The more people that you're staffed with, the more you're going to sell. And so we're having a lot of success right now with the sales group, and staffing is a big part of that.

Hey. Good afternoon, and thanks for taking my questions. And let me add my congrats, Craig, that's huge in terms of being a grandpa. Not really.

Thank you.

So I wanted to ask a little bit about some of the investments that you're making, Chad. Can you talk a little bit about the investments behind service as well as R&D? And specifically, I'm looking at the gross margins and trying to think through. You've ramped up the investments. It sounds like the NPS scores are going up as a result. How should we think about the further pace of the investments both in terms of cost of service as well as R&D and how that's going to unfold over the course of the year? And then I've got a follow-up.

Yeah, Mark. I'll take the gross margin part of that question. One thing on the gross margins, like you mentioned, is headcount. But this quarter, we brought our fifth building at Corporate Online. And so we saw an increase in the depreciation both on the building and on the equipment and furniture and fixtures as it related to that building. So part of that gross margin was the additional depreciation, which also hit other lines of depreciation in the income statement.

I want to emphasize that we are actively hiring in operations and are open for business. We hold only 5% of the market and have a unique product. Our focus is on our sales methods, customer service, and significantly on product development, which impacts our R&D expenses. The increase in R&D in the second quarter is due to the launch of numerous products; we released double the number of products this past month compared to January, which was also a productive month for releases. Our products are essential to the value we provide to our clients, and it's critical that we consistently prioritize this area. We have ambitious goals for our product development, but we are also cautious about our expenditures and aim to generate quality revenue that contributes to a strong profit margin. All of this is taken into account when we plan our budget and spending.

Great. And then it sounds like, I mean, with a 24% increase in terms of units sold so far year-to-date, is that part of the reason why we would anticipate seeing an acceleration with regards to the revenue growth in Q3 relative to Q2? Just wondering how baked in that is as opposed to hoping for additional incremental sales from the new salespeople.

Sure. So let me correct one thing; 24% is the unit growth for the second quarter over the prior second quarter. Year-to-date, we're about 15% in unit growth. I was just making the point since Amy has taken over. Now I will say, so far for third quarter starts, July starts, which are always the largest of a quarter. Your first quarter month is the largest revenue of any quarter. Our July starts are up 40% from a revenue perspective. And so again, these are about one data point, but it's from where we're starting. And we get to start with the best product, we get to start with the best sales training and we get to start with the best service model. And so for us, it's a continuation of work in our 2024 plan into next year.

Thank you for answering my question. I wanted to clarify the situation regarding the increase in new customer activity alongside the slight decrease in the higher end of the guidance. How should we interpret the effects of the additional payroll run revenue on the model? Has this aligned with your expectations? I'm interested in understanding if there are any other factors influencing the higher end of the guidance. Thank you.

Yeah. I would say all of the current client factors that we discussed even at the end of 2023, those still exist today as far as additional payroll run opportunities and inefficiencies gained when someone uses our product correctly. And so all those factors continue to exist, but we also have many mitigating factors that we're able to guess and pull the levers on. And again, we have a lot of confidence in what's going on with both our sales organization, our service organization, and of course, our product with what gives us confidence as we head into the end of this year and then as well as 2025. And so yes, anytime we focus on something, we're going to have some results from that. We've been focused all year on the client value achievement strategy, which does include meeting clients where they are and helping them achieve that ROI. It's impacting our service model from a positive perspective and it's impacting our net promoter scores. And those are commitments that we're not going to be backing off of.

Hey, great. Thanks for taking the question there. I guess maybe just kind of pull it on the last couple of lines of questioning. Just how is kind of the back to base motion kind of trending? And I guess on the back of what sounds like solid new units coming on board. Just how are you feeling about that back to base motion and kind of what that's implying for the growth outlook versus what you were expecting before?

Yeah. My opinions on that haven't really changed. I mean, it's very important for us to meet each client where they're at and make sure that they're utilizing the product to get the full value of it. And we're still very focused on that. I mean, you look throughout the history of Paycom, we've sold a lot of product, and it's very important that clients are utilizing it the right way to get ROI out of it. There's a lot of things we're also working on in product and developing and releasing that also helps with that. And so, it's not like we've abandoned working with clients to be able to help them purchase new modules from us that can help them drive that ROI. But we have changed the game a little bit in making sure that we're doing our part to make sure that clients are achieving the level of ROI needed for their satisfaction. And so that really hasn't changed for us as far as what we're doing throughout 2024 and what we're focused on here. It continues to increase every month. We are adding more clients, and each new client is starting with higher Beti usage than before. For those already using it, their usage continues to rise. With user-friendly technology, adoption is progressing well. However, some clients still may not be maximizing the benefits due to timing or specific initiatives. We are working with these clients in their own context, and sometimes they eventually come around. For example, a company with 2,500 employees recently acknowledged that using our payroll system cut their labor costs related to payroll processing in half, reducing the time from four days to just hours. This potential is available to all clients, but our priority is to support them where they stand today. We will align with their timeline rather than imposing ours. For new prospects, we aim for them to realize the full value we provide, which will enable them to achieve the ROI that only Beti can deliver for new clients.

Great. Thanks so much. Chad Richison: We're advancing our database count from that perspective and we're also continuing to enhance Beti. Beti is significantly improved from what it was at the beginning of the year. We are committed to further automating all of our solutions. Great. And then with the extended buyback, is there any way to think about the approach around that? Just relative to there's been some obviously variability over the last year or so, just any thoughts moving forward as to pace or progression of the buyback?

We bought back a significant number of shares, specifically 574,000 during Q3, and a large amount since July 1st. This reflects an opportunistic approach to the buyback. Additionally, the previous program was about to expire, so we established a new one for another two years with a value of $1.5 billion.

Hi. This is Phil on for Siti. You guys mentioned you added Beti in Canada, Mexico, Ireland, and the UK. Are there plans to add Beti to other countries?

Yes. As we develop these markets, certain countries have specific considerations related to their unemployment laws. Therefore, as we advance in these regions, we certainly expect that to occur.

Great. Thanks. This is Zane Meehan on for Jason Celino. Just one from me on the uptick in the EBITDA margin guide, nice to see that moving up by 50 bps. Just wanted to ask what's driving that increase and where you might be getting more efficient in the next or in the second half of the year? Thanks.

Yeah. I mean, we kind of look across the entire organization and just look for efficiencies. I mean there's no levers we're really trying to pull to do that. And really it was the second-quarter be really flowing through to the full year and then raising it on top of that. So really nothing that we're pulling any levers for.

Hey, guys. This is Ryan on for Alex Zukin. Just one question on the CRR teams. So can you just provide an update on where the CRR teams were focused in the quarter? Are you still structuring commissions towards Beti conversions of the base and system usage or are they starting to lean more back into the upsell, cross-sell motions? And to the extent that they are still focused on the Beti conversions, when could we see them kind of shift back to the upsell, cross-sell focus?

I'm not able to share the specific details of a CRR's process today compared to last year due to competitive reasons. However, each CRR works individually with clients, and since not every client is in the same position, their approach varies across their territory. It depends on whether I'm working with a client who hasn't fully completed the client value achievement strategy or one who has. This doesn't mean there aren't additional revenue opportunities with each client; it just involves certain methods we implement to ensure clients are reaching their goals before we proceed with sales. I wouldn't describe this as a significant change from any of the previous quarters this year.

Great. Thanks for taking my question. Just first for Craig. Just you mentioned bringing the fifth building online during the quarter. Any changes to thinking in terms of CapEx for the year? Is 12% of revenue still the right range to think about? And any of those builds that are planned in the near future that at the tip of your mind?

Yeah. I mentioned that we just finished the last building. We've got a couple more projects throughout the end of the year. So kind of as we talked earlier, what we thought the percent would be for the year somewhere in that 11% to 12%, probably still thinking that. As we look at next year, we really don't have any large projects on the plan. So we mentioned even on the last call that we would expect CapEx to be potentially single-digits next year as a percent of revenue, and that really bodes well for the free cash flow conversion, which we're also focused on.

I wouldn't say we pay much attention to it. Any opportunities related to data aren't necessarily strategic or unique from my perspective. I believe our focus should be on anything that can enhance our clients' experience with Paycom, and most opportunities align with that goal.

Yeah. Great. Good evening, everyone. Thanks for taking my question. Maybe, Chad, on you think about the product roadmap and the focus on automation, should we be expecting sort of more specific modules to help drive that outcome for your customers? Are you going to be reengineering things that you've already put out there to increase the level of automation? sort of any sort of high-level thoughts about the direction you're embarking on here?

Sure. We focus on identifying the problems we need to solve and what aspects we want to automate. This serves as our starting point, regardless of whether it involves our current systems or new additions. The emphasis is on the problems we are addressing. When it comes to automation, it spans our entire suite and may include opportunities for additional modules. These evolve naturally as we execute our initiatives, allowing us to evaluate the return on investment for each and identify potential revenue opportunities. Our approach is to prioritize automating challenges for our clients and finding solutions. Occasionally, we can capitalize on the problems we address by generating additional revenue opportunities. Now you asking if we've sold a client that has zero U.S. employees and they're just in the country with zero domestic employees? Is that your question? You may have fallen off. I'm going to answer that question and assume it was. For sure, Canada, I believe, we could have clients that just had that. That was our first one released. I would be surprised at this point if we have a client just in Mexico or the UK or Ireland that doesn't have a U.S. base connection. But I would expect in Canada, we would have some of the talent.

Yeah. Thanks for taking the question. Just wanted to follow-up on that global payroll front. I'm curious what you're seeing on the demand front for geos like Canada that have been in the market for a bit longer and just how long it takes for new geos to start ramping more meaningfully?

Having native payroll in Canada marked the first time we developed a separate country offering. We had been focused on the U.S. for 25 years, which provided us with valuable insights. Our experience in Canada paved the way for further learnings in Mexico and the UK, allowing us to make various developments that were applicable across different regions. This process has greatly enhanced our global HCM product, which is not limited to just native payroll but is a robust offering that we are continuously automating. All these advancements come together to create a compelling value proposition. Yeah. I mean, again, the factors that we talked about that were impacting us at the end of the year are the same factors that impact us today. When you're talking about how fast or what have you. We also have mitigating factors that factor into that as well. But when you're talking about what happens there, you're really talking about how fast is our client base going to utilize the most efficient product in the industry and then utilize it the right way. And so, we've kind of quantified the expectation of the opportunity that could be cannibalized from good usage, but it's also differentiation. And I think we get that back in other areas. So all that's to say is, when will we be through that type of thing, I don't know, but I do think that there's mitigating factors that we're able to deploy. Again, to achieve client value, to help the client achieve value that they're helping us there as well.

Thank you. In terms of float revenue, can you discuss what the updated annual guide is embedding surrounding float revenue, including Fed fund rate assumptions? And was there any extending of duration during the quarter or plan for the rest of the year here?

Yeah. I mean, we're definitely looking at extending the duration as we're talking about some rate cuts in the back half of the year. So as you're looking at the full year, we start to kind of factor in some of those potential rate cuts that seem more certain at this point. And then as you start to layer in and extend duration, you're basically on that amount of money, you're basically taking a rate cut because it's going to be lower than the short-term rate that you could get on that. So yes, we're definitely looking at that.

Thanks for everyone's questions and interest in Paycom. I'll now turn it back to the operator.