Paycom Software Inc (PAYC) — Q3 2024 Earnings Call Transcript

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

Thanks, James, and thank you to everyone joining our call today. I'd like to discuss how Paycom's automation continues to transform our industry, then I'll review some recent client wins and industry recognition, before turning it over to Craig, who will review our financials and guidance before taking questions. We are investing in our highly-differentiated automation platform that is delivering ROI for our clients. 20 years ago, users and buyers chose the Paycom system because they wanted to do more for themselves. Today, people buy Paycom because they want to do more for them without the need for day-to-day involvement in the software. We already have the most automated system in the industry and we are rapidly moving toward full solution automation, driving even more ROI for our clients. Our award-winning solution, GONE, is just one example of how Paycom simplifies tasks through automation. GONE was recently named a top HR product by HR Executive Magazine and for good reason. It is the industry's first fully automated time-off solution that handles all time-off requests. Before GONE, nearly all time-off decisions were unmanaged. A recent Forrester study found that GONE can generate an ROI of up to 800%. By automating time-off decisions, individual managers save nearly a week of unproductive hours annually. Additionally, the study found that on average, companies using GONE saved nearly five weeks of unproductive time in the areas of HR, finance, and accounting every year. Without GONE, 10% of an organization's labor cost goes substantially unmanaged, resulting in increased costs from overpayments, errors in scheduling, staffing shortages, and operational disruption. One client utilizing GONE is an auto dealership with nearly 500 employees spread across multiple locations. GONE saved this client approximately 200 hours of unproductive time per week, while ensuring a consistent time-off request process and improved management across the organization. With GONE, this client reports having reduced decision fatigue among managers and team leaders. Not only is GONE automating mundane tasks, it is also having a positive impact on employees. Beti continues to be a differentiator, and clients using it are experiencing its benefits. We recently onboarded a 1,000-employee hospital organization with over 20 locations. Utilizing Beti, this bilingual workforce has already reduced their payroll processing time by 85%. This organization also appreciates that their managers greatly benefit from Manager on-the-Go, which consolidates their managerial tasks into a single app, streamlining approvals, PAF management, applicant tracking, and more. This client currently boasts a 99.7% DDX score, reflecting the user-friendly power of Paycom Software for the organization. Our development teams have been focused on automating tasks across the platform that are easily adopted by our client base. Because of this focus, both this quarter and throughout the year, we've launched more products and enhancements than at any time in our company's history. There are several examples of automation we recently launched that are having a significant impact on HR and recruiting departments. One such automation is our position management enhancement that automates reporting structure and hierarchy changes needed due to individual employee changes such as promotions and transfers or large-scale organizational changes such as acquisitions or restructuring. Another example is how we enhanced our recruiting module. The advances in our recruiting product have dramatically increased the application completion rates and significantly reduced time to fill. What was already a very fast application process has now been reduced by 50%. Internally, we developed and deployed an AI agent for our service team. This technology utilizes our own knowledge-based semantic search model and enables us to provide service to help our clients more quickly and consistently than ever before. The AI agent continually improves over time and is having an impact on helping our clients achieve even more value out of their relationship with Paycom. By utilizing our own AI agent, we were able to connect our clients to the right solution faster, improving our immediate response rates by 25% without any additional human interaction. As a result of our continued focus on solution automation, ROI achievement, and world-class service, we also increased our Net Promoter Score by 24 points year-over-year. On the sales side, we are seeing continued momentum, particularly with our outside sales reps. System automation matters more to businesses than ever before, and our sales force is delivering on the market's needs, which is driving our goals. We still have less than 5% of the addressable market. We remain focused on executing strategies that will produce extremely high ROI and automation for our clients while continuing to differentiate our solution through automation. Finally, I'm pleased that Paycom was recognized as one of the best employers for tech workers by Forbes and one of the world's best companies overall by Time Magazine. These testaments showcase our culture and the impact our technology is having on workforces all over the globe. We are executing on our 2024 plan, and I'm very pleased with the progress. Our success in 2024 will set the foundation for future growth. With that, let me turn it over to Craig.

Thanks, Chad. Before I review our third quarter 2024 results and our outlook for the fourth quarter and full year 2024, I'd like to remind everyone that my comments related to certain financial measures will be on a non-GAAP basis. We delivered solid third quarter results with revenue and adjusted EBITDA coming in above expectations. Third quarter revenue of $452 million increased 11% over the comparable prior year period. Within total revenues, recurring revenue was $445 million for the third quarter of 2024, representing 98% of total revenues for the quarter and growing nearly 12% from the comparable prior year period. GAAP net income in the quarter was $73 million or $1.31 per diluted share based on approximately 56 million shares. Non-GAAP net income for the third quarter was $93 million or $1.67 per diluted share. Third quarter adjusted EBITDA of $171 million or a 38% margin was better-than-expected, primarily due to revenue upside and our continued focus on automation. We expanded our investments in the area of AI, automation, and international expansion, resulting in a 20% increase in adjusted R&D expense to $55 million in the third quarter of 2024. Adjusted total R&D costs, including the capitalized portion, were $84 million in the third quarter of 2024, compared to $69 million in the prior year period. Our tax rate in the third quarter came in higher-than-expected, largely due to one-time discrete items recorded in the quarter primarily related to return to provision adjustments. For Q4 and the full year 2024, we anticipate our effective income tax rates to be approximately 28% and 24%, respectively, on a GAAP basis. We estimate Q4 and full year 2024 non-GAAP effective tax rate to be 27%. For the fourth quarter of 2024, we expect stock-based compensation expense to be approximately $27 million. Turning to the balance sheet, we ended the quarter with a very strong balance sheet, including cash and cash equivalents of $326 million and no debt. The average daily balance of funds held on behalf of clients was approximately $2.3 billion in the third quarter of 2024, up approximately 10% year-over-year. During the third quarter, we repurchased approximately 300,000 shares for $44 million. Since July 1 of last year, we have repurchased approximately 2.3 million shares, representing nearly 4% of total shares outstanding, and we have $1.49 billion remaining on our buyback authorization. During the third quarter of 2024, we paid approximately $21 million in cash dividends. And earlier this week, the Board approved our next quarterly dividend of $0.375 per share, payable in mid-December. Now let me turn to guidance. Following solid Q3 results and our expectations for the fourth quarter, our revenue guidance range for fiscal 2024 increases to $1.866 billion to $1.873 billion, or approximately 10% year-over-year growth at the midpoint of the range. We are raising our expected adjusted EBITDA range to $745 million to $752 million, representing an adjusted EBITDA margin of 40% at the midpoint of the range. For the fourth quarter of 2024, we expect total revenues in the range of $477 million to $484 million, representing a growth rate over the comparable prior year period of approximately 11% at the midpoint of the range. We expect adjusted EBITDA for the fourth quarter in the range of $184.5 million to $191.5 million, representing an adjusted EBITDA margin of approximately 39% at the midpoint of the range. Overall, Q3 was a good quarter with better-than-expected revenue and significant adjusted EBITDA upside. We have an attractive high-margin recurring business model, a solid balance sheet with no debt, and strong cash flows. We will continue to focus on strengthening our competitive position through automation and delivering even more value to our clients through ROI achievement. With that, we will open the line for questions.

Perfect. Thank you. Congrats on a great solid quarter. Chad, if you think about the reporting season so far for the payroll companies, it speaks towards more of a stabilization or a really stable market, and everyone is still hoping for some sort of recovery. What are you seeing out there in terms of end demand, etc.? How does the pipeline evolve? How are the sales conversations going at the moment? Do you have any kind of more color there, please? And then for Craig, any comments on float and how you think about float going into next year as well?

Yes. I mean, the demand is strong out there. We have an automated solution and more and more people are looking to automate. We continue to get stronger. In fact, last month was our largest sales month, September, both for this year as well as over the history of our company. We continue to get stronger in sales, and that's been important to us to continue to move the product into the market so clients can experience the ROI that can be derived from the fully automated solution.

Yes. I would say, Raimo, on the float revenue, for every 25 basis point cut, it could impact us as much as $6 million on an annualized basis, and we've already seen a 50 basis point cut and maybe a couple more this year. So, as we're looking into next year, that's going to be something that's going to impact us. And then, we're also starting to look at layering in some more long-term considerations on that float balance.

Hi. Good evening. Thanks for taking my questions. Maybe first one, Chad, for you. Interesting to hear about using AI in the customer service organization. I'm curious if that's technology that Paycom has built, or if you're using a third-party, and how you're thinking about that translating into savings on the cost to serve side? Do you think that can be something that can be monetized as a feature at some point as well? And then I have a follow-up for Craig after.

Yes. So that's internal. We built that ourselves and we've been using it. It gets better and better as we mentioned on the call. It sped up our process by 25% in terms of being able to connect clients to the solution quicker, whether that be a configuration question, a tax question, or what have you. That's really been helpful to us and it continues to improve from that perspective. And I'll let Craig answer.

Great. And then Craig, maybe just as a follow-up, when I think about the acceleration, it was good to see that. Have we turned the corner on the CRR cross-sell headwinds and any associated Beti headwinds? Should we think about the fourth quarter guidance as a good starting point for 2025, now that we've started to see a reacceleration?

I mean, there are still benefits being gained by clients that utilize Beti. Even when you look at our tax resolutions this year versus last year, they are down one-third. So, Beti is still driving efficiencies amongst those clients. As far as CRRs, they continue to help clients achieve the full value of the software and they are continuing to do well. But in order to sell a client an additional product, you really have to ensure that they are utilizing and having success with the products that they have purchased. So, we have a lot of CRRs that have got their clients in the right solution, and we have a lot of them well over plan in their quotas now.

Hi. Good evening, and really nice to see the acceleration with regards to recurring revenue. Chad, you mentioned several things, but I'm wondering if you can talk a little bit about the drivers behind that acceleration. To what extent is it increased module uptake for things like GONE relative to some of the improvements that have been made with regards to the sales go-to-market and training that you've implemented recently? And then I've got a follow-up.

Sure. I mean, I would say that GONE definitely helps sales because of its automation. GONE isn't priced separately, so it's included in one of the modules that most of our clients already have. GONE is just a way to automate that module fully. That also helps sales. I kind of said on the call, I mean, 20 years ago, people bought our system so they could do more with it. Today, people buy our system so that it can do more for them without their involvement. I mean, 20 years ago, I'd go to a fantasy football draft and do the draft and then set my lineup. Maybe one week I'm playing two kickers by accident. Today, people can go and have that draft, set it on auto-draft, and set it on auto lineup. They're usually the ones that win the season. And so that's really the concept of our system. If you set it up right, it's going to automate everything for you. And Paycom has the best case scenario for usage in our industry, and it's getting more clients to that. We have a lot of success with that, obviously, in our go-to-market with new clients.

Great. And then, any comment with regards to just kind of the sales process and the sales training?

Yes. Sales is doing really well. I mean, unit counts, as I mentioned last time, continue to be elevated. Go-to-market teams continue to sell more than we have in the past. As I mentioned, last month was our largest sales month we've had to date and ever.

Thank you for taking my questions. Chad, I had a follow-up on the AI agent or the AI technology that you're developing. Do you see an opportunity in the future to productize what you're developing internally, maybe in your future versions of your recruiting product or other products in your platform?

I would say this isn't the only area in which we're using AI. We have it in several products that we both have released and will be releasing. There are definitely opportunities to monetize AI. As far as this particular solution, it's really helping us on the back end and helping our clients as well. I think we're going to see results and benefits from that in other areas of efficiency across the board within our own organization.

Thank you. And then one question for Craig. Just in terms of the EBITDA upside in the quarter, it was a much bigger beat than we've seen in previous quarters. Just wanted to ask you about the expense profile. Did any expenses slip into Q4? Or is that just primarily from the upside in the top line?

Yes. I mean, it was primarily from the upside in the top line. There were a couple of things that impacted the beat. Some of them were at the corporate level, and then some of the marketing may have had a little timing, but other than that, just efficiencies throughout.

All right. Thanks for taking my questions. So you mentioned in the press release moving towards a full solution automation. How should the investors think about this period right now, where you've kind of been aggressively making some changes to the platform behind the scenes? Is this something that you think is largely complete at the end of '24 or sometime in '25? And are the implications that we should be thinking about from our end is that the EBITDA margins can potentially move up as we move past that kind of elevated period of investment?

I mean, automation does drive efficiencies. There's no doubt about that across the board. We're also very ambitious because we only have 5% of the market. There are certain areas we want to capture. I would just say about automation, since our founding, we focused on innovating for our clients and differentiating ourselves from our competitors by delivering that maximum ROI, which is good for everyone. We've doubled down on innovation to include the full automation, and the software used in our industry will look different in a couple of years, and we're the ones who are building it.

Got it. And then just following back up on that client utilization of modules that have already been sold, it seemed like the last couple of quarters you've been monitoring that pretty carefully yourself. Are you seeing any change in terms of making the effort with the cross-sell team to get the utilization higher, or is it still kind of consistent with what it's been the last few quarters?

Yes. It's continuing to go up in a good way. Sometimes utilization isn't always reflected in time spent in the system. Oftentimes, the best way to utilize our system is to set it up and leave it alone, so it can actually do the work for you. We're having a lot more of that where people trust the system. You can make 20 decisions today and help us configure something in such a way that it will fully automate 4,000 decisions you would otherwise be making every day. So much of what we bring to market is about doing that.

Okay, great. Thanks for taking the questions here. I guess maybe to start, just want to ask a little bit on the 4Q guide and outlook here. I mean, I think kind of pretty good beat here, but it does look like the full amount kind of rolled through to the year. So can you help us maybe think about what's happening in Q4 that may lead to a little bit of the change in the guide or some of the puts and takes that we should be thinking about for Q4?

Yes. So, as we look to Q4 and then the full year, we narrowed the range, we increased the bottom end, and narrowed the range some. Q4 is the one that is the hardest to predict, based on the number of bonus runs that you have and other types of off-cycle runs, as well as we had a 50 basis point cut in the interest rates and potentially a couple more as we approach the end of the year. That's really what I would say as it relates to the guidance for Q4 and full year.

Okay. Are the factors influencing it mainly due to changes in the float assumption, or are there other changes being considered in the outlook?

Not that I would call out. I mean, more interest rate cuts on that.

Great. Thanks so much. I wonder in terms of the EBITDA beat, Chad, I think you talked about revenue and some automation. Is there any way to think about how much of the revenue upside was due to automation? How far along is that automation initiative through the organization already? And how much more is there to go in terms of maybe not necessarily numbers but percentages, whether it's on the front end or back end? Is there any way to frame that a little bit?

Yes. I mean, I think there's a lot of automation to go. In a perfect world, the system would just work for you as you look at it. You wouldn't even have to log in. There's a lot of automation to go. We're a company that eats our own cooking. Of course, automation is going to impact us and our back office positively. But yes, I mean, automation is exciting. It's fun to do. It's fun to actually watch a client enact it and be able to trust the system and watch what it can do for them. Because that's really what it's about, the return on investment they achieve, and being able to do something that they couldn't do anywhere else.

That's helpful. And then with the commentary on that September, the largest sales month ever, is there any way to break that down into how much of that is kind of white space as opposed to competitive takeaway? What's driving that? Is that kind of just incremental Beti adoption or just because it's a really nice data point?

Yes. So that's going to be our bookings. So that's going to be pretty much new business, new logo ads. That's going to be the overwhelming majority of it. Of course, all those will have Beti as well. But that's that number.

Hi. This is actually Devin on for Jason today. Thanks for taking our questions. I just want to double click on the outperformance in the quarter on the revenue side. Would you attribute the beat there mainly to new logo strength in the quarter? Was it stronger back-to-base motion, or did you see better retention among employees within your customers? More color there would be helpful.

Maybe it's primarily going to be just new logo ads. I mean, that's the overwhelming majority of our new revenue is going to be new logo ads.

Got it. That's helpful. And then just one more for me. Just curious how the new cohort of sales reps, I believe you guys added 60-plus new sales reps last quarter. Just curious how those have been ramping versus expectations?

Yes, very well. We have a very strong sales model, a very strong go-to-market. I would say that our sales reps are very fired up about the product they're selling and what can be delivered to our clients. They've been doing very well, as reflected by both the starts number and unit numbers that we gave both last quarter and commented on bookings this quarter.

Hi. Thanks for taking my question. I just wanted to see if you would comment on the adoption of Beti, particularly with the customers who were kind of slow to adopt. Have they seen any increase in adoption from that slower cohort?

Yes. We are definitely still meeting clients where they are to help them achieve value through the products that they utilize from us, whether they have Beti or not. But you do continue to have clients that see the value of Beti and continue to implement it. All new clients have been coming on with Beti now for about three years.

Great. Thanks for taking my questions. Just first, congrats to Chad. And going back to earlier comments, just back to the CR team, where are they in terms of helping clients achieve full value for that software? What percentage of the base have you gone through and optimized their spend with Paycom?

Yes. CRRs is helping clients achieve full value. But if I'm a CRR and I have a quota, it's my job to help clients ensure they have all necessary products to reach full ROI. There are certain products I want to sell them. But in order to sell them those products, I must ensure they are utilizing the current products they have. CRRs will be involved in that process. But we continue to do that at Paycom, regardless of whether a CRR is working with an individual client. We do have service individuals focused on helping clients ensure they're configured the right way to get full usage and value from the systems they've purchased.

Yes, some of the pressure on the gross margin was the new building we brought online at the end of Q2. We had a full quarter of the cost of that new building. It wasn't just depreciation, but also some allocations of headcount and corporate support. Additionally, some pressure was from client service headcount. As margins get too high, we might be a little understaffed. We're in a good place staffing-wise on that group.

Good afternoon. This is Kyle Aberasturi on for Dan Jester. Thank you for taking our questions. Can you talk about capital spending trends and how you expect that to evolve next year? And secondly, on segment performance, was there anything to call out in terms of up-market versus down-market performance during the quarter?

Yes. I mean, obviously, we're going to spend for growth first and will definitely invest in sales, marketing, and R&D where that's one of the line items that continues to grow. After that, we're looking at stock buybacks. We've done some stock buybacks this quarter that you guys have seen, as well as dividends.

From segment performance, up or down market, no change on that. We're seeing strength in both.

One thing I would say is we finished that big building this year. We would expect CapEx next year to trend down a little bit, probably below 10%.

I want to thank everyone for joining our call today, and I want to thank our employees for all their hard work and commitment to Paycom's success. We look forward to seeing investors at several conferences this quarter, including the UBS Conference in Phoenix in early December and the Barclays Conference in San Francisco in mid-December. Thank you. Operator, you may disconnect.