Paycom Software, Inc. (PAYC) Earnings Call Transcript & Summary

I want to welcome everyone who's dialed in today, day 2 of the 23rd Annual Oppenheimer Tech Conference. I'm thrilled about the leadership team here of Paycom. This has been a top idea of the franchise for about 5 years now, continues to be, so really excited to go over the story with our listeners, especially those who are new. Our speakers are the leadership team. So we have the CEO and founder of the business, Chad Richison. And with him, we've got the Head of the Finance Organization, the CFO, Craig Boelte; and also James Samford, who heads up the Investor Relations program with the company.

So Chad, for the new listeners here today and people who probably haven't heard the story or new to the story, can we just start at a very high level with a brief introduction of yourself, maybe how you started out the company and the company itself?

Yes. So I had worked in the industry prior to starting Paycom in 1998. I started Paycom when I was 27. The goal then was to have an easier way to do payroll, the Paycom Payroll. I always say we want to be the best at payroll. Pay is in the name. So anyway, I started off just doing payroll, shifted over to add some time in attendance and employee self-service in the 2003, 2004 time period and then just continued to build out the system using the same database so it eliminated integration. So we had a single database system. From there, we shifted over the usage side to the employee base because we had a very simple system. The iPhone started becoming prevalent, so did easier-to-use consumer-based technology in the palm of your hand or at home. Technologies become more readily available for everyone. And so as we shift, we've shifted now since over to the employee side to where employees interact with this same single database we developed initially for the user buyer, is now being utilized also by the employee base, getting HR and others out of that data transfer process, which creates more value for the businesses that we work with and a better experience from the employee standpoint of transfer data. So I walked you very quickly from our beginnings in 1998, with 13 credit cards and an SBA loan, to very quickly where we're at today, I say quickly, 22 years later.

Thanks, Chad. That was a good introduction. We'll go through the -- let's go through the shaping the opportunity here for the next couple of questions and where the company life cycle is at this moment in time. So tell us about the business model and the go-to-market strategy, who you're disrupting out there in the market and how you think about the TAM and how penetrated the business is today.

Yes. So we focus on businesses that have between 50 and 5,000 employees. Now we continue to sell, companies that have over 5,000 employees. It's not a systems issue. It's a strategic selling initiative that we have, to be in that range of 50 to 5,000 employees. Also important to note, we've always had one inside sales team that catches inside sales leads that are below 50 employees and then also out of market, out of territories we serve. We've also continued to expand that team, and so now we have both inside sales that capture smaller businesses, emerging business below 50 employees. We have our traditional sales model. And in that go-to-market strategy, it's a sales manager who manages 8 salespeople. Each of those salespeople have their own territory, defined by zip codes within a geography, and that's how they're managed. Our old model was obviously you went out. You met with the client, a prospect. And you had those conversations face-to-face. Now we're doing face-to-face virtually as we sell in the model. And so our go-to-market's always been targeted prospecting, which is where we actually reach out to prospects that we've identified as good candidates for us in the mid-market. We continue to do that today. Nothing's changed there. We're continuing to do our targeted prospecting, but that's being impacted in a positive way in providing additional sales opportunities for us now through our advertising spend, which is greater supporting our sales efforts. But our go-to-market strategy is by using territories, sales managers managing salespeople and continuing both the targeted prospecting as well as our marketing and advertising initiatives.

Yes, Brian. And in terms of the TAM, I would say, we calculate that we still have less than 5% of the TAM and a lot of runway in front of us.

I guess, payroll is pretty mission-critical. People like to get paid on time and not violate the regulation. So terrific. We tapped into the value proposition a little bit. Maybe you can share with us the value proposition. For years, you were leading, driving the industry towards self-service. Clearly, you're probably not getting pushbacks on that anymore with the working-from-home now. But can you share with us, is there a tangible ROI? Or what are the buyers getting by adopting Paycom?

Yes. I mean we've always done cost justification and an ROI case for prospects. That's part of our sales process. Some of that's going to be delivered just by elimination of multiple systems, elimination of old, outdated processes. But then also, you have some system performance opportunities that we actually calculate for a business through the DDX score. According to the research that was done by Ernst & Young, that every data transfer point of data that a business transfers themselves versus having an employee do themselves is duplicative in nature and cost the company $4.51. And so if you look at a business during any 1 month, they could have 100,000 changes in our system. And what you would like to see is of those 100,000 changes, you would like to have seen them made by the employee base so that they would have 100% DDX score. If they had 90% made by the employee base, then now we have a 90 DDX score, which means they had 10,000 changes made by someone else in the middle of that data process, and that would have caused the company quite a bit of money, close to $50,000 that month. And so there's no one that's reading an employee's mind. Anytime a data needs to be transferred from the employee into the system, and it's not done from the employee, it's duplicative, if an employee is making phone calls, if an employee is sending e-mail, which I mean, these days, you don't even know who's e-mailing it. Maybe it's the employee asking you to make a change. Maybe it's someone sitting in Cypress. We don't know. Who knows, who had either has control of your e-mail or the employee's e-mail, and so you really can't trust data movement from many of the traditional sources that were available to us 10 years ago. And so as we look at it today, it only makes sense that data is transferred directly and securely from the employee, and every time it happens, the business owner, business unit wins. And so that's what we've been focused on from the value proposition today, which all stems from having a single database. Because if employees have to use multiple systems and it's complex, then you start adding a whole another layer of difficulty for an employee to do their job. And you either have a system that does the work for you, or you have a system that you have to work. And at the employee level, they would much rather have a system that does the work for them because it's easier.

Sure thing. Chad, I want to dive into some company specific here, specifically just about the company, about the moat of the business. And the importance of the business is this all-in-one direct sales and service model. So can you share with us, the way I would set it off, like how important is it in your space to build this business infrastructure that can scale continually to acquire customers at better economics over time? Because what we've seen in the past in the mid-market, the small business market, you usually think of the channel as a primary distribution avenue, but you built a direct model. And this is just my opinion, but ever since I've covered the company, it always works. It always seems to work. So why has Paycom been able to succeed at this better than so many other companies in the space? And we see it clearly in your growth and margin profile.

Well, I mean, a direct sales model is going to give you more control over the model, obviously, both your go-to-market, client expectations. And so I think from a direct model, we've had a lot of success with that. Is there -- I mean, would we look at other opportunities as we move forward, if there's -- if there are better ways to sell our product? We're seeing some of that right now through advertising, which we've done a little bit and had success, but not to the extent we're doing right now. We've changed our sales model to be virtual. Potentially, buyers stay in a virtual buying pattern. If buyers don't stay in a virtual buying pattern and they go back to a face-to-face buying pattern, then they're going to see us in their lobby. But if buyers shift to an online buying pattern, that may open up additional -- whether it be channels or methods that we can deploy to get in front of people, obviously, that's something we would look to do. But we have less than 5% of the TAM right now, and so we have quite a bit left. And so if there are areas or different processes we can implement at Paycom to help us accelerate that and the knowledge out there and people are more aware, then those are all things that we would look at in the future. But right now, we're in control of our own destiny as we reach out to prospects as well as reap the benefit from the increased advertising spend we could do.

Sure. That's a good lead-in into the next question, which is about reasons to kind of why people are buying technologies here during the pandemic. So if we think about before the pandemic, pre-pandemic, the secular trends in the market already were very strong. You had digital transformation, there's skill shortages, there's technology disruption, too few workers or more workers, great secular trends in the HCM category. And we know those typically accelerate in the downturn. You don't get these new secular trends. But the question I wanted to ask you just is on the buyer motivation right now during the pandemic, if you're seeing any different reasons than you saw before the pandemic on why they're buying your technology during this crisis. And ultimately, do you think COVID-19 is an accelerator of the category's adoption?

Yes. I mean for sure, it is. COVID is an accelerator, the pandemic we're going through. And I think that has to do with usage and how people are actually going to be using technology. We've been saying it into the future. I'm in a future somewhat here. And what I would say is there's a different level of confidence coming from prospects that there was pre-pandemic. And so pre-pandemic, we're having the conversations, your employees will use it. We know you're not used to it, but we're going to shift. Employees are going to be the people who are making all of the changes in your system. Okay. We believe you, let's get moving. There's some intrepidation in moving through that process. Today, I would say there's a lot higher confidence with prospects that are calling us to make those shifts. I think that comes from -- we're past the early adoption stage, and they're seeing how their own employee base is adopting all types of technology. I mean COVID, you're not just adopting HCM technology. I mean I didn't use Zoom until 2 weeks after -- I think it was March 19, I used my first Zoom call. And so HCM is just one piece of the new technology that businesses are having to have their employees leverage right now. And I believe we're in the rise of the autonomous worker. I mean I think worker autonomy is definitely on the rise. And so I think there's a lot more confidence when people are making the call into us or we're calling them, more confidence on both ends that this is the best solution for them to be able to manage their current environment as well as what it will look like in the future.

And in turn, maybe just a follow-up on just maybe the use cases that are happening right now or maybe even emerging in the future. Is there anything new that's happening? Or is it more just an acceleration of what was happening before from self-service, employee experience, workforce management, learning, remote workers? We've kind of heard these as big positive beneficiaries of the pandemic.

Well, I would say it's the comprehensive nature of everything. I mean to the extent before you thought your systems were kind of working but you were doing all this stuff on the back end anyway because you had free time and that was part of your system, well, now you've been forced to use all your technology. So now it's -- you're forced to use it. Before, it's like, I was kind of using it. Now you're being forced to. So if you're deploying a system that you thought was going to be employee-friendly, that your employees could truly use in a comprehensive way, but you had never tried it before, it's maybe the first time you're running into the fact that, hey, the system's not doing exactly what I'm needing it to do. Meanwhile, Paycom is focused on implementing an employee usage mandate for your business to where employees use this system. We want them to try to break it. That's what we've been working on for a long time. And so it's a different mindset there on what's happening with the business. But I think as we all come out the other end of this, now there's some definite significant negatives for the pandemic. Outside of the whole people's health and dying and everything else, there's a significant negative to the business side of what businesses are challenged with, but I also believe there are some positives. If you're looking for a silver lining, again, we all wished it wouldn't have happened and we would keep doing the old way we're doing it, which was working and moving business. But there is a positive side from a business efficiency standpoint that is going to come out of this. Every company is going to come out of this much leaner than what they were from an efficiency process and potentially even employment standpoint in the future. And I don't think that from a long-term standpoint, from the business perspective, that it's necessarily going to be a negative impact on our efficiency initiatives as we look into the future.

Thanks, Chad, for sharing those industry views and kind of what we're seeing. Maybe we'll bring you back to Paycom specifically. And maybe you can share with the audience, especially for our newer listeners, why you win, the differentiation in the market. So you're certainly competing against some much larger legacy system players in the market. You've got best-of-breed companies that are in the market, too. Shed a little light on why you win. Are there any common needs or business insights that seem to be most topical when customers are going through either a newer expansion sales process with Paycom?

Yes. I mean I will say that we win today the same way we won 10 years ago. Now it's different the way -- different ways you access it today than what we did 10 years ago. But it's a comprehensive single database solution. I mean if we're going against a competitor, it's usually going to be a payroll system connected to -- and I'm going to give you an extreme. You may have a payroll system that has its time and attendance system that's connected to a benefit administration system, connected to a learning management, connected to an expense management, mileage tracking, performance and comp, what have you, COBRA system. I mean you can go on and on. And so a business is going to have to build that out by using one vendor and attaching multiple others. Or you're going to have to find a comprehensive solution. And so that's always the way we've won on the back end with the user buyer, making it easier for them to have a comprehensive solution and eliminate integration. Well, now that you're rolling that out into employees, I mean, user buyers have some level of tolerance for complexity, where employees have none. Employees have 0 tolerance for complexity. I mean you're making me do it, and I'm doing my job. So it's got to be very simple. It's got to be easier than sending e-mails and phone calls. And so -- and that's what we've made. And so I would say it's the same value proposition of why someone's buying, but we've been able to extend that all the way out to the employee base, which has its own set of advantages once people deploy it to the employee base.

I wanted to just ask you about the barriers of the business. You're the right person to ask for this because you started this company and you have scaled it over 20 years. So why can't someone else do it? Why can't some startup build the next-generation Paycom platform? What would they have to overcome?

Yes. Well, of all the public companies that I'm aware of or even the ones that were public, that are private, we're kind of the new guys, and we're 22 years in this. I do think anybody can develop anything. So I'm not someone that says, well, no one else can develop a system. In fact, we see different people develop systems. It is critical from the payroll side. Payroll has to be perfect. We run perfect payrolls here. Last week, 0 checks wrong, 0 checks wrong. So I'm not even talking about a business. I mean we don't have any checks wrong. And so at Paycom, we track perfect payrolls. If we have a -- if we have one check wrong at one company, that's an imperfect payroll. So we track that. We track perfect taxes. We had 0 tax issues 3 weeks ago, 0 tax issues over 15 days, 0 over 30. I think, last week, I think we had 5 over 15 days. So now that's down from thousands 5 and 6 years ago. And so we've just become a lot more efficient at how we manage and what's important to us and having perfect payrolls, perfect taxes. And so what I would say is, and I've said this before, in our business, it's somewhat high risk, low reward. If you get it right, so what, people expect their check to be right. They worked for it. Make one mistake, and you're going to be paying tax penalties. You could have labor law issues. So we've really focused on that. So if someone's going to get into the industry, they need to process perfect payrolls because it's also, we'll call it, some -- a little bit liquid plutonium on the payroll side. You can use it to power an entire city and blow the place up if you don't use it right as well. So you got to have it correct, and payroll has got to be perfect. So if someone's going to enter into our industry, LMS and items like that are easier and fun. Payroll changes every day. I mean we're looking at labor law right now that's changing in Illinois, where on scheduling, if you have to give someone they're schedule 2 months in advance, and then if you change it x days prior, there's a shift premium that's paid for the time worked. So it seems to be the new frontier in both employment and tax law at both the state and federal level that we're seeing right now. And so if you're going to get into the business on the payroll side, it's got to be perfect. And I think that's why we haven't had that many entrants into the payroll side for a long time now.

Yes. I would echo that, too. I mean just the time and labor management pieces, you're dealing with all the different states in California as well as reciprocity between states. You're living in Connecticut, working in New York. So the payroll side is really the, kind of the barrier to entry to payroll and time and labor management.

It sounds like complex stuff, for sure, on it. Chad, I wanted to ask you just about the bookings momentum, certainly top because you updated us on the earnings a couple of weeks ago. So you gave a recent update on the business over the last 4 months. I guess the way I would set it up is since the business has bottomed here and really the recession, I think, bottomed in April, it's really been a banner time here for new sales over -- at the company. And you talked about the bookings strength being sustained in July on the last earnings call. So maybe you could take us more granular here and maybe shed some light on what creates sort of that, what created the strong sales execution over the past several months. And then how do you think -- how well do you think that this can get sustained here in the second half of the year and continuing into next year?

Yes. I think we had a couple of things. Number one, I'm just going to stick with the value proposition. I mean if you didn't believe it before, you definitely believe it now. So there's that opportunity, but our sales reps are getting a lot better in this as well. I mean sales deals, even though it takes us the same amount of time to set them up, we're able to filter through interest fairly quickly. I mean I said it on the call. Before, you may have gone on a call on a Tuesday, and then 2 weeks from then, you would schedule another call and then maybe 2 weeks out, another call. Now you're having a call on Tuesday, Thursday and the following Monday. And so I think deal flow, because of all the distractions, are moved off of everybody's table. It has made it easier to view the functional differences and benefits of our product. And so I do think you're having some of that. Lead volume is elevated. So anytime you have an elevated lead volume of interest, you're going to have more at bat. So I think that lead volume being up, our value proposition resonating, salespeople getting better on sales calls because of somewhat, in some of these cases, are shorter sales cycle as well as usually have your manager with you on multiple calls now. Before, our sales managers are our best salespeople as well and good at process management. Well, when you have them, they can go on 5 or 6 calls a week, and now they can go on 12 to 15. It makes a big difference in your -- in having them with you on these at bats. So I think we've got some development happening as well within the sales organization. Craig, do you want to add anything to that?

No. I think that's good.

He hit all the points. You got it. Chad, why don't you catch your breath for a second? We'll ask some financial questions here for Craig. So Craig, can you shed some light here on how the pandemic is -- could potentially impact the future margins here for the business? And I'm just wondering if the pandemic changed your view on your future investments. Clearly, advertising spend is up, but maybe your real estate and your T&E spending is down. But how do you think about this maybe over a longer period, the pandemic's impact to how you think about the investment profile?

Sure. I mean we kind of called out on the call kind of how it impacted from the revenue side and how that flows into the margins. But we are seeing some efficiencies like the T&E and some of our trainings that would normally be scheduled for Dallas or Oklahoma City, where we're doing some of that virtually. In terms of some of the investments, we do have sales offices in cities that we have leases on. Obviously, right now, those sales reps are working from home. But to the extent we need to get them back into the offices, we'll do that. I think it's probably a little early yet to make that call. We'll continue to evaluate that. But we're obviously not entering into any 10-year leases at this point. We're going to kind of evaluate that as we go along. So I think as we move through and kind of come out towards the back end, we will find some efficiencies in the model as well as well as how we're servicing clients internally. We've called that out, that we've continued from our service individuals to be able to gain some efficiencies there on how we're servicing our clients.

I wanted to ask you of maybe just any comments that you could share, just maybe about the customer economics and the customer value. Clearly, there's some volatility this year because we're just coming out of a recession. But maybe if you look at it over the last 12 months or in more of a normalized period, can you share just maybe any qualitative comments on what you're seeing with the customer lifetime value comps?

Yes. One thing Chad mentioned a little bit earlier is just our retention rate. We were at that 91% for 6 years and then ticked that up to 92% and then last year at 93%. So obviously, the lifetime of the value of the customer increases as that retention rate goes up. Also, as we're bringing customers on, they're taking more of our products. So we mentioned it at IPO, they were taking about half of our products or more and they're continuing to do that, but we have more products to offer. So we are seeing the value, the lifetime value of those customers continue to move on.

I wanted to ask one more question, and I'm happy to open up to the buy side for a couple of questions. Again, coming back to the investment and the growth investments, you did highlight on your earnings call that -- you even highlighted on the Q1 in that, in the depths of the recession, that you plan to continue to invest in sales and marketing during the downturn here. As we look ahead here in the second half of the year, can you maybe just share with us maybe some of these newer initiatives that you're putting in or increasing investments that you're most excited about here for the second half of the year?

Yes. I mean I think we're going to be doing more of the same. By now, I would hope that anybody in the U.S. has seen our commercials. So I'm sure you'll see some new ones, but it's going to be more of the same. And again, we're not really branding Paycom as much as we are advertising a new way to use these types of technologies now, which work both now and into the future. And so you'll see more of the same from us as long as it's working, as long as we're getting the at bats. If we're not, then that's not a spend we would continue because as I mentioned, our traditional model is what we call targeted prospecting, which happens twice a week, and that has not stopped during this. And so that's just being helped through the ad spend and creating -- generating additional interest.

And I would say the other thing, Brian, is, I mean, obviously, we're continuing to spend -- invest heavily in the R&D side to bring on additional R&D talent as we continue to expand our existing product and bring on new products as well.

We've spent before, Brian, on advertising a couple of years ago. And at end of the quarter, we spent a pretty good chunk on some advertising then. And then in subsequent quarters, the revenue went up because the advertising worked. The margin profile of our business hasn't changed. If anything, it continues to get stronger as we're able to service more with less as the clients use the product more. So every deal that we bring on carries the same margin profile. And so we would expect that as we continue to sell through these next couple of quarters, with this advertising spend, that there would be success on that and it would turn into recurring revenue that has high margins associated with it.

Okay. Chad, so we've got a couple of questions here from the buy side. I think they're both kind of a little bit more on the longer term. So I'll just read it. The first question is that it's basically thinking about the path to $2 billion in revenue, that the company is going to pass $1 billion in run rate within the next year here. So what do you need to further scale the business to reach the $2 billion mark? What do you see as maybe the biggest headwinds or challenges to going from $1 billion to $2 billion?

Well, we need time. That's all. We need time to get to $2 billion. So it's focusing on the same things right now. I mean I've always tried to focus on growing the rate at which you grow, which, again, is the new business revenue that we're generating right now. So I mean I feel really good about our opportunities into the future. I would have, regardless of what happened on the sales side. You would have wanted to get back to where we were because we had a strong value proposition. But I do believe that's being accelerated. Our value proposition and the understanding of it is being accelerated. And as employees use it at one company and go to another, they're bringing us in. I mean we're getting referrals that way. So we're just having a lot of success now. I don't know why that would reverse into the future, and I think we'll continue to grow into the future as well. So yes, I mean, I would expect us to get past $1 billion and then get to $2 billion in the appropriate time.

The other question that came in, a little bit more on the longer-term growth, but it had to do with the expansion of the customer base and maybe even the deal sizes. And so the question that they wanted to ask is, and you've talked about this in the call, on how the deal sizes had -- there's been some compression, simply from the shrinkage and employee headcount that's happened. So they want to know about what happens when the reverse happens. How long -- the question is how long from that last recession did it take before you started to see companies normalizing their employee count? And is it the right way of thinking about it, that there could be a symmetrical effect to what's happened to the business this year with the employee count?

Yes. I mean if we're talking about the last recession we went through, that was a different situation, with the mortgage crisis and just a different -- didn't really impact the employee counts the way we're seeing today. This situation we're dealing with in the pandemic is specifically related to reduction in force. And so are we expecting that to come back at some point? I mean I do think that, yes, I mean, as health clubs open, as the airlines start flying again in a more significant way, as people travel, start going out to eat more, you're going to start having, I think, more employment come back. We just -- we don't know when that would be, and we're not forecasting that into the next couple of quarters. We're also not forecasting it will get worse either because, again, we've seen stabilization in our numbers since the end of April, measured all the way through July. And so I'm not 100% sure that there would be a catalyst to do that, even if there is, which I would expect there to be a higher rate of infection as we head through the fall and into the winter. I still believe that our clients are in survival mode now. Could we have some failures? I mean on average, yes, you could -- I'm sure you could have some of that. But we're also picking up some wins as well along the way. We still have clients that are adding units or opening a location or adding to their employment base just as you have clients that are furloughing employees. But for us, they're averaging out. And again, roughly $2 million impact per week is what we had seen at the end of April, and it's been consistent, right, in that $1.95 million to $2 million range. So I don't -- I think we're looking at it being flat, at least as it relates to our client base in the future. Now if you remember on the call, I mentioned there's multiple ways unemployment's calculated. We've seen it stabilize, and you would expect it to hit us first. I mean you're going to lose your job, not get a check, then you're going to go file for unemployment, and then it's going to be rolled up into the unemployment number or you'll be part of the survey for the unemployment -- monthly unemployment number they give. And so I think that we've seen stabilization in that number. You've maybe started to see a little bit of that in the unemployment numbers that are being actually filed right now. But still, even last week, 1.01 million claims filed, that's still almost 5x larger than the pre-COVID levels of 200,000 a week. So again, we haven't seen it getting better on our numbers. We haven't seen it get worse. We've seen it stable since the end of April.

Sounds good. We ran out of time. I want to thank Craig and Chad for representing Paycom. And I hope our new listeners will take an opportunity to look at the story and the opportunity. And James, thank you very much.

Thanks for having us, Brian.

Thank you.

Thanks, Brian.