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

And I think we're live. I think we have everyone. That's great. Welcome to day 3 of the 24th Annual Credit Suisse Tech Conference, and thank you for being here with us if you're still tuning in. My name is Yaoxian Chew. I'm an analyst here on the software team at Crédit Suisse. I'm delighted to be joined here today by Chad Richison, Founder and CEO of Paycom; Craig Boelte, CFO of Paycom; and James Samford, Head of Investor Relations. Paycom went public in the New York Stock Exchange in 2014, and it's really been a one-way ride since. Gentlemen, it's a pleasure to have you with us here today. It's not quite as fun as Arizona, but thank you for finding and taking the time to speak with us here today. The format of this, just to clarify up-front, will be a fireside chat where I'll direct the conversation over a number of different topics. But to investors listening in, if you have any burning questions, do try to e-mail them to me and I'll squeeze them in, as appropriate. But with that, let's get started.

Let's start on the topic of catalysts, Chad. I think last quarter, you had mentioned that without a catalyst, we wouldn't expect employee counts to improve. And I think we've talked at some point about what those catalysts could be, a vaccine, more government stimulus or on the counterpoint, more lockdowns, shutdowns or a second wave. We're in this awkward fork in the road right now as it relates to how it could play out catalyst-wise. What's your view? What are you watching for most keenly? And how are you managing the business for this today as we stand at the start of December?

Yes. And so we reached, what I'm going to say, stabilization. It stopped getting worse. Our current clients' loss of their employee count stopped getting worse in May, and we started to see stabilization. With the quarter that we announced in August, we actually did give the exact number of what the headwind was doing to us. It was around $2 million a week from the employment count perspective, then you add another $350,000 just from interest rate lowered toward the end of mid-March. Actually, they lowered interest rates another 150 basis points. That impacted us there. In August, we did -- we gave that number. And then with the last quarter that we just announced, we did say that we've seen stabilization in that number. To the extent there was any improvement in that number, it would have been to the extent of $100,000 a week, depending on what week you measure. And so -- and then they -- it was at that point in time that we said without a catalyst, we would not expect improvement in that particular number. And so a catalyst -- you're correct. A catalyst would be an end to the pandemic and/or, as mentioned, a vaccine or something that gives more consumer confidence to where people are traveling, going out more and what have you. We're not seeing that yet, but we're hopeful for that into the future. Again, we've stayed focused -- now that we have stabilization in our number, we've stayed focused on the activities that we control, which is improving our retention rate. It's continuing to release good product that drives ROI for our clients as well as continuing to focus on rapidly adding new clients to our platform. And so we focused on the controllables, and we're going to wait and see what happens with the others. But with stabilization, we do believe that we're going to be able to continue our growth initiatives and strategy as we lap first quarter.

Got it. Very helpful. What about the customers themselves? What are the clients saying? Do you think the mood has gotten better or worse real time as we head into the end of the year? Or are people on pause until you call out the confidence issue, the catalyst issue? And is it too early to get a sense on what people are saying about 2021 at this point? Are they giving you visibility saying, "Hey, I'm ready to hire again," or it's just too much uncertainty to really have a view at that point?

Well, anybody that's in business wants to get back tomorrow. I mean I don't know of too many businesses that aren't ready to get right back into business. And as soon as everybody can do that, the better. I think that's what most business attitudes are. I don't know that there's many businesses that would hope for this to go on any longer. And so I think that there's a lot of hope out there, but it just really depends on what part of the country that you're in. Some part of the country is substantially open right now even though you may not have a high level of consumer confidence. And then in other areas, you still have some shutdowns. So I think we're going to be dealing with a mixed bag. Again, we've seen stabilization. We're not calling out any new numbers today. We've seen stabilization. We can add new clients during this environment. We can focus on retention during this environment, and we can continue to develop good product and put it out. And that's what we're doing. And I am hopeful that there will be an end to this, and I do think there will be an end to this as we get in further into 2021.

Great. As are we all, for sure. Let's talk a little bit about budgets. And clearly, there's been a lot of reprioritization of CIO budgets and even just thinking about how we spend dollars in businesses today from a customer perspective. There's some investor speculation or at least a growing thesis that HCM payroll this year may have taken a back seat relative to other priorities and projects but -- for example, getting a paid Zoom account by which we can run a whole conference. Do you think that's true? Have you seen that in your customers itself? And I guess where this question is heading is that as we move into next year, what's been deprioritized this year ends up being more of a tailwind? Do you think that's something that you can see at all in your conversations?

I mean first of all, somebody is buying a product and spending money on a product that is going to cost the organization. That's one thing. In our environment, our product actually pays for itself. So I hope someone never pays money for HCM. That would be the goal. Why would you ever spend money? So really, if someone wants to add more into their budget, they should shift to Paycom because that's what we do. We're a product that pays for itself through usage and ROI achievement. It's real. It's a real return on an investment. And so in order for someone to make the shift to us, it should be freeing up budget, not costing budget because most -- all the business that we bring on, we're using other vendors and oftentimes multiple vendors coupled together to produce the same result that we produce with one software. So when you talk about budgeting and what have you, any time a product is going to add additional cost to an organization, that's something an organization needs to think through. In our environment, our product is going to reduce those costs and actually deliver funds back into the budget of these businesses through ROI achievement. So I'm not saying it's not important. It does matter what type of finances a company has to be in an effort to -- in order to run their own business. But as it relates to a shift in our business, we're one of those companies that help free up budgets so that people can spend in other areas as we produce an ROI for them in this specific area of HCM.

That makes a lot of sense. And certainly, we've seen it show up in new business and bookings and the way you guys have really been putting up performance and execution quarter-to-quarter. We can see all the sequential revenue numbers and they really are fantastic. But let's dive into this a bit more if possible, if you can help us out around the nature of this new business. In terms of win rates and segment of the market, where are you winning disproportionate share from? Who are you seeing more of? Who you're seeing less? And as we think about it, is it more in the mid-market, lower? Where's the sweet spot for all this new business? And where is it coming from?

Yes. Over 90% of our revenue is derived from businesses that have greater than 50 employees. So I mean the sweet spot of our business is going to be the mid-market, which we focus. We do continue to be pulled upmarket. We moved from 50 to 2,000 employees as a range to 50 to 5,000 employees about 2 years ago. We do continue to be pulled upmarket. I really can't call out differences in sizes of business and/or different vendors that we're seeing different today than what we've seen in the past. It is important to note that we have added -- or we do have right now 4 sales teams of 32 people that focus on down-market, small business type, emerging business market, which is the sub-50 market. So you would expect that because we have more of those people now that we are having more wins in that group than what we would have had in previous years, where we may have only had 5 people and not even a team. But when you look across the board, it's the usual suspects of competitors that we're displacing as well as size of companies that we're focusing on.

Got you. And maybe to dig into this a bit more. The customers that you're winning, are they currently fully staffed? Or are they slimmed down? And I'm just trying to get a sense of this because as we think about recovery and the recovery path whether you get a second degree of uplift as people hire back.

Yes. It's going to be across the board. As we went into this pandemic early and we started shifting our compensation structure for salespeople because they were bringing on a client -- and the company may have only been 200 employees at the time, but when we started the process of selling them, they had 800 employees. And so what we didn't want people to do is hold on to those deals. We wanted to go ahead and get it started. And so we shifted at that point in time to give our salespeople 6-month audits and longer audits on deals. We would say we're not going to commission it now for you if you choose to wait because it's a growing company. And so yes, we have some of that. Now how much of that comes back and exactly how much of it is, I wouldn't say we're -- that's not something we're looking to track. We're looking to get the business on as they add in employees, as they expand. That happens all the time within our model. But we do know it was happening because we did change some of our commission structure early on to allow salespeople who are selling deals to businesses that may have a deflated employee count at the moment due to the environment. We did change some of those structures. So yes, I am sure that even the new clients that we are bringing on, there are going to be some of them that may look to add later as things come back to more of a normalized environment.

Makes a lot of sense. Let's talk a bit about the displacement opportunities. And I think you spoke to it with the clear ROI proposition that you guys have put up in terms of budget priorities and everything else. But is there anything in this environment? In particular, has the messaging, pricing or go-to-market, changed in a way that you think is resonating particularly well? Are you emphasizing that whole DDX portion, the ROI portion? Or is this more of the same as just the Paycom value proposition shining through? What's changed in that aspect of it?

Yes. I'd say we're getting better at the same playbook. I mean that's the way -- we had this playbook 18 months ago of really what we were trying to drive. And even through the marketing efforts, I mean 1st of this year and the very 1st -- February actually when we were doing earnings, I mentioned that our leads were up 600%. So I would just say that we're getting better at the same playbook that we've had. Obviously, we expand our technology developments that we're able to do, and we're going to continue to announce and put out new technology. But when it comes to the employee being the primary users in relation to data transfer, that's something that we've been driving for some time now. And we're really starting to see that resonate throughout all businesses. I mean I've said it multiple times that when -- as employees, when we're not at work, we're consumers. In our consumer lives, we use consumer-based technology. I bought a shirt for the first time online during the pandemic. I don't know if I'll walk into a store again. And so that transition has happened. But then we all go back to work and it's 1992 again. And so what we're helping businesses do is leverage the same technology that their employees are already using when they're consumers in their consumer life. We're helping them leverage that for business at work so that businesses can receive the same ROI that retailers and other vendors receive as consumers are out making purchases and interacting with systems. And so that's what we're doing now, and it's just driving that same result. I do believe that the pandemic has produced a stronger proved source of the reasons why you would use or why employees would have a direct relationship with those -- that database I do think in the world, to some extent, conspiring to help us right now. But it's been right the whole time. It just doesn't make sense that employees wouldn't make their own selection because they are anyway. No HR person or operating person ever read an employee's mind. So in order for that data to get transferred, I've either got to send it through a middle person where they can do the input or I've got to do it myself on a complex system that someone else is checking to make sure I did it correctly anyway because everything you're changing in payroll and HR is significant and needs to be accurate so you could have that. Or I'm able to do it myself, and that's really the way that we're focused on, having employees have that direct relationship with the database so that everything is accurate, so that employees have a better experience and also so that the business can win, the company that they work for so that they can recoup a lot of those -- both soft costs and hard costs that exist in a spaghetti string model where you've cobbled together multiple systems.

Got you. Helpful. As we think about that, just to dive into that a bit more. Clearly, it's a very differentiated value proposition. DDX and the success you're having shows through. But can you share a bit more detail how this increased end-user engagement has directly benefited Paycom as a company? I know you've shared in terms of services resources in the past. But what are the implications, financial model-wise, in terms of margin, whether it's resources saved or even top line? Any implications there would be helpful.

Yes. Well, from a top line perspective, it's bringing us more leads. I mean we do have more buyers that are calling us now, and they understand the differentiation and so they're calling us for it. I would say there's been times in the past where someone would call us and they understand Paycom but maybe not specifically the differentiation and we've had to kind of walk them over that bridge of usage, where today, you have more of that, and that's on the revenue level. But how that impacts all the way through is when we sell the truth and someone actually uses the product that we sell, we win with the truth. And then they implement the product and their employees are actually using it, then that does a couple of things. Number one, obviously, it impacts the company that we sold very positively as their employees are interacting with those systems, and they have one system versus multiple. But it's also helping us because they are becoming more proficient users of the software. And so we are gaining efficiencies within our own model in different areas when that happens. We mentioned either last quarter or the quarter before that when we ended 2019, we had the same number of service individuals that we had at the end of 2018, and we grew 30% in 2019. So we're able to service the same -- we're able to service more clients with the same people because the clients have become more proficient in using the software. And the software is working for them versus them having to work the software. Because when the software is working for you, just like my iPhone right here, never called Apple and asked them how to use it, not one time. But if you're working your software, you're going to make a lot of phone calls. So that's the difference. It's being able to produce a software that works for a client that's easy to use. And yes, obviously, that's also having some impact on us as well, meaning less calls.

That's great. That's great.

That case in point, we've gone through the pandemic and our call volume is down this year. So 2019, no pandemic. We moved to virtual, put everybody home, and our call volume's gone down. That's only because of usage in the product. There's no other explanation for it.

Yes. And I would say the other area we've seen it is in our retention numbers. We were at 91% for 6 years, picked up to 92%. And then last year, we were at 93% retention. So it also shows up in those retention numbers.

That's great. Maybe we pivot the conversation to remote operations, and it's sort of a 2-part question here. I know you guys have been spending time in the offices selectively, doing Zoom calls with us, and thank you for that. But clearly, you've functioned and executed really well with a fully distributed, 100% sort of workforce at this point. This is pretty different from the sales office rollout strategy that was the foundation of a lot of Paycom's early success and growth. Do you have a view as to what your company looks like post-pandemic at this point in terms of either office footprint or a hybrid remote presence? And is there a time frame in which you're thinking about how to deal with this?

Those are things we're working through right now. I mean the short answer would be I would expect us to be back to the way that we were with -- there's going to be some differences. What we don't know yet -- or our client is going to continue to buy online, just like I'll continue to buy my shirt online. Will clients continue to buy software online? Or will there be that expectation that people do come in and meet with them? That's not something we're trying to drive. That's something we're going to be aware of and watch. And then we're going to go where that takes us. And so we'll have to kind of see what happens from that. From an employee perspective, we've done very well because we're a company of metrics. We give people the metric. People do a great job of hitting the metric. We measure the metrics. I do think if you're in this remote environment exclusively for long, long periods of time, it can have an impact on culture, especially for new people that you're bringing into a culture. If you already work for a company and you go remote, that's one thing. But if you're coming into a culture new and it's your first day and your first day is remote, it's a little different. And so I think like every company out there, those are things that we're having to think through. We were fortunate enough to be in an industry where we could send people remote. A lot of our customers just -- they don't have that luxury. They're gloving up, masking up. They have to be in the building because that's the type of business they're in, whether it's manufacture or grocery or different industries. And so we were fortunate in that. But we'll see what happens as we come back. We're going to be smart about it. We're going to be safe about it. And so there's a goal for us to get back, and then we'll just kind of see. From an office openings perspective, absolutely. We're -- our office opening strategy is intact. Whether or not our own employees go into the office and then do Zooms with prospects that aren't allowing us out there or whether we go right back to the way things work, I doubt things will go right back to the way things were. I'm just not 100% sure of all the changes that we'll run into, but I do believe we'll be fine with them.

Got you. And what about from a customer perspective? Are the technological needs and demands of HCM and payroll changing for remote workforce? Are people using your products differently? Is there a demand for more modules one versus the other from a demand and product road map perspective that you're thinking about here?

Yes. But that has been -- yes, the answer to your question is yes, but that has been happening progressively for the last 2 or 3 years. I think a lot of that more so driven -- less driven by the pandemic and more so driven by younger generations that are now getting into either decision-making positions within businesses. I think this year, 50% of your workforce are millennials. This year, 2020 was the first time that the workforce percentage moved over. 50% are millennials. And so I just think that with the proliferation of software and how people use technology, especially consumer-based technology, everywhere else, with a workforce that is used to growing up with technology, that's really driving that change that has been happening. And to some extent, the pandemic, I'm sure, definitely exposed a lot of the weaknesses that are inherent in a multiple system model that people might have. So anyway -- but I do think that it's the younger generations that continue to enter the workforce that have an expectation of technology doing something fast, doing something simple that is also helping drive that.

We have a very common investor question that would be helpful for you to help clarify here and that -- as it relates to unemployment stats in Paycom. Obviously, everyone looks at the Bureau of Labor Statistics, the unemployment stats here. And the big question last quarter was things are getting better, but I think investors were surprised as to why there was not more of a benefit into the employment base as it relates to macro indicators that they see. Can you help clarify the puts and takes and where the correlation might break down as it relates to your growth rates?

Yes. I mean well, first of all, it's the understanding of the way unemployment is calculated. And I think you have to first, in order to go with this, make an assumption that as it gets better, those people are actually going back to work, not just falling off on unemployment and what have you. I would state it this way. We have 5% of the market. So if someone lose -- if we lose an employee out of one of our clients, there's 100% chance we've lost that revenue because they were working for one of our clients and they left. So we're not going to get that revenue. If that employee goes and gets a job somewhere else, there's a 5% chance it will be at one of our clients. So they would need to come right back to our same client, I guess, if you're looking at it from that perspective. But I kind of gave up being drugstore economist once we started calculating the exact amount that it was impacting our business, and we called that out. When I look at our improvement that we mentioned versus many of our competitors, it all seemed similar in the total improvement to the extent there was and/or impact. We also -- it seemed to get very, very bad progressively until about May and then started to get stabilized. And like I said, to the extent we called out any improvement, it would have been about 5% improvement. Again, that's a $100,000 weekly improvement on $2 million weekly headwind due to employment attrition of our current client base.

Got you. Thank you for clearing that up. And I have to ask again about margins and investment. Clearly, this year, you've leaned in hard in marketing and digital advertising in a way I don't think we've seen in the past. Can you walk us through how much of this new level of spend remains variable and how much of it should we think about in terms of necessary investments to drive growth and where they are and how we should think about margins near, medium, long term from your perspective?

Well, the revenue that's generated from the advertising spend is -- even as a percentage, it continues to grow, is going to be much larger than what we could spend additionally in advertising. You get to a point of diminishing returns in advertising. We've got a pretty healthy spend on it right now. I don't know that we're -- that there's -- that there would be a whole lot more that we would look to be able to do unless we found new techniques or what have you. So -- but from us, we have a healthy advertising spend, but it's producing healthy results. And the way this should work is those healthy results continue to turn into high-margin revenue, which helped cover the advertising spend. So all that's to say is we're going to continue to spend aggressively on advertising, providing that it works. We're not going to overspend on advertising, which you absolutely can do as an organization. And that's why we measure it every week. And so I think we've done well with our advertising spend. If you'd ask me, March 15, about spending as much as we've spent on advertising, I mean I would have said no, that will never happen. But we're having a lot of success with it. So I see it as something we'll continue to do.

That's great. And I have I think -- I want to be cognizant of time but I have one last one here. Just if we were to look 1 year ahead from now and we're sitting on the stage in Arizona again in 2021, what do you hope to look back and say, "I'm glad we accomplished this year in 2021," for the company?

Well, self-service payroll. We'll be rolling out self-service payroll for sure in 2021. We're starting to use it ourselves now at Paycom. So right now, pay period ends on a Saturday, and everybody starts collecting all the payroll data and putting it all together so they could submit it to the payroll company on a Tuesday or Wednesday so that you can all have checks in your account on a Friday or direct deposit. In the new model, when pay period ends on Saturday, your payroll is done. It doesn't necessarily mean you have to pay it out by then, but it does mean that all the necessary transactions have happened prior to that. And you, the employee, have already approved your net pay. And so that will be a significant development into the future as you move to full payroll automation. Payroll is not something that you can do 1 million different ways. It's either 100% accurate or it's 100% wrong. And so because it is something that can be measured at -- with 100% accuracy, it's something that can be automated. And so that's what we've been focused on. And as we look into next year, it will be taking all the product that we've developed and putting it -- and it being, I guess, layered out in a way that leads toward full-service payroll. What I mean by that is an app -- is your employee app where people were getting used to the DDX and driving 100% usage, getting it to 100%. Then you layer on Manager on-the-Go because managers need to very quickly approve time cards, expenses, time-off request, overtime work. There's different things that a manager has to approve. And we want that approved during pay periods, not waiting until it's over or waiting until employees have already been paid now you have to manual -- do manuals and void check. So we're very excited about the automation that's going to be delivered into the future as people use the product correctly. And that's what we've been driving at for the last 2 or 3 years now.

That's great. Looking forward to seeing it. And I think with that, we're out of time. But thank you very much for today. It's always a pleasure.

All right. Thank you.

Stay safe. Take care.

All right. Thank you.

Thanks, Yao.

Thank you.