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

All right. Thank you very much. Welcome to Cowen's 49th Annual TMT conference. I'm Bryan Bergin, Cowen's services and software analyst. Very pleased to have with us here Paycom, leading HCM software provider. With us from senior management, we have Chad Richison, President and CEO; and James Samford, Head of IR. Guys, thanks for being with us today.

Thank you, Bryan.

For anybody in the audience, you have the opportunity to submit questions. You can do so through the webcasting platform, and I can work those into the conversation as we go.

With that, we're going to get right into it. Chad, I want to start on demand. And just overall, as the U.S. continues to reopen, can you just talk about the primary themes that you're seeing in client demand today? And as things start looking more normal, has COVID caused any lasting impacts to HCM client-buying behavior?

Okay. Yes, I would first say that, for us, demand has been very strong since the third week of April of last year. It kind of shut us down for a little bit, and then it was more self-imposed and then opened us back up. And we continued to see strong demand from that point on. We did increase our advertising budget, which increased our lead volume. All of that remains elevated as we sit here today, and so demand has been strong. I do believe that the pandemic -- and it definitely produced a lot of negative things for us as a country and everything else and definitely the loss of life being the most sad about that, but it did have some impact on our business as far as usage. When pandemic first started, we didn't really see a max increase in usage as people, I think, were more shifting to the at-home, work-from-home model. But after that, we did. It continued to shoot up as more and more people pushed usage toward the employees where they -- the employee had the direct experience, the same way they would in their consumer life, and so we did see that. That has remained elevated. Something else, I think, has changed a little bit as in how prospects buy. Prior to the pandemic, we did try to sell in the mid-market virtually and had 0 success. I mean we would pitch 100 deals and get one of them, so it's very difficult. As we move through the pandemic, I believe that people were more easily using things like Zoom and what have you. It became the norm. And so how prospects buy changed a little bit in the pandemic as you started seeing those buying behaviors which were traditionally reserved for in-person meetings move online. And so where that also helped us is the number of appointments someone can have in their chair is a lot more than the number of appointments someone can have if they're driving around a geography having meetings. And so for our reps, in some cases, they had -- were able to have double the number of appointments that they would normally have in a week and same with our sales managers. And so I think there were some positive use cases and sales cases that have come from the pandemic. In all the bad things that happened, there were a few positives that came from it, and we're still in the midst of realizing all that today.

Okay. Showing some things that in the last year in this hybrid setting as we go forward, you posted multiyear record growth in units in 2020, which is quite impressive, considering the backdrop. And it seems like you maintained strong momentum in the first quarter as well. What's enabled you to potentially sustain that momentum forward? And what types of leading indicators are you tracking that give you the confidence to sustain momentum?

Yes. So unit momentum last year, I think, was driven by a couple of things. The advertising spend definitely helps when you're doubling, tripling, quadrupling the number of businesses that are requesting product demonstrations from you. And so that really helped as we continued to drive that. We also talked about how we had added an inside sales group, and we picked up units that we would have traditionally maybe not been in the market for more on the small business side. And so that also helped drive some specific unit growth. And then our average billing per client stayed roughly the same because we also added more clients at the top end of our range which helped average some of the per-client billing averages out, even though we did have one of our larger percentage unit growth years in 2020.

Okay. Now that was interesting. You kept that average client pretty flat despite that influx of lower-end units. The -- as we consider the base, talk about the impact on that client employee base and how that's changed from the start of the pandemic. It sounds like you've only had a mild improvement in that pre-pandemic employment base. Just given the weekly impact you've talked to us about, what are your assumptions there on the employment recovery going forward?

Yes. And so the impact on our pre-pandemic client base was, as we said, about $1.9 million to $2 million in weekly impact, again from employee attrition from those clients. I mentioned in fourth quarter that, to the extent we saw any improvement, it was anywhere from $50,000 to $100,000 a week in improvement, and it wasn't consistent. You'd have it 1 week, not the next. And so as we reported, first quarter, I said we haven't seen any meaningful improvement in that number. So we're still right at about the $1.85 million negative impact. Our -- we've never baked in macro improvements into our guidance. Never really had a need to it until you go through this. But we've never baked in macro improvements into our guidance. We haven't done that here. I do suspect at some point in time, some of these clients will add. And that's not to say that we don't have clients that are adding people to their employment number. It's just as we measure that pre-pandemic client base, we took a snapshot and we've continued to watch that. And the improvement is, as I've discussed, I do think people at some point in time, some of them will continue to expand their opportunity. I don't know that all of it comes back. I don't know that, that would be reasonable from where we sit today. I think the longer time someone goes without, potentially that might be their new normal, so we'll just have to see for us. We needed to lap the pandemic's impact on us. That's a calendar impact. And we did that. As we've come out of first quarter, we've put together our strongest second quarter guide we've had since 2017. So we're focused on the go forward. We only have 5% of the market. So really, we have the dry football in our hand right now, and it's up for us -- it's up to us to be able to move product, and we're having a lot of success doing that right now.

Okay. One thing we consider is you look at the U.S. labor market, you've had tight talent markets that have been widely reported here, particularly across SMBs. I'm curious, is that something that your base is expressing to you? Or is there -- the stability in a base more indicative of potential exposures you may have to the phase of the reopening in certain industries or regions?

Well, no, it's a tight market. I mean where we see that's an applicant tracking even. I mean if you don't have a very simple way that people can apply, I mean, people almost want to do quick apply. Give me your name, address and where you worked last with an e-mail, and I'll take that as an application because what you find is people aren't in market very long. If I'm looking for a job, I go online. I apply for 10 of them. I've got 2 offers in 3 days. And so things that we're seeing out there is that people don't stay in market very long. Again, the ones that jump in market, you still do have some on the sidelines that haven't chosen to yet get back out there. But for people that are out there, those employment opportunities come pretty quickly to them. And so speed to move through an applicant where we would first see that in a tight market. I also think in a tight market, you look to automate certain things. It's not like people have a plethora of payroll, HR and other departments to move data either. And so I think it's a tight market everywhere. We're able to help people, find people and get them applied for very quickly and then onboard themselves into our system and as they work with our system directly, to handle payroll, time and attendance and all the other HCM products that we provide or functionality that we provide.

Okay. It sounds like it could play into your strategy of full payroll automation. I want to get into that, but I first wanted to ask a question just on retention. So when you discuss retention rates, can you give us a sense for 2020 versus prior years, what have been the driving factors for you in retention because it has improved over the last couple of years? And then as we think about pieces of that, how do you consider client and losses, out-of-business client losses versus competitive?

Yes. Well, we haven't changed the way we measure retention. We've measured retention the same way since 2007. It's a 12-month trailing revenue trail, which I don't think is unlike the way our competitors measure retention. If we hadn't had the pandemic impact last year, retention would have improved. Our retention started improving -- it corresponded directly with the DDX strategy and usage of our products. I'd said even 2017, I mean, we're good at selling products. It's getting clients to use the product the correct way is what we've been focused on. We call it swinging the jackhammer. I mean you can break up concrete, if you want to swing a jackhammer. You can also turn it on and break up a lot more concrete. And so with us, it's using our product correctly. As we got more and more clients to use the product correctly, they realize the benefits of using the product. It turned into actual ROI for them, and that's what has been improving our retention now. For I believe 3 years straight, we were at 91% for 6 years. We then went to 92%. We then went up another 1% to 93% in 2019 and then held that in the year 2020 as we were facing those headwinds.

Okay. So certainly, the usage strategy has been something that you're attributing that success to. Can you just talk...

I would attribute all of it to that. I really would. I mean if you're using the product correctly and you're getting value of it, you also -- out of it, you are also changing the game for others because if someone else is going to come in and replace that product, they're going to have to deliver the same level of value. So I believe as we continue to help our clients drive that value throughout their own organization through an employee usage strategy, which makes sense, we had a lot more success retaining clients.

Okay. How much of the base is using the product the way it should be used, in your eyes, as far as DDX?

We have over 90% -- I haven't given the specific numbers on DDX. It's continued to go up. We're at our highest level right now we've ever had, as we sit here today, and so it's well over 90%. And so that would be the answer to your question is, on average, all of our clients have been well over 90% of all of their changes being made directly by employees. We don't really count that as a win. A win would be a client that 100% of all their changes are being made by employees, and they refuse to do anything outside of that. And so we continue to have increasing numbers that are at 100%. But if you look across -- in aggregate across all of our client base and you average that Direct Data Exchange score, which is the score of employees going direct into the database with no data being touched by anybody else, it's well over 90% in aggregate for all of our clients, and it does continue to increase month-over-month.

Okay. And as we understand it, DDX needed to be in place -- the behavior needed to be in place for you to pursue the strategy of full payroll automation and ultimately BETI. Can you talk about what else you needed as beyond just DDX, how does this differ from competitor solutions? And as we think about BETI longer term, at what point do you expect adoption in your clients to just be running fully through BETI?

Well, 12 to 18 months I expect us to get to 100%. It might be 98%. I mean even with Manager on-the-Go, we got to 99.4%, had to kind of pushed that extra 0.6% through. But -- so I do expect this to be at 100% at some point, just because it makes sense. I mean doing it the old way wouldn't make sense. Your question, as far as what else you need, you needed all the products. I mean it's not a payroll alone. What BETI does is take functions and actions that employees are already taking. They're already clocking in and out. They're already requesting time off. They're already doing expense reports. They're already enrolling in benefits. They're already making direct deposit changes. They're already doing all of these things in the system themselves. So what BETI does is organize it in a way that they finally have a goal line. Before they're clocking in and out, they don't know how it impacts their check. They're enrolling in benefits, they don't specifically know how it's going to impact that check. They're requesting time off or receiving holiday pay that they don't know. And so what BETI does is explain to them how all the actions they're taking impacts their check, and then it compares that check to prior checks. I'm confident that half the American workers have no idea what a payroll check does. I mean they know what the net is. They don't know what FICA is, which is FICA, or federal -- they don't understand all the ways or how pretax deductions impact that check. What we're finding out with clients that are already using BETI and those employees and the employee feedback is that for the first time ever, they truly understand what's going on with that check and how it's impacted by their actions. And what that does also is eliminate all that effort on the back end for payroll, and it also eliminates manuals, voids, all the mistakes that both clients and employees make when you fly blindly into every payroll. And so all we are doing is giving the employee an answer to all the work they've been doing, and we're giving them that answer prior to payroll being submitted. So that if there is any questions, changes or what have you that need to be made, it can be made then by the employee directly without having to wait. We do not force employees to approve their check. BETI will pay by exception. So if you're a salaried employee and you're somebody and you haven't made any changes, you haven't requested time off or even if you have, BETI is going to pay you by exception. You just -- you didn't approve it. But that's the way your current payroll works right now anyway. You fly blindly. You figure out what it is. And then if you want to make a change, you do it later. Over 80% of the American workers live check to check. So where some of us may not even know exactly how much money is exactly going to go into our account this Friday, for some people, being off $22 is a big thing. And so that's -- those are the things that BETI solves. And across any client base, you're going to have all sets of employees. You're going to have your salaried employees, you're going to have your hourly employees, and you're going to have even commission employees, so different groups. So BETI's provides something for everybody, especially for the business, as it helps eliminate both exposure and liability for the client.

Okay. And your initial live clients on this were for this quarter or later this year?

No. We had a couple of handfuls of clients that we added first quarter. We're in the process right now. We'll add another 100 over this second quarter. I expect this to open it up to all clients by July. And then sometime during this year as we go out and we sell to new prospects, BETI is included in that. It's an additional fee, but it will be the way we support payroll in the future.

Okay. So as we think about the impact to revenue, this begins to build probably on the 2022 story. Is that fair?

Yes. I mean it's going to have some -- it's going to be accretive to our current year from a revenue perspective, and I mean, it will have an impact on 2022 as a point to remember. It is one product. It's 1 product of 29. It's built accordingly that way. I also think BETI is going to -- so it will have some incremental impact on revenue. I think it's going to have a big impact also on retention as well as our ability to go to market and new client sales.