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

Good afternoon, everybody. This is Mark Marcon. I follow Human Capital Technology and Solutions for Baird. Our next presenting company is Paycom, a rapidly growing SaaS provider of payroll and HCM solutions that has arguably one of the most intuitive single database solutions out there, has been gaining share rapidly relative to a legacy players as well as companies that haven't used SaaS solutions in the past. The company has significant runway for growth with just basically a 5% share of the TAM and is focused really on the 50 to 5,000-employee market, although the attractiveness of the solution has garnered new clients, both on the lower end and even below the targeted market as well as above. With us today, we're extremely pleased to have Chad Richison, the Founder, Chairman and CEO of the company. Chad founded the company back in 1998 and has served as CEO ever since. He's actually got one of my favorite American success stories. He started up the company with 13 credit cards and a small business administration loan and basically built the company from the ground up, and they have a terrific culture that is truly unique within the space. We're also very pleased to have Craig Boelte, the CFO of the company. Craig first joined the company back in 2006. And then also online is James Samford, the Director of IR. Chad, Craig, James, thanks to all of you for joining us.

I'd love to start just by talking a little bit about your amazing resilience during the COVID pandemic. You quickly shifted over to virtual selling. And you've had a really good strong performance ever since the third week of April. So I'm wondering if you can talk a little bit about some of the lessons that you ended up picking up from that? And how is that going to change Paycom on a go-forward basis? Like what are some of the lessons and best practices that you've learned that you can apply to continue to gain share throughout the space?

Yes. And so our virtual selling really corresponded with prospects virtual buying habits. At that time, kind of everybody shifted over to a virtual type format. We also went to virtual selling to meet the prospects where they were living at the time. I think virtual selling has provided a lot of benefits. It seems oftentimes easier to schedule virtual meetings. And I think that in some cases, you can get a lot more people at the table for things like product demonstration and what have you. And so as we look into the future, we're really going to follow the prospects leads on this or the businesses that we seek to engage with. We're going to follow their lead on how prospects would buy our product. But I do think in the future, you will continue to have some type of hybrid model between both some in-person meetings, again, when it's safe to do so as well as still maintaining a virtual selling format. Now virtual selling in our smaller business group, we've done the entire time, and we'll continue to do. But in the mid-market and above, which represents greater than 90% of our revenue, I would see us being a little bit of a hybrid mode.

Just In terms of that hybrid mode, how are you doing it with your own internal personnel? You've been very famous for having a very disciplined sales force with strong cadence in terms of activity, strong leadership. How are you managing that in the current environment?

Yes. And so well, it's similar to the way it was prior to COVID. It's just that we've moved to be virtual and actually we've been able to have more meetings, not just with prospects, but also with each other. As I had said that -- as we were going through this, I mean, before when you have a manager or a regional manager riding around with the salesperson, which definitely that's the Paycom model, where we do have managers and/or regionals that would ride around every week with salespeople. They can only maybe be on 1 or 2 appointments a day depending on how far each appointment is from one another. And oftentimes, match, you're going to be with one salesperson per day. In the pandemic, you're really -- throughout the pandemic as we've virtually, you've been able to really be in multiple meetings one right after the other, due to the fact that we're in this virtual selling environment. So I think that it's produced some positive opportunities for us in that from a training, spinning up new employees with the number of meetings they can have. If it takes a certain number of sales costs before you become proficient in selling the Paycom solution, I believe that, to some extent, the pandemic helped us accelerate some of that. Now the drawbacks are it does become more difficult for any company. I mean, I don't care who you are definitely in our environment, it has been. It's a little bit harder to spin up new people that have never stepped foot into an office and are only -- have only been a part of a virtual culture. So I think that we're all excited about getting back into the office, doing it safely, but assuredly, to where we get that collaboration going again and to have those strong proof sources that surround us.

Okay. So it sounds like you're not all back in the office yet internally?

No, we're staggering back in, and we would expect all to be back in the office by the end of August. But we are -- we have been moving people back. I'm here in the Oklahoma City office, have been. We've started with supervisors that have started going sales managers and other managers will start trickling in through July and then our general population will start alternating back in, in August with the anticipation of being everybody back to the office in September, provided that, it's still safe to do so.

Great. If we think about last year, you had a -- considering the circumstances, you really had an amazing year. Revenue despite the fact that interest -- the interest income on the float ended up plummeting and everything that happened with the pandemic, you still ended up growing revenue by basically 14%, all organically to $841 million. It sounds like you had a really strong year in terms of new logo wins. And I'm wondering if you can talk a little bit about the source of the new logo wins, particularly when we think about some of the legacy players that have been talking about how they actually had higher retention rates over the last 12 months, partially because of the processing that they were doing for PEPM, Like what were the source of the new logo wins? How has that been different than what you were previously seeing?

Yes. Well, I wouldn't say it's been different at all. Now we have added, as you know, Mark, now we have 4 since our last -- since we've last updated, we have 4 small business -- emerging business sales teams that sell businesses that have less than 50 employees. And so you're going to have had more of those than what we would have had in 2019 or 2018 because we now have more teams for that. But really, our advertising and marketing, the increase in that really did help us produce. I don't know if it was a record percentage number of new logos added. But the highest I've seen in quite a long time. As far as the sources of those usual suspects can't really state that that's changed at all. We have always talked that the overwhelming majority, much more than 80% of all of our new clients that we had used a prior vendor. And most of that, at least half of that comes from the same legacy provider. As it relates to payroll now, it's important to understand that payroll is but one of the products that we displaced. You have other products that are oftentimes integrated either in front of the payroll or around it, that we also replace those products as well. But from a payroll-only competitor type, I would say that, that has been consistent.

Great. And then, obviously, there's a big investor question with regards to just, you were impacted by a decline in terms of the number of employees per client, you get paid on a per employee per client basis. We basically came out of the first quarter with 12.3% growth, obviously, Q1 is impacted by the W-2s, which basically reflect all of 2,000 in terms of the employee counts. Now we're basically looking at a reacceleration of 27.6%, roughly speaking here in the second quarter. And it sounds like when we think about the guidance that you gave for the upcoming balance of the year and the coming quarter, we weren't really anticipating much of an improvement in terms of the macro environment. But clearly, things are getting better. So how should investors think about this kind of the rebound in terms of employment, which will probably go in stages between now and the end of the year. But how should we think about what sort of impact that could end up having as the year unfolds.

Yes. Well, through the first quarter, we had stated that we hadn't really seen any meaningful impact on that weekly drag that we had on our current client employee base. Obviously, as you mentioned, things are starting to get better. They're starting to open back up again. We do have more requisitions for jobs that we're able to track that we had seen in April and people are starting to open up more job requisitions. Obviously, everybody knows it's a tight labor market. But we are seeing more of that. We have not baked any macro improvement into our guidance because we've never baked on in macro improvements into our guidance. Throughout the pandemic, we stayed focused on the 3 controllable things that we can control, which is continuing to put out product, new developments at a fast pace, which we did a lot of that during the pandemic, continue to maintain a world-class service, which we held a very strong retention rate as well as continue to increase the number of clients that we added to our platform, which, again, I mentioned that in 2020 from a percentage basis of new clients added to our platform was the highest percentage we've had in some time. So we stayed focused on the controllables. I absolutely hope that things come back. And I would expect that at some point in time, they will continue to layer in and improve. And I believe we're going to see some of that improvement with our pre-pandemic client base. But as we sit here today through the end of March, we saw stabilization in that number, not that it was improving in any meaningful number. We've had some early times in April talking about new job requisitions that have been open, but we'll see how that's reflected in the future quarters.

Great. So I mean within the existing client base, and I'm going to -- I'll switch over to new logos a little bit more later. But within the existing client base, can you talk a little bit about -- we've obviously got the benefit in terms of the number of employees per client coming up. But it would also seem like this environment would also give you more opportunities to sell some of the modules that you've previously had that you may not have sold. So we can take a look at your entire talent acquisition suite and everything that hiring is really front and center. So I would imagine that there's cross sales and opportunities there. And then if we can talk a little bit about the potential uplift that we could end up getting. We've got Manager on-the-Go, which has done really well. But then talk a little bit about BETI and everything that, that does. So can we talk first about the older modules and just the uplift that you're potentially seeing there? And then we can switch over to Manager on-the-Go and BETI.

Yes. So during the pandemic, you did have products that became even more popular. Learning management was something -- there's a lot of online training and learning happening during the pandemic. Our background checks has another product that as of late has continued to take off as people continue to hire. You mentioned talent acquisition. We all kind of can remember the low doc loan process that we went through. There's a little bit of a low doc applicant process that people are doing now, quick applies. We call it, where someone just inputs just enough information to apply for a job because businesses do not have the luxury anymore of going through long application processes. You oftentimes have to fill those positions sooner rather than later because it's an applicant market right now. And they oftentimes don't wait long for a job. And so you are seeing a little bit different trends created by the pandemic, which is helpful to our sales are accretive to our new business sales. As far as BETI is concerned, BETI is kind of the final step in how someone uses our product correctly for payroll. As employees, we all fly into the payroll -- pay date blind, every payroll day, we fly into it blindly. We did all the work. I mean we clocked in, we clocked out. We did our expense report. We enrolled our kids and benefits. And we requested time off. We know which -- where we're getting holidays. I mean -- so we did all the work, but we still don't know what the result was until it hits our bank account the day over maybe sometimes the night before. And so what BETI does is take all the work you're doing anyway and it organizes it in a way and explains how all the work you did, how that's impacting this check gives you the ability to approve it or not approve it. If you don't approve it, maybe you didn't approve it because you didn't agree with it, and it can be corrected right then. Maybe you're a soured employee that's somewhat indifferent, maybe your cup runneth over. And so you're choosing not to approve your check that week. And so it will be submitted with that approval. But what we are seeing with clients that use BETI, 90% of their checks are coming in approved by employees because about 80% of employees live check to check, and it does matter if their payroll is off by $30. And so that's what BETI does. It explains somebody's payroll to them from payroll to payroll. It explains it well ahead of the time of any payroll submission that when payroll -- when the pay period ends, payroll is done. It also reduces exposure and some liability on the side of the employer because now you're having employees do the work, confirm the work. And really, employees, they know what they should be paid. They know what should be in their account. And if you can get all that, if you can come to -- gain that agreement from them early on versus after the money is already hit their account, it's a best practice. And so that's really what BETI does. And even the explaining of a check, why your federal income tax is different this time than it was last time. Why this benefit is being deducted this time versus last time. I'm confident just as we watch people use BETI, that half of the American workers don't really understand the check and what encompasses that check. They know it as taxes, but they don't really know what the tax rates are, how they calculate, how pretax impacts that, how a 401(k) plan can impact that taxation. And so BETI walks people through that process of understanding, so that as they move forward, they have complete control over that payroll again with the clients' permissions that have been set up.

And how is that resonating in terms of the selling proposition? How is that -- how is it working with the clients that have put it in? Can you talk a little bit about when you explain the ROI because there's some obvious benefits. I mean one is basically, you're going to have fewer times that you're going to have to go back and redo the work. There should be an efficiency gain in the payroll department within the client, which would be an obvious ROI. But can you just talk a little bit about like how you sell it? And what sort of the response has been from a selling perspective, but also from the clients that have implemented it? Obviously, you eat your own cooking. So you've experienced it yourself. So I'm wondering if you could just illuminate things for investors.

Yes. Well, we've been using it since last year. As we went through the first quarter, I mentioned that we had a couple of handfuls of clients. And then I said that by the next time we report earnings, we'll be putting on another 100 clients. We haven't started selling it to new clients yet. But the feedback is going, as you'd expect -- I mean, it's going very well. Employees are definitely engaging in it. Now the employees are already engaged in our software. So it's not like we're having to go and say, hey, start using the software. They're already using the software. They're already doing 98% of the work. That just puts the end on it. So the feedback from employees has been very good, even some of the comments that I just made about my belief that employees didn't truly understand their check. We're getting a lot of that feedback back. So the first impact is employee morale. You want to upset employees don't pay them for it. I've always said payroll is high risk, low reward. You do it correctly, who cares. You're supposed to get people paid correctly. And if you don't do it correctly, that impacts volume around, you could be penalized for different tax payments being wrong and what have you. Now if you look at the back end, so on the employee side, there's a lot of wins for them that they have control and they know what's going to be in their bank account. Again, a lot of employees live to check. Most employees live check to check. Now on the side of the payroll administration, who they love it when 98% of the payrolls come in approved already because they know that 98% of employees for sure have looked at and already approved their check before any submission through the ACH system. And there's not a payroll person in the world that doesn't want to get your payroll perfect. They all want to get the payroll perfect. So on their end, what they get is perfect payrolls, and it also eliminates manual checks, voids and adjustments. If I do your check wrong, I've got to wire money into your bank account. I've got to voyage your other check and that produces a manual on my GL. If it crosses over tax time period, now I have tax adjustments. And so -- and then if you're an employee that maybe was short at $40 and you had other bills hitting your account that can cause overdraft. And then so potentially, you could have a client that would have to pay certain over or may choose to help that employee mitigate some of those problems by paying for their overdraft protection and fees. And so you could have some significant back-end savings coming to the client, depending upon how blind they're flying into each payroll day.

Great. And that's clearly differentiated relative to everybody else within the market. It also seems like your you're one of the holdouts with regards to on-demand payroll so far. But it seems like with these capabilities, you'd clearly be in a position to do it if you felt like there was clarification from the IRS and others that met your level of satisfaction. How are you thinking about that?

Well, first, I would say we have the data and our clients are welcome to use third parties at their choosing. The data is there. It calculates it up to the minute. So people are welcome to do that. We haven't engaged in providing it ourselves the daily pay or providing early loans to employees.

It's not a loan, they've earned it.

Well, again, in payments and someone does have the ability to run payrolls in our system every day. If somebody has been paid a wage, taxes are due. And so that's kind of the rub there. I would caution employers in actually calling something and earning and not paying the taxes to the appropriate tax authority, whether it be the IRS New York, California, whoever else they may be paying to. But again, I don't believe that's a differentiator for any of us. I do not know of a competitor that wouldn't have the data for someone to choose to do some type of daily pay. It's just in our situation, we would have up-to-date exact to the minute data. And I would prefer that if people chose to pay that out that they actually run a payroll and pay taxes. It's also not lost on me that there are reasons why people would need $30 today or $40 tomorrow or something like that. But I would hope that people could access their funds without being charged high interest rates, which, Mark, you calculate $2 every time you take out $20, that adds up to a pretty high interest rate. And then even in some cases, you get to wage an hour. So anyway, it may become a thing. I can't really say as we've looked at, we are able to look and see who has debit accounts or pay card accounts because they're ACH for us in many cases. And so we're able to look at the ACH accounts and see we're not seeing a lot of growth in those -- in that area. It does seem to be a little bit confined to specific industries. And then even in those industries, it's confined to a very smaller subset of their employee base. So -- but again, it's out there. Our software does not preclude someone from using someone to do that.

We've got a report that we're going to be publishing next week on it in terms of like all the various players. The adoption of some really large employers has been pretty darn high. So -- but we -- unfortunately, we only have 4 minutes left in this session before we go to the breakout, and we will have a breakout fortunately. But I wanted to switch over to talking about the margin because, obviously, we're seeing a reopening. The number of employees are going up. The pace of sales continues to be really good. You're obviously going to spend a little bit more initially as things reopen. How should we think about the margin trajectory? You've always had some of the best margins within the space. And even with the reduction in terms of interest income on the float, you continue to maintain those really high margins. How should we think about the pace of margin expansion after the intermediate reopening period.

Yes. I wouldn't say that the reopening would impact our margins significantly, Mark. And even through the pandemic, we've had very strong margins, close to 40% on that. And as you mentioned, we had some very high-margin business that left the float revenue as well as kind of the reduction in those employees. That was a very high-margin business. So really proud of kind of where margins have been and the fact that we've been able to hold them. As we continue to go through coming back, I mean, obviously, we're going to spend as appropriate and growth is number one for us. So to the extent that we would give up a percent of margin, we would expect to get an additional percent of growth. We're just not going to give up margin for no growth. So -- or not an additional amount of growth. So -- and we look throughout the model and look for efficiencies, and we'll continue to do that as well.

Well, will it actually end up increasing your efficiency and therefore, potentially be margin accretive?

Yes. I mean I believe it will. I mean we're tracking for it. And I also think that BETI put from a long-term perspective have an impact on retention. I think it will have an impact on our ability to add new logos. It is differentiated. I think it's the way payroll should be done. We should have all been doing this to begin with. But we didn't all have the technology and the ability to do it in the past, and now we do. And the fact that employees are used to going direct to a debt base, whether they're ordering a coffee, a plane ticket, doing their banking, getting a movie ticket. I mean they go direct to databases everywhere else in their life when they're a consumer, and they come to work and it's 1992. So let's let the business win with their employees the same way that retailers and other -- and others win with consumers. And so that's allowing those consumers and our employees to go direct. And that's really what we're doing. And now we've made that very easy to do. And that benefits the employer. So I do think BETI is going to be positive, accretive to our revenue. I do think it's going to have some level of impact on our retention as you look at it over time. And I do believe because it's differentiated and it's the right way for a business to deploy payroll. I think it's going to impact our ability to sell more business in the future.

That's great. Just one short one. But just how should we think about just the adjusted EBITDA conversion over to free cash flow going forward?

I mean, in terms of our adjusted EBITDA and free cash flow, the main thing that impacts our free cash flow is the construction of facilities. And so we continue to look at that and kind of moving forward, kind of what -- how we're going to expand in terms of facilities and then -- so it's kind of where I'll leave it on that.

Great. I've got so many more questions. And as you mentioned, we could go for 4 hours. But unfortunately, we're going to have to stop right here. Chad, Craig thanks a lot for doing this. We really appreciate it. Thanks for everybody who joined us. And we are going to have a breakout session. So if you consult your Baird conference schedule, you should see the link for that, and we'll be doing that starting in 3.5 minutes. Thank you all.

All right. Thanks, Mark.

Thanks, Mark.