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

Thank you, everyone, for joining. My name is Josh Beck from the KeyBanc equity research team. We're incredibly happy to have Chad Richison, CEO of Paycom, for a fireside chat. If you do have questions, raise your hand. I'm more than happy to get them in. But we'll just jump right into the fireside if that's good with you, Chad?

Sure.

Excellent. Well, the theme of the conference is emerging tech. So I want to start with the topic of innovation. You've obviously been a leader in the industry for years and decades, but I really wanted to talk a little bit about BETI. It's one of your more recent innovation. Certainly, this is consistent with your view of empowering really the employee to take control over the data. So would love to hear a little bit about the introduction, kind of what drove you to release this product and what the reception has been?

Sure. And so we've been working at it for a while to be able to automate the things that can be automated within our industry. And as we continue to automate through both the employee app and many of the other products that we've been bring to the market, we did see an opportunity that there was -- that we would be making that effort toward automating payroll as well. A lot of the things we've automated in the past are more components of the payroll. You have to lay the roadmap before you could actually get to full payroll automation. BETI stands for Better Employee Transaction Interface. And really when you look at it, only the employee really knows if their information and data is correct, and that knowledge wasn't being leveraged until after the fact. And so many things happen negatively if a payroll is not done correctly. I myself don't necessarily live check to check, but most Americans do, and it matters to them whether or not their account was short at $40 or $70. Sometimes it can be the difference between feeding the kids or paying the bills over that time period. And so we see that there's a high level of interest by employees of wanting it to be perfect. And I've never met a payroll person that didn't want the payroll to be perfect. They always do. And so we came up with a product that fully automates the payroll cycle and allows all of the issues that would have traditionally been fixed after the payroll to be fixed during the payroll to where all payrolls can be perfect.

Excellent. Another area has been DDX. It's certainly enabled some very deep analytics around really how HR and HCM technology gets utilized. Ernst & Young has put out some studies leading to leveraging this technology. And I was looking historically at the last couple of studies, and it seems like it's nicely moved up. I think it was 4 39. In the most recent study, I think it was 4 70 per manual entry. So maybe just give us a little bit of background on DDX, and what some of the implications are to HR groups when they think about these rising costs of manual entry.

Sure. And so what the Direct Data Exchange does is, it scores and calculate poor usage versus good usage. And so if your employees have the ability to transfer information from their mind directly into the database, and that's not touched, that's good usage. Any time the employees transfer their information from their mind into some other system that's been input or imported into a database by a third party, that's not great usage, and that usage produces exposure. There's effort by a third party to be able to do that. And so Ernst & Young came up with the calculation of when someone in HR or payroll makes this change themselves versus the employee, the costs associated with that now is, I believe, $4.51. And so someone looks in the Paycom database and they say, okay, last month, we had 100,000 changes. 90,000 of those were made by employees. Therefore, that's good usage. The 10,000 changes that were made by payroll and HR, that should have been made by employees. That's bad usage. That cost $4.51 per change made. It's not something we charge, but it's something that the client agrees with and calculates as a true cost based off not only the raw cost of the person making that change, not only opportunity cost or what else they would have been doing, but also there's liability involved. I mean you can't guess that when employees worked. You can't guess that what they wanted for their tax treatment. You can't guess at whether or not they're putting their dependent on the plan. And so all of these are things that need to be made directly by employees. They weren't really able to before because you didn't really have a system that would allow you to do that, and today, it's just not necessary for HR to be in the middle of the data transfer process, and that's what we've been working on. And we're seeing that happen with BETI and all the other products we've put out there.

Is there a ceiling? I mean can you give us a sense of -- it's probably tough to quantify, but if you look across your customer base, how much of the input is coming from the payroll group, the HR professionals? And where could that go over time? I mean could it be dramatically different where if somebody is all in and all these technologies, employees handling everything, where are we and where could it go?

When the Paycom System Universal, less than 10% of the changes are duplicative, meaning less than 10% of the changes are being made by HR and payroll. So well over 90% of all changes in the Paycom System Universal are being made directly by the employees with that HR payroll touching anything. Where can that go? 100%. I mean HR and payroll shouldn't be making any changes. I mean if I give you a raise, I should make that change, but that didn't come from your mind, that came from mine. If it's coming from your brain, you should be the one interacting directly with the database. Anything else is just more difficult for you and creates bad debt integrity for the business. And so that's what we've been driving at. And once you get to full automation, you eliminate a lot of the liability and exposure that's inherent in our business. I mean you get to -- and I've always said, I mean with apps, you can order a coffee. But if I get my coffee wrong, I just get another coffee. I can order -- I can order say, I want to watch Star Wars and maybe it serves up the Notebook. And then I'm like, Well, I really want to watch Star Wars, just get another movie. That doesn't happen in payroll. You get my check wrong and now I have electric bills bounce thing. My rents bouncing. Now you have to wire money to me. You have to void out my check. You have to create another manual. You have to cover my overdrafts. You forget to put one of my children on a health insurance plan. I got to wait until open enrollment. Something happen. So there's just too much exposure, and there's no reason why those employees can't be doing it themselves. And what we're finding out, they'd rather do that than -- and have a direct way to input than working with the 8 leg at Octopus with no head with so many businesses. That's what they've deployed to their employees, multiple systems and e-mails and other types of databases for when those don't work. So...

Great. Well, where do you -- we've talked a lot about areas where you've innovated and led the industry. What are some important themes or areas of innovation and investment that you see down the road?

Well, I think it's continuing to automate at the employee level, which allows business to automate. The only way a business can win at payroll is to have an employee do it themselves. Otherwise, it's just cost. They know that you're having to put out there to make sure things are correct and accurate. And so you're just going to see more and more of that at the employee level of full automation because it is how business, payroll, HR and everyone else wins. In fact, I mean you have the same issues with the tight labor market on the back end of payroll and HR, you do everywhere else, and there's more and more laws now that are coming out. I mean are they to hire more and more people? Or should they give those employees that responsibility in the palm of their hands, which, again, it's already coming out of the employee's mind. So it should be them the one that's doing the work.

I want to tie this a little bit into pricing because it seems like when I think about your platform, I think about the incredibly high usage and more of the onus going on the employee, it seems like you're probably saving these companies, a lot of savings on HR personnel, HR cost. Like you said, if you have the Octopus, you have 8 different systems and there's a lot of license and maintenance in that. And so when you think about the per employee per year pricing, how do you see that trending? Is that on an upward trajectory? How would you characterize that?

Well, it's steadily been on an upward trajectory as we continue to put out product that has a per life charge and as they take that on as the client chooses to purchase that product, it does increase the annualized revenue for any one employee, but it's also increasing their return on investment. And so the way I like to think of it as over time, as we continue to increase the return on investment that our clients achieve, it only makes sense we get to share in a portion of that we create. And so we've remained consistent in that.

Great. Shifting gears a little bit to the TAM. So I think you went public in 2014. So getting to that decade milestone. You're still less than 5% penetrated. So just where do you think the industry can go over time? What are some of the constraints or roadblocks you need to overcome to drive much higher penetration?

I think you break out the payroll TAM from everything else. When we IPO-ed, I think the payroll TAM was $16.5 billion. That was an IDC-type number. You can calculate it multiple ways. But what's really -- what we've really seen grown is all the other TAMs that are now becoming part of our industry. Learning management wasn't really part of our TAM in 2014. Now it's something we do, expense management. And I can kind of go on and on about different things that have now become a part of our TAM. The other point is that the TAM itself is growing at a dollar rate more so than we are. So we remain approximately 5% of the overall TAM. I think before we used to say, we're less than 5% of the overall TAM. Now we say, we're approximately 5% of the overall TAM. So -- and we've been saying that now for, I don't know, about 3 or 4 years. So it's a very good industry. It's a very important industry, and people always talk to me about new entrants, but we're the new guys and next year will be our 25th year in business.

Yes, young kid on the block, 25 years and counting. If anyone does have questions, feel free to raise your hand.

Just following up on TAM things, Chad. So I just want to have more clarity on what that TAM where it presents say it reflects of 5% of that. And the other 95%, is that customers are already using another payroll deposits that are [ 1% ] are already using something else? And what percent of 95% and are using [indiscernible]?

Yes. Usually, you're -- and you have to remember with us when we go into displace, we're displacing more than just the payroll vendor. We're displacing the time and labor management vendor. We're displacing the expense vendor. We're displacing the benefits administration vendor. Calculating it a different way. In 2009, there were about 126 million American workers at the time. At that time, about 55 million of them were in our sweet spot. This was at IPO. Since then, we've gone from 50 to 2,000 employees all the way up to 10,000. So there's more in our sweet spot now. At that time, we said, our opportunity for any one employee annualized was $400. So that came out to about 200 or about a $21 billion TAM. Since that time, we've developed a lot more products than what we had been. So that amount has gone up as well as the number of employees in our TAM has gone up as well. So that's how we calculate it. But even your information from some more like IDC or someone like that would show those TAMs continuing to grow, especially as newer captured. New industries are even captured within HCM.

Okay. But again, that 95%, though what percent are using...

80% would be using another vendor. And about half of our takeaways come from one vendor on the payroll side. So you have about 80%.

The other side of [indiscernible]

The other side of what?

The other side would be [indiscernible], not the payroll side.

Well, the other side, yes, we -- yes, exactly, the other side is going to be a mixed bag. I mean probably expense management were taken primarily from one of the larger vendors. Learning management can be a little bit different from one to the next and then benefits administration is going to be different. But from a payroll perspective, which, again, in order to compete with us, you have to be good at the payroll side. It's typically about 80% of our wins come are competitive takeaways, and then about half of those come from one vendor.

Another one here.

I'm assuming 100% of your customers have payroll. You could adopt to your other products such as the ATS Recruiting, Learning Management et cetera?

Yes, we haven't given out specific attach rates, but one thing we've said would still be consistent today is that clients take about half of our products at the time of initial sales. So at IPO, we had 18 products that would have been more than 9. Today, we have 29. So they're taking 15 or more. What we've also said with the exception of payroll, which everyone has to take, the longer we've had a product, the more successful its uptake. So the products that we've had longer more successful. Now BETI does require clients to have a certain product set because it's the usage of those products that create the payroll automation through BETI. And so there are certain products that you have to take now when you're onboarding with Paycom, where before you didn't necessarily have to have them you could add later. I will say, though, those products have traditionally been our most popular products anyway with time and labor management and benefits administration and those types of things.

Maybe going back to a point you brought up on drivers behind the TAM expansion. Certainly, one of them you mentioned is the employee size and the target market. And you really uniquely had success both going down and up market. I think -- in a lot of cases, it's hard to do one from a lot of tech companies that I've covered. So to do 2 is pretty unique. Maybe just starting with the SMB segment. Obviously, that's more of an inside sales orientation. Just help us understand the success you've had and how you're thinking about that segment?

Yes. I mean, well, I would say that we went down market more of a defensive effort. It really corresponded with the amount of money we were spending in advertising. We're spending a lot more money in advertising since April of 2020. At that time, we really just had a team of inside sales people. Now we have 10 teams. So we have 80. And really, that just came from the lead volume. Our outside sales are still primarily. We do get leads and one have you, but they're still primarily driven by targeted prospecting, where we are reaching out, where we've gone through our marketing, our scripts and what have you, and that's really the way we've done it. Our inside sales complete opposite. It's all driven by inbound. And really what happened as we continue to spend on these leads, our lead volume continued to go up also with small businesses. And you have a woman that owns a bank, a large bank, and her husband calls in with a 4 employee, ice cream store, and we don't even return the call. So you've got to pick up all of the business available, and we're good in that business as well. Typically, down-market, they want less product because not everything applies. When you're down market, I don't have to deal with COBRA, ACA. There's just a lot of things that don't apply to me because I'm in a more of a smaller business. And then after you get over the 50 employee, really announce more even 25 employees, almost everything applies. So that's the case there.

Great. And at the other end of the...

I'm sorry, one more thing. Around 95% of our business is derived from businesses that have between -- that have over 50 employees. So our revenue targets still are coming from that mid-market.

And double clicking on the true the mid-market and really the upper end. I know when you did the IPO, I think the upper band was 2,000, and it moved up to 5,000 and now it's going up to 10,000. So what have you seen in the market that made it, right, strategically a good fit for you to focus on these larger and larger customers.

The employee. HR and payroll have a tolerance for complexity. I've even said in the past that sometimes you might say, they're willing to pay extra for it, but employees have zero tolerance for complexity. And what we're seeing is, we're winning at the employee level. And so there's no such thing as an enterprise-level employee. I can work for a 500-employee company to Dagmar for a 50,000-employee company tomorrow, but I'm the same person with the same level of expectation with the same level of data. And so it's like anything else. If I'm used to using a remote control and then one day, you come in and you just take that away from me, I don't do well going backwards with technology. We're finding that employees that use us at one company and go to others, they're not doing well with going backwards in technology, regardless of the size of the company. And so I would say that the larger businesses have overcomplicated at a necessity. It was necessary for them to do what they did, but now it's just an overcomplicated big mess of the system. And honestly, the mid-market has more automation than enterprise businesses now in regards to HCM because it's overcomplicated by point solution providers. And you log into it once every 6 months and do one thing and you're almost retrained on it each time. And then you go to another product, we all know what I'm talking about. And so I just -- that's not going to last because there's just no need for it to be that complex in the future.

Well, maybe just -- I know we're getting up on time here, but just to wrap one financial question at you. Really good report. Obviously, your retention is moving up to 94. Your client growth at both the client and parent company basis showed really good growth, 9% to 10% range. You've guided to mid-20s with about 40% EBITDA margins. Obviously, that's Tier 1 for the rule of 40. How do you think about managing, right, that balance between growth and profitability? What do you see as some of the most important drivers for the topline moving forward?

Yes. I mean, well, first, I would say, I believe margins are created through growth disciplines. We've always been a very disciplined organization in regards to growth, and our growth creates margins. I started this company with an SBA loan and 13 credit lines. So old habits die hard. And so I mean profitability and margins inherent in our pricing and go-to-market strategy. And so I would say that we're very disciplined in that right now, even in the returning cash to shareholders. We've been able to buy back quite a bit of shares over time. I mean over $4 million worth of share -- or sorry, over 4 million shares we've retired through share repurchases. We've been in this situation right now. We're quite honestly, the stock has been down a little bit. We continue to look for ways to be able to return cash to shareholders. One way that we continue to review our dividends, and we would be a high-growing dividend payer, but at the end of the day, one of -- if not our largest shareholder, I expect to receive something each year. And I believe that -- well, I know that we're going to continue to be cash generative and continue to have the opportunities to produce both a return to shareholders on more of a continual basis as well as that growth that we're known for that with the best product in the industry you should expect.

Yes, definitely a very unique profile. So I wanted to say thank you so much for your time, Chad, and thank you, investors, for joining us, and hope you have a great rest of the conference.

Thank you. Thank you.