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

Good afternoon, everybody. I'm Mark Marcon. I follow human capital technology and solutions for Baird. We're very pleased to have Paycom as our next presenting company. Paycom, as most of you know, is a rapidly growing SaaS provider of payroll and HCM solutions with a large and growing TAM. They basically have less than 5% share of this growing TAM, and they've got a really long runway for growth, which is one of the things we're going to talk about. They do focus on companies with 50 to 10,000 employees, although they frequently go above that in terms of the size of clients that they end up getting. With us today, we're extremely pleased to have Chad Richison, the Founder and Chairman and CEO of the company. Chad is one of my favorite stories. He founded the company in 1998 with 13 credit cards and an SBA loan and grew it up from there. He still owns 14% of the stock. And I don't think you've sold very much, if anything at all. Prior to founding Paycom, he started his career in ADP, so he knows one of his competitors extraordinarily well. We're also very pleased to have Craig Boelte, the CFO. Craig joined the company in 2006 as the CFO. And then sitting in the back, we've got James Samford, the Director of IR, who's raising his hand. So thanks for joining us.

Chad, one of the things -- we're just going to go directly into the fireside chat. We also do have a breakout session, which will be in Aster A afterwards, and that will be an opportunity for all of you who are interested to kind of go through things. One question I'm asking every single company, so it's just part of doing research. Obviously, there's a lot of topics in the news today about the macro environment. And so one of the key questions is just what are you seeing right now? Are you seeing any sort of change in the behavior? It seems like CEO of one large bank kind of flipped his perspective in a week, so -- and that was last week. So just wondering, are you seeing any sort of changes, any sort of differences out there in the environment?

No, not related to anything macro, not at this point.

Okay. Great. And then the other thing is if something were to change -- last time, you ended up growing 19% in 2020, all organically. And that's with rates being cut, not to mention what happened with employment, instead of being on your normal 25% to 30% organic growth trajectory. Can you talk a little bit about the recession resistance of the business? And one of the things that was really amazing was how you were able to, after one short blip of a quarter in terms of when you kind of retooled everybody to work from home, how you got everybody back on stream in terms of new sales. So I'm wondering like what's the perspective from a salesperson's perspective? What's the perspective from a client who was kind of going through this but deciding, "Hey, I'm going through this, and I'm still going to end up switching my system?"

Yes. Well, there's a lot of questions mixed up in that. But I would first say, I mean, our service isn't a luxury item. Every business has a phone, a website and a payroll company, and so it's not really a luxury item. So for us, as you even saw in the pandemic when there were competitors talking about people not wanting to switch during the pandemic and what have you, and the retention rates were holding for some, we actually grew quite a bit in the pandemic and had a lot of success. And that's because of the strong ROI that we deliver on the product. And then as you went through a tight labor market, you had something very similar to that in which people were tasked with doing more with less, and technology allows you to do that. As far as the recession, I mean, the word recession doesn't hurt us at all, and it would have to be the impacts that we would need to see by what would happen through that. Traditionally, our industry, as a whole, as you followed it for quite some time, has been very resilient during a recession. Rising interest rates are accretive to our margins as well as our top line. We had mentioned that for every 25 basis point jump in interest rates, that's another $5 million in top line revenue for us. A lot of that you would expect to fall through to the bottom line. And so normal gyrations in unemployment also, I don't see that having a material impact on us because it's our 25th year in business. We've been in business for 24 years. We've gone through the different time periods with unemployment fluctuations. It would have to be something significant like what we saw during the pandemic, where roughly 15% of our revenue were treated through our current client employee attrition through the downsizing and what have you. So it's hard for me to reconcile right now a tight labor market where still a substantial number of jobs are going unfilled with a massive shift to unemployment, but it would require something like that to impact us as far as uncontrollables. The other things we control, how much we're able to sell and what our product development is and what have you. So -- but it would have to be something related to massive unemployment, a shift to massive unemployment very quickly, like what we saw in a pandemic. So...

Great. And then you mentioned the ROI proposition, where even if you're going through a downturn and you're uncertain, it's certainly beneficial to switch if there's a positive ROI. For the investors who aren't familiar with the intricacies of HR systems and clients potentially using ADP and Kronos and an old Taleo system simultaneously, can you explain the ROI proposition that you would go out to a client even in a downturn where it would be like this is going to be accretive to your business in general? And then I want to delve into some of the newer things that you're doing later.

Yes. In the simplest of terms, the data transfer model has changed in our industry, and what I mean is the data transfer from an employee into a system. Traditionally, that model has been run by HR and payroll who would transfer the data from the employee into multiple systems. Maybe the employee had some access to technology. In our model, the ownership of those tasks are at the employee level. So basically, what we do is we remove the payroll and HR administrators out of that data transfer model, which increases that integrity within the system and allows us to automate a lot more for them. For instance, in our model, employees do their own payroll. Payroll starts when the pay period begins. And by the time it ends, payroll is over. So that's our model. In our model, people do all of their own enrollments. They do all their own data changes, and it's all in a single system. So there's no integration required by HR and payroll. And so through that, we're able to produce an incredible amount of return on investment as our clients deploy our products and employees use them. We actually calculate bad usage of a system through what's called our DDX, or Direct Data Exchange. And what it does is it measures the amount of changes made directly by the employee into a system, data point changes made directly into the system or tasks generated into the system. It compares that with changes made by an HR, a payroll or an administrator individual. So in any company, you might have 400,000 changes that were made this month. Let's say all of those were made by the employees and that HR and payroll didn't touch any of the data points, that would be 100% DDX. In the Paycom system, in aggregate, all of our clients are averaging in the mid-90s. So once someone uses Paycom, right now, we're in the mid-90s of employees actually doing everything themselves. And...

And you calculated what that transaction...

So the cost is $4.51. It was actually a calculation done by...

Ernst & Young.

Ernst & Young. The cost of duplicative data, not just the actual cost of input and what have you, but the data integrity cost, the exposure and liability for maybe that transfer being not accurate at the employee level.

And then just in terms of just hard costs savings for a client, the time to payback is very rapid, and you've calculated it.

It's about 4 months. Once someone shifts over to our system, an ROI is not something we walk in with. It's something that's generated through client discussions. And so different clients have different ROIs, and different clients have different payback of those ROI. But in the traditional setting where we're going in replacing multiple systems, we're replacing their payroll system, their time and labor management system, their expense management system, their benefits administration system, their onboarding system, their paid time-off system. So as we replace all of these systems with one, you can maximize return on investment through both employee usage as well as you get to reclaim both hard cost, which might be those costs that you're actually paying for those systems, as well as the ability to -- the costs associated with integrating them and keeping them operating. And then also you have soft cost savings, which is the liability associated with not having a single system where you have inconsistent data which can create labor law liability issues that can create tax law liability issues. And so when you're able to reduce that exposure, there's also ROI associated with that.

And then in addition to being able to present those, it seems like a lot of clients actually have employees that are really satisfied with the system. They're using it a ton. And one of the biggest proof points for me in terms of like your growth and the sustainability is your ability to continue to grow in markets where you've been well established for a long period of time. So I'm wondering if you can talk a little bit about the feedback that you're getting in terms of employee usage and this kind of the viral nature because you've got some employees or some clients that have employees that leave them, they go to different companies, and they say, "Why aren't we using a system that's as good as that?" And you take a look at like Tulsa, Oklahoma, Oklahoma City, some of the markets where you've been in for the longest time, and you're still growing at a rapid rate. So I'm wondering if you can talk a little bit about that.

Yes. Well, first quarter this year, Tulsa was our best city for the first quarter of this year. And Tulsa, we've been open in since 2001 or '02.

'01 or '02.

So -- and it's a small city, 450,000 people. We've been there for over 20 years. But again, almost everyone is a prospect for us. So -- but in answer to your question, 5 years ago, no employee even had an opinion about the human capital management company. Nobody cared. You use whatever product was handed to you. And so you log into a learning management once a year to do sexual harassment. You log into your expense management, every time you have expenses. You kind of get it. Today, employees are starting to care about what products they're using at work because everything else is more difficult than going direct. I mean, it's easier for me to order a coffee than to enroll a child in benefits. If I make a mistake in getting the wrong coffee, they just give me another coffee. If I make the mistake in benefits, I'm kind of in trouble. So it should be as simple to enroll in a benefit or to ask for time off and everything else as it is with what you use everywhere else in your life. And so what Paycom has done is we've taken a consumer-based approach to technology, and so we're just leveraging the consumer-based usage patterns we see when someone's ordering something online or ordering a coffee or a flight or using their bank, we're leveraging that for business, and now we've taken everything direct to the employee. As employees get used to it, nobody does well going backwards in technology. I start taking technology away from you, that's a problem for you. And so because of that, when employees leave someone who uses Paycom, and they go to another company, sometimes they're asked to kind of move back into the 1995 model. And oftentimes, that makes their job more difficult. And so for the first time in probably -- we've been seeing this for about 2.5 years now where rank-and-file employees, a truck driver, a sales clerk, whoever, which doesn't have a lot of influence in the decision-making process of business, they're bringing us into these companies. And again, their influence isn't high, but their knowledge of what's wrong with the current product that, that company is using and the inherent problems with that model, we're able to leverage that even 3, 4 years ago.

And that's something that you -- it didn't happen by accident. I mean, you've been very purposeful about that. One of the things that I was impressed with in terms of going to Oklahoma City is the rooms where you actually -- you've got your R&D teams, and they're assigned projects, but then you end up like sitting over the shoulder of a truck driver or a retail store clerk and actually watching them use it. And if they can't use it, then it doesn't go out.

That's exactly -- yes. I mean, I've never used a manual to work my iPhone. So we wouldn't want a manual to work the employee-based system. It should be very intuitive, and I've said that before. I mean, you have to have a product that works for your technician that might have their MIT degree. You've also got to have a product for someone that might not be as educated or as technical in regards to these types of products. Because across the client base, you're going to have all of that. And our expectation is 100% that the employees will be doing all of the activity and work 100%. Because let's face it, HR and payroll, they don't read our mind. These people, they're not reading your minds. So the best way for you to transfer data is through a single system. And as they do that and as they deploy that, it allows HR and payroll people to become more strategic in an organization versus just transferring data.

And what that's translated to is -- so you've got a hard cost ROI. You've got a really user-friendly system. So that works. But then you've got to communicate that, and so that's marketing and sales. And you've taken a differentiated approach to marketing and sales as well as the pace of office openings. And I'm wondering if we can delve into that a little bit. So in terms of opening up offices, I remember in the early days when we were covering you, a lot of other companies were talking about, "Hey, we're going to increase our sales force by 20%. We're going to increase markets at a certain pace." You took a differentiated approach. You basically said, "We're only moving -- opening up a new office if we have somebody that's ready." I'm wondering if you can talk about your leadership development program and how you assess people and how do you judge in terms of like when we're ready to go into a new market. And if you can talk a little bit also about the sales performance of some of the people that you've brought on because you've had some pretty stellar rises in terms of some of your salespeople where they come in. And year 1, year 2, they're really producing well. So I'm wondering if you can just describe that in terms of the differentiation of your approach.

Yes. And so we open up an office with a current sales manager. We relocate them to a new territory, and then we backfill them with the sales rep who's ready to be a sales manager. That's been our bottleneck to opening up offices. We opened up one in 2019, and then we've opened up 5 or so in the last 6, 9 months, call it. Actually, I think it was like November through February, we opened up 5 offices. The reason why we hadn't opened up more is we didn't have the capacity to do that within our own team. Our future leaders program is what you're talking about, where we do identify future leaders, get them trained and ready. We've had a lot of success increasing the amount that any one salesperson can sell. In fact, this year, I would expect a sales rep or 2 to sell more than an entire city sold 6 years ago. So we have 8 sales reps per team. About 5, 6 years ago, our first -- it was the first time a sales rep had sold $1 million. We had a sales rep sell a couple of million dollars not long ago. And then this year, we had multiple sell a couple of million dollars for the year. Again, I expect that by the end of this year, we'll have reps selling very close to what an entire city would have sold around IPO. So that has to do with us continuing to get better at sales, having a stronger product that's differentiated, continuing to go upmarket because we are selling larger deals and then all the -- obviously, we also have more product to sell to that size of client. So it's kind of many things working together to increase the productivity of our sales organization.

Glad you brought up going upmarket because one of the things that for people who delve into the metrics, it's like you give your client count, so we can tell like, okay, what's the growth in terms of the number of clients year-over-year, and then we can go through the calculations in terms of like, okay, what's the size? And one thing that some investors pushed back on was, a, this past 2021, we didn't grow the number of clients at the typical pace, but you're selling more to your existing clients. You've got the in-house systems in terms of -- from a sales perspective, but you're also selling really large clients, some of which would be surprising to some folks in terms of being well over 10,000 employees. I don't want to spill any beans in terms of any names that you don't want me to. But can you talk about like the entrance into some of these really, really large companies and the success that you've had there?

Well, I will say in regards to client count, we had similar client growth, up and down a little bit, 6%, 7%, then we had a growth rate -- revenue growth rate of 30%-ish or what have you in like 2019 and as you looked in years past. 2020, we added a small business group because we started advertising big time in 2020. And our ads don't say, "Don't call us if you have less than 50 employees." So we got a lot of calls for businesses that have less than 50 employees. And so we spun up inside sales groups to handle that. They produced a lot of units, and it's good revenue. It's just smaller amounts of revenue. That side of our business, the sub-50 employee group represents about 5% of our revenue. So 95% of our revenue is derived from companies that have greater than 50 employees. So 2020 was a little bit of an anomaly for unit count growth, and then we had that comp in 2021. But what has been driving our results has been a continual move pulled -- being pulled upmarket as we're finding larger and larger companies are looking to deploy a single system. I think that, over time, people had gotten used to integrating point solution providers. It's getting more and more difficult to do that, and that's very difficult to roll out to the employee. The user changed. 5 years ago, the user of our system was an HR or payroll administrator. And if you looked at the data point changes in our software, they made most all of them. Today, the user is the employee, and they're expected to make the data point changes. And so I can -- HR and payroll sometimes has a high tolerance for complexity on the back end. Sometimes, it equivalates to job security. Employees have 0 tolerance for complexity. They'll throw it back at you if it doesn't work. So our focus has been on making it very simple for employees to use the technology. And through that, your HR and payroll departments who are already overburdened with all the additional labor like -- now cities have power. I mean, everybody is coming up with different labor laws per city, county and everything else. They're already overburdened. It allows them to offload and displace a lot of that burden by having the employee do it themselves because, again, only the employee knows what's going on with their own data.

In terms of moving upmarket, to what extent has the marketing campaign -- I mean, if I take a look at the Barbara Corcoran ads, they're ubiquitous on CNBC in the afternoons and highly effective, I mean, clearly driving things. What's the top of the pipeline look like for larger clients versus smaller clients in terms of what you're seeing in terms of the inbound prospects?

We actually measure that. But I mean, when you're saying larger, we measure it at the in mid-market and above, and then we measure it below. It's been consistently growing for us as far as the lead generations on both levels. Larger deals, I mean, you're going to have some advertising that works, but also you do -- we do a lot of geo-targeting. If we know your prospect for us, we're going to geo-target your location. And as your employees fill out to look at their Facebook, it's going to serve up our ads from your IP address. And so we're kind of in a situation where employees have more influence. They have more data. They have more influence, so they're able to help us sell deals. Before, if we were running something on television, if you saw it on TV, we're marketing toward a payroll and an HR person. So we're wasting a lot of advertising dollars if we're putting an ad on ESPN, and we're trying to hit payroll and HR people only. We're wasting a ton of money. It's better to go direct, which we did. Now that we're actually the tail somewhat wagging the dog in regards to the employee base, having an opinion and having very strong usage, we're able to advertise a new way to do something, and we're impacting those employees as well. So we have a message. If you watch our advertising, the message is as much to the employees of these clients as it is the potential client on a go forward. So we're able to maximize our advertising dollars that way.

Great. Currently, you've got just -- well, your last published data was roughly less than -- slightly less than 34,000 clients, less than a 5% TAM. And you've got 54 sales teams, of which 5 were just opened. What are the -- from your perspective, what are the challenges to being able to sustain this 20%-plus growth rate for the foreseeable future? And how big do you think Paycom could ultimately become?

Well, I mean, I think -- well, we do have the best product. We are differentiated in that way. And I don't know why someone would be larger than us, other than maybe they had a head start on us. As far as what's in -- what we're focused on, for us, it's really in execution as long as we continue to execute. We are very innovative, and we innovate products that produce a return on investment for our clients. We know what those are. We know our industry very well. And so for us, it's to remain disciplined in what we do. We take a very disciplined approach, whether it's to sales, product development or what have you. And I do believe that our product will continue to drive results for the clients, and I would expect us to continue to capture TAM. The fact that we only have approximately 5% of the TAM shows strength of our industry. My bet is during a recession, if you went back and look at some of our larger competitors, they probably did okay.

They did.

So rising interest rate -- again, it takes some massive unemployment hit very quickly to really take an impact on us. I would have thought nothing could impact us until the pandemic. So now I know we're not pandemic-proof.

Well, and...

But I think from a recession standpoint, I do think our entire industry is going to do okay.

You still grew in the mid-teens.

We still grew mid-teens.

With high margins. Speaking of margins, You've got this growth rate. You're investing for growth. You've got the second highest margins in the industry. You've got the highest gross margins in the industry, and that's on a GAAP basis. How should we think about the margin profile going forward?

Yes. So I mean, we've had very strong margins for many years. And really, it was our DNA from the start. We became a profitable company and wanted to stay that way.

So the GAAP Rule of 65 company.

There you go. So I mean, we're going to continue to invest for growth. And along the way, we would expect strong margins. And can they rise? I'm sure they can. We're not really pulling any levers. But as we look out in the future, we would expect to continue to have strong margins but continue to invest for growth.

Will you let some of the float income benefit flow through?

We'll have to see. I mean, we would hope that some. But yes, I mean, to the extent that we could reinvest some of that, Mark, and continue to drive future growth, we would go ahead and reinvest some.

But oftentimes with us, the reinvestment works, so it produces more margin. I mean, when we talked about in 2020, we said we're going to spend wildly in advertising and start spinning an app. Well, it produced more margin. So I mean, if you're doing it correctly, anything we spend should return as high-margin revenue. So I think it's more of a timing piece. So...

And then your balance sheet, you're -- it's not ADP size, but I mean, you're throwing off a fair amount of cash. How should we think about capital deployment? You've grown organically.

Yes. I mean, we're -- I would expect us to still be primarily an organic grower. We haven't done any acquisitions. We've done buybacks. I think we bought back 4-point-some million shares of stock. I've talked about dividends as well. I mean, honestly, one of the biggest mistakes that I believe we made during the pandemic is the stock went down to $163, and we didn't load up on debt in order to buy it back then because we remain cash generative. You can kind of see where our revenue is and where cash is. We expect that to continue to increase. And my hope would be that in the future, we're able to take advantage of share prices that are short term in nature and what we believe significantly undervalues the company.

That's great. Unfortunately, we're out of time. Please join me in thanking Chad and Craig for an interesting discussion.

Thank you.