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

Afternoon. Next up, we have Paycom. We're thrilled to have CEO, Chad Richison; CFO, Craig Boelte. I'm Kevin McVeigh, the HCM services analyst here at Credit Suisse. Again, we're thrilled to have Paycom. I'd like to keep this as interactive, if possible. What we'd do is walk over, sit down, start off the Q&A, and then try to weave in folks in over the course of the next 30 minutes or so, and we'll go from there. So again, Chad and Craig, thank you so much for taking some time out for us.

I've started each one of these -- and it sounds pretty basic, but just -- Paycom has been such a differentiated story, Chad, within HCM. Just give us a brief overview of the company. We were saying earlier, you're still one of the most exciting companies. You're about to anniversary your 25th year. Maybe take us through what I think has been a revolution as opposed to evolution from when you started the business to where we are today. And just to put some context around that, Paycom sits in the 50 to 10,000 employee range. And I think one of the things that's been really differentiated is the amount of module growth you've enjoyed. And just really help us understand kind of the evolution of the business from really [ Tom and I feel ] to kind of where you are today. And then I think we'll just kind of build on that.

Sure. Well, in starting the business, we had moved payroll to the Internet. And at that time, it was primarily payroll only, but payroll on the Internet. And that was somewhat differentiated for the time because not many people had access to their data on the Internet in a decentralized environment. As time went on, we continued to expand further past payroll and include the entire HCM system but do it in a single database so that the back office wouldn't have to work with integration. As we continued to evolve, we found that the back office began rolling out product to the individual employees. And where payroll and HR individuals have some tolerance for complexity, employees have none, no tolerance for complexity around using a certain product. And so we were one of the first people to actually bring it into the employees. And today, as we continue to innovate, in addition to payroll and HCM and having all those products in a single database, we've been able to move into the environment where employees now do their own payroll to where you're actually being able -- you're able to skip a lot of processes that are inherent in the old model of having a payroll person start payroll after pay period end.

And Chad, I think part of the real differentiation has been BETI and kind of the adoption rate on that. Maybe help understand the nuances of BETI and why it's been so effective because part of our core thesis is the addressable market is so large. And then within the context of that, we've had just a seismic shift in the consumption of benefits. That's still very, very early stage. So maybe how does BETI fit into that and continue to drive just the adoption across the broader HCM universe?

Sure. And so you start with the premise that no one in the back office is reading an employee's mind. Somehow, that data has to get transferred from the employee to the back office. And so you start with that and actually having the employees interact with their data and actually make their own data changes and confirmations. Once you have employees doing that, you can actually automate things further such as payroll. And so we already had employees clocking in, clocking out, requesting time off, enrolling in benefits, applying for the job, doing their learning management. You have all that data in the system. Putting it together so that employees can also do their own payroll because in most cases, employees are the only ones that know whether or not their payroll is correct or not, at least the top line data, the earnings piece. And so by leveraging the employees and you have a person that's willing and interested in making sure that their check is correct, by leveraging their desire to make sure it's correct, you're able to eliminate and reduce certain exposures and liabilities that exist for an employer by paying somebody incorrectly. You've got 65%, call it, of the American worker that lives check to check. That's not just your hourly worker. You never know. You even have salaried employees that it's very important that they get paid the exact amount. And so what we found is that because employees are the ones impacted when they're not paid correctly, they're more than willing to correct everything and make sure it's accurate before a business incurs the exposure risks and costs associated with correcting. So we've just moved more into the employee experience. It's got to be very simple for employees and you've got to have a system that does it all. And that's what we've created over, like you say, 25 years.

And it's interesting because it's a win-win across, right? I mean employees get paid more timely. There's minimal correction for the clients themselves and just a much more seamless process. I wanted to spend a little bit of time just on the growth algorithm of the business because there's been such enviable growth but consistent cycle to cycle. And sort of preparing for this, I even looked at how the business behaved through COVID. And despite a seismic shock in employment, I think your worst year-on-year growth was 7% when you saw this massive runoff and just essentially shock to the employment. So it just really underscores the optionality that HCM creates. Maybe talk about some of the secular growth drivers, whether it's the modules, whether it's -- because it seems like a smaller portion is the actual job growth more broadly in the economy, but just what kind of drives that growth? And again, it tends to be well in excess of 20% plus, but just help the audience understand that a little bit.

Yes, it's go-to market. I mean, that's really what drives our growth. Even in the worst quarter we had, like you said, it was 7%, which I don't even like to say because that's pretty bad. But it would have been worse if we didn't have a strong go-to-market. And so really for us, both now and to the future, it's about a strong go-to-market. We only have 5% of the market. We have a differentiated strategy that contributes a significant amount of return on investment to any client that uses us. So for us, it's about that. Even our 2 largest clients, you combine the number of client -- our 2 largest competitors, from a size perspective, you combine the number of clients they have, it's 1.7 million. We have about 33,000 as of last report. So just there's a lot of opportunity there for us. And we're still working with the same competitors that we've had in the industry. We're the new guys and next year is 25 years. So we're still working with the same competitors. So for us, controlling our growth has to do with our go-to-market and adding new logos onto the system.

And maybe just to follow up on that a little bit because I think another really differentiated part of the story is how differentiated your sales hiring process is. So maybe talk to that a little bit, and we could weave that into -- I think you opened 4 offices, 4 or 5 over the last 2 years or so. Maybe talk about where we are in that process and as those offices mature because I think, again, another really differentiated part is that go-to-market strategy on the sales force.

Yes. So we have 55 sales teams, 54 of those are hunting sales teams where they're outside sales reps. We typically look for someone that's not your traditional -- doesn't have your traditional sales experience. We look some for people that have less sales experience. We do require a bachelor's degree or better because they're going to come into a learning environment, and it's important that they crave learning because you have to learn the system and you have to learn certain persuasion skills and analysis skills. We then hire people, build them up. We take a current sales manager who's successful with us, we relocate them to a new territory for us, and they build something from scratch. That's how we start a new team. And then we backfill them with salespeople who are now ready to be sales managers, and that's how we've grown our footprint.

It's really -- and I think in conjunction with that, you've really increased the retention -- client retention over time the last couple of years, and that continues to move forward as well. As we think about the different modules because you really continue to kind of enhance and grow that, how should we think about the penetration rates across the different modules based on clients? And does that vary based on average client size? Or is there any way to think about that?

Yes. So clients, when we first start with them and we're supposed to onboard them, they're going to typically take half or more of the products that we have at the time. Now we've been in business since 1998, so we have clients that we onboarded in 2006 back when we only had 9 products. And so their half would look different than those clients that we onboarded yesterday and how many they would take. But we do have up-sell opportunities. We are -- we're not a land and expand. We're a land large, and we're always looking to expand. But our new business revenue, when you look at the breakdown of our new business revenue, the overwhelming majority of that, from a percentage basis, is always new logo adds just because of the size of revenue opportunity in a new logo versus what your ability is to up-sell any one client.

Got it. And there's always been a lot of question around the macro environment. So maybe just to touch on that a little bit, is there anything you'd call out or any kind of things you would call out from a macro perspective that just changed? Or it just feels like I have to ask the obligatory macro question?

I don't really feel like macro will impact our go-to-market. Even in tight -- as we've experienced tight labor markets or even as you have some gyrations in unemployment, people look to do more with less. We're replacing a spend that they already have. It's very rare that we run into greenfield opportunity where someone is using Excel to do a payroll or something like that. They all have this expense already. We're coming in with a better, more efficient system that has a stronger ROI from that perspective. So I don't see the macro impacting the go-to-market. I would have said that I don't know that macro could have a significant impact on us. But we went through COVID and I know that unemployment can. And so what I would say is to the extent the macro has an impact on us to the negative, it's going to be more in regards to what happens with employment. I've said before that if employment goes from where it's at right now, and it gains 150 basis points over a 4-week period, we're going to feel that in that quarter probably to the extent of about 150 basis points. If it does that, if it has that impact, more of a normal gyration over time, not 100% sure it would have a meaningful impact on our numbers. We just have to see. But we know significant increases like what we saw during the pandemic can have an impact on us from an employment perspective. I don't know if Craig would add anything else to the macro side, but that's kind of the way I see it.

I think the other thing, just to follow up on that too is you're pretty diversified from a vertical perspective. It's not like you've got outsized exposure anywhere where you'd say, right, if tech is starting to roll a little bit, you folks might see that. Am I right in terms of...

Yes, for sure. I mean we're very diversified in terms of different industries. So some of the ones you're hearing about now that are maybe harder hit, we don't have any overexposure to those type of, let's say, tech. So...

And as you think about -- there's been kind of certain, I don't know if I'd call it subtle shifts but ACA, COVID, the adoption of modules, particularly around COVID as clients have become more distributed, have you seen acceleration in that? Any kind of change in the module adoption?

Well, ACA was its own animal. Everybody had to get on that within a 6-month period of time. No, we haven't seen anything like ACA with a rapid adoption. I mean I will -- through the pandemic, a learning management system became a lot more popular because you're having to do training, you're having to do different things even more remotely. So there's different points in time where a module can be -- have some popularity. For us, the popularity of our modules typically follow the time line in which they were developed. The longer we have a module, the more the sales staff gets comfortable with it. Version 2, 3 and 4 is always better than version 1. But I would say the only outlier to that was the ACA where you had to get everybody up on it right away.

Got it. I want to keep this interactive. Does anyone in the audience have questions?

I think they would.

I want to just -- I think someone is going to come around with a mic.

Thanks, Chad. A question on -- I saw that you guys launched a Vault card. It was a -- I think in the past, you've spoken about you're not going to launch something like that until the market is ready for it. So can you maybe talk to current market environment? How long have you been testing maybe in beta? And kind of what are your expectations? How should we be thinking about it?

Yes. So Vault gives the ability for an employee to actually put money on a card versus in an account. I'd like to think that people in mine and Craig's generation, if we're unbanked, it's because someone wouldn't bank us. Some of your younger generations unbank by choice. And so these types of pay cards have become more and more prevalent being used by people. You even have people that are -- they have a bank account and they have a certain pay card. And so as we look in our system, we can tell which employees actually use pay cards. And up to now, none of them have been our pay cards. So a pay card is an opportunity. Vault, being that for us, is an opportunity for us to be able to provide this ourselves to the employee, those that want it. And then we get to share in revenue from the interchange rates charged through the merchant vendor, so we get to share in that. Thank you.

I actually have a similar question. A lot of your competitors, they -- I think the Vault card is 2-day early payment access. A lot of your competitors are doing earned wages. Can you just help me understand why haven't you gotten to that level yet? Are there complexities, regulatory? Or is there not a market fit or is that something in development?

Well, so we're separating the 2. One is everyday pay or being able to be paid every day, Vault's more the method in which you would receive that payment. So they're 2 separate -- there are 2 separate things. Vault, we've come out with. In answer to the everyday pay, I've always stand consistent with the thought that if you're paying an employee, you need to deposit and file their taxes. So anything Paycom would ever come out with, and we work on things all the time that makes sense to us, that said, I mean, we don't prevent our clients from using daily pay options. But for us, anything that we would ever come out with would keep the client whole. Oftentimes, you get to the end of the pay period and maybe you allow the employee to take more than what you were able to deduct because someone still has to pay their health insurance, they still have to pay for the taxes and what have you. And so as we've looked at those types of products, what would be important for us is if we do roll something out, would be keeping the client whole and paying the taxes along the way. We kind of stayed out of that. The other thing is I'm not big on charging the employee. We would never roll something out where we're charging the employee to access $40. Employee wants to access $40, you charge them $3 to do that. I just -- I've got a little bit of a problem with that. I don't think it's good for employees to get used to having easy access to payday loans. So to the extent we do it, and it's actually an early payment of the money you've earned, your net ought to calculate that -- to that versus a guesstimate, and taxes ought to be paid. So that's what I would believe in that. Thank you.

Just on the competition and market share side, who are you generally gaining share from? Is it probably the top 2 competitors? And how do you feel positioned versus some of the other newer HCM players in the space?

Yes. So our wins and who we take business from typically follows the size of the market that those businesses would have. And so your largest vendor out there represents the most -- I'm not going to advertise for them and say their name. But your largest vendor out there would have -- we would take the largest share for them. It's important to note that any time we're taking share, you have the payroll vendors that we take share from. But then you also have the expense management vendors, time and labor management vendors, benefit administration vendors, learning management system vendors. And so when we're going in to replace, we are replacing the payroll side, but we're also replacing the other items that connect to payroll because our value proposition is providing it all in a single database so that you eliminate integration at both the back office as well as the front employee. But I would say that we -- where we're going to see our competitors are -- would be based on the percentage of that market that they have is who we're going to see the most.

One more question on the Vault card. What's the logic behind the 2-day free pay? Is it just an incentive for people to adopt? And will you have collected the money from the employer by that time?

Yes. And as the -- go ahead.

Yes, we will have collected it from the employer by that time. And so...

The difference is the way you move the money. 2 days through ACH. The one day or the same day, you might call it, is through an API. So it's the way you're able to move money into these cards. That's why it is. You don't have to wait for ACH to clear.

That's great. I want to follow up on a couple of maybe -- just because we're talking about money movement, maybe talk about float. Float is something we haven't had in about 30 years or so, starting to scale. Just thoughts, philosophy on kind of how much of that goes back to the market versus reinvestment? And it's just, I guess, float within maybe just the broader context of price because I think price has been something, historically, you've been very thoughtful on, haven't really leveraged and just any thoughts as to the float dynamic today? And how should we think about that in terms of reinvestment relative to maybe margin expansion?

Yes. So first, on the float, we're carrying about $2 billion of average daily balance. So we kind of talked about that, what our balances are. And we invest that fairly short term, so that's kind of the way we -- our philosophy has been on the float. And then we'll kind of look -- I mean, growth is first prize for us. So to the extent we can reinvest and drive growth, further growth, then that's something we would look at. And then anything -- we're not going to be wasteful either. So some of that would fall to the bottom line, we would expect.

And as we think about, I think, conversion from bookings to implementation to go-live, you've always been very, very efficient there. Maybe talk to that process a little bit because I think it's, again, another real differentiator is how efficient you've been from the time of booking, actually closing the sales, to implementation to go-live.

Yes. So depending on the size of the deal, you have up to either 13 weeks or up to 17 weeks to get a deal started in the Paycom model. We do -- that's not to say if a client takes longer that, that can't happen. But 13 and 17 is what we're focused on. And at that point, you start impacting the sales rep negatively if it's not up by that time. Data gets stale. So if I start converting you today and I'm not getting it done with your convert, I just stay in a perpetual conversion. Now it's also important to state that we're not really doing any interfaces as we go through that with multiple products and other things. So oftentimes, when we're converting someone, we're grabbing the data and we're having to get it from multiple systems. And you have an -- you may -- your address may be different in your benefit system than it is in your payroll system, and you may not have even looked at your time and attendance system for 4 years. And so there's a cleansing of data because before, your data exists in 6 different places or 7 different places. And with Paycom, it's going to exist in one. And so we can even get wrong departments out of it. And so there's a data cleansing that we go through. Now you have employees using the system, so employees start using the system before they're even converted, so that they're able to look at their data. Now they're responsible for the data and we go from there. So I've never believed in long conversions because that just -- nothing good ever happens on a backlog. You got to get clients up and running.

And maybe we talk about the sales -- we were talking about this a little earlier, but I think you folks are big believers in face-to-face as opposed to Zoom. And you didn't see any real slippage of sales conversions through COVID when you pivoted to Zoom. So maybe just philosophically, how we think about that?

Face-to-face is needed. Yes. I think we probably stayed in Zoom a little bit too long, to be honest with you. So I think face-to-face is important for us. And the reason I say that is because we rolled out BETI, and it's a visual product. And when you're talking to someone -- the very first time someone ever heard, now your employees do their own payroll, they heard it from us. They didn't hear that before. And so it's a better pitch for us and a better -- we can present our value proposition better in person. And so that's why now, we are all back to 100% in person.

And then just going down the P&L a little bit. You've always had a very, very efficient tech stack. Even when you look at the R&D as a percentage of revenue, it scaled up a little bit but still well below your competitors. And you over-deliver on that. Maybe can we -- and I think it's, obviously, from when you built it initially. What was that real point of differentiation? Because even with the step-up in R&D, you're still well below and really over-delivering from a revenue perspective in terms of your peers.

Yes. Well, at IPO in 2014, I think our adjusted R&D expense is 2.5%, so it needed to go up. But we still had a differentiated product back then. We're developing in a single database, so as we develop products where there's a lot of considerations, we're not having to make with how is it going to interface with this or that. I think that's helpful to us. We stuck with automation as well. We do development primarily in 2 different areas in the U.S. I think that helps us with synergies as well. So we have a motivated R&D group. And even their comp and how they're paid is a little bit unique in that they're comp based on performance, which is consistent with most departments of Paycom.

And as you think about the business because obviously, it's gone through a tremendous amount of transformation. Again, part of our core thesis is we're still very early in terms of tech transformation of benefits. But as you look out, kind of like what are areas where you kind of continue to focus and just try to get your view on what do you think you're still not getting full credit for as you think about the go-to-market strategy and just the model, more broadly?

Well, I mean, from a credit perspective, full credit perspective, I mean, I think the investment community decides the value. I think that our model has been very efficient, but it's also very effective in what we're actually able to deliver for a client. Clients that use our system and strategy the way it's supposed to be used, they're getting an incredible amount of return on investment. And as you see us continuing our innovation, it's really about automation at the employee level. There's just -- all these back offices have been built out. And if they were doing it today, they would not be the same way as when they built it. They just wouldn't because you've got employees that now use multiple systems. They may not even remember their log-in. It's not easy for them to use. And we're providing a product that's very easy to use at the employee level. And we're finding that when employees do their own payroll and you take it away from them, that's a problem for them. If you take their ability to see a check away from them, I'm sure that's a problem, too. But the ability to do their payroll, know that it's perfect, fix any inaccuracies before it's paid, that's a big thing for employees. Not to mention the impact that you have on the employer with the risk and the liability and exposure you're able to reduce, if not eliminate, in many areas.

And do you think -- because one of the things you've really seen a nice improvement is your retention rates. I think you're up around 94% now, 91%, 92% couple of years ago. Is that BETI? Is that sales because it's, again, just incredibly impressive retention rates? And does that continue to kind of march forward here?

Yes. I mean you always have a certain amount that you lose from buy, sold and merged. But I definitely think you have the opportunity to continue to increase retention. Ours is a situation with how we measure it, it wouldn't go over 100%. So I wouldn't say we would get to 100% since it can't go over 100%, but I would say that there's still room.

And then maybe -- I know we might about it a little earlier. But just from a pricing perspective, any thoughts about that pricing more broadly?

Yes. I mean, look, we did our first pricing adjustment ever in 2019. We did it to a subset, a group of our client base. We said at that time, it represented about a 1% revenue bump for us. We also talked about, as we do price increases or pricing adjustments over time, it's -- for competitive reasons, it's not something we would talk about. But I did say just from a philosophical perspective, that as we add additional functionality and product into our system that we don't charge for, like DDX and many of the Manager on-the-Go and other products that were -- Ask Here and other products that we develop that we don't charge for, it only makes sense that we get to share in the return on investment that we create for that.

And there's a ton of leverage within your clients, too, as they scale up their HR departments and just get a lot more deliverable from their existing footprint as well.

Correct. I mean you can, as they add employees and what have you.

Any other questions from the audience?

Thanks again. BETI has been a really great big differentiator. I'm just curious, what would be the next kind of trend or something that we can look forward to?

Yes. I mean, we don't discuss development until it's out. But I mean, what I tell them, the sales staff and the CRR group, is I don't have anything after BETI. I mean if you're not out there moving BETI and you're not out there getting clients to understand the significant value available to them when they use BETI, there's nothing coming behind it. Everything we have is coming behind this full automation at the employee level. And there's a lot we can do at the employee level with how they interact with HR to where HR, payroll, recruiting and other departments won't have to touch data. And even decisions that are being made by these groups, they won't have to go through decision trees because we can also have those within the system. So everything we do from here on out will revolve around the BETI process. But really, it's about employees using the system, and they're the major users from a data interaction and confirmation perspective.

Thank you. Chad, Craig, thank you all so much.

All right. Thank you. Appreciate it.