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

Welcome to our next session. I'm really happy to have the team from Paycom here. It's really nice like we're going back to wave before the IPO and done the IPO and now seeing a nice successful company. It's really nice to kind of keep following you and just kind of seeing the progress, so I'm really happy.

Let's start a little bit about like more the industry. Like Chad, you talked a little bit about the innovation in your space, like if you think about it, like in the olden days, you would say, well, it's payroll, just don't screw it up and then off you go. But like I think a lot of stuff is changing in Eurospace. Can you maybe just talk about that evolution?

Sure. Well, I mean, it starts with its payroll, don't screw it up. I would say that's very important in our industry. And then the things you can deploy to make sure that doesn't happen, so that both employees and employers don't suffer the consequences, that's meaningful. And so with us in 1998, we started with the Internet, and that was innovative [indiscernible] we really move to the single database solution to where we eliminated integration on the back end. That became innovative. And then we rolled that out to the employees, we came out with an app and then for employees. And then we came out with an app for managers with Manager on-the-go. Then the DDX strategy that measured the number of data point changes made by employees directly into the database versus what the client or the employer was making for them. And then today, we've taken it even a step further with Beti, in which employees actually do their own payroll so that they can correct mistakes before it impacts either the employee and/or the employer. And so we've continued to innovate around automation. But also you look at the way consumers use technology in their personal life. That's changed over the last 25 years. We weren't ordering a coffee with an app 25 years ago. And that really accelerated during the pandemic in many cases, if you wanted a coffee, you had to use the app. And so the more that employees have had technology in the palm of their hands, it's made it easier for the back office to automate those processes direct to the employee. And we've been able to leverage that through innovation for the benefit of both the -- our client as well as for their employees.

And how does it change the competitive situation? Like as we said, like initially, like you had ADP cumbersome, but they didn't screw up your payroll, it's fine. Now like you have more innovation coming in. Like how do you see that playing out in terms of like competition, replacing people, et cetera?

Yes. I think it definitely strengthens our value proposition and the return on investment that our clients enjoy, which I do think changes the competitive landscape. Being the first to do something is we can say, well, I don't know anybody that beat us to the Internet, but now everybody is there. We released an app. Now different people release app. But what I will say is different is our strategy. We have been a contained system that's a single database to which all functionality triggers. So data stays within the system. And now that we've changed -- who the primary user of those data point changes are being the employee, I think that we've made another shift in innovation. So from our standpoint, the return on investment is significant. I believe that the only way to do payrolls is to have the employees do it, impacts them the most, they're the ones that know if it's correct. And I see a world where everyone is doing their own payroll into the future. And I believe that you'll see competitors shift to that model into the future because that's really how a client wins at payroll.

What -- if you think -- if you talk to the -- I mean if you look at the progression in your space, and you mentioned it a little bit, it's like you maybe have started with Internet now everyone is there. And I see there's an industry themes like someone comes out and it's a good selling point for a while, and then they are ones like -- this. So then they come up with a real solution or a marketing solution that kind of looks like that. How do you think about the Beti now actually requires kind of much better systems in the background. You can't just kind of say, well, I do this for the employee because the systems need to be there. Like is the durability of the competitive advantage kind of better now or longer now?

Yes. I believe it's extended. What happens is you somewhat changed the buying criteria of the prospect base or of the client base. The buying criteria starts to shift to a more employee-focused, employee usage type buying criteria. And so -- and definitely, that's the case when you apply Beti. I mean Beti only works because we have a single database, because we have that functionality. Someone's already enrolling in the benefits. They're already requesting time off 30, clocking in and out. They're already managing their expenses within our system. And so Beti works around those scenarios. So in order for competitors to be able to exact the functionality of Beti, you would have to have a similar type experience for the employee to do the work before you get to the point, payroll.

And so on that note, like, if you think about market share evolution, like you've been gaining market share for as long as you know now, but you're still kind of a small part of the market only. Like how do you see that evolving, like for you?

We're continuing to grow. You look at our space, if you're looking at who you have as an option for payroll above 1,000 employees, it's the same 4 companies you had 25 years ago when I started Paycom. If you look below 50 employees, the public companies in that space are the same companies they were when we started Paycom. And so we're the new company, and we're 25 years old. And so I think it's a very healthy industry from that perspective. Payroll is a very difficult function for any business. And I think it's a difficult entry point for someone to start a payroll company because of the expertise and the importance in getting it right.

I mean it's also like the fact that the same 4 guys are still there. I mean, you must be looking at the number of companies that you potentially could gain and it's still like you have like years ago?

Yes. I mean well, just with our top -- just with the 2, what I would say, the largest names in our industry, if you combine their client count, it's 1.7 million clients, and we have 33,000 as of our last time we reported a client count. So the opportunity there for us is enormous. We have talked about how we have a 5% or less of the total addressable market available to us U.S. domestically here. And so there's still plenty of opportunity for us.

I wanted to switch gears a little bit, like -- like in terms of innovation in the space, the one thing that came up was like to pay an employee kind of earlier, like you just launched a solution there, like can you speak to that?

Sure. And so we launched Vault. To separate that from DailyPay, it's not a DailyPay option. It would be the method through which a DailyPay item would be paid. So what Vault allows, it does allow for someone to the extent that payroll has been run. You could access those funds earlier because it uses an API versus the ACH system that many normally runs through. But Vault is an opportunity. We put it out there so that employees could actually utilize it. What we found in our database is that about 5% of the business companies employees that -- or sorry, 5% of the employees at companies that use Paycom are using pay card type cards. And so it was an opportunity for us to allow them to use our card and that's what Vault is. To the extent we ever do early wage access from a DailyPay type environment, we've always said that it wouldn't be something where we charge an employee, and it would be something where we would keep the client a whole because oftentimes you pay the employee early, then you get to the end and realize you [indiscernible] some money, and that's just -- it's not a good business.

As well as pay taxes when they're...

Yes, yes, pay taxes, we're doing. And I don't think it's great financial health to train employees to...

Spend the money we have to...

Well, to take money out early and to some extent, pay 20%, 30% interest rates on the loans that you're basically.

So how do you -- like the question I get from investors is Vault like your first step into that journey, and you kind of could potentially kind of do without the 20%, 30% interest because like you could handle it. Is that the first step? Or is it more -- it's an option, but I don't want to go further?

Well, we -- once we develop something, then we release it, we don't really talk about what we're developing for. But you would have to have a Vault before you had the other -- important to have a place to pay it.

Is there also like an argument to think about like where like what's the demand of my client base? Because if I have a lot of like kind of [indiscernible] workers, et cetera, there's probably maybe more demand for that type of solution where like Barclays most people probably wouldn't kind of use it anyway. So why offer?

Well, there's definitely industries where you're -- and it's primarily in your more transitory type that -- there's definitely industries where early wage access has been more popular maybe than in some other industries. I would see both of it, though, a DailyPay option in both as kind of -- well, now we have it to kind of deal at the point where we would be offering both. I don't see either a really a differentiator for any of us because everyone kind of already has something in that realm already now. So I don't know that it'd be necessarily innovative or product or a differentiator. I do think it provides revenue opportunities and to some extent, some convenience on the side of the employee as well as the client so that they don't have to use a third party to either grab a card or do something.

Yes. So what's the -- how do you monetize this? Sorry, I probably should have...

So well, there's no charge to the employee or the employer. Just like any Visa-branded card, you participate in interchange rates and the merchant vendors charge to be able to move that.

Yes. But how many days earlier do you get -- like no, it's like 1 or 2 days, I think, like how much spending do you think will come through that?

We'll have to see. If someone takes the card and they actually go to an ATM, there are a certain number of free transactions provided, so that if someone chose to take their money off of that card, they could do that without any fee associated. So we're not taking a fee from the employee or from the client, it would be from -- we would be participating in those interchange rates. And that would just depend on how much the employee uses that card. We don't really have any good data on that. We didn't before. We went through this process. We will in 6 months. Right now, we knew the number, roughly the percent within our database that even used a card, finding out how much they use will come.

And that's 5% number you quoted earlier?

Correct. Yes. Correct.

Okay. Good. Okay. Let's shift gear a little bit. Like on everyone's mind is the economy a little bit. And I mean, so far, touch wood, like for your market, like it didn't seem like to impact you so much. What are you seeing out there in terms of like behavior from clients?

Not much change. I mean I will say that we're not a luxury item. We are replacing a spend that they already have. It's primarily the same competitors that we've had. I think with anybody, especially in our space, nobody wakes up with, hey, today, I'm going to switch payroll companies, then I get to go to the dentist. I mean it's just -- it's not something people wake up wanting to do anyway. And so you have to have a strong value proposition. You have to have a strong return, believable, measurable return on investment for people. And then it's -- that's when they make that shift. And so we don't cost. We're not a net cost for someone. We're the low-cost provider through ROI achievement. And so we're not seeing any change in the go-to-market and/or appetite to deploy a more modern and a more sophisticated employee-focused system.

I mean the -- and I don't know if you remember in the previous cycles, like since you are -- like we're having a very high ROI kind of like you're kind of lowering the cost for the client. Did you have to change your sales approach or like you have a well-trained sales force like in terms of like the enterprise guys, now you need to focus more on value or like a recession. You need to focus on ROI. It's like, well, you should have done that the all time. Like -- is there any change for you? Or is it like it's the same proposition, so we just keep doing what you're doing?

Well, where the shift came was when we started doing employees do their own pay now that's where -- I mean you'd call a prospect and -- they might hang up on you. What, that's crazy. But it's also differentiated, and it is the way. Once people come on to our system with all of our new clients within the first 2 payrolls, half of their employees are doing their own payroll. That's the thing. And we're not selling it to the employee. They're just -- they prefer to have accurate pay at the appropriate time. And so they're already motivated. A substantial amount of employees live check to check. And it's not always our employees. They're salaried employees that live check to check. And I believe that it's 60% or more of the American workforce check to check. So it's already inherent with them that it's got to be perfect. I mean if you're expected to make $450, you make $310 and it's on a Friday, that could be the difference between you -- children, paying electric bills, I mean what have you. And so it's already inherent with people that they want to make sure they get paid correctly. And again, I've never met a payroll person that wouldn't move heaven and earth to make sure someone's paid correctly. And so by marrying the 2 -- prior 2 payroll getting done, I mean it just works very well so that you don't have reversals, manual checks, voids, wires and everything else that happens, the consequence suffered after the fact with the employee.

And the -- I don't know if you like remember, we talked to like a few quarters ago, it was like, look, post pandemic, it was a little bit of a wake-up call for a lot of people in terms of like the systems are really kind of out of date and launch kind of build for doing this sort of stuff. Do you -- is that kind of oh, shoot, I need to do something kind of fading a little bit? Or do you still see that in the client base that their set?

It's still very strong. One other thing that happened during the pandemic is it forced consumers to use technology differently, too. And we're consumers before and after work, during work, we're employees. And so -- but we're the same person. And so I think during the pandemic, you had a lot more people downloaded. We all have 5 more apps on our phone now than what we had prior to pandemic. And so you got -- you had the consumers, employees being used to going direct, confirming selections and they're used to that type of technology and the immediate ratification of making those confirmations. And so that's not going backwards. That's sticking. And so you have a lower tolerance for employees on complexity because they know it's easier. So I also think you have employees tolerance levels that have lowered around the willingness to do something that's complex when there's an easier way. And we're able to leverage that for the benefit of the clients because if you have employees willing to do it, in fact, they prefer to do it, you can leverage that as an advantage to you. Every time I use my Starbucks app to order a latte, I'm doing that for my own convenience, but they're winning. And so you just take that same type of philosophy on a larger scale to work.

And the -- if you think about the work in -- like in your client based environment in terms of hiring employee shortage, there was like a period post pandemic where it was like, you couldn't hire fast enough, and we just [indiscernible] market. Is that changing now? And the question -- first of all, let me ask you that. Like is that changing? Are we going back to more normal?

I think we're getting closer to it. Definitely, we're off the bottom where we were 10 months ago, we have an open position, 4 people apply and you've got a week to hire them, and everybody's offering signing bonuses. We're not at that level these days. So it's more of an employer market than what it was. But I wouldn't say we're all the way back to maybe pre-pandemic, but...

And the -- on that note, like, I mean, like -- I don't know if you were able to listen to our COO this morning, like the employment -- unemployment numbers are kind of lagging. So like what we see at the moment is like that the market is changing a little bit, our expectation is that unemployment is going a little bit higher. What's the situation for your client base in terms of like if they have to -- it's more next year, like kind of lay off people like how much of a sensitivity you have there?

Prior to the pandemic, I would say we have very little sensitivity to or very little bit after going through the pandemic. I mean it's an impact. So I think a lot of it has to do with -- to the extent unemployment goes up, how fast does it go up? And what's the degree? I mean you go from 3.7% to 5.7% -- over the course of the year. There's some mitigating factors we have, and I'm not going to say that wouldn't impact us, but there's some mitigating factors we have along the way. If it goes from -- or 3.7% to 5.7% over the course of 2 or 3 weeks, probably going to input impact us 200 basis points, so it's negative for that quarter. So how quick it happens. And again, we learned that during the pandemic, where it all happened within like a 6-week period of time. How quick it happens doesn't matter to us.

Questions as well in certain industries are we more exposed to certain industries that you maybe you've read more about that have been hit on that. Obviously, we're pretty industry agnostic and not overly exposed to tech or some of those industries.

Okay. That's true, yes. And then like how do you think about the factors have grown in the drivers of growth. And you're going to say like are you asking the question again, but it's more to clarify for investor base because I get the question a lot like office openings, I like it doesn't matter, like it does matter, but it doesn't matter. And like how do you think about that? And maybe just kind of help us understand a little bit like what's the driving factor for you is cracking like, oh, we're missing that much revenue in the year, so we need to open up some offices? Or like how -- what's the internal thinking for you in terms of doing that?

Well, sales rep productivity is key to our growth. And when we IPO-ed, I'd said if a rep sells $1 million, I'll name the award after. Two years later, reps sold $1 million. And then a couple of years after that, one rep sold $2 million. This year, I'm sure we'll have a rep sell $3 million. That's about what an office would have sold when -- so now that's what individual reps are selling. So there's no doubt that rep productivity is #1 for us when it comes to growth. Now the number of reps do matter. It does matter how many offices we're able to open. The offices that we opened up early this year will have very little contribution this year. We'll have more of a contribution next year and a greater contribution in 2024 because then they're mature. And so opening up offices is important because it gets you more sales reps. And we've been able to do that. Thankfully, we were able to do that this year, and we'll continue to do that into the future. But -- we also make our numbers through executive reps at mature offices continuing to sell to larger deals, selling more product, and just being more successful in their close ratios as we go to market.

Yes. And on that note, like what's the thinking around the inside sales motion that you guys kind of have started -- had developed a little bit? I know you kind of lower tier accounts can do that or regions where you haven't been. Is that like in the new modern world, not the way it kind of scale as well, like?

Our inside sales just deals with companies that have less than 50 employees, that kind of -- our build out of that kind of corresponded with our advertising spend, in which a lot of the leads we were receiving were less than 50 employees. We wanted to catch them because we do have a solution for them, and we didn't want to ignore. And that's why we built out that group. I had 5 people originally. Now I think we have 10 teams of 8 people each. It's important to note that only 5% of our revenue is derived from companies that have less than 50 employees. And so we do have that market. As far as a go-to-market and outside sales, we shifted to go right back into the field in September. Honestly, I believe that we probably waited a little bit too long to get back in the field. I think those face-to-face interactions are very important, especially when we're talking about a different way to do something, we're saying now employees do their own payroll, that's a different way. That works better face-to-face. And so we're back in the field face-to-face now on the outside sales. Inside sales, we still do inside selling and from the emerging business market. The below 50 employees, and I wouldn't see that changing with that group. Nor would I see our outside sales shifting back to inside.

And the other notion is like compared to like, say, IPO time frame, there's so many more products that you have now that you can sell. Like where are we on that journey to go back to your 33,000 customers saying like, now I have Beti, now have these other things like do you not want it? Like how do you ensure that, that kind of transition kind of happens?

Yes. So we have a separate group. They're called client relations reps. They actually go out and upsell current clients products that they could utilize that they don't currently have. They come in -- they used to come in after the first 30 days of the sell. Now they come in after the first 60 days of a sell, and they're the ones that manages that relationship upsell opportunity.

Do you get a quota from you? Or is that okay?

Yes, they do have a quota. And they're set up with a manager and people to do the same. I mean they're also focused on usage. They have usage metric. They have retention goals. And so sales, but they also have a service configuration and usability component, which is a little bit different than those reps that might be more of [indiscernible].

Yes. And then if you think about from the new sales that you get. I don't know if you broke it out and you're going to shut me down probably now. But like you ever break it out. So the low 50s like they're kind of upsell, cross-sell? Is that like how important is that?

What we've said it's important because the main reason it's important is you want the client getting the full value of the...

How the usage...

The ROI. I mean it's very important -- it's very important for that. From a percentage of our new business revenue, the overwhelming majority has always come from new logo adds just because of the size of the revenue associated with when you first land versus what you upsell to them later. But the mix has always been -- we've always had some upsells as well. It's been measurable as well. And so I'm just saying it's been very consistent with the exception of the 6 months where we had ACA where we got every right away. Other than that, it's been very consistent, again, overwhelming majority being new logo add.

Okay. Perfect. And then last few minutes, I want to spend on profitability margins. It's obviously a lot more important. The reason why I kind of holding back a little bit is like you kind of have been pretty strong on that subject anyway. Like if you think about that progression going forward, like there's a lot -- you start to spend more marketing and you saw that the results are coming in, so that's nice to do that. Like how do you think about margins from here?

Yes. I mean we've had very strong margins, Raimo, have a good mix of profitability and margins. To the extent we can spend more and drive further growth or stronger growth, and that's what we would obviously do. But we're not a company [indiscernible]. So to the extent it needs to fall the bottom line, it's going to. And so that's kind of the way we've always done it. I know we've talked a little bit on free cash flow. One thing we talked a little bit on that is just -- we had an extra payroll Paycom did this quarter. So that impacted free cash flow. That should be back up fourth quarter on that as well as we're taxpayers. So that's another impact that impacts our free cash flow as well.

Yes. Yes. Okay. Perfect. And then like if you think from your perspective, like, Chad, you've kind of built this business now over many years, like what -- is there a kind of an intention to think like, okay, I could use M&A for something a -- I could do international? Like how do you think about like the Paycom over the next few years?

Yes. I mean we're disciplined in our approach. I wouldn't expect us to do anything unnatural for us. I guess for us, M&A isn't incredibly exciting. I mean I think you could look at maybe there are some areas where you get an opportunity to buy some expertise. But when it comes to be able to innovate a product, I don't see us doing a whole lot around that other than us continuing to innovate the way we do.

Yes. Good. okay. Perfect. 20 seconds left. So I think we did really well.

Very good.

Thank you. Thank you.

Thank you.