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

My name is Mark Marcon. I follow Human Capital Technology and Solutions for Baird. Our next presenting company is Paycom, one of the leading and fastest-growing and highest-margin payroll and HCM providers to companies with 50,000 to 10,000 employees. With us today, we're extremely pleased to have Chad Richison, Founder, Chairman and CEO. I always love Chad's story. I mean, he started up the company with 13 credit cards and an SBA loan back in 1998, and he served as CEO ever since. Prior to founding Paycom, he actually began his career in sales at ADP, where he excelled. So he knows the business extraordinarily well from the ground up. Also with us, we're very pleased to have Craig Boelte, the CFO. Craig joined the company back in 2006, and when the company was generating about $3 million a year in revenue. And prior to that, he was actually the CPA on the outside for Paycom. So obviously, both gentlemen know the company extremely well from the ground up. Chad, I'd like to turn it over to you just to give kind of an introduction. There's going to be a few people in here who don't know the company. So if you want to introduce it, and then we'll get into the fireside chat.

Sure. So Paycom started in 1998. This will be 25 years this year, started off first on the internet, primarily payroll. Over time, we continue to build out our database to include all the other HCM products to where both employers and employees can use one single system to be able to handle hire to retire activities. Since then we've now rolled out Beti, our self service payroll option with the expectation that employees do their own payroll for hourly or check to check employees. It's already inherent. They are already doing it themselves through our system and over time we're getting others to do it as well.

That's fantastic. Chad, I am asking 2 questions to every company out of the 22 that I'm hosting for this conference. One is just, what you seeing just from an employment perspective and a macro perspective, generally speaking, like if we take a look at the BLS statistics, they continue to be relatively strong. What are you seeing in terms of your client base in terms of new hires and things of that nature?

Yes, I mean, we are not seeing a negative macro impact at all. I know from our own hiring of employees. It's gotten easier to hire than it was in, I would say, year-or-so ago, where people were all getting signing bonuses and everything else. I don't think you're seeing as much of that right now. But from our own data internally, we're not seeing any negative numbers coming from that, which again would show up in our number through attrition of current clients' employees.

Great. And then what are you seeing just in terms of wage inflation with regards to your employees or your clients' employees?

I would say that, that started to happen in 2021 and 2022 with a type market. It kind of went along with what I said was paying signing bonuses and what have you. We've have seen that moderate quite a bit across the board.

Okay. Great. And then the other question I am asking everybody is about there feelings with regards to generative AI, just what's the -- what are the potential positives? What are the potential negatives? Believe it or not, I get some questions about, hey could certain employees be displaced by generative AI, and therefore, could you have fewer employees to pay through your clients or how does that work?

Often take with technology also new industries develop. I mean I don't know how many people lost their jobs when the calculator came out. In regards to AI, I mean, I do [indiscernible] impacts us is massive unemployment that happens very quickly and the pandemic, the negative impact to us happened in the first 6 weeks, then it moderated and then started to improve, and we've had stabilization since probably July of 2022, even within our numbers from an employment. So when you look at how can the macro impact us, it's hard for me to see how it impacts our go-to-market because I also think when people are challenged to do more with less, they automate. We're a good fit there. And again, we have 5% of the market. Our 2 largest competitors have 1.9 million clients combined. We have 36 -- ratchets up very quickly within the course of a 2-month, 3-month period, and it goes from where it's at right now from 3.7% to 6% over the course of a couple of months. It's going to have an impact because we can't outrun that quickly of the impact on our current client base and their employees. If that happens over the course of 2 years, and I think there's mitigating factors we have to impact that.

And for perspective, for those of you who don't know, I mean, the lowest quarter that you had during COVID, again, the June quarter when we think about COVID really hitting in March and April, you still ended up doing 7% growth. And for the full year of 2020, you still ended up growing 13%.

Yes. Those numbers don't really seem that positive, but...

No, they're not positive by your standards, but -- okay. Great. And then one other thing that's impacting the macro is interest rates. Craig, do you want to talk a little bit about just the duration and the balance, and how that's evolving and what sort of lift we could end up getting in terms of margins from that perspective?

Yes. So on the interest rate and on the balances we hold for clients, it was $2.4 billion first quarter. Typically, it will come down a little second and third quarter, if you look kind of historically at the balances and then move back up for fourth quarter. So we've been very short term in our duration. But as rates have started to peak and it may come down a little, we're going to look at could we layer that out a portion of that balance longer term to kind of hedge against those potential lower rates in the future.

Great.

We're not looking to do anything unnatural and mitigating from a -- the best way to mitigate any flattening impact that interest would have on us is through logo ads, new business ads, but we're not looking to do anything unnatural from that from a perspective. We've been doing it 25 years. When I started Paycom in '98, we're getting 5.4% interest on overnight sweep accounts, and it represented like 16% of our revenue. Then went through a period of just trying to keep the dollar hold, getting 0 and then it's kind of creep back up. But I mean if you've been in this industry long enough, you know it's going to move up and down, and you don't want to do anything unnatural by chasing it as well. So...

Great. Let's talk a little bit about go-to-market because we run into skepticism when we talk about from a positive perspective about your prospects. Some people wonder, gee, the market must be getting saturated. Everybody's got a payroll system. Let's talk a little bit about what makes Paycom different, both in terms of your go-to-market strategy, the way that you organically grow your own sales force, but obviously, importantly, the solution itself and the efficiencies it can drive.

Yes. I mean for us, the solution kind of solves the problem that exists today. I mean, if you look back 10 years ago, the major users of a human capital management system or payroll system was the user buyer that was the person that was in the payroll department or the HR department. The major users of the systems today are the employees. They just are. I mean, the data comes directly from them into the database. No HR or payroll person ever read your mind. I mean it had to come from you into the system and doing it directly versus using multiple systems and e-mails and everything else is the most efficient way for an employee to actually make the change as well as confirm the selection that they made. And so we've been able to produce a lot of ROI for our clients that way, and that's through providing a very simple system and a single database that employees can use. People in the HR and payroll department, they're overworked, overtasked. And they -- but even then, they have some level of tolerance for complexity. Employees have zero tolerance for complexity. You give them a complex, but they are not going to use it. And so the business doesn't benefit. And so one thing we've realized that whether you're an employee at a 200-employee company or whether you're an employee at a 10,000 or 20,000 or 50,000 employee company, you still have a very low tolerance for complexity in what you use. And the largest companies in the world have the worst systems than they are. They're terrible. They're the 8 legged octopus with no head. They are multiple systems, your data is in multiple systems, they don't work together and they're not good at integrating it. So we believe that replacing all of that with one system that's highly functional, highly configurable and is a very simple product to use. It is complex things, but it's a simple product to be used for the employee. We believe that's what drives ROI, and we see that within our client base and prospects.

In terms of talking about that simplicity, just to give the audience appeal for that like when you go to the R&D team and you give them a new module to come up with or the whole process development team decides on a new module, can you talk a little bit about like how you test things out? What's the process in order to ensure that a frontline worker can actually use it?

Yes. I mean it's a measure twice, cut once type approach. And so a lot goes into the research of something. But we'll actually have different people use products. I used to say if one of my grandparents couldn't use it, it doesn't work because you want something -- I mean I don't think anyone ever looked at -- and again, what we've done is we've taken our enterprise technology and made it for a consumer. So we've taken a consumer approach to enterprise technology that employees using. I don't think anyone's ever uttered the word, I don't like this software, it's too easy. And so you start with that approach, you would like a software that only has you do the minimal required to be able to complete the task. At Paycom, we're not trying to see how long we can keep you engaged with our product. We're trying to see how fast you can make the functional change and move about your day to impact the result that's needed. And so that's what we focus on. We focus on doing complex things simply. And so our approach is that.

And you do measure the usage. You had the DDX, you are early in terms of that from an employee perspective. It's been more than a year now since you've rolled out Beti. What are you seeing with Beti in terms of the usage, the adoption, and just how is that resonating in terms of new prospects?

Sure. And so the DDX is the Direct Data Exchange. It measures the number of data impressions that employees make directly into the database versus the number of data impressions that are made in the database, which is what we call duplicative effort, meaning the employee put it in this system and then it got into the system or the employee sent an e-mail to somebody and they typed it in and it got in the system. And so the Direct Data Exchange measures efficiency from data getting into the system. At Paycom, we're at about 95%. 95% of all data impressions in the Paycom system come directly from employees that's measured by the DDX. With Beti, we're over 50% now of the employees do their own payroll. Again, it's inherent with anybody that lives check to check or hourly. They're going to do it automatically. It matters to them if they're short $40 or $100 going into the weekend. I mean there might be some people in this room or if you're short $100, it doesn't impact in your weekend, but 60% of Americans, that's a big amount, and it impacts what they're able to do over the weekend, their plans or what bills they even pay. So they'll do it. They actually look. It matters to them that they got their time and a half. It matters to them that they got all the hours. It matters to them that they got their expenses on that check, and so they'll do it. And so as we see new clients come in, it's 50% or more of their employees are doing their own payroll, and that will continue to move up. But with the DDX, we're already at 95% for all data impressions. We have many clients that are at 100% in the DDX.

Great. And then can you talk a little bit about the ability to upsell to larger clients, like you have been moving upmarket. And I'm going to get to international, but just domestically, you went from 2,000 to 5,000 to 10,000. I know you've got clients that are well over 10,000. But what's that move like?

Yes. I mean upmarket, it's not a product deficiency. Our product is highly scalable and it works well. Like I said, there's no such thing as a small business employee and a large business -- you're an employee. But it's really the change of the buying criteria up markets change. The buying criteria upmarket used to be buy best-in-breed and integrate it, okay? Well, they're not good at that. They're not good at integration and the products don't work well together. So that started to change to implement a single database solution where employees do it themselves. And as that buying criteria change, they continue to change going upmarket, which made it easier for us to engage in those businesses. We don't have a high tolerance for a 3-year sales process, and it's important for us to be able to work our process and reflect a strong ROI in the process, gain sponsorship so that we can move forward with the client. So that's what I would say has changed up markets to buying criteria plus. I mean I don't think they're producing HR and payroll people anymore that want to do a lot of integration. I mean, I just -- I don't think that happens. I think they'd rather focus on the things that HR likes to focus on, which isn't fixing data and system issues that come up by having disparate systems.

Great. And just to continue the path, you recently announced that you're going to expand internationally. It's going to start with HCM and then eventually have native payroll. Can you talk about what drove that decision and how investors should think about it, both in terms of revenue opportunity? And also, we've heard -- we hosted a dinner last night, some investors are worried about incremental cost.

Yes. Well, first, the opportunity. As we went through the pandemic, we only charge clients for the number of employees that are paid, not the number of employees stored in our system. Some of our competitors charge for the number of employees stored in the system. And so it impacted us in a big way. I think we lost 14.5% of our current clients' employee base like within a 2-week pay period or something. So it impacted us. And then we started looking at our database. Well, if we did charge per record, what would that look at? And we found clients that look like they had 1,000 employees, you look at their database, they have 10,000 employees, and they're not even in the U.S. They were using our system and putting different data in there. And so we looked. We already have a demand because we do have clients that have international presence right now. They use us domestically, and they'll use third parties outside of that. We looked at our demand. First product that we developed -- we took all of our current products with the exception of the gross to net calc in payroll. And we put it in 15 different languages to where to work in 180 countries, we, perspective. So that's what we're focused on right now. I mean people talk about the expense, but it's what we do. I mean -- and to be able to capture international for this year is currently in our guidance. So...

And when you think about that international opportunity, I mean initially, you're looking at U.S.-based companies that have international operations. What percentage of your existing 36,000 clients have some sort of international operations?

I mean you have some of that there, I would say, but they're typically your larger ones. And so when you look at percent of clients or percent of revenue opportunities, larger, but also, I mean, we've only been missing one thing to do the largest companies in the world, and that's the fact that we don't have international. Someone that I say, well, no, you guys are -- you're unwilling to work an integration strategy with 9 other products. Yes, but that's not going to change. So then the only thing we're really missing is the fact that we don't have international, then we can do everything in one system. Well, now we do have international HCM, and we'll be continuing to roll out the payroll throughout this year and next year.

How many employees does the biggest client that you have? So you don't need to name the client.

About 20,000. And we work with clients above 10,000 employees. It's our marketing efforts are focused between 50,000 and 10,000. We have 5% of our client base is below 50 employees. We get call ins and referrals and what have you, but we're just not marketing specifically to them. So sales reps can go out and sell above 10,000 employees and half. It's just our marketing efforts are in that range.

I mean given the global opportunity, given the fact that even domestically 5% of the market, how confident are you that you're going to be able to continue to grow 20% plus assuming we don't have a significant recession?

Yes. We're focused on accelerating our growth rate. We're always focused every week, and we have weekly quotas. So we're focused on selling as much as we can. We have 5% of the TAM with a unique value proposition that generates an incredible amount of return on investment. And so I believe it's in our core. Guidance is guidance. That's what we've provided for this year. And I just -- I would be disappointed if we're not able to continue a strong path of growth and capture all that's available to you. I think most everybody is doing payroll wrong. Half of the clients that use Paycom right now are doing it wrong. So they get on Beti. So that's what I believe. And I believe we're going to see great efficiencies within our industry. And those aren't things that we've necessarily seen in the past. People have always deployed our systems defensively so that they don't get sued or so that someone gets paid or so that tax gets paid. And I think over time, you're going to see them deploy this more as a focus on return on investment because it's there for them. I've always said, product cost the same, whether you get your return on investment or not, so you may as well use it right, so that you get that return.

One thing about that's different about Paycom is you don't spend money just for the sake of spending money. So you currently have some of the highest margins in the business. How do you think the margin trajectory goes? Because obviously, it's a scalable business model. You've got very high gross margins, 85%-ish. How do we think about this...

I mean if you've ever started the company with an SBA loan, 13 credit cards and you're losing $30,000 a month, once you get positive, old habits die hard, so you don't look to go back into that. And so to me, you create margins through sales discipline. That's the way you create -- I think that's the only way you create margins, just do sales discipline. You have a disciplined approach. You get the client to understand the value proposition and use it correctly that creates the value for them and then we get the share in that as well. And so I believe it's through that, that you create margins, and we've done a good job of doing that as well as understanding why prospects buy in the first place, so being able to develop software that meets that need.

Yes. And I would also say that, I mean, just in the model, we always look for efficiencies, Mark. I mean we're an efficiency play for our clients. We also look for it in our own model, where can we do things quicker and easier and continue to drive those margins.

Great. And can you -- I mean -- so there's -- I mean, you're already doing 42% adjusted EBITDA margins. Is there upside to that from a 5-year horizon perspective, I mean, could you even get to 50%?

Well, guidance is guidance. We haven't updated our long term goal. There's -- I mean, we're capturing growth. We're focused on growth. So like Craig said, there's opportunities. We continue to add products. And as we've added products, I mean, a lot of them are 100% gross margin products for us. So there's opportunities there.

Can you talk a little bit about the free cash flow? Because you get compared to some companies that are barely profitable or their leasing space. Talk about your free cash flow and your approach. And then what does that mean from a longer-term perspective because you won't have lease costs?

Yes. So I mean, a couple of things that impact our free cash flow is we currently own our operations facility as well as our data centers. So those are things that we own and control. The other thing, like you mentioned, Mark, is I mean we're profitable. So we pay taxes. One thing last year that impacted us on the tax side. Our rate was -- it didn't impact the rate, but it impacted when we paid the taxes, is the 174 deduction on the R&D expenses where you had to capitalize that and expense it over 5 years. So probably impacted us $24 million to $26 million just on free cash flow last year. But obviously, we're looking at that conversion rate between adjusted EBITDA and free cash flow. And to the extent we can impact that, we definitely look at that in a positive way.

And over time, I mean, you should actually see that conversion rate increase materially, particularly if you don't have to...

Yes, you have to continue -- yes, exactly.

You get to a certain -- yes, I believe we're still on our way to -- we're still growing. So...

Chad, one thing that's really distinctive about Paycom is also your culture. This is the way that you approach things in terms of sales, in terms of growing your own salespeople, how would -- for somebody who doesn't know your culture all that well, how would you describe it? How would you talk about the fact that your people are all coming back to the office, how is that working for you?

Coming back to the office was necessary. I mean that's where I mean I hope our competitors and everybody have people working out of the home because I will tell you, coming back to the office for us has been hugely impactful. I believe there's a certain focus people get when they're in their office and a certain focus, at least in our industry, if you're talking about servicing clients, selling clients and what have you, that's been very important. And so -- but I mean, we're a culture of we like to win. We're competitive. I think we're a culture of fairness for sure, treat everybody well. And we're gritty. I would also say if you walk around the Paycom walls, grit is a part of our culture. I mean, we're there to work and we're there to win. And when you win, and you're working, that's when you have fun. And so that's what we're focused on.

And can you talk about your approach in terms of developing office branch manager and some expanding...

Yes. And so with Paycom, we look for salespeople that typically have less than 2-year outside sales experience, we do not look for experience, and we do not hire reps that work in the industry. So if you work for a competitor, we don't hire you. And then if you have more than a couple of years of outside sales experience, we typically wouldn't hire that person either. We look for people that are in changing career. Maybe you were in retail, maybe you doing something else. We do require in our sales department, a bachelor's degree or better. And that's the way we operate. So -- and then the way we grow is we take a current sales manager, relocate them to the new office that we're opening and then backfill them with the current sales rep that's ready to be a sales manager, and that's how we've grown our 54 sales offices.

That's great. Unfortunately, we're out of time in this room. So please join me in thanking Chad and Craig for a terrific discussion.