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

Hey guys, welcome to our next session. Really happy to have Chad Richison here from Paycom. Chad, you and I go back many years, and it's great -- always great to see you.

To get everything from the -- on the same page, like you reported Q3 results. There was a lot of questions in the market about like how to think about the results and what you said there. Maybe from your perspective, like how -- to get everyone back on the same page, like so how did it play out for you?

Yes. And so Q3, we announced our results. In doing so, we did talk about the things that impacted our revenue in Q3. We called out the preemployment business that we have and that we saw some softness in that area. We did talk about the impact that more efficient payroll from the beginning on our revenue model from Beti revenue cannibalization aspect, if you will. And then we also talked about our client value achievement strategies, that as we move into both fourth quarter and next year, and that's a [indiscernible] whether they're on Beti or not. And then the other piece I would say is that we have been talking about the fact that our CRR groups, which have traditionally upsold products to current clients, are really focused on helping clients achieve the value from the products that we had sold previously. And that group is down this year compared to last. Well, they've always been up, and this year, they're down. So those are kind of the 4 factors, I would say, that impacted third quarter. And then as we look into the future, that impacted our [indiscernible] as well as the initial outlook that we made for 2024.

Yes, yes. I mean if you think about it, a lot of that seems very, very temporary stuff, so I kind of am not concerned about you guys. But maybe let's double-click on some of that. So Beti, like for those in the audience that are not like that familiar with it, so when you came out with the idea of Beti, like what was the kind of core thinking there?

Yes. I mean the core thinking with Beti was that as more and more employees engaged in our app, as more and more employees engaged through Manager on-the-Go and data was flowing, as we released the Direct Data Exchange, which measured good usage, the number of changes or interactions that employee had with the database directly without it being duplicative effort, were going through some of the process through HR payroll, we really saw the benefits to that. And then now that you have an employee base using the product, you can expand the ROI available to the client as well as impact employees' lives. So I have been ensuring that payrolls are accurate the first time so that there's not a lot of after-the-fact fixes, which impacts both the employee as well as the company. And in doing that -- and what does shift, who does payroll, if you will. It's not to say that the payroll person is not important, but it does allow them to be even more successful when employees are engaged with it from the beginning. And because it was easy, it was -- meaning, easy for us to utilize, because it did create great value, we came up with Beti.

And I apologize, probably a terrible question, like for -- you talked about that engagement of employees with that. And I'm probably not in the timed kind of contract. So for me, looking at payroll doesn't happen to me that often on this. What do you see? Is there a certain type of employees that do that in your client base? And what do you see -- you said like you see good usage, like...

Yes. I do think there's a push versus pull. And there are certain employees that are just [ impacted ]. The impact of a missed day's pay or a missed expense reimbursement, or not having the correct overtime hours or not being paid for the credit shifts or what have you has a much larger impact maybe than you have on it. But one thing I've realized even about salaried employees, it's not that they don't care about what-have-yous, it's that they have some trust in the current model, and so it impacts them. And so from a company perspective, when you look at what Beti does, it really not only predicts [indiscernible] from the market that you're in to make sure things are accurate and/or fixed after the fact, but there's a substantial amount of liability and risk associated with paying someone wrong. And then as you get more and more employees that each company has, especially further upmarket, it becomes almost impossible. After-the-fact corrections are baked into the model. So we're having a lot of success with Beti. That's not going away from us. I do think there has been opportunities in our rollout, if you think back to a couple of years ago, of our current client base of things we could have done to help them achieve full value out of our system, whether they went on Beti or not. We still have about 1/3 of our clients that aren't in Beti. And making sure that they are able to value the current product they're using has been very important to us.

And then the -- are you like just doing it for the sake of keeping your R&D guys happy. There's a reason why you think -- you were thinking so strongly about Beti. But can you speak to that a little bit? Like is that just an Paycom-specific thing? Or is that something that actually should impact the whole industry and everyone should be worried about or thinking about that?

Well, I mean, I think it's the right way to think about it. And so there are certain employees like yourself or others that might be like, well, I mean, I look at my check once a month or every 2 months and it's not -- I mean, if it wasn't incredibly wrong, then I'm okay with it. But from a company's perspective, you have a make-up of a lot of different employees, and so there is a push and pull. We have some companies that they mandate that because of the impact that it has on their base. It doesn't matter if they're a salaried employee or not. If you're a salaried employee, then it just ought to be that much important for them to use it, and you still save the company just by verifying the right state. There's a lot of ramifications to that. And so -- but I do think that it's a client-by-client choice. But I think as you look into the future, it's the right way to do something. And then when you apply other ways to automate, that's important as we just come out with GONE and other source of automation, which an employee can -- say at midnight an employee would request time-off in the old model, they have to wait for a manager to approve it or someone to approve it. And then maybe on Monday, if it's not approved, they're tracking someone down to approve it so they can book their flight, would go on and book their flight right in. Or not, and hope that you know, based on the amount of capacity that a company might have available for their workforce and what their settings are. So in a perfect world, an HCM system would just do everything you wanted it to do and you never had to log into. I mean that's full automation. And so I know we probably won't get to a system where you don't have to log into. But there's a lot of changes in the way that, especially in the last year or 2, opportunities to accelerate automation in certain areas. And so if you start with the right problem to solve and so -- and Beti did. Beti started with the right problem to solve. You do have people that aren't paid correctly and they lived through the weekend like that and they have to borrow money to get through, we have that. You also have people that are salaried employees that didn't really care if it was right or wrong and still got it fixed, and they may have found out on they weren't in the right state for 2 quarters. Even that has an impact on the business. And so when we go to develop a product, we focus on what is the value for the client, what is the return on investment for them, how did they win in deploying this. And with us and our focus on that, we'll continue to develop more and more out.

And then if you think from that perspective, like if I'm a client, it seems like a no-brainer, like my stuff gets fixed before I have to run another payroll cycle or kind of correction cycle, et cetera. From that perspective, it should be fine. But you'd be almost sacrificing a little bit of extra revenue because there's less extra kind of tasks that need to be run. So you must be feeling really strongly about getting this right for you but also for the industry.

I mean, ultimately, what I'm going to say is cumulative revenue for all of us, I think ultimately, at some point, that goes away. I mean you are -- whether there's tax issues, whether it's not revenue. I mean if people are like, well, we don't charge companies for that, we just bake it in to our pricing. Regardless of how you kind of judge that, those tasks that you would look to eliminate from every model, whether someone charging for it or not because it's -- there are punitive tasks someone has to take any time they have to make a correction, punitive to the employee. Whether someone's paying someone to do it or not, they've accrued some level of liability for the fact that it's run. There's some level of risk there. So it's the right move for us and our industry. I think that the areas where we could have executed a little bit differently with in our base of -- realizing also that priorities of areas where we think everyone would want to move because of the value to achieve for them, every business has their own process that they go through. And if I had an opportunity to rerun time, I would develop and impact the same product I developed, I would have deployed it to market the exact same way for new logos. But I do think that there would have been messaging and value that could have been displayed with our current client base, because we did allow for there to be a little more distortion around its value. And now that we have shifted into controlling the error that we did, what we want for the client, whether they use Beti or not, there's some realization on that of mitigating areas of...

So if I listen to you, like -- so there's some guys at the moment that say like, oh well, we are per employee per month, but they just kind of have a higher monthly price. And then that kind of includes whatever kind of new ones that need to be happened anyway, so that's kind of [indiscernible]. But in a way, if Beti -- if you have Beti in your client base, your clients should ultimately pay less, because it's a big competitive advantage that you have over the other guys. Is that correct?

It is. I mean if you are just looking at these, I will say that the value of Beti is not really measured by how much you're saving on the ability to pay us. It's all of the other impacts that it has within your business with the employee, with the labor and effort it takes you to fix it, for the liability and risk that you incur for being wrong in the first place. So I think that's an important piece to look at as well. But -- and as far as from a competitive standpoint, we've always had different pricing models. I'm still not 100% convinced that we don't have our competitors also charging on a per payroll per transaction basis. I don't have data that supports that, but I'm sure that there are also certain competitors that are doing more PEPM. But from core payroll provider, there just are transactions that have always been inherent within our model.

Yes, yes. But they should, in a way, be much better competition, yes? I mean from that perspective, can you give us an example? Because like to me, at the moment, it seems odd, like you kind of go to your client and say, look, this is what I'm going to do to you and it's better for you. And a third of your client base still says like, yes, not now. Is there like a process change or is there any change that needs to happen to combining Beti that kind of keeps them holding back? Because they -- yes.

Yes, there is. There is change management at the front end. Beti, with the old model, you really start the payroll process after the payroll ends, so after the pay period ends. So if the pay period ends on a Sunday, Monday I'm collecting all the data, and Tuesday I'm going to send it to the payroll company. In a Beti type environment, you start your payroll at the pay period beginning and when the pay period ends, it's done. So there's not much after-the-fact work in regards to that because the work has been done. So there's a little bit of a process change there and change management for Beti. It does depend on how close their pay period end was to actual check date pay, what have you. So those types of things do matter. But the current process is really -- I mean, it's just -- it's messed up a bit when you're not using Beti. Because -- I mean even in this case, when we did GONE, I mean, 52% of time off approval happened after the time's already been taken. 52%. So -- and oftentimes right before payroll. So then you have 20 states that require you to pay out that time off accrued but not yet paid. So those things are very important. And so as you continue to automate, that's what happens. I would say that in our current client base, we are now meeting them where they live. Versus trying to get them to utilize our product right now, it's meeting them where they live. Because all of our clients have different objectives of what they're trying to accomplish for their business, and accurate payroll is always one of them. But I think that our approach right now, how we're working with our clients, is going to be important for us.

And then the -- you talked earlier about one of the factors was the customer success team because you kind of -- we used to kind of push more on Beti. If you kind of pushed slightly less going forward and give the customers more flexibility, does that mean in theory you can repurpose this -- or not repurpose, but get them back to the old kind of cross-selling...

Yes, I kind of said this in the past. If you kind of go back and look, I said that if you sell a client a product and you're billing them $10 and you're using $6 of it trying to go out there and sell them another product, you're creating more of a problem for a client. You really want the clients to achieve a value to what they've already bought. And that's what our CRRs are doing. It's not that CRRs are selling the product, we do. It's just they're selling a lot less of it than they've ever done in the past. That group has typically always been up. And this year, they're going to be down $20 million in sales, because they're out there on-site with clients, helping them utilize the products that they have. We are not out there pushing them. I'm not going to say that we weren't at some level, but I also think that we've gotten better at both how Beti is utilized as well as how we work with each client in helping them achieve the full value, whether they're on Beti or not.

And I think we've spent a lot of time on Beti now. Let's just move on a little bit. Let's talk a little bit about your move upmarket and your move international. Like how is that going? Where are you in that journey?

It's going very well. We started with our global HCM product, which is our HCM products in, I think, it's 15 different languages, networks and 170-something countries. And then now we've started adding native payroll. And so that means we've gone to different countries, we spec out what each country has for full service payroll, tax, banking, the whole thing. We're doing it all ourselves. And then we started rolling that out. We did Canada earlier this year. We announced Mexico in the last quarter, and we're continuing to build those opportunities out. And we believe there's 18 to 20 countries that represent over 80% of the total opportunity.

Yes, yes, yes. And so will you do all of those in a -- is that the plan, yes?

Yes, and we're building that and rolling it out.

And how do I have to think about it? So it's building up the -- building out the payroll and then start selling it? Or will that be more like the larger clients that you're signing at the moment, you can run also their Canadian business for them or their Mexican business? What's the go-to-market strategy there?

That's correct. We have a built-in demand already for clients that we have. What they're utilizing external to us, and an opportunity to bring it all into a single [ contract ], taking that opportunity. So I mean long term, we'll sell those in Canada. But we do also have opportunities here in the U.S. for businesses that have a Canadian presence or have a Mexico presence. Traditionally, global is done through third party in-country partners, where someone feeds that, has it processed and would sent back to the vendor. And so we have the functionality for all this independent systems.

Yes, yes. And then the -- as part -- I would almost do it as a similar -- no, not a similar motion, but as part of that, you also have a slight move upmarket. And so because that need for international comes more -- doesn't come naturally at the 500 employees, obviously they have 5,000, 10,000, 15,000. What are you seeing in terms of that move upmarket?

Yes. So we've started -- we've gradually been pulled upmarket. I mean we've got clients with about 20,000 employees and what-have-you. But we did announce that we now have defined market that focuses on businesses that have 25,000 employees or more. And definitely a global experience, both in HCM and the additional payroll modules are definitely helpful in that. I think it can be table stakes and then [indiscernible] in any of the calls and you're going to have something like that. So that does help us.

And are you changing, like you could have -- you go higher up and usually it's like a very specific, like HR buying centers, et cetera. Do you need to change your sales approach and how you sell and guide the salesperson in that?

It's a -- in answer to we've pulled our own to do this, so when I'm talking about it, it's working with a different salesperson, no. There is a different sales process that you go through to work with a company of that size just because the number of stakeholders. Now it's not always a different process, but it's rare that it wouldn't be, if you will, just because of the size and the number of stakeholders. And typically, they operate in, oftentimes, a more decentralized environment as well. So you have a little more of that.

And then how do you do -- like because I do seem to remember your historic sales model was very much driven about sales velocity. If it was more than 60, commission would go down. I don't know if you've [indiscernible]. Like you have these slightly bigger deals, it's difficult then, because again, to pull this off in 60, it's kind of going to be a tough one. Do you have like separate sales force or like one guy for sales function that does it? Or how do you do kind of...

Yes, this group is broken out from a core sales group, just because they're doing the sales calls versus [indiscernible] up the resource that you need with them. Because there are certain things we're going to run into with large amounts of data that requires some discussion on the politics of...

But it must be exciting for you. Like I mean, do you remember when you started the company with all your credit cards. And now, you're selling into operations that are like 20,000-plus employees.

Yes, there's a lot of work in between. But yes, it is. I mean when we can create the volume, that's important. I think that as we complete this upmarket, we would need to get more and more proved sources of success in that market. I think that our product is very strong because of its full automation in many areas for a business. And so I'm really excited about that. It does expand our TAM. But we still -- we're focused on the market. We're focused on, too -- I don't want to make it sound like we're just moving upmarket, we're automating for everyone, all the markets that we work in. And we're very focused on each level of it.

And one of the points you mentioned was on the pre -- earlier, like in terms of the impact that you saw with some preemployment services. Is that -- was that something that was company-specific or is that kind of a moat in the market that you have?

Well, I mean, I think we're probably the 10th largest preemployment background checks business that they actually hire people to go to the courthouse and [indiscernible] out, it's not something we outsource. So I have to say we're the outsourcing company that doesn't outsource a thing that you should. And so when it comes to background checks, we have with quite a bit of revenue in regards to that. And we called that out because we did see some impact in that, in this whole set of categories.

Is that like a -- was there something in that August, September time frame that was different? Or is that kind of more like slowing?

I mean I feel like in regards to the background checks, August, September, that type of thing.

Yes, yes. Okay. Okay, that's interesting. So then guidance for next year, like the one question I got then is like, so how does Chad think about spending? Then like -- because like it -- how do you think about profitability in the business and manage that kind of growth versus kind of profit margin?

I mean my tolerance for waste hasn't changed. So you mentioned the 13 credit cards and the SBA loan. And once you get out of debt, which we don't have any debt, it was like $29 million that we paid off, so now we don't have any debt. But once you get out of that, old habits die hard. So there's no initiatives that we're going into 2024 that I can think of that make a dramatic swing with how we operate the business. We're going to continue to capture opportunity. For us, growth is important and first prize when we go to spend. But for me, I don't see this as an additional spending that gets us different necessarily. I think this is some execution opportunity that we have and kind of that open approach with current clients. And we want to go to market for new clients. It's continuing to display the value that's available with the differentiated product.

Yes, yes. And how -- like obviously, there's a lot of new stuff coming out, like you mentioned GONE, as well as like a new way to automate things, you have Beti coming out. How excited are you about what's going on there? And how engaged are you?

Well, I've been very engaged. It's just that I hadn't -- product didn't report directly to me for the last 7 years, and I took back over product in September. Now I always had projects, Manager on-the-Go. Beti was my project that I ran. GONE, I ran GONE. So I always worked with the product that was for my own projects. And so I see opportunities for us to accelerate client value through different technologies that are available, plus we've gotten now better at it.

And then last question for me is like the -- you're cash flow positive. You said you paid down your debt. How do you think about usage of cash then? Like at the moment, it's almost of an opportune time to think about kind of buying back shares aggressively, because like you believe in it, the market might not quite kind of see eye-to-eye with you. How do you think about usage of cash?

Well, buyback. We do have a buyback in place. We did announce about 3 quarters ago a dividend as well. So I mean, I think you have those. Again, growth is first prize, but we're already spending on advertising and we're looking at how much more would we need to spend or what have you. We did get to a point of diminishing returns on advertising, and that kind of goes into that next piece of it as well. But I think we have to have a measured approach in everything that we do. I mean this isn't about this quarter or next quarter, what have you. I have a view of where we need to be and what we need to do. I'm not indifferent about the impact to shareholders. I mean I've got friends, my friends, family members. I've got a little bit -- I've spent time at their houses as much as my house, and we have half of their savings in Paycom. So I mean it's important to me, the value that we're able to achieve. And we do that through the appropriate strategies of what we go through. And so I'm very happy about that. And I do think that what we're dealing with right now is transitory with our client base, but that's part of it. And we're doing everything that we can do to create the maximum amount of value. And every time we've done it, we've won. I've often said we're oftentimes early. We're not -- we're oftentimes early, we're not wrong. And when you're the one creating the innovation and the products, this is the bigger problem, you oftentimes have to deal with some of this. And I would say that the Beti transformation of who does the payroll and who interacts with that data was a big one for us.

I mean in a way, like it was fair play to you. It was a gutsy call. Like it's part of -- like a public company with a professional CEO probably wouldn't have done that because it means both in the short term, but like on [ why move around that ]. So...

Yes, but there's -- yes, I mean, we've got to make it count for everything. For me, that's a -- that's just not really worth any points.

Yes, yes. Okay. Yes, yes. Okay. Chad, thank you. It's great to talk to you again.

All right. Thank you.