Paycom Software, Inc.

and gentlemen, thank you for standing by and welcome to the Paycom Software third quarter 2020 quarterly results conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session.

To ask a question during the session, you will need to press star 1 on your telephone.

And please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Mr. James Sanford, Head of Investor Relations of Paycom. Thank you. Please go ahead, sir. James Sanford Thank you, and welcome to Paycom's third quarter 2020 earnings conference call. Certain statements made on this call that are not historical facts, including those related to our future plans, objectives, and expected performance, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements represent our outlook only as of the date of this conference call. While we believe any forward-looking statements made on this call are reasonable, actual results may differ materially because the statements are based on our current expectations and subject to risks and uncertainties. These risks and uncertainties are discussed in our filings with the SEC, including our most recent annual report on Form 10-K and our most recent quarterly report on Form 10-Q. you should refer to and consider these factors when relying on such forward-looking information.

Any forward-looking statement speaks only as of the date on which it is made, and we do not undertake and expressly disclaim any obligation to update or alter our forward-looking statements, whether as a result of new information, future events, or otherwise, except as required by applicable law. Also during today's call, we will refer to certain non-GAAP measures.

including adjusted EBITDA, non-GAAP net income, adjusted gross profit, adjusted gross margin, and certain adjusted expenses.

We use these non-GAAP financial measures to review and assess our performance and for planning purposes.

A reconciliation schedule showing GAAP versus non-GAAP results is included in the press release that we issued after the close of the market today and is available on our website at investors.paycom.com. I'll now turn the call over to Chad Richardson, TACOM's president and chief executive officer.

Chad? Thanks, James, and thank you to everyone joining our call today. I also want to thank our employees for delivering another excellent quarter. For today's call, I'll spend a few minutes on our third quarter 2020 results and the long-term drivers of our business. Following that, Craig will review our financials and provide some perspective on guidance, and then we'll take your questions. I'm very pleased with our performance in the third quarter with continued strong demand for our solutions in a large and expanding human capital management market. We have less than 5% market share, which gives me a lot of confidence in our long runway. The unemployment headwinds across our pre-pandemic client base remains relatively unchanged from the second quarter. But our product value proposition is having a lot of success and we are plowing through the headwinds with strong new business sales. Q3 revenue and adjusted EBITDA came in at $196.5 million and $67.5 million respectively, both ahead of our guidance thanks to strong new client ads and benefits from operational efficiencies. Based on combining our implied full-year outlook for revenue growth and adjusted EBITDA margin, we expect to hit the Rule of 50 in 2020, despite being in one of the most difficult economic times we've ever seen. And I believe we will improve on the Rule of 50 in 2021. Our marketing plan in the third quarter delivered strong demo leads, leading to strong new client sales, and we plan to continue to spend aggressively on advertising to fuel future revenue growth. The challenges created by the pandemic are exposing the shortcomings of disparate HCM systems, which are cobbled together for multiple vendors, and the value proposition of Paycom's single database solution is stronger than ever for companies of all sizes, including companies well above our target range. We continue to be pulled well above our stated targeted range as larger companies look to leverage automated processes for their own employees. At the same time, our small business ads have continued to increase in 2020 as we continue to build out our inside sales force. Manager on the Go continues to gain popularity and was recently named a top HR product at this year's HR Technology Conference. we are receiving more leads and referrals as the industry shifts toward an employee usage strategy. Since the end of Q1 2020, usage of Manager on the go has nearly doubled. 98% of all Paycom clients have deployed Manager on the go. Manager-on-the-go fundamentally changes manager workflows and accelerates the speed that data moves throughout the system, which further increases the ROI of our solution and sets us up for future usage patterns that pave the way for future product innovation and automation. DDX usage continues to trend upwards towards the 100% mark up from the low 90s. In July, we changed our sales procedures to ensure that new clients commit to 100% usage. We are now at our highest DDX usage rates since launching the industry's only software of its kind last year. CEOs and HR executives continue to see the savings from an employee's direct relationship with the database. As a reminder, when an employee makes a data change themselves, the company saves $4.51, and the savings are calculated in real time using the DDX. We are extremely ambitious with our product roadmap, and we are continuing to invest in R&D. The pandemic's impact on our pre-pandemic client revenue remains stable, and it's unclear if or when those same clients will add to their employee counts. When we reported earnings in August, we said that without a catalyst, we wouldn't expect employee counts to improve, and thus far, it has not improved materially, nor has it gotten any worse. As we work through these unique times, we will continue to remain focused on three controllable activities, providing world-class service to our clients, rapidly developing new technologies, and increasing the number of new clients added to our platform. Our execution along these three fronts has been exceptional. Based on the strength of our new client revenue trends, differentiated value proposition, less than 5% estimated market share, and the effectiveness of our marketing and advertising campaigns, I'm confident we can deliver even stronger full-year revenue growth next year on top of our newly established base, even without any improvement in our pre-pandemic client's employee base. The digital transformation for businesses is accelerating, and our investment to expand our market share is working. Leads continue to be driven by users, employee referrals, and our investments in advertising, and all are up year over year. We are putting a greater distance between our product, value proposition, and that of our competition, and we believe we are the clear choice for those seeking a more efficient way to manage HCM needs. I'll stop there and hand it over to Craig to review the financials and guidance. Craig? Thanks, Chad. Before I review our third quarter 2020 results, I would like to remind everyone that my comments related to certain financial measures will be on a non-GAAP basis. I'll briefly cover our Q3 results and trends, then I'll provide some high-level comments about Q4 guidance. Last quarter, we discussed how the effect on our current client revenue of lower headcount at our pre-pandemic clients represented a loss of approximately $2 million in weekly recurring revenue. The impact of 150 basis point interest rate cuts that occurred in March represented an additional loss of roughly $350,000 in weekly recurring revenue. To date, we haven't seen any catalysts that have materially changed this weekly headwind. Our growth is therefore largely coming from new client business. In the third quarter, we generated total revenues of $196.5 million, representing growth of 12.3% over the comparable prior year period, driven by strong new business wins. Within total revenues, recurring revenue was $192.7 million for the third quarter of 2020, representing 98% of total revenue for the quarter. Total adjusted gross profit for the third quarter was $166.8 million, representing adjusted gross margin of 84.9%. Adjusted total administrative expenses were $113.3 million for the third quarter as compared to $94.4 million in the third quarter of 2019. Adjusted sales and marketing expense for the third quarter of 2020 was $58.3 million, or 29.7% of revenues, up from $46.7 million in the prior year period. Our deliberate increase in the advertising and marketing efforts over the last several quarters are translating to more demo leads and virtual meetings and increased close rates, and we intend to be aggressive in this area again in Q4 to drive further market share gains. We expect Q4 sales and marketing expense to be similar to Q3 on both a GAAP and adjusted basis. Adjusted R&D expense was $19.7 million in the third quarter of 2020, or 10% of total revenues. Adjusted total R&D costs, including the capitalized portion, were $29.8 million in the third quarter of 2020, compared to $24.8 million in the prior year period. Product innovation remains a key driver of our growth, and we will continue to expand our R&D investments to further differentiate our solutions. Adjusted EBITDA was $67.5 million in the third quarter of 2020, or 34.3% of total revenues, compared to $66.6 million in the third quarter of 2019, or 38% of total revenues. We are deliberately investing in future growth through the pandemic and believe this sets us up well for accelerating growth in 2021. Our gap net income for the third quarter was $27.5 million, or $0.47 per diluted share, based on approximately 58 million shares, versus $39.2 million, or $0.67 per diluted share, based on approximately 58 million shares in the prior year period. For Q4, we expect our effective income tax rate to be approximately 29%, and our full-year effective income tax rate to be approximately 22% to 24%. Non-cash stock-based compensation expense was $19.5 million in the third quarter, and we expect non-cash stock-based compensation for the fourth quarter of 2020 to be approximately the same as Q3 2020. Non-GAAP net income for the third quarter of 2020 was $40.6 million or $0.70 per diluted share based on approximately 58 million shares versus $41.1 million or $0.70 per diluted share based on approximately 58 million shares in the prior year period. We anticipate fully diluted shares outstanding will be approximately 58 million shares in the fourth quarter of 2020. As of September 30, 2020, we have repurchased over 4 million shares since 2016 and have $172 million remaining in our buyback program. Turning to the balance sheet, we ended the third quarter with cash and cash equivalents of $156 million and total debt of $31 million. Cash from operations was $66.8 million for the third quarter or a 24.5% increase over the comparable prior year period. The average daily balance of funds held for clients was approximately $1.1 billion in the third quarter of 2020. Now let me turn to our guidance. For the fourth quarter of 2020, we expect total revenues in the range of $212 to $214 million, representing a growth rate over the comparable prior year period of approximately 10% at the midpoint of the range. We expect adjusted EBITDA for the fourth quarter in the range of $76 to $78 million, representing adjusted EBITDA margin of approximately 36% at the midpoint of the range. Based on this outlook, we now feel we can comfortably deliver a combination of revenue growth and adjusted EBITDA margin to hit a rule of 50 despite a pandemic and lower interest on funds held for clients. We estimate the pandemic's impact lowered our recurring revenue base by a total of roughly $90 to $95 million over the last three quarters of 2020, in addition to the loss of sales earlier in the year while we transitioned our sales organization to the work-from-home model. Our focus continues to be on mitigating the impact of the pandemic on our business by providing world-class service to our clients, rapidly developing new technologies and increasing the number of new clients added to our platform. We have a strong balance sheet, a highly profitable recurring business model and a rapidly expanding value proposition. With that, we will open the line for questions. Operator? As a reminder, to ask a question, you will need to press star 1 in your telephone. To withdraw your question, press the pound key. And your first question comes from the line of Raymond Lenshow from Barclays. Your line is open.

Two quick ones. Chad, you talked about the... You talked about the new business doing well. Do you have any kind of data points that kind of help us or any more commentary around that to kind of help us understand the momentum that you have there? Yeah.

Well, I mean, our bookings and our leads, our new business sales and our new business starts have all remained, you know, at record highs. And from where I sit right now, I don't see that changing. You know, now that we've returned to guidance, we're focused on that piece. I do believe that you see these numbers that we've added reflected in our current quarter as well as in our guidance piece. As a reminder, a deal that might start at the beginning of a quarter, we would receive 100% of the revenue for that new business. And should that deal start at the middle or end of the quarter, we would receive proportionate revenue for that business, but we would receive all of the revenue for that in subsequent quarters. So how deals start matter, but for us, you know, leads have been up. Sales have been up, and so has Start. So very happy with what we're accomplishing right now.

Perfect. And then one follow-up. In your prepared commentary when you talked about COVID, you mentioned that obviously the headwind is that people have a lower employee count, and since you get paid on a per-paycheck basis, that hurts you. So in a way, if you think about it, it's a good way to understand it. At the beginning of the crisis, people were furloughed. uh you know then they didn't come back and so you're kind of running with that gap and then as you think about next year as hiring starts again and you new clients that you win you kind of fill up that that gap that was created is that the right way to think about it

Well, we're actually going to look to fill the entire gap with new clients added. That's what we've done up to now. I mentioned that we haven't seen any material changes in our pre-COVID client, the impact on our pre-COVID client base. And so, you know, we did mention how it was $2 million, anywhere from $1.95 million to $2 million of loss that we were seeing per week. We mentioned that at the end of August, or sorry, at the beginning of August, and we did say that we'd seen stabilization in that number throughout the second quarter. As we sit here today, we can't call out that that number has changed materially. I mean, you may have had a small impact one week or another of less than $100,000 impact on that number to the positive. So, you know, to the extent it was 2 million, it might be a little above 1.9 million, depending on what week you measure. But, you know, we said in August that without a catalyst, we wouldn't expect the impact on a pre-COVID client employee count to improve. And while the unemployment has improved since that date, it's still double what it was pre-COVID, it hasn't materialized, you know, for our clients who reduce staff. And it makes sense. I mean, there's nothing that's really happened since August that would... cause a hotel to all of a sudden start hiring their people back or restaurants or entertainment business or health clubs. So, you know, the fact is, is those businesses are more surviving. I wouldn't necessarily call them thriving at this point. And, you know, we're waiting on either an end to the pandemic or some type of a stimulus before I think we'd see some meaningful change to that. So as we look into the future, we believe we've established a new base. Hopefully we get some tailwind out of it. But right now I'd call it more of a crosswind as it's stabilized and, you know, We're jiving through that, and we can get to where we need to get by adding on new clients, which I will say we've been doing, adding on new business at record pace through the pandemic. So I don't see a situation in which that stops for us as our value proposition has only gotten stronger.

Perfect. Hey, congrats. Thank you. Well done. Thank you.

Your next question comes from the line of Samad Samana from Jefferies. Your line is open.

Hi, good evening. Thanks for taking my questions. I hope everybody's doing well. Maybe, Chad, just a starting point, I want to follow up on Ramo's question around new bookings. If I rewind back to 2019, the company has added about 3,000 new clients. That's about 750 average per quarter. I'm just curious, to further frame that new bookings, is it fair to assume that you're adding more than that $750 per quarter kind of on an annualized or quarterly basis exiting July into 3Q? We're just trying to maybe numerically nail down what that booking suggests.

Yeah, I mean, well, what I can tell you, and I haven't called out exactly units, you know, units would be based on how many smaller deals we got versus larger deals. I'm more talking about the revenue generated, whether it's a larger or smaller deal, the aggregate amount of revenue that we are both selling as well as converting. uh you know continues to remain strong and has been at record uh record levels as we've continued on now it's gotten better right in the beginning we were trying to get back to pre-pandemic uh which i'd mentioned uh in our first quarter i believe i gave that announcement either the very end of april or first of may that we had gotten back to pre-pandemic sales uh levels You know, after we had backed off for a little bit and kind of curled up into a ball and was kind of waiting to see what happened, we got back to pre-pandemic levels. Last quarter, I talked about how that's even accelerated, mentioned that we've had our best month, as I reported in August, talking about July. And then what I've talked about this quarter is just the continuation of that in that we continue to get stronger and stronger in both the book sales as well as the – start its sales.

Great. Maybe just as a follow-up to that, the commentary, both you and Craig mentioned 2021 or looking ahead to that, and I believe re-acceleration of revenue was mentioned. I'm curious if you could maybe just frame that a little bit. When you say that, is it in terms of accelerating from 2020 levels, or should we think about acceleration in the context of back to what Paycom was historically growing when we're thinking about kind of a high 20%, 30% type of grower in 2018 and 2019?

Yeah, well, you know, we've calculated the impact on our revenue right now. Now, nobody has to guess how many fingers we're holding up. We're telling you how many fingers we're holding up. So, you know, we've already calculated the amount of the impact that that has on us. And so, and we also believe that, well, we know it's been stable. And so, you know, as we turn into next year, obviously we have a first quarter comp that, you know, doesn't have much COVID impact on it. But as we move into those subsequent quarters throughout the year and we're lapping COVID numbers, you know, with a new established base and added clients during this time. I feel very comfortable about our ability to get back to, you know, very strong growth numbers with strong adjusted EBITDA numbers as well.

Great. Thanks, guys, and glad to hear about the strong bookings performance again this quarter. Thank you.

Your next question comes from the line of Yao Chu from Credit Suisse. Your line is open.

Hi, everyone. Good evening. Thanks for taking my question. I hope you're all keeping well and safe. Congrats on the quarter. Remarkable execution from everyone involved here. I had a question around one of the comments that ADP made on the recent quarter, and it ties a little bit to that you're mentioning around stimulus, Chad, in terms of a catalyst. They said stimulus helped clients that would have fallen into bankruptcy, and there remains continued uncertainty as to further stimulus and strain from partial shutdowns. I want you to take on this two ways. Number one, how do you think further stimulus or like thereof would have a meaningful impact on the path of recovery for your business? And two, how do you position the business or go to market motion differently to react to the possibility of stimulus?

Yeah, well, I mean, we're operating our business to succeed whether there's a stimulus or a fast end to the pandemic regardless. And so, you know, we're focused on those things we can control. And there being a stimulus or there being a, you know, a stimulus that actually works to drive business growth, you know, we'll have to kind of take a wait-and-see approach on that. But I do think that a stimulus can bridge the gap between those businesses that may be going out of business. It could be the difference in them going out of business or their survival. As we look at the amount of revenue that we've lost per week, which, again, has been stable. There is an amount of business there that we've been able to identify that has gone out of business. It's a smaller number, but there is a percentage of the hit that we are taking on these headwinds that we would not expect to come back just because it is a – you know, it's related to business closures. And that's a much smaller amount. I mean, I would say that represents, you know, probably less than 10%. It's probably in the single digits of that amount that we've lost every week. You know, I would say a 90% or more of it is still in business processing with a lower employee count.

Gotcha. Super helpful. Thank you. One quick follow-up. Wanted to double-click on inside sales, which you called out. Can you remind us of the size and resources you've dedicated to this effort, what the learnings have been, and any particular module or need that's resonating with clients in this environment?

Yeah, so right now we have four inside sales teams. They are fully staffed at 32 employees. Obviously, they each have managers. They focus on the businesses that have below 50 employees. We've continued to generate interest down market. Thankfully, we had inside cells before we made the shift because I would say our outside cells, they're not using the exact same model to cell that inside cells is using, but they do use a lot of the same technology and methods through which to connect. And so, you know, we've continued to grow our inside cells, obviously, when you add a number of inside salespeople much larger than what you had the previous year, you would expect to have success down market. And so we do continue to have success down market as well with our inside sales group.

That's great. Thank you. Congrats again. Thank you.

Your next question comes from the line of Adam Borg from Stiefel. Your line is open.

Great. And thanks for taking the question. Just maybe for Chad, now that we're in the typically strong selling season, just given the pandemic and the changes that have been caused, any sense on how the HCM modernizations are being prioritized relative to past years?

Well, I mean, I think that our advertising is helping with that. I wouldn't say that people wake up in the morning excited about shifting over, changing over their human capital management products. You know, I would It's probably about as many people that wake up excited about going to the dentist. However, if you have enough pain, you are excited about going to the dentist or making those changes. And as we've moved through COVID, I think that the pain points have become more apparent. and using outdated systems where employees have multiple systems that they need to use. So actually, they oftentimes go without. The shift to employee usage, I mean, that's the thing moving forward. We're not going backwards as a society, and you're going to just see more and more businesses figure out that they can leverage their own employees' desires for their own benefit and receive a very strong return on the investment that they're paying with Paycom. So we're going to continue to drive that and receive those benefits. And again, the pandemic has only exposed, you know, the problems with using disparate outdated systems. And so, you know, we're focused on that and we're having quite a bit of success. And that's going to continue through selling season. Great. Thanks a lot. Which for pay comms all year round. Excellent. Thanks again. Your next question comes from the line of Mark Marcon from Baird. Your line is open. Hey, good afternoon and congratulations. Wondering with regards to the bookings that you're seeing, any change at all in terms of the composition, in terms of the source of the bookings?

Are you seeing that are more that are coming from, say, regionals relative to some of the bigger competitors that are out there?

And, Chad, I think you also mentioned that you're being pulled up market even beyond your range. Can you expand a little bit on that in terms of what you're seeing?

Sure. So as far as the bookings, they're all similar. There's just more of them. It's the usual suspects. You know, I did call out that we do continue to be pulled up above our targeted range or our stated range, I should say. And that's been happening, I mean, that's been happening since we went public. We continue to be talking about being pulled up above our range. And so that's continued to happen during this environment as well. And so we have both that as well as, as I mentioned earlier, we have built out our inside sales group much larger than what we had this same time last year. So you would also expect that we would be having some success moving below 50 as well as that was, you know, somewhat traditionally, I don't necessarily want to say ignored, but it was not a focus for us. And now we have a group and several teams that are making that a focus down market. It sounds like, you know, you're being barbelled a little bit in terms of being pulled up and down, which is great.

Can you talk a little bit about, you mentioned that the close rates are improving. How much and what do you attribute that to?

Yeah, we're not going to call out exactly the specifics on that improvement. We've always had better close rates as you measure them over time. Your one-month close rate on selling a deal is going to be different than your three-month close rate. Again, if you give a deal a little bit longer, you might have a higher close rate. But I would say the one thing that I would point to that I believe that's really helping us with our close rate is the fact that we are catching a more interested and knowledgeable prospect. We're hitting the airwaves hard with our advertising. We've been doing quite a bit on digital, as well as we've had significant word of mouth from employees that go from one company to another. And then bring us in. And so, you know, when someone's calling us now, which, again, is different. You know, oftentimes most of the business we've brought on we've called. And I'm not stating that still isn't a large part of our business. But, you know, one thing that has gone up recently. you know, as a percentage has been the number of call-ins or interested parties that are requesting those demos. And they're just more educated on what our value proposition is going into it. And I think that that's leading to a higher level of close rate for us right now. Great. And then one last one. It sounds like you're getting more logos, but can you talk a little bit about upsells to the extent you're seeing them? Yeah, we continue to upsell to current clients. It's never been anything that we've ignored. We've always done that aggressively, and that remains the case today. No change in percentage from upsells to current clients versus new business revenue that we're onboarding to our platform. So no changes in percentage there. We're not upselling more to our current clients now. As a percentage... of new revenue added than what we've done in the past. Great. Thank you very much.

Your next question comes from the line of Daniel Jester from Citi. Your line is open. Great. Thanks. Okay. My question, everybody. First, maybe a question on margin. Year-to-date EBITDA margins are down, I think, about four points compared to the same period in 2019.

uh can you just reflect like how much of this is just the float revenue going away versus other factors impacting the business and as you think about the margin structure of the business going into next year kind of what are the puts and takes you should be thinking about in terms of the potential to improve off of this year's level

Sure. So, you know, the EBITDA margin's down, like you said, about four points. I mean, that's primarily from the float revenue that we were receiving, which is a high margin piece of our business, as well as the fact that our, you know, current clients are paying less employees. I mean, that's also a piece that impacts that margin. So, you know, the things we've been extremely proud of is just, you know, our gross margin stayed fairly consistent even through this. And, you know, And, you know, we're seeing efficiencies throughout the organization, both in our servicing organization and, you know, our onboarding as well as just the sales organization. So, you know, as we move into 2021, you know, we talked about, you know, hoping to improve. And obviously the margin is one area we're going to continue to focus on. But, you know, the other thing is we're super focused on revenue growth. So, you know, we're going to spend to in terms of sales and marketing for that revenue growth as well.

And then I know that implementation is a very small part of the revenue base, but it is growing at half the pace on a year-over-year basis as subscription revenue. Given sort of the commentary about the strength of new bookings, should we see improvement in the growth rate in that implementation revenue line in the upcoming quarters, or how should we be thinking about that? Thanks.

Yeah, as a reminder, the new booking, the setup revenue that we charge clients We capitalize that and recognize that over a 10-year period. So, you know, the amounts that we're charging for that setup goes into the deferred bucket. So, you know, you're not going to see significant changes in that on the revenue line. As a reminder, there's other items in that line as well. You know, we have certain hardware sales as it relates to time and attendance and some other items as well.

Great. Thanks, guys. Appreciate the comments.

Your next question comes from the line of Brian Schwartz from Oppenheimer & Company. Your line is open.

Thank you, and thank you for taking my questions this afternoon. Chad, a follow-up question here on the implementation. Are you seeing any change in the pace of the implementations, whether it's the smaller deals that you're doing or the higher deals? Have they changed at all here in the virtual world?

No, not really. I mean, you know, we did have a transition period, right, of deals that we had sold, you know, January, February, and March that had a certain expectation of what conversion would look like. And then, you know, we changed what all that looked like. I mean, you were expecting someone to come out to your office. You're expecting different training on site. I mean, there was a lot of things that we had to change. But as we sit here today, that's all filtered itself out. Any pushes that we had through into the second quarter, we started to all see that come back. And as we sit here today, our no-start rate for business sold is not unlike it was last year. So they're very similar. So I think as we moved throughout the quarters, you did have some pushes. You had a few delayed starts just because we had to really go back and not going to say resell because we never really lost the deal, but we did have to acclimate them. to a different process mindset of implementation. And we've done that, and those deals have been onboarded. So as we sit here today and as we look forward, there's nothing to call out on any type of either elongated time to go live or accelerated time to go live.

And if I could ask you the follow-up question, Chad, just thinking about it moving ahead. you know, do you feel that you have enough sales capacity here? You know, you said you're fully staffed with the inside sales, but, you know, clearly, you know, what you're talking about, the velocity of the new deals and the bookings and the advertising, and then, you know, correspondingly with your services organization to be able to continue to deploy these new customers and, you know, achieve the high satisfaction levels that the company has always been able to do.

Yeah, I mean, you know, you always want more salespeople. We're continuing to add salespeople. I think one thing we've been able to do, you know, in the beginning, again, we had to shift over to the new model. We've done a good job of that. We did pull back on hiring at that time. We've since, you know, put the gas back into hiring. And we started doing that early this summer where we started getting back to that. Our sales reps are having a lot more success right now. We're having significant productivity gains amongst our same sales organization that we've had. Our office opening strategy is still intact. We still do plan to open up offices as it makes sense. Also, right now, every city is open. So we're able to really sell from anywhere right now. So I see us returning back to the same model we had in the past at the appropriate time. we still may receive some efficiencies through selling. You know, look, if the client's going to continue to buy online, maybe they do, maybe they don't, I don't know yet, you know, then we're going to continue to sell that way even though we may be back in our offices, you know, selling from those desks instead of selling from our home desks. So, you know, we'll kind of see what happens. But so far, you know, with the exception of the negative impact, that the pandemic's had on our current client pre-pandemic revenue as well as interest rates. With the exception of that, every impact that we've had as we've gone through this has really been positive. And, you know, we're very happy about, you know, about what our future looks like right now. And really, that really is driven by the value proposition. I mean, that's what's driving everything. You know, we have the right value proposition for business, and they can make that shift very easily right now and start – they can receive a product that works for them and pays them back versus a product they have to work and that's costing them money. And so that's really what's driving it.

Last question for me for Craig. I think you got this question here before kind of just more directly about thinking about the margin trajectory for 21. I'll ask it a little bit differently because you've given a lot of callers here so far. You know, are any of the savings that are happening today, let's just say T&E from having the remote workforce, Are any of those sustainable here as we think about 21 or, you know, any other items such as leases? Maybe you can share with us how you're thinking about, you know, the Paycom organization, you know, returning to work and any color on that would be helpful. Thank you very much.

Yeah, I would say on the travel and entertainment, you know, obviously that's at a much lower level than it had been in the past where we would bring an entire sales organization in to train. I mean, a lot's going to depend on what it looks like next year. I mean, if we get back to normal and, you know, we'll see those numbers start to go up some. You know, so I think that's what I would say. I mean, on the leases, we're still evaluating that. You know, but at this point, you know, we're continuing kind of as normal until we see what it looks like in 2021. And just to kind of dovetail off of that, you know, we haven't been expanding our adjusted EBITDA percentages by pulling levers. We've been doing it by selling profitable business that all follows the same margin profile, and so the more business we sell, You know, over time, we are receiving that benefit of the increase of adjusted EBITDA. And so when we look into next year, saving money on travel and entertainment and those types of sales, you know, I mean, we're not going to spend... you know, poorly on it. But that's not really our objective is saving that. Our objective is to continue to accelerate revenue, continue to onboard clients, and capture, you know, more than the 5% of the market that we have today. And that's what's going to drive our margins as well as our revenue growth into the future.

Thank you very much.

Your next question comes from a line of Alex Zucan from RBC. Your line is open. Hey, guys. Thanks for taking my question, and congrats as well. Maybe just the first one for me. Chad, can you remind us, what's the vertical exposure for the business? You mentioned one of the reasons that you didn't see kind of the same uptick from employment bouncing back was because of the hospitality, travel, maybe restaurants.

Can you remind us what's the exposure rate there?

Yeah, we're industry agnostic, and so we've said that. You know, I guess you could somewhat calculate the exposure rate in that we've told you guys exactly what the weekly impact to our revenue has been. from those same clients having employee attrition, layoff, furloughs, or what you have. But I would say it's a little bit different everywhere. Some states have restaurants doing better than others. Some states are doing better at restaurants because the weather is conducive for their business. And potentially, if the weather does not hold up, we could see a different situation. But, you know, what we've seen up to now is people were being responsible early on with preparing for the pandemic, at least our clients. I think I mentioned early on. I mean, when we were reporting second quarter, first quarter, that we do think many of our clients took their hits early because we started to see some of that in mid-March as they started to make those moves. So, you know, I'm hopeful that people start to add back, and I think that they will at some point. We're just not waiting on that to happen or being dependent upon that for our future growth initiatives. No, that makes total sense. And I guess do you expect walk us through, you know, because you've seen a round of stimulus get enacted and if you can kind of share with us from a timing perspective, if we do get stimulus, you know, at some point, you know, very early in the year, when would you expect that to actually flow into your customer base hiring trends? Or is that not the right way to think about it? Yeah, I don't know. You know, when you look at stimulus, I would say even stimulus in the last package had a much larger impact on small business than what it did midsize and large business. at least from my standpoint, of kind of what we saw, who took what, if you will. And so I just think all that just depends on what type of stimulus they're putting out there. If they do a stimulus that's tied to quality jobs, of people producing quality jobs with certain amounts of pay and you get your stimulus based on that, or even a stimulus that has some reimbursements based off of the company adding quality jobs, it's probably going to be a pretty nice tailwind for us. If the stimulus comes in sending checks directly to individuals that are at their house, you know, we could have a tighter labor market. So, you know, we're just going to have to see from that. But again, I'm going to separate us from the impacts of employment. The changes in employment that have impacted PACOM, we've seen those stabilize now. for, I mean, four or five months. And so, you know, as we head throughout this quarter and definitely as we head into next year, we're expecting that to be stable. And then we're expecting to be able to, you know, hit our growth objectives through adding new clients to our platform, which, you know, has really, we've been doing a good job right now. And I think as we lap COVID with COVID, you know, we're going to be in good shape. That makes sense. And then maybe just the final one. When you talk about bookings trajectory, you talk about new record bookings this quarter. Last quarter, I would say you talked about record months as well. When I hear you say faster sales cycles, more informed buyers, more effective and efficient go-to-market, is it fair to ask you then, are you seeing accelerating sequential bookings growth you know, 3Q to 2Q, and if you kind of stay on cadence, you should see the same thing, 3Q to 4Q. Yeah, I want to get away from calling out bookings each time. You know, I have been calling out bookings because we weren't giving you much of anything else, and I thought that, you know, well, listen, I at least want to tell people that even though we're not guiding, bookings are going well. Now that we've returned to guidance, I don't want to keep talking about bookings, but I have said this on this call that we've been having record bookings, you know, as we've gone through each of these quarters in COVID. Last quarter wouldn't have been any different, and our expectations for this quarter for bookings that we're entering in wouldn't be any different than that. Perfect. Thank you, guys. Your next question comes from the line of Ryan McDonald from Needham. Your line is open. Good evening, gentlemen. Thanks for taking my questions. You know, Chad, first one for you. When you look at the new client wins that you've had in these strong bookings, what sense do you have of the capacity that these clients are starting with on the initial land in terms of, you know, in total employees? I'm sure it's a bit different for each client, but trying to get a sense of what the potential uplift could be once we're starting to see these new clients start hiring again. Yeah, you know, I don't have a good feel for that. I mean, I look at it, a client that onboards with us with 500 employees has 500 employees. Will they grow to 1,000? Maybe. Could they be 200 next year based on other factors that may not even be COVID related? Maybe. And so, you know, as we go and we add clients, we don't try to get that myopic in what the future could bring because that's not controllable by us. And so what is controllable is the number of new clients we add onto our platform. That's completely controllable by us. You know, we only have 5% of the market. What's controllable by us is continuing to expand our value proposition and therefore the return on investment foreign clients and then also what's controllable for us is the world-class service that we provide in an effort to keep all of our clients that we're currently servicing choosing Paycom and so that's what we're focused on getting more. Hopefully we're selling some clients that are in industries that are growing but that's not how we're going to market right now. And Craig, just to follow up for you, you know, it looks like free cash flow was quite strong in the quarter, not only from a margin perspective, but also, you know, the conversion rate from the better free cash flow compared to, you know, last few quarters here. You know, what drove the strong performance there, if anything that you'd call out and how sustainable is this from a margin perspective as we look ahead to fourth quarter and next year?

Thanks.

Yeah, so we had a very strong operating cash flow for the quarter as well as free cash flow. You know, obviously some of that's timing on some of those accruals. We did have a little benefit from a tax rate for some items that were specific to the quarter. But, you know, overall we felt like it was a good quarter in terms of operating cash. And then on free cash flow, you know, our CapEx was – uh fairly uh similar to where it was uh last quarter so i'm excited about both of those great thanks due to due to time constraints we ask that you please limit yourself to two questions and your next question comes to the line of city pentagrahi from mizuho your line is open

uh thanks for taking my question uh i just want to dig into the uh your commentary on that rapidly uh investing on the new product and technology so chad you talked about two uh two products like ddx and manager go which basically increase your stickiness and maybe roi for your customer but during this pandemic have you come across any kind of customer need or requirement that could potentially even drive new revenue opportunity cross-selling into your base, like on-demand pay or any of that kind of product.

Sure. Well, we've seen significant usage patterns be deployed around learning management. We recently upgraded and released our enhanced background checks product into the market, which has actually allowed us to – eliminate some partnerships that we had on the back end. And we've seen that impact go out there. But again, manager on the go, I would say, well, DDX last year and then manager on the go being so significant this year has allowed managers to really improve the data flow and the timeliness of it. And, you know, it's been no surprise for anyone that we are trying to automate this industry. because it needs to be automated. You know, it's complex, it's high risk, low reward. If you get it right, who cares? You're supposed to get people their benefits. You're supposed to onboard them. You're supposed to get them their checks correctly. So nobody really cares if you get it right. And if you get it wrong, there's significant penalties. And so the more you can automate these products, the bigger win for the business. And so that's what we've been focused on throughout this. And, you know, each product has a plan and as we work out those plans we continue to enhance each one of the usage patterns for each of those products. And so we've been doing that through the pandemic across the board on all of our products, whether it's performance, whether it's onboarding, whether it's learning management, background checks. You've mentioned a couple of products that we've added. And so we'll continue to do that. And, you know, we also look forward into the many product initiatives that we'll be rolling out here into the future. Your next question comes from the line of Brian Bergen from Cowen. Your line is open.

Hi, guys. Good afternoon. Thank you.

Wonderful up on demand. It sounds like you've had good success across each subsegment of the market. Can you dig in around your ability to serve the larger clients? We get some questions around enterprise client ceiling. So any metrics you can share on the scale of the largest clients or any details that better gauge your ability to serve that top end?

Well, I mean, we're serving clients that triple our stated range. If you're talking about that from a top end, you know, we have a direct focus on clients that we prospect, and the primary reason for that is we do believe that You know, the way they make a decision fits with the way that we sell. You know, our salespeople at Paycom sell every week. And so, you know, we definitely choose those prospects. We continue to be pulled up market as businesses realize it doesn't have to be as difficult as they've made it in many cases. And so... You know, there's usually more decision makers the further up market you go, but you're also typically dealing with more product but less functionality that they've deployed. You know, oftentimes you run into somebody that has a 15,000, 30,000 employee company. They deploy technology. They've spent $2 million on it, and it can do three things. You know, it's not really a strategy. So I do see us over time continuing to be pulled up market because I do think we're a better fit for businesses that just don't want to work that much on just software. It was a necessity 15 years ago. I might even say it was a necessity seven years ago. It's just not necessary right now. So I see us continuing to have success up market as well. Okay. And then on sales and marketing, I think it was slightly lower than you had projected there. Is that just a function of greater efficiency on the spend you were making?

Any color on the better variance there versus outlook? And the learnings you can share about sales and marketing targeting and efficiency in this environment?

I would say on the sales and marketing, some of that was more timing. You know, slightly lower third quarter and then fourth quarter, we called out what our fourth quarter spend is. But, you know, we're going to make sure that what we spend in marketing, that it's efficient and that we're getting the return that we expect with that as well. Yeah, we account for every dollar in marketing. So, I mean, you know, if we're spending an advertising dollar, we need to get that back. So, and, you know, and thus far that's what's been happening.

All right, thank you.

Your next question comes from the line of Irvin Ramnani from Piper Sandler. Your line is open.

Thanks for taking my question. One of the things you mentioned was the continued progress you're seeing, beginning from traditional players. Are you seeing any of these traditional players enhance their technology to become more competitive? or are you still able to keep the distance from them?

Yeah, so I mean, I've never thought that our competitors have been asleep at the wheel. You know, it's been a very competitive industry for a long time. I think that you've seen us, well, we have for sure delivered a different value proposition in the beginning. It was, you know, I don't know anybody that beat us to the Internet. I don't know anybody that beat ADP to second. Then you looked at the single database solution that we had built out. That was different than what our competitors were doing, which was primarily a sell best in breed, buy best in breed, and integrate. Now we've shifted to an employee strategy in which you have to be online, and you really have to have a single database. Employees don't want to use multiple systems. You know, we continue to differentiate our product by the ROI that's delivered to the client. If you want to receive the ROI on a software investment similar to Paycom, I mean, you're going to have to use Paycom, you know. We're not going to beat our competitors at being them, and they're not going to beat us at being us. And so we're going to continue to... widen the competitive moat as it revolves around usage. And we're going to continue to automate even more and more as we move on.

Great. In the past, you have shared a metric on aggregate cost savings by using your DDX. Are you able to share a similar stat in terms of aggregate savings from your clients using GDX?

Well, so DDX, what DDX does, it actually measures the savings each time an employee makes a change in the system versus if HR makes the change for them. The thought is that any change that an HR department makes, HR payroll, benefit department, hiring department, any change they make for that employee and or applicant in their system is duplicative. They did not read that applicant's mind. They did not read that employee's mind. And so that employee and or applicant could have made that change themselves if they had had easy-to-use technology because that employee is making all changes themselves everywhere else in their daily lives. Why not leverage that at work for the business? And so what the DDX does is it adds that up. And if a client, you know, it wouldn't be uncommon for many of our midsize clients to make 100,000 changes in a month. And if, you know, 2,000 of those changes are made by the HR department instead of the employees, that's a company that has a 98 DDX, 98% DDX rating, you know. But they made 2,000 changes. HR made 2,000 changes in the database. So, I mean, you know, it's going to cost them $90,000 in hard-slash-soft-cost changes. savings that they left on the table because they did the work themselves. And so that's a calculation that was put together by Ernst & Young. I believe when it first came out, it was $4.39. It was updated earlier this year for $4.51. And as we move into next year, I'm sure it'll be updated at some point again. Your final question comes from the line of Josh Beck from KeyBank. Your line is open. Thanks so much for taking the question. I just wanted to ask a little bit about the return on sales and marketing spend.

It seems quite favorable when I hear your commentary about new bookings and market share gains. So, you know, really as you look into next year and if we remain in this work-from-home environment. Is that an area that you want to continue to lean into? Just would like to hear your framework and how you would evaluate that investment as we go into next year.

Yes, for sure. We'll continue to lean into it. I mean, we're having success. You know, there's been times throughout the quarter that we realized that, you know, we can spend more, but we're not necessarily going to get more. I mean, you know, sometimes you can spend double and it only goes up 5% on different advertising. As you go through this, we've become smart on this. And really how we've done that is by measuring every dollar that we're spending. Obviously, we had more powder in the keg this quarter. And, you know, if we had thought emptying that out would have brought us more leads, then we would have 100% done that. You know, I'm interested in training a percent of adjusted EBITDA for a percent of growth. We're just not going to train a percent of adjusted EBITDA for a percent of nothing. So, you know, we've been focused on it. Leads still remain at record levels. Sales remain at record levels. And new client sales are remaining at record levels right now. So having a lot of success and looking forward to next year. And fourth quarter.

Good to hear. Really helpful. Thank you. All right.

All right. This brings us to the end of our question and answer session. Mr. Chad Richardson, I turn the call back over to you for some closing remarks. All right, I want to thank everyone for joining us on the call today and to all the PACOM employees for their continued commitment and execution. Over the next couple of months, we'll be at several virtual conferences this quarter, including Stiefel, RBC, Needham, Credit Suisse, as well as Barclays. We look forward to speaking with many of you again soon and appreciate your continued interest in PACOM. Thanks, operator. You may disconnect.

ladies and gentlemen this concludes today's conference call thank you for participating you may now