Paycom Software, Inc.

conference over to our host, James Sanford, Head of Investor Relations.

Thank you, and welcome to PACOM's earnings conference call for the third quarter 2023. 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 quarterly work report on Form 10-Q. You should refer to and consider these factors when relying on such forward-looking information. Any forward-looking statement made 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 financial 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 will now turn the call over to Chad Richardson, Paycom's President and Chief Executive Officer. Chad?

Thanks, James, and thank you to everyone joining our call today. We delivered solid results in the third quarter with very strong profitability. I'll focus on PACOM innovations that are transforming our industry and strengthening our competitive position. Following that, Craig will review our financials and our guidance, and then we will take questions. Throughout our 25-year history, PACOM innovations have been transforming the payroll in HCM industry. And now we have fundamentally shifted how businesses use core HR and payroll products. We started transforming the industry in 1998 by moving payroll to the web. We have made many innovations in those 25 years, but none more important than do-it-yourself payroll for employees with VETI. This is a paradigm shift for our industry and delivers tremendous value to our clients when employees do their own payroll. Along with our focus on automating and innovating all of our current products, we're continuing to enhance our global HCM and payroll product for international enterprises. Today, we announced that we are expanding our global payroll product to include Mexico. During the third quarter, employees in Canada started doing their own payroll with Betty and now employees in Mexico can too. We are continuing to help clients navigate to the new way of doing things and as a result, Nearly two-thirds of our clients have made the shift to Betty. For most employees, the value of a perfect payroll is oftentimes immeasurable. If their check is perfect, they don't need to borrow money from a friend or family member to get through the weekend or make a bill payment. How do you measure the value of that? We're getting better and better at helping employers measure the full value available to them when payrolls are perfect. A portion of that value is easy to calculate because it's the value they receive by the elimination of after-the-fact payroll errors that require correction payroll runs, manual checks, voided checks, direct deposit reversals, additional wires, tax adjustments, W2Cs, etc., etc. Perfect payrolls eliminate these common after-the-fact payroll corrections that would otherwise be billable. So the more employees do their own payroll, the greater the savings delivered to the client from Paycom future billings, which results in lower related revenue recognized by Paycom. I'd like to thank our employees for their consistent execution and their commitment to our long-term strategy. I also want to wish Paycom a very happy 25th birthday. I look forward to many more. And as many of you know, we're just getting started. With that, I'll turn the call over to Craig for a review of our financials and guidance. Craig?

Thanks, Chad. Before I review our third quarter results for 2023 and our outlook for the fourth quarter and full year 2023, I would like to remind everyone that my comments related to certain financial measures will be on a non-GAAP basis. We delivered fundamentally strong results this quarter with solid revenue and earnings growth. Revenue of $406.3 million was up approximately 22% compared to the prior year period, but came in below our guidance range as a result of lower than expected service revenues and unscheduled payroll runs. As Chad mentioned, Betty adoption and usage creates tremendous value to clients as they experience perfect payrolls and eliminate errors, corrections, and unscheduled payrolls, which would otherwise be billable items. In addition, our CRR teams continue to focus on Betty adoption and overall system usage, which resulted in lower cross-selling revenues. We delivered very strong gap net income and adjusted EBITDA in the third quarter. Net income was $75.2 million, or $1.30 per diluted share based on approximately 58 million shares, and adjusted EBITDA was $165.6 million, representing third quarter margin of nearly 41%, up over 300 basis points year over year. Non-GAAP net income for the third quarter of 2023 was $102.4 million, or $1.77 per diluted share, up 39% from the prior year period. During the quarter, we repurchased over $76 million worth of stock and paid nearly $22 million in cash dividends. As of September 30, 2023, we have retired nearly 5 million shares, and when combined with dividends, we have returned over $700 million to stockholders. We still have $1 billion remaining under our buyback authorization, and the board has approved our next quarterly dividend of 37.5 cents per share, payable in mid-December. Adjusted sales and marketing expense for the third quarter of 2023 was 94.3 million, representing 23.2% of revenues. We continue to hire top talent to expand our sales footprint and invest in marketing to drive lead volume. Adjusted R&D expense was 46.2 million in the third quarter of 2023, or 11.4% of total revenues, up 20 basis points year over year. Adjusted total R&D costs, including the capitalized portion, were 69 million in the third quarter of 2023. The capitalization rate increased approximately 33% in the quarter as we continue to invest in new products and support our international expansion efforts. Third quarter gap tax rate came in at 26.3%. For the full year of 2023, we expect our effective income tax rate to come in at approximately 29% on a gap basis and approximately 26.5% on a non-gap basis. Turning to the balance sheet, we ended the quarter with a very strong balance sheet, including cash and cash equivalents of $484 million and total debt of $29 million. The average daily balance of funds held on behalf of clients was approximately $2.1 billion in the third quarter of 2023. Now let me turn to guidance. Throughout 2023, we had been seeing moderating upside to our guidance model, which corresponded with increases in VETI usage and macro headwinds from inflation that may impact each client differently. Now that more clients are achieving the ROI that VETI has to offer, It has eliminated certain billable items, which is cannibalizing a portion of our services and unscheduled revenues. With 10 months of data from increased beta usage, we're incorporating the impact that our client's ROI achievement has on our model. Based on these factors, we expect fourth quarter 2023 total revenues to be in the range of $420 million to $425 million, representing a growth rate over the comparable prior year period of approximately 14% at the midpoint of the range. We expect adjusted EBITDA for the fourth quarter in the range of 169 million to 174 million, representing an adjusted EBITDA margin of 41% at the midpoint of the range. With our Q3 results and our Q4 guidance, we now expect fiscal 2023 revenues to be in the range of 1,679,000,000 to 1,684,000,000 or approximately 22% year-over-year growth at the midpoint of the range. We expect adjusted EBITDA in the range of 712 million to 717 million, representing an adjusted EBITDA margin of nearly 43% at the midpoint of the range. Combining our expected revenue growth and adjusted EBITDA margin, we're still on track to reach the rule of 65 in 2023. As we look out to 2024, we have a number of strategic initiatives that we believe will further strengthen the value clients receive from our offering. We are making strategic performance and client value decisions that we feel are best for our long-term relationship with our clients. Our mission is to ensure and achieve client value, and that is our focus. Our guidance for the next 15 months assumes the impact from the strategic revenue decisions we are and will be making. As a result, we believe it is prudent for us to set expectations for 2024 year-over-year revenue growth of between 10% and 12%. We'll have more visibility when we provide formal guidance in early February. With that, we will open the line for questions. Operator?

In the interest of time, please limit yourself to asking one question. If you'd like to ask a question, please press star followed by 1 on your telephone keypad. If for any reason you'd like to remove that question, please press star followed by 2. Again, to ask a question, it is star 1. As a reminder, if you're using a speakerphone, please remember to pick up your handset before asking your question. We will pause here briefly as questions are registered. Our first question is from Raimo Lenschow with Barclays. Your line is now open.

Hey, thank you. I'm just trying to get a little bit more clarity on the BETI impact. So if I'm listening to you, it sounds like BETI is the main problem here or the main issue for what's going on. But it has been launched for a while. So why do we see the impact so dramatically now? And maybe you can link it in with the strategic revenue decisions for next year? Is that kind of betty or do we need to think broader here? Thank you.

Sure. I mean, first in regards to the first one, you know, better usage has continued to increase throughout the year for us and that continues to increase. You know, we've been pretty close to guidance almost every quarter this year and so Craig kind of talked about that moderating throughout the year and

We're seeing what accelerated impact Betty has, and then Craig, you can add kind of the... Yeah, so, Ron, I mean, it impacted it in a couple of different areas. I mean, obviously, the unscheduled runs to correct payrolls and some of those service revenues that we have as it relates to correcting payrolls, those numbers were moderating, and they typically come in towards the end of a quarter. So that's part of the impact for the quarter. you know, as well as the CRR impact, which I called out on the prepared remarks. And then, you know, also, you know, the pre-employment services came in a little light. So, it was really a combination of all four of those items.

Our next question is from Samad Samana with Jefferies. Your line is now open.

Thanks for taking my questions. I want to unpack a couple of things to follow up on, on Ramo's question. I mean, if I, if I think about the dollars that you would add based on that 10 to 12% growth in 2024. Yeah, I guess I'm curious based on the staffing levels of the organization, should we see either a change in the cost structure or, you know, just thinking about dollars added and sales headcount that's adding it, just how do we, how do we kind of square those two things, especially with the offices that you added? in late 21 and early 22. I'm just trying to understand because 10 to 12% would be a pretty significant departure from the growth we've seen historically.

Yeah, you know, we haven't given any guidance as it relates to the cost structure, Samad. I mean, that's something we'll be looking at. One thing we just wanted to do is give you guys kind of an indication of what we would expect, you know, with some of the things we're seeing now as to how, you know, 2024 would be shaping up.

And maybe just, I guess, follow on on that. So I understand that Betty's efficiency drives maybe some services revenue that you would have otherwise gotten. But what about in terms of whether, can you give us any update on maybe the number of new customers that you added in the quarter or ARR added in terms of new represented seats? That can maybe help us think about either growth in customer count going forward or what are you assuming for that for 2024? Just Any follow-up would be helpful.

Sure. I mean, what we can tell you about what we see right now is outside sales remain very strong, inside sales remain very strong, and cross-selling with our CRR group continues to be down as we are focused on these current clients that we have.

Our next question is from Brad Reback with Stifel. The line is now open.

Great. I'll keep it simple. Is there any ERTC revenue in 2023?

Brad, I know some of the competitors have called out that type of revenue and that it was going to have an impact. Our client bases are quite a bit larger than what you're hearing from some of the competitors in terms of our client size. I know, I'm sure there was some, you know, we had some people that were applying for the employee retention credit. And, you know, most of that I think you have to file by the end, you know, first or second quarter of next year. And the IRS has kind of put a moratorium on that for a period. But, you know, I would say it's not significant.

Our next question is from Mark Markin with Baird. Your line is now open.

Just following on on the other questions. Thanks for taking my question. Is it possible to break down like, you know, what the impact was with regards to, you know, what you're seeing in terms of these efficiencies? How much you're seeing out of the CRR group? And can you clarify what you mean by the strategic revenue decisions that you're taking for next year, does that mean potentially pairing some clients or not renewing them or what exactly does that mean and how does that, how does strong outside sales correspond to the 11 to 12% growth?

Sure. Well, the first question is you may have a client that was used to, you know, they're supposed to be running 13 payrolls in a quarter. You know, and they were running 19 and now they're back to running 13. And so you have some of that going on with Betty as well as, you know, a lot of just the fixes. I mean, it just eliminates everything. I mean, perfect payroll's a thing. You know, new clients come on with Betty and half of their employees are doing their own payroll by the end of the first month. You know, our new logo sales are strong. Like I said, inside sales is. Our cross-selling, I mean, you know, it's been pretty weak. And that's not going to change for a little bit. I mean, we're not going to keep trying to sell more products to a portion of the base, you know, not using and receiving value. We're going to go back in and partner with the client to ensure they're achieving the full value available to them. And so, you know, that's a big part of our strategy here. And I will say our strategy is related to the base, not the go-to markets.

Our next question is from Brian Schwartz with Oppenheimer.

Hi, this is Ari Friedman sitting in for Brian Schwartz. Thanks for taking my question. I guess like a question I have is can you talk about like the what you're seeing just in terms of the SMB and mid-market in terms of demand in comparison to last quarter and how it's trended? Thanks.

Demand remains strong. I believe that what we're talking about is more specific to PACOM and not something that would necessarily, well, I mean, be happening with the rest of our industry. I mean, we've made a big paradigm shift in going through this. These are things that we've done before as we've gone through these types of things. And I think that we've stayed very dedicated and there's a lot of clients that, you know, that we have that we continue to onboard all the new ones that continue to get great value. And so, you know, we're going to stay focused on what we're doing and also, you know, looking out for our current clients. Thank you.

Our next question is from Joshua Riley with Needham.

Yeah, thanks for taking my question. Has anything changed in terms of customer retention in the last couple quarters? And how much of an impact, if any, is that having on the Q4 and the initial 2024 guidance?

Sure. And so, you know, neither what I would call is our surprise in the third quarter, nor our larger than normal, you know, adjustment for fourth quarter guide. related to any change in our expectation for retention achievements said a different way there have been no changes to our retention expectations since we gave q3 guidance on october 1st our next question is from steve enders with city hey great thanks for thanks for giving the question here maybe just a

I guess, follow on to the last question. I mean, it seems like gross retention hasn't changed, but it's more of a view of the net retention dynamic. I guess, first of all, is that the right way to be thinking about it even for next year as we think about the load change guide? And I guess, any way to quantify the change in net retention that you're kind of talking about here?

Sure. We report gross retention once a year in February. As I've said before, we measure retention throughout the year. It's usually strongest in the fourth quarter. In February, we'll give our gross retention number. When you're looking at retention of revenue specific to a client that is using the Paycom system, if they're a new client, you know, that revenue retention remains strong and specific to that one client because they were new. It's not something we had previously. If they were a current client, as we transition them to Betty, that does impact their future billing with us. And so absolutely, as they continue to get great value, it is, a lot of that value is reflected in reduced billing. I mean, I would say from a customer perspective, that's a smaller portion of the overall value that they received for Betty. But, you know, I mean, look, the only people that went in the old model is the payroll company and, you know, whoever's getting the accolades for fixing all the errors. I mean, the employee and the business loses. And so, you know, we're continuing to work with our clients on that.

Our next question is from Siti Panigrahi with Mizuho. Your line is now open.

Thanks for taking my question. Chad, what I understood is that Bayley now seems like cannibalizing your services revenue, but have you thought about the incremental revenue that you could get from Bayley or even raising pricing? I understand you even did it for free. Have you thought about any changes strategically to offset some of this services revenue coming from your unscheduled payroll?

Yeah, I mean, I will tell you right now I'm focused on, you know, the client value and the differential between, you know, what they're paying and what they're actually achieving. And, you know, I've kind of been saying it for a while. You know, we've got the early adopters, the late adopters. I mean, Betty rollout to new clients was revolutionary. I mean, our go-to market is continuing to be unchanged You know, and the health indexes for that group. And by that, I mean the usage, how many employees are using it, manager on the go, everything across the board. They're very strong. You know, Betty rollout to our current client base, I mean, it was heavily nuanced. And it's not Betty's fault. You know, Betty's the way to do payroll. You know, people may need some time to see the value, and I get it.

But, I mean, Betty's still the right way.

Our next question is from Brian Sergin with CB Cowen.

Hi guys. Thank you. I'm just trying to unpack this 2024 early growth to you. And if I just think about how we understood your growth algo before, I guess in round numbers, if normal growth was around 20%, which we figured 15, 75% of the 20 points would have been new logo driven. It sounds like there's demand there, but this is a pretty sharp disconnect versus the 10 to 12. So can you help us with this?

Sure. I mean, new business sales as well as cross-selling within our base has always been a mitigating factor to any type of transition shift we make like this. And again, new business sales remain strong. In fact, most of the calls we get in is about Betty, you know, We've got our first enterprise rep, and they're only targeting deals that have greater than 25,000 employees. It's current rep of Paycoms. And they've got plenty of leads. And so it's a paradigm shift that we've been making. But as far as the go-to-market and the new business logos that we're onboarding, I mean, we're not having issues with that, and we're not looking to make changes in regards to that.

Okay. Is the activity that you're seeing for clients, that usage, is it occurring any differently with any particular client segment sizes, i.e. larger clients using it more and having that bigger impact?

You know, I would say that's more specific to the setup of the client, at what time we actually went and set them up, and kind of how we walked through that. It's also kind of dependent upon their own payroll and how they're doing things. As far as does it have a bigger impact on one versus the other, if deployed correctly, potentially, but the larger the impact would really be based on how much were you messing it up. I mean, you get to some points in large companies, and I mean, they don't even have a prayer to do it correctly. I mean, they just don't. And then if you're dealing with a four-employee company, do their employees not care about perfect payroll? So from that standpoint, I mean, it's the way to do it. And like I said, the only person that wins in the old model is the payroll company. We've been charging people to fix mistakes for 80 years, our industry. Mistakes that we've allowed them to make. And so, yeah, we could look at, well, if we eliminate all these mistakes, we're not going to have as many direct deposit reversals and tax changes and W2Cs and new payroll runs. I mean, we get it, and we've been mitigating it with business sales along the way. But now our CRR group, as I said on the last call, we're dedicated to helping clients achieve value. That's where we're at today. And the decisions we're making today will drive long-term share or long-term value for our shareholders, me being one of them. So the decisions we're making today will allow us to get to the next step. But we're not abandoning and or changing our strategy in regards to Betty. If anything, I would say we're leaning in more.

Our next question is from Jason Salino with KeyBank.

Great. Hey, guys. I'm just also trying to unpack, you know, these new numbers. And when we look at the exit rate from Q4, you know, it kind of assumes a 14% growth rate. So the early look for next year is a deceleration from that. So I guess I'm just trying to wonder, you know, this early look you're giving us, does it imply incremental bookings headwinds?

no bookings from our go to market no our next question is from arvin romani with piper your line is now open thanks for taking my question uh yeah i i just was um i had two questions you know one is um can you just expand on the kind of the strategic initiatives you're taking that's kind of causing you all to kind of, I guess, do what's right for your client, but see like de-estimation in your revenue growth. Can you just expand on what specific strategic initiatives that you're taking?

So, I mean, we're making strategic decisions with our base to make sure they're achieving full value. You know, we don't really need to telegraph more than that. I don't want to share what we're doing. And I'm not going to hand one end of the thread from which someone can pull. I can tell you that all these decisions are specific to what we are doing with our base and not our go-to-market or new clients.

Our next question is from Bob and Shaw with Deutsche Bank.

Great. Thanks for taking my question. Chad, just one clarification on one question. the 10% to 11% guidance, is it fair to say those headwinds that you're seeing next year, it's primarily or all due to changes in assumptions to your customer base? Or is that more a little bit on the new logo side as well?

No, it's a paradigm shift. And no, I would not say it's regarding, again, back to my previous statement. We're not seeing anything within our go-to-market. And by that, I'm talking about outside sales, new logo, and or inside sales. new logo from that perspective. You know we've made a paradigm shift. I mean we can't change the industry and not change the industry. So you know we've been going hard at it for two years and I mean that's not changing. Some of the largest companies in the world are going to be using Betty. It can be challenging to make a paradigm shift but you know it's not our first rodeo. I mean back in 98 would have been a lot easier to install Windows 95 on a software 486 desktop with a hard drive communicated with a modem, like our competitors. In 2003, it would have been easier to partner with Best in Breed. We don't necessarily do what's easy. We do what creates value for our clients and drives the return on investment. When we stay disciplined doing the right things, we accelerate opportunities for ourselves, the client, and consequently drive shareholder value, which is very important to me personally.

Our next question is with Robert Simmons with DA Davidson.

Hey, thanks for taking the question. How much revenue are you generating today from your international efforts and how quickly do you think that can ramp up? Is that included in the outlook for next year or would that be a central upside to those numbers?

I think what Craig was trying to give is more an initial outlook, if you will, a nod to all the initiatives that we have right now as we move forward. I do believe that next year, we're already seeing it now, will be continued to be pulled up market, but still focused on our core market that we focus on. But we'll continue to be pulled up as we have been. And yes, a big part of that continues to be the global HCM product and expansion into additional countries. I mean, zero employees were doing their own payroll in Canada until I think it was August. And, you know, now employees in Mexico will be.

Our next question is from Matt Fowle with William Blair. Your line is now open.

Hey, great, thanks. Wanted to ask, one of the items you mentioned were some macro headwinds from inflation. Maybe you can just clarify how big of a factor that those are, and then in the initial 2024 guide, what you're anticipating from a macro or a demand perspective, any change there? Thanks.

I mean, from the macro, you know, headwinds, where we're seeing it specifically is in related to pre-employment services that we have. So that's really more in regards to that. That carries through.

Yeah, and we would expect that to carry through into the fourth quarter and into next year as well.

Our next question is from Adam Berger with Bank of America.

Hey, thanks for taking the question. I guess kind of open-ended, but what's like the silver lining in this from like a investor's shoulder perspective? Like when rates go up pretty materially since there's potential cost savings there when you use Betty, does this help with the move up market, give it more value? Just trying to think about, you know, past this initial cannibalization period, like what should we look at like as the positives on the other side?

Thank you. Yeah, no, I think that's actually a good point. First of all, I think you should see this as a transitory period. And we've kind of been talking about our continued ability to move current clients over to Betty and help them achieve value. I came out and said, I hope all clients are on it 100% within the first, because it produces that much value. I thought it'd be quickly. You know, we have a third of our clients that we want to make sure are getting value out of Paycom with what they're using. And we also want to be able to preserve the opportunity to, you know, be able to sell them on the real value of EDI and the opportunity it has for them.

And our last question is from Alex Zukin with Wolf Research. Hey, guys.

Thanks for taking the question. I guess maybe just a clarifying one. If I think about recurring revenue versus services revenue, what's the right way to think about services revenue specifically for Q4 or implementation revenue and then for next year? Is that just going to be something that trends down significantly from where it's scheduled to end this year? I know you've typically not provided that level of detail, but it sounds like this strategic shift is associated with maybe some elimination of that implementation or services revenue.

Yeah, I mean, you know, there's going to be two pieces.

There's a services revenue and then obviously the unscheduled to do some of those corrections as well. So, you know, I mean, as you've seen throughout our history, you know, you kind of see a sequential Q3 to Q4. So you can tell that a lot of those services revenue and unscheduled, even though some of them relate to bonus runs, there's quite a few of those in Q4. So as we were looking at the Q4, that's really the impact. that we saw in the Q4. And some of that's going to carry over into 2024. And that's why we thought it was important for us to give that initial look.

And we've got 50% of our employees. OK, go ahead. That's fine. We've got 50% of the ones using Betty that the clients have deployed to Betty. 50% of their employees are now doing their own payroll. So that eventually goes to 100. And then eventually, you know, we continue to work with our client base. And so all that's to say is our clients should be getting more and more efficient if it actually works. That's the way the value would be showing up. And then to us, it'll show up and go to market.

So, all right.

There are no more questions. Okay, sorry.

I'm going to go ahead and... Very good. Want to thank everybody for joining the call today. Over the coming months, we'll be hosting meetings at a few conferences. In mid-November, we'll be participating in meetings at the TD Cohen and Needham virtual conferences. On November 28th, we'll be attending the UBS Global Tech Conference in Arizona. In December, we'll be in San Francisco at the Barclays Global TMT Conference. We look forward to catching up with many of you soon. Operator, you may disconnect, and thank you.

That concludes the conference call. Thank you for your participation. You may now disconnect your lines. That concludes the conference call. Thank you for your participation.