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Paycom Software, Inc. (NYSE:PAYC)

Q2 2014 Results Earnings Conference Call

August 5, 2014 5:00 PM ET

Executives

Craig Boelte - Chief Financial Officer

Chad Richison - President and CEO

Analysts

Raimo Lenschow - Barclays

Albert Chi - JPMorgan

Brad Reback - Stifel

Operator

Hello. And welcome to the Paycom Second Quarter Fiscal 2014 Results Teleconference. All participants will be in listen-only mode. (Operator Instructions) After today’s presentation there will an opportunity to ask questions. (Operator Instructions)

Please note, this event is being recorded. I would now like to turn the conference over to Mr. Craig Boelte, Chief Financial Officer. Please go ahead, sir.

Craig Boelte

Thank you and good afternoon. Before we get started I would like to note that certain statements made during this conference call that are not historical facts, including those regarding our future plans, objectives and expected performance are forward-looking statements within 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 we have made are reasonable, actual results could differ materially because of statements are based on our current expectations and are subject to risks and uncertainties.

These risks and uncertainties are discussed in our final prospectus that was file with the Securities and Exchange Commission on April 15, 2014. You should refer too and consider these factors when relying on such forward-looking information.

We do not undertake and expressly disclaim any obligation to update or alter its forward-looking statements, whether as result of new information, future events or otherwise, except as required by applicable law.

Also during the course of today's call, we will refer to certain non-GAAP financial. A reconciliation schedule showing GAAP versus non-GAAP results is currently available in our press release that we issued after the close of the market today, which is located on our website at www.paycom.com.

I'll now turn the call over to Chad Richison, Paycom’s President and Chief Executive Officer. Chad?

Chad Richison

Thanks, Craig, and thanks to everyone joining us both on our conference call and online. I'm excited to spend this time with the investor community, as we believe that the human capital management industry is at the beginning of a multiyear transformation and that this presents opportunities for well-positioned providers to capture the value offered by this change.

We believe that Paycom is leading the charge of this transformation due to our superior technology and unique approach and is poised to grow faster than the industry by continuing to grow our market share.

As you can see from our earnings release, this was another outstanding quarter for Paycom. Demand for our software as a service technology and end-to-end human capital management solutions remains very strong and our differentiated offering is resonating in the marketplace.

We saw accelerating growth in the second quarter with the 39.3% increase in total revenue to $33.3 million, approximately 98% of which was recurring. Annualized new recurring revenue, which is an estimate based on the annualized amount of the first full month of revenue attributed to new clients also increased in the second quarter to $11.5 million, up from roughly $8.3 million for the same quarter last year.

Results are driven by the power of our single database, end-to-end solution and the associated superior data that comes with a single database that spans the entire employment lifecycle.

This data is key to our value proposition. We capture employee data from the applicant all the way to retirement and everything in between, providing functionality and talent acquisition, time and labor management, payroll, talent management and human resources, all of the functionalities included in one solution, which eliminates the need for integration with other systems, making it easy to use and more efficient to manage.

For employers this means that when an applicant has hired into the system his or her data is populated across all functionality from payroll to performance management. Employees love this because there's one less browser and one less database to log in to, plus our solution puts all relevant, accurate and secure information at their fingertips, such as their pay rates, deductions, benefit selections, performance reviews and much more.

Now before I do a deep dive into our technology, I want to backup and spend a few minutes describing our view of how HCM will evolve over the next few years and how this evolution will transform the way that companies manage their employees and leverage HCM to drive business.

Let's turn back the clock about 15 years to the year 2000, at that time, Internet usage was ramping and the cloud was virtually nonexistent. Based on our experience, we believe at that time human resource professionals accounted for virtually all usage of HCM functionality and data. We believe the C-Suite usage was very small, mostly in the form of high-level printed reports and employee usage was very low as well.

Fast-forward to today, the Internet is everywhere and the use of cloud computing and fast models are continuing to grow. Looking at usage of HCM applications and data today, we estimate that HR professional’s usage still accounts for the overwhelming majority of total use. C-Suite usage has grown slightly but employee usage has grown substantially.

What does this mean on a practical basis and how does this form our vision of HCM? Simply put, we believe and have been executing with this belief for years that the optimal model of HCM is one where the employees are empowered to enter their own personal data into the system, as well as retrieve such information at will.

With Paycom our client’s employees enter everything from new higher data and time off request to expenses and changes in beneficiaries. This model is much more accurate and allows employees to access much more data than they had previously. It also allows HR professionals to spend less time on data entry and occupy more strategic roles within the organization.

As you look at the next wave of workers, today's youth are growing up surrounded by technology. It is clear they will be overwhelmingly comfortable with entering their own data. Based on our view of industry trends, we expect that over the next few years, employees will be entering much more of their own data and account for significant usage of HCM systems.

Employees want and expect to be able to manage their information, empowering them with the ability to do so, helps keep top talent motivated and engaged, a proven driver for reducing turnover, improving productivity and increasing customer satisfaction.

In addition to improved employee engagement, we anticipate that these changes will ultimately drive efficiencies, lower costs and potentially unlock new ways of doing business that will improve our client’s day-to-day operations.

We believe Paycom is the most favorably positioned company in the HCM space to take advantage of this trend. Due to the fact that we provide the functionality and data analytics that businesses need to manage the complete employment lifecycle.

As you know a key difference between Paycom and our competitors is the way we have approach building our HCM suite. Many of them have chosen to simply integrate their own products or integrate products from other vendors for core functionality like talent management, applicant tracking or benefits.

Our suite is built as one unified solution using our Paycom framework. Aside from not being dependent on others to deliver our core functionality, this approach gives us key engineering benefits, such as a more seamless user experience and significant code reuse between modules. Each time we built within our framework we get faster and more efficient at building HCM applications.

The most recent example of this strength was displayed during our new client redesign where we chose to build new code generation tools that automatically write much of the predictable coding we would have done, leading us to faster development and greater overall consistency.

This client redesign follows the employee redesign from last quarter and we have received extremely positive feedback from our clients, who now have the ability to access the system anywhere, anytime and from any device.

This development framework has allowed us to create a broad unified suite that allows us to approach clients with a full-featured solution from the onset and allows our clients to transform their payroll and HR efforts immediately upon implementation of the Paycom system.

Even with our expanded solution, we continue to improve. At Paycom, we can leverage the work we put in several years ago in establishing our single database architecture and create new applications and features more quickly for minimum cost.

Additionally, as you might expect all new applications and functionality work well with our existing suite, which makes for easy conversations with clients as we present our solution. Our software development team continue to innovate and deliver and we launched several new features this quarter, including Paycom Push Reporting, which is a smart analytics feature that generates reports based on client’s specified metrics.

Push reporting eliminates the need for someone to pull or generate a report. It does the work for you. Client feedback on our push reporting functionality has been extremely positive so far. And we've already new client wins because of this feature.

Last quarter, I highlighted our employee self-service redesign with responsive coding that dynamically adapts to any screen resolution that the employee may be using. As I mentioned earlier, this quarter we rolled out this enhancement to the client side and the response has been tremendous.

Our clients are now able to be more productive than ever with the ability to access key HCM data and processes from any location and the device that best suits their needs. These are two recent examples of how our clients are pulling our technology development teams deeper into their development efforts and strengthening our competitive position in the marketplace.

As I highlighted last quarter, we view our sales organization as a key competitive strength. And I'm pleased to report that the momentum of our sales efforts has continued this quarter. As we continue to increase new business sales across our mature and growing offices, while adding new clients at a robust pace.

I'm particularly proud of the speed with which we are ramping up new team members at the five new sales offices opened in the first half of 2014 and the skill with which our experienced team members are helping our new associates learn the Paycom culture and how to sell the Paycom way. As a reminder, although new sales teams won't reach maturity for 24 months, we look forward to them making revenue contributions toward the end of this year.

To sum it up, Paycom is continuing to succeed in our mission to bring enterprise class solutions to the market in a profitable and efficient way. Our investments in technology and expanding our sales footprint are already yielding positive results. We believe we are at the beginning of a multi-year growth cycle as new and potential clients continue to learn how Paycom can help and improve their businesses.

I will now turn the call over to Craig to discuss our financial results. Craig?

Craig Boelte

Thanks Chad. Our momentum continues into the second quarter and we were pleased to see this reflected in our financial results. Before I review our second quarter results in our updated outlook for 2014, I want to again quickly review a few key elements of our financial model.

As we detailed last quarter, the vast majority of our revenues are recurring revenues. These are based on client fees for our broad and growing suite of applications which include talent acquisition, time and labor management, payroll, talent management and HR management applications.

The services related to recurring revenues are rendered during each client’s payroll period and are charged and collected as part of our processing of the client’s payroll, which provides reasonable collectibility and excellent visibility. Our cloud-based SaaS models supports gross margin of approximately 80% with cost of sales largely consisting of hosting and support cost, along with employee-related expenses for client support, delivery and bank charges.

As Chad highlighted earlier, we believe our data is a key competitive advantage and to this end, we operate our own data centers. Regarding our operating expenses, we pay commissions to our sales reps based solely on new sales at the time of their first monthly billing cycle. This is a one-time commission paid which we recoup over the life of the client relationship.

While our continued robust topline growth results in near-term increases on our sales and marketing expenses, this is more than offset over the long term, given the predictable recurring nature of our client relationships. With this background in mind, let’s review our results for the second quarter.

As a reminder, as I review our fiscal second quarter results and our outlook for the third quarter and fiscal 2014, our comments related to certain financial measures, including adjusted EBITDA and non-GAAP net income or non-GAAP financial measures, which excludes stock-based compensation and other non-recurring charges, including transaction, expenses related to our initial public offering as well as losses related to retirement of related party bid.

Total revenues in the second quarter 2014 grew to a record $33.3 million, an increase of 39.3% compared to the same period last year. Within total revenue, recurring revenue was $32.7 million, representing 98.2% of our revenue and growing 39.6% year-over-year.

Annualized new recurring revenue or ANRR was $11.5 million, up from $8.3 million in the same period last year. Our continued strong revenue growth in the second quarter was primarily driven by the addition of new clients. We continue to see success in adding new clients in our mature offices, which are offices that have been opened for at least 24 months as well as adding new clients in our more recently opened sales office. Total gross profit for the second quarter was $26.9 million, representing a gross margin of 80.9%. This compares to gross margin of 8.1% in the prior-year period.

Turning to operating expenses, for the second quarter, total administrative expenses were $23.8 million as we continue to invest ahead of our growth opportunity by adding new sales offices, adding to our R&D talent, an incremental cost of being a public company.

Adjusted EBITDA was $6.1 million, or 18.2% of revenue compared to $4.4 million, or 18.4% of revenue in the second quarter of 2013. Non-GAAP net income was $2.1 million or $0.04 per diluted share based on 50.3 million shares versus $0.5 million or $0.01 per diluted share based on 48 million shares in the year-ago period.

Turning to the balance sheet, we ended the quarter with cash and cash equivalents of $14 million and debt of $27.4 million. The debt represented financing on our corporate headquarters. During the quarter, we use net proceeds from our IPO and existing cash to retire $65 million of outstanding debt.

With that, let me turn to guidance for the third quarter and for fiscal 2014. For the third quarter, we expect total revenue in the range of $34 million to $35 million, representing a growth rate of 33.7% at the midpoint.

We expect adjusted EBITDA in the range of $4.5 million to $5.5 million representing an EBITDA margin of 14 .5% at the midpoint. For fiscal 2014, we expect total revenue to be between $143 million to $145 million, or 33.8% year-over-year growth at the midpoint. We expect adjusted EBITDA in the range of $22 million to $24 million, representing an EBITDA margin of 16% at the midpoint.

In summary, our momentum continued into the second quarter and we anticipate ongoing success through the rest of the year as we leverage our investments in R&D and sales and marketing and strive to deliver revenue growth.

With that, I like to turn it back to Chad.

Chad Richison

Thanks Craig. In conclusion, we had a great second quarter in our first years as a public company. We remain very excited about the opportunity we see for our company. We believe, we are well positioned to leverage our ongoing sales momentum and technology advantages to continue to drive innovation across our technology platform, take share and build our recurring revenue base for the next several years.

With that, I’d like to turn the call back to the operator and open up the lines to take any questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And our first question will come from Raimo Lenschow of Barclays.

Raimo Lenschow - Barclays

Thanks for taking my question and congratulations to a great second quarter. The first question I have -- like I had, was can you talk a little bit about the dynamic of the payroll versus non-payroll this quarter?

Chad Richison

Sure. Raimo, as we've talked about in the past, all of our new business comes in, well, all of our business that we have, every client that we have here now comes in with the payroll offering. And so everything that comes in does have the payroll. We continue to expand our product offerings. And we’re becoming more aggressive in the initial sales call to where we have been able to penetrate more as somebody comes in upfront.

Raimo Lenschow - Barclays

Yeah. Okay. And then on these non-payroll modules like what are the trends that you are seeing there? What are the modules that are easiest to sell and where do you see growing momentum starting to pick up more?

Chad Richison

Like our competitors, I mean, this is -- we don't necessarily disclose module by module, we do see it as one solution. I mean, however, I will say unlike others, I mean, we are providing the ANRR. We have 30 sales teams, 6 to 8 reps on each team focused exclusively on new business wins and the overwhelming majority of all ANRR comes in new wins is what they are.

Raimo Lenschow - Barclays

Yeah. We look at that. Okay. So you open up five offices in Q1. Did you open up any more in Q2 or are there plans or are you just now in a staffing mode for those five offices?

Chad Richison

Correct. So we did open up five offices in Q1, which was a couple of more than what we had forecast. As we stated earlier, it takes on average 24 months within the ramp-up to maturity and we’re seeing them trend to that point now.

Raimo Lenschow - Barclays

And so -- are there plans for doing more this year or like are you done for the year basically, the next cycle starts next year?

Chad Richison

Well, we’re always reviewing opportunity. And as we go into the future quarters, I mean, that something will definitely be looking at. But we didn't open up another one this quarter because we opened two additional first quarter early.

Raimo Lenschow - Barclays

Yes, okay perfect. And then last question for me is like so as now as a public company what has been the reaction that you've seen from the client base and kind of working in the market environment, has there been any change and improvement because you've got more recognition or any change from a competitive nature that ADP is taking you more seriously now or anything along those lines?

Chad Richison

Well, I can't speak from the competitors. I know that we are finding it easier to have conversations with the clients and win prospecting.

Raimo Lenschow - Barclays

Yes. Okay. Perfect. That's it for me. Thank you.

Chad Richison

All right. Thanks.

Operator

(Operator Instructions) And our next question will come from Sterling Auty of JP Morgan.

Albert Chi - JPMorgan

What’s going guys? This is actually Albert Chi on for Sterling. Great job on the quarter. The results were pretty solid, but just a question I have is, do you think you could update us on the competitive environment from both your HCM SaaS competitors and maybe touch on what some of the larger incumbents have been responding with. I know when your competitors on the larger incumbent side had, kind of had talked about strong demand in the SaaS application. So can you talk about the dynamics between the sort of response and what's currently out there in terms of your direct competitors? Thanks, guys.

Chad Richison

Sure. Thanks for the question. So we've been competing with substantially the same people, since I started the company in 1998. It's really been the usual suspects, save a couple of new ones, maybe smaller ones. It’s a highly competitive market and our competitors continue to come out with new products and target new markets and new market segments all the time. We still plan on taking market share and growing. I mean, it's been our model since we started and we continue to be strong at it today.

Albert Chi - JPMorgan

Thanks.

Operator

And the next question will come from Brad Reback of Stifel.

Brad Reback - Stifel

Hey guys, how are you?

Chad Richison

Hey, Brad.

Brad Reback - Stifel

Chad, to your comment earlier about higher attach rates, can you give us any sense of how much higher ANRR for your customers today, where it might've been a year ago or two years ago?

Chad Richison

I can't give you specifics on that, the specific number, but it's trending up. We have added new modules if you will. Again, we’re selling one solution but we've added new product features over the last three years. So as we go into a new client or a new win, we’ve have more to sell them.

Brad Reback - Stifel

Okay. And then just one quick follow-up on the new office side and the potential to add in the back half of the year. If there is an opportunity, does EBITDA guidance potentially assume some of that or have a factor in for that or would that be added expense to that guidance? Thanks.

Chad Richison

I do not -- I'm trying to get to the just of the question. We are -- we would choose to open up an office or not based on the opportunity or demand or our ability to accelerate it once open. And we don't really go into a market that we don't plan to have a lot of success in. So I wouldn't necessarily say it's EBITDA guidance that's driving that decision.

Brad Reback - Stifel

Yeah. No. I apologize. If you did open offices in the back half of the year, would that be a headwind to the $22 million to $24 million EBITDA guidance you gave or it might that already had some wiggle room and conservatism baked in that it could handle it?

Craig Boelte

As we look to the full-year guidance on adjusted EBITDA, we feel comfortable with the numbers we provided and included in that is increase in sales force headcount as well.

Brad Reback - Stifel

Great. Thanks very much.

Chad Richison

Thank you, Brad.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Chad Richison for any closing remarks.

Chad Richison

All right. Well, thanks again to everyone for participating in today's call and for your interest in Paycom. We appreciate your time and we look forward to speaking to everybody next quarter. So thank you.

Operator

Our conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.

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Source: Paycom's (PAYC) CEO Chad Richison on Q2 2014 Results - Earnings Call Transcript

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