Paycom Software's (PAYC) CEO Chad Richison on Q2 2016 Results - Earnings Call Transcript

| About: Paycom Software, (PAYC)

Paycom Software, Inc. (NYSE:PAYC)

Q2 2016 Results Earnings Conference Call

August 02, 2016, 05:00 PM ET

Executives

Craig Boelte - CFO

Chad Richison - President and CEO

Analysts

Raimo Lenschow - Barclays

Michael Nemeroff - Credit Suisse

John DiFucci - Jefferies

Albert Chi - JPMorgan

Trevor Upton - Pacific Crest Securities

Brad Reback - Stifel

Mark Marcon - Robert W. Baird

Jim MacDonald - First Analysis

John Byun - UBS

Ryan MacDonald - Wunderlich Securities

Operator

Hello. My name is Dan, and I will be your conference operator today. At this time I would like to welcome everyone to the Paycom Software Inc. Second Quarter Earnings Conference Call. [Operator Instructions]

I would now like to turn the call over to Craig Boelte, Chief Financial Officer. Please go ahead.

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 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 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 filings with the Securities and Exchange Commission including our quarterly report on Form 10-Q for the quarter ended March 31, 2016 and our Annual Report on Form 10-K for the year ended December 31, 2015.

You should refer to and consider these factors when we rely on such forward-looking information. Any forward-looking statements 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 the course of today's call we will refer to certain non-GAAP financial measures. A reconciliation showing GAAP versus non-GAAP results is included in the press release that we issued after the close of the market today which is available on our website at investors.paycom.com.

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

Chad Richison

Thanks Craig. Our momentum continued through the second quarter of 2016. We had excellent results with revenue of $74 million representing growth of 51% over the comparable prior year period. We are pleased with our performance and believe ourselves success is due to the growing recognition of the benefits that can be gained from Paycom's single database architecture.

Our organically built and internally trained sales force is focused solely on the U.S. market which we believe holds ample opportunity to fuel our growth for many years to come. In fact we believe that we are still in the early stages of a multiyear mission to gain market share and grow into one of the largest providers of cloud-based payroll and human capital management software.

To further illustrate what drives our confidence, I would like to share some insight into some of the ways that Paycom solution helps clients to improve their workforce processes and succeed. When client select Paycom they are not just buying the product, they are also improving their processes and unlocking ways to engage their workforce by aligning with the strategic and knowledgeable business partner.

At Paycom we developed our payroll and HCM software to work seamlessly with each other leveraging the true power of our single database system to enable executives to run their businesses more efficiently.

When we engage with a new client the Paycom system represents an opportunity for them to not only enhance their existing processes but also institute new processes to enable the C-Suite to better manage their workforce. Since it is frequently the first time they have had all of their HCM data available in a single place.

So in addition to implementing the Paycom system for new clients, we are often helping them to put best practices in place that are enabled by our system. These improved practices drive even greater efficiencies and also increase client engagement with the Paycom solution across the entire organization from front-line employees to the C-suite.

Finally, leveraging both our talented development teams and also our internal analytics, we gain insight into client usage across the entire system application-by-application, employee-by-employee. Using this data we identify best practices for each aspect of the Paycom solution and bring those findings to our clients.

We are now using our internally developed learning management system to teach our clients and their employees how to best use the Paycom system .Our clients have enjoyed this new radiant -- media rich learning platform known as Paycom University and this is been a great introduction to the power of our LMS offering.

The constant improvements to our system in helping clients to optimize how they can use it for having a positive impact on sales, we are seeing productivity improvements across the entire sales organization. These improvements are evident in our results and guidance.

Turning to the market I will now provide some comments regarding the upcoming changes to the FLSA overtime regulations. As many of you know in December the rules regarding overtime pay will change dramatically. The annual salary threshold for employees overtime exemption will increase from approximately 24,000 to over 47,000 per year.

Similar to the ACA this will have a broad and significant impact on many American businesses. From our perspective ACA compliance initiatives were effectively tasked to the HR departments particularly within the mid-market where most employers were already providing appropriate health insurance to their employees.

In contrast the proposed changes to the overtime law will demand attention from the C-suite as business leaders looked to accurately measure and potentially adjust their employee compensation strategies to ensure compliance with the law in the most efficient manner.

We believe the FLSA potentially will have significantly greater financial impact to clients in the midmarket than the ACA. As with the lead up to the ACA compliance deadline, we are seeing a wide range of knowledge and preparedness among current and prospective clients.

Many companies have not yet acknowledged let alone embraced the impending changes. This is where Paycom serves as a knowledge resource to future and existing clients. We provide a substantial amount of information in the form of white papers, webinars and of course they are highly trained sales force.

The proposed FLSA changes are providing useful conversation starters for our sales reps as we believe that the Paycom solution offers the best option for employers to adapt to the potential upcoming changes in the most strategic and efficient way.

And with that I'm pleased to highlight our recent announcement of the FLSA toolkit which is part of our government compliance application. This FLSA analytics tool is simple yet powerful and uses employee data to perform the cost analysis of workforce restructuring strategy and can help executives to determine the best course of action when looking to navigate the changes to the FLSA law.

This tool is yet another example of the ability of our R&D organization to comprehensively develop products that serve the needs of our clients. We continue to invest in our R&D in the second quarter growing our adjusted R&D expense 114% year-over-year.

As with prior earnings calls I will now provide a few examples of notable client wins within the quarter. I will remind everyone that our target client range remains companies with 50 to 2,000 employees. However larger clients above this range continue to see increased efficiencies and value by implementing the Paycom system as they look to abandon silo technology that no longer meets their needs.

First, we on boarded an assisted living company with multiple locations and over 3,000 employees. They had been using a competing vendor for payroll and relied on several other HCM vendors while also performing manual processes for many key functions.

After transitioning from a large number of providers this client really values having a single completely integrated system additionally a greatly appreciated our on-site implementation and training which was tailored to the client's needs and schedule.

Next we converted a restaurant chain with over 40 locations and nearly 4,000 employees that also had been using a competing vendor. In addition to the benefits gained from a completely integrated system this client was attracted to Paycom because of our learning management system. The prior elements provider was not fully integrated with the payroll system and because of this they were not achieving the results they needed.

Of course this client is also enjoying the benefits now of having all of their HCM functions in one application including talent acquisition, onboarding, background checks and many others.

Lastly, we welcomed an entertainment company with over 5,500 employees across several states. They had been using an in-house system prior to Paycom and we're searching for a solution that would be robust yet easy-to-use across their entire employee base. They also wanted to standardize hiring practices and communicate better with their workforce. With Paycom they were able to accomplish these objectives through a combination of surveys and personal action forms.

Finally, with several locations in different states they experienced challenges in the past organizing their data and maintaining compliance with multiple tax jurisdictions. With Paycom their tax compliant processes are now automated.

To close I would like to highlight that we were recognized as one of the achievers 50 most engaged workplaces for 2016.This accolade is a testament to our culture and also the use of our own technology. Having an engaged workforce helps us attract and retain top talent which allows us to effectively compete in the marketplace.

And finally as many of you know earlier this year Welsh, Carson and its affiliated entities distributed their remaining Paycom shares to their limited partners and general partners. After yesterday's board meeting Rob Minicucci and Sanjay Swani step down from our board. Both were formally nominees of Welsh, Carson who served on our board for several years and we would like to thank them for their service.

With that I will now turn the call over to Craig for an update on our financials and our guidance. Craig?

Craig Boelte

Thanks, Chad.

Before I begin I am pleased to announce that our Founder and CEO Chad Richison has been elected as Chairman of our Board and will succeed Rob Minicucci. And before I review our second quarter results and also our outlook for the third quarter and full-year 2016, I’d like to remind everyone that my comments related to certain financial measures will be on a non-GAAP basis.

We use adjusted EBITDA and non-GAAP net income as supplemental measures to review and assess our performance and for planning purposes. Adjusted EBITDA is a non-GAAP financial measure that excludes non-cash stock-based compensation expense and certain transaction expenses that are not core to our operations.

Non-GAAP net income is a non-GAAP financial measures that also reflects adjustments for non-cash stock-based compensation expense and certain transaction expenses that are not core to our operations which are further adjusted for the effect of income taxes. A reconciliation of the GAAP to non-GAAP measures discussed today is included in our press.

We experienced a strong second quarter with total revenues of $73.9 million representing year-over-year growth of 51% from the comparable prior year period. As Chad mentioned we experienced ongoing success of our sales teams as our solutions continue to gain traction in the marketplace.

Within total revenues recurring revenue was $72.5 million for the second quarter of 2016 representing 98% of total revenues for the quarter and growing 52% from the comparable prior year period. Total adjusted gross profit for the second quarter were $62.3 million representing an adjusted gross margin of 84.3%. This compares to 83.6% in the second quarter of 2015. For the full 2016 we anticipate adjusted gross margin will be within a range of 82% to 84%.

Total adjusted administrative expenses were $43 million for the quarter. This amount compares to $30.1 million in the second quarter of 2015. Adjusted sales and marketing expense for the second quarter of 2016 was $24 million. Adjusted R&D expense of $4.1 million in the second quarter of 2016 represented an increase of 114% from the comparable prior year period.

Adjusted EBITDA was $22.6 million or 30.6% of total revenue in the second quarter of 2016 compared to $13.1 million or 26.8% of total revenue in the second quarter of 2015. We experienced a strong increase in adjusted EBITDA due impart to sales out performance and also increased cost efficiencies across our organization.

Non-GAAP net income for the second quarter of 2016 was $12.4 million or $0.21 per diluted share based on approximately 58.7 million shares versus $6 million or $0.10 per diluted share based on approximately 58.4 million shares a year ago. The effective tax rate was 35% for the three months ended June 30, 2016. We expect the fully diluted share count in the third quarter to increase by approximately 725,000 shares less the numbers of shares withheld to satisfy tax obligations due to the vesting of restricted stock with market based vesting conditions and also less any share we may repurchase pursuant to our previously announced repurchase program.

Turning to the balance sheet we ended the quarter with cash and cash equivalents $80.9 million and debt of $29.3 million. As a reminder this debt represents the financing of our corporate headquarters. We were proud to recently complete the third building at our campus which help accommodate our growth. We recently entered into a new loan agreement in connection with construction of a fourth building and are excited to commence the early phases of design and development.

Cash from operations was $24.6 million for the second quarter reflecting our strong revenue performance and profitability of our business model. The year-to-date average daily flow balance for funds held for clients was approximately $660 million.

With that let me turn to guidance for the third quarter and for fiscal 2016. For the third quarter of 2016 we expect total revenues in the range of $75 million to $77 million representing a growth rate over the comparable prior year period of approximately 37% at the midpoint of the range. We expect adjusted EBITDA for the third quarter in the range of $13 million to $15 million representing an adjusted EBITDA margin of approximately 18% at the midpoint of the range.

For fiscal 2016 we’re increasing our revenue guidance to a range of $325 million to $327 million or approximately 45% year-over-year growth at the midpoint of the range. We’re also increasing our full year adjusted EBITDA guidance for fiscal 2016 to a range of $83 million to $85 million representing an adjusted EBITDA margin of approximately 26% at the midpoint of the range.

With that we will open the line for questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Raimo Lenschow with Barclays. Your line is now open.

Raimo Lenschow

Thank you. A couple of questions if I may. Chad I know you don’t give ANRR numbers anymore and you will not answer me on this one but if you could talk qualitatively about like how was business activity in the quarter, obviously the numbers look really good but we are looking at revenue which is kind of more backwards looking. How does the quarter feel for you in terms of when compared to kind of what you saw previously

Chad Richison

Well I kind of thought you answered the question in the first part of your question but so I mean obviously like you said it’s not a metric that we talk about anymore. Obviously we have had continued experience strong growth as it relates to onboarding of new clients. We’re very focused on that and we look to continue to do that into the future.

Raimo Lenschow

Okay perfect. It was worth trying. And if you look about the FLSA Act like how do we have to think about it in terms of all these different we had the ACA now we have this one. For us in terms of modeling purposes how do we, I mean is this kind of an ongoing every year thing that kind of new stuff will be coming out and in terms of magnitude how should we think about this.

Chad Richison

Yes, and so the FLSA is actually going to update for the first time in 12 years beginning December 1 of this year and it’s going to go from a $455 per week threshold to $913 per week threshold which means employees that are paid salary that make less than $913 a week which is roughly $47,000 a year will be subject to over time.

In that you can only account for 10% of bonus and commissions basically nondiscretionary income, you can only account for 10% of it and so if you have a person that is making $40,000 in salary and they are making another $30,000 in commission and bonus they are actually subject to the overtime rules and so you would actually have to start tacking hours on that individual and paying them over time even though their gross amount is much more than the $47,000 but it’s how you are paying it.

So our tool allows them to go through the analytics of both those people who are salaried employees close to the range that may not have enough over time where they keep them at that range to again efficient in their payment, as well as identify those employees who are going to make above $47,000 when you include the 10% bonus and commission and potentially these employers would chose as I believe we would to make that, to restructure that employee's commission and bonus compensation and actually put more into salary so that they do not have to pay them over time and therefore track hours.

Now as far as the change beginning in 2020 they actually because this was the first time they had made the change in 12 years, in 2020 they’re actually going to start increasing it every three years keeping in line with the economy. And so we don’t - this isn’t going to go away. It’s going to kick off on December 1 and like everything else people are going to have to continuously manage it and I believe it’s going to have a great impact on companies that do not manage it successfully.

Raimo Lenschow

But you it’s basically just another add on model basically, a module like you have, like obviously 2020 or more?

Chad Richison

Correct. This actually, this toolkit it actually now embedded in our government and compliance module which we already have and so we do intend on providing clients with this module. We also are using it for discussion purposes because clients just now both clients as well as new prospects are just now deciding what exactly are they going to do, who are they move where and what is the impact. So they can actually run if then scenarios.

If I change their salary to this and their bonus is this what’s the count for me and what does that mean in my business. And also this has been reconciled every quarter by the employer and any under payment has to be remitted at that time to each employee. This is a DoL, Department of Labor type thing and so unlike ACA compliance where you are filing returns directly with the IRS at the end of the year, this is something where employees if they were underpaid not unlike if they were underpaid right now through not having the correct minimum wage or what have, they would file a claim with the Department of Labor.

And so that’s really how this is managed at this time. I have heard that somehow that DoL and IRS could be working together in certain areas on this but I haven’t seen any regs come out on that yet. So that’s where we’re at today. Like anything every year it’s more and more regulation, more and more changes and more and more the businesses have to deal with and that’s something we do. We’re good at making it easier for them to handle what's often times forced on them.

Raimo Lenschow

Okay, perfect. Thank you very much. That’s very helpful. Well done.

Operator

Your next question comes from the line of Michael Nemeroff with Credit Suisse. Your line is now open.

Michael Nemeroff

Hi, guys. Thanks for taking my questions and a nice quarter. Just looking at the EBITDA guide for the rest of the year and looking where it started, I’m just in terms of really impressive and I'm curious for Craig what has changed on the expense side, where you’re getting so much leverage?

And then as it relates to new office openings Chad given that you're seeing so much success on the profitability side, could you maybe give us a glimpse into how you’re thinking about the number of new office openings in 2017 and whether we could see a sharp increase from where we've been for the last couple of years?

Craig Boelte

Okay. Michael with respect to the adjusted EBITDA and then the guidance for the rest of year, for the first half of the year obviously the forms filings was very strong at the beginning of the year. And so that had a - that additional revenue flows through to the adjusted EBITDA. And the costs associated with that aren’t all that significant.

And then as we look through the second quarter you kind of look up and down there the lines of the income statement and we saw some margin expansion go up and down. And we had some in the gross margin as well as G&A and sales and marketing. So as we continue to outperform on the revenue line a lot that is falling through to the bottom line.

Chad Richison

And as far as the office openings we have opened the most offices that we've ever opened this year and that combined with last year I believe puts us at about 10 or 11 that have actually been opened in the last - yes, 11 opened in the last 19 months.

And so we're still absorbing all of those openings and all those moves and at the appropriate time where it makes sense for us to expand even further we’re going to look to do that.

Michael Nemeroff

Is there any limitation on increasing the number of office openings, do you have enough experienced managers that you could open more offices if you choose to?

Chad Richison

Well, I mean, I'm not going to really guide to exactly what we’re going to do next year at this time. What I can tell you is that for sure the longer someone is in a territory with us the more experienced they gain and they’re more qualified that they have.

And just a little of numbers over time the more offices you have with the more maturity amongst each office, the more candidates you're going to have as well. But for right now, we're very focused on continuing to absorb what we've done and really experience the benefits that we are experiencing from those offices that have been opened longer than 24 months.

Michael Nemeroff

Thanks for taking my questions.

Operator

Your next question comes from the line of John DiFucci with Jefferies. Your line is now open.

John DiFucci

Thank you. Chad and Craig the results are impressive but revenue as you know given the SaaS models as far as backward looking, the cash flow is really strong so that that's good it sort of helps us look forward a little bit. But Chad could you give us any color at all even subjective on the momentum of the business in this quarter relative to the last couple of quarters?

Chad Richison

I think the revenue in the guidance speak for itself. I know that as far as closest for us I mean, we’ve continued to have a very strong closes on our deals and that is as far as onboarding clients. We continue to be pulled up to the top end of the range, I mean, each quarter seems like now I have highlighted those companies that are actually exist above our range.

And that I mean our executive reps we continue to have more executive reps mature as many of you know it takes about 14 months, once a rep starts with us for us to them to achieve executive rep status. And that group represents the overwhelming majority of everything we sell.

And so we continue to have more executive reps added each month as we continue on and we just continue to get stronger and stronger.

John DiFucci

That's helpful. And into that - to that last point maybe if you can talk a little bit about not necessarily the new offices and the new how they open and we know that that's there some time that it takes for them to take hold. But offices that are in transition from new disorder mature and how these offices - and then that the term mature I know isn't necessarily mature and that it's not going to grow anymore.

But those with more tenure how they've progressed in regards to their contribution to the results, is it - have things continued similar to what they've done in the past, recently you talked about what you're talking about here where you are getting from other customers, has that trend continued at all or any changes in regards to any of that?

Chad Richison

Yes, I mean it’s all increased. I mean the top office we’re going to have this year is going to outsell the top office we had last year. Maybe we had some significant top rep sales last year but already we have people on pace at pace to beat that. And so we continue on. And then as far as the success of moving up market and selling it at the top end of our range and not that we at all want to ignore the lower midmarket because we have had great success there as well.

But we do have more product to sell. The product we continue our R&D efforts so it gets better and better. I mean we just talked about our FLSA toolkit that we are now embedding into our government compliance tool to help people be able to navigate the new regulation. And so for us we wake up every day and really try to get better than what we were the day before. I think using our own training modules make it as made it easier for us and we’re going to continue to do the same as we move forward.

John DiFucci

Great, thanks Chad. Nice job.

Operator

Your next question comes from the line of Mark Murphy with JPMorgan. Your line is now open.

Albert Chi

Hi, Chad and Craig, this is Albert Chi on for Mark Murphy and I’ll add my congrats on the great quarter. So I want to ask kind of it’s a follow-up to Raimo’s question on the – thanks for providing the details around the FLSA. But just wanted to get a better sense of how we should size the relative impact of the overtime changes versus ACA? And I know you had talked about how ACA related billings as a percent of revenue would be around the low single digits in 2016. Do you have any sense of how that’s going to shake out for the overtime?

Chad Richison

Well I think the impact to our clients and prospects as it relates to overtime is really going to be at the expense on their. And most companies the largest impact that they had at with the ACA expense was what they paid either us or one of the competitive vendors or really is about maintaining compliance. Most of the companies in the midmarket were offering affordable healthcare. And so to a large extent the expense associated with ACA was what they were paying their vendor or what they're using themselves to stay compliant and make those ongoing decisions.

Not that it's all one to one in that every bit of their expenses what they would pay a vendor but I mean it’s a substantial portion. As it relates to this it really just depends on companies make-up coming, if they have employees that are salaried at $40,000 salary and these employees are working 60 hours a week they’re going to have to convert that $40,000 employee into an hourly employee and they’re going to have to pay them over time, time and an half on those 20 hours each week.

And so it's a significant change and so companies who are good at analyzing and predicting both what has happened, what they have currently and what they expect to happen in the future based on what has happened in the past. Those companies who are good at that are going to save themselves a lot of money. Those companies who aren’t or either going to spend a lot or potentially have DOL cases opened up. And so that was really my statement and that this is much more impactful I believe for an organization when you’re talking about pay and salary and, kind of what you have to pay.

There's – there aren’t really many choices for workarounds on it. You just have to really be good and know your dad and that's where having a single database comes in when you have the payroll time and attendance data and other – and the exact same assistant compensation data, non-description and compensation data and everything in the same system it’s easy to gather. And you have history tables that have this information.

And so I believe it’s going to have a significant impact and I still believe we’re at the very early stages of it being something that clients even want to an exercise that they really want to go through.

Albert Chi

Got it. That’s interesting. So do you think I guess broadly do you think that these changes could weigh on company’s earnings in any particular way?

Chad Richison

I think it depends on the company I don't see how it has -- I don't say on any midsized company how it has zero impact on their expense. I just -- I couldn’t see really a situation and unless they already were paying everybody that had a salary over $47,000.Then potentially that could be the case and when you get into companies that have 600, 700, 800 employees or 400 employees you typically have more diversity then just to add. And so I think it’s going to have an impact on businesses for sure.

Albert Chi

Got it. Thanks very much.

Operator

Your next question comes from the line Brendan Barnicle with Pacific Crest Securities. Your line is now open.

Trevor Upton

Hi, this is Trevor Upton for Brendan. Thanks for taking my questions. Just a follow-up on the FSLA question. I am assuming that Paycom would benefit through increasing adoption of the government compliance application is that correct?

Chad Richison

That is correct.

Trevor Upton

And can you guys talk about kind of where the penetration of that currently is.

Chad Richison

We don’t talk about adoption rates for our products but I do believe that we do have some bandwidth in government compliance to go out there and be able to push this product and to the client can then leverage it to manage this highly sensitive cost area for them and then I also believe it’s a major conversation starter that we have with prospects.

I do believe we were like ACA we were very quick to this and when we developed something we developed a comprehensive system that not only helps them out of the gate but helps them on an ongoing basis. And even there is a lot of the thinking for them as far as being able to predict data points based on prior data points over the same period. And so I think that we’re going to get some bets with this, we’re going to having conversations with this and like everything else we’re going to see it move forward.

Trevor Upton

That makes sense. One of the incumbent service providers decided ACA as a change event that’s increased churn for them, it sounds like FLSA should have a similar impact?

Chad Richison

I don’t know what necessarily impacts other company’s churn but we do have a very good product. We had a good ACA product and I believe that our FSLA product we have at the gate is a very strong product and like any of our products we’re very committed to make the necessary changes along the way as regulations change.

Trevor Upton

Okay, thanks and then lastly can you talk about the impetus for the share buyback and how you weight that versus other uses of cash?

Chad Richison

Well I think it’s our goal. We started off with our share buyback last quarter. It is out goal over time to reduce the overall share count. We looked at our cash and what we’re really able to do at this time and we felt like it was an appropriate amount to start that now.

Trevor Upton

Okay, that’s all I have. Thank you.

Operator

Your next question comes from the line of Brad Reback with Stifel. Your line is now open.

Brad Reback

Great, thanks very much. Craig just real quickly on the gross margin guide for the year that’s 82% to 84%, it would imply somewhat of a tick up in cogs in the back half. Are there any specific guidance causing that?

Craig Boelte

No, as we look at our gross margin guidance we kind of kept it at that 82% and 84% and then if we over achieve it tends to be closer to that 84% in terms of our over achievement on revenue. Now one that we’ve pointed out is we have to hire in front of the revenue growth. So as we look quarter-to-quarter we want to make sure that we have the people in the bench to service that growth and those cline clients that come on board. So that’s kind of it fluctuates potentially from quarter-to-quarter. It’s really on a headcount basis.

Brad Reback

Great. Thanks very much.

Craig Boelte

Thank you. Do we still have an operator.

Operator

Yes. Your next question comes from the line of Mark Marcon with Robert W. Baird. Your line is now open.

Mark Marcon

Good afternoon thanks for taking may question and congratulations. Just wondering if you could talk just about the sales teams just in terms of like what the latest count is in terms of total and how many you would consider to be mature right now. And then as a follow-up to that if you could describe what sort of activity the mature ones are currently seeing particularly in some of the older market just in terms of pipeline, level of growth prospects going forward. Thank you.

Craig Boelte

So we have 42 offices right now, 11 are still in the process of maturing so that leaves us with 31 that are currently mature being that we’re now in August. And I would say that as far as how one looks different than the other, the substantial difference outside of the first maybe six months opening is really going to be the staffing in each office.

I mean, a newer office is going to have a couple of sales reps in it maybe two or three and a mature office is going to have in between seven and nine sales reps at full staff. A new office is going have zero executive reps and the mature office - four, five, six or more and so it just makes a difference and that’s why it takes a little bit of time for these to mature.

As far as the activity and the expected quota for new reps and everything else those remain the same and so it really what changes is just the progression and maturity stage that they are out of that time.

Mark Marcon

Great. And then can you just talk a little bit more about pipeline that you are currently seeing just in terms of new opportunity, there are fees that are out there, the hits that you are getting. What sort of impact is the success that you’ve seen thus far helping with regards to potential client recognition acceptance et cetera?

Craig Boelte

It’s always really been strong that we’re really in an industry where people really like tenderness as they continue to engage their workforce. I mean, it hasn’t been that long that there has really been technology that where you could really even engage a workforce. I mean if we think back 15, 20 years ago it wasn’t that often that people were leveraging this type of technology in the cloud to communicate with employees in a meaningful way as well as the rest of their management staff to be able to collaborate on important items that can impact cost, HR and what have you and so we’re continuing to see that.

So I’ve never really seen a time where it’s been down. I think that anytime you have a great solution you are going to get your at best out there. I think the longer in the business the more popular you get. The more references you have at different levels the more references you are able to create and so we’re just continuing our momentum as have in the past and I would say it’s been all similar and that it’s been very strong demand there for a long time I think for our entire industry.

Mark Marcon

Great and then one last one just any other comments with regards to this client retention rates what you are seeing there?

Craig Boelte

I mean, as far as our client retention rates that’s a metric that we actually disclose each year and as all of you know it’s been flat the same for the last four years and it is something we definitely focus on at Paycom how you continue to set a company up, make sure they are good from the get go and then continue to increase usage along the way. You definitely want to have your clients using the technology they are purchasing and so that’s something that we’re very focused on for us from a retention standpoint to always.

Mark Marcon

Great, thank you.

Operator

Your next question comes from the line of Jim MacDonald with First Analysis. Your line is now open.

Jim MacDonald

Good afternoon guys and Chad congrats on becoming Chairman. Could you tell your thoughts on are you going to replace the two Welsh, Carson directors that resigned?

Chad Richison

Yes, it is our expectation that we would be replacing that. We’re in the process right now of conducting those interviews and we’ll be announcing those in the future.

Jim MacDonald

Great and as a follow to Mark’s question as you grow so rapidly how do you think about maintaining your service quality and really making sure your clients have a seamless experience?

Chad Richison

Well luckily I’ve had years and years of practice. From our standpoint we’ve continued to grow, I think we’ve got a 40% CAGR over the last five years and so you have to continue to do that. Really it’s about the processes you put in place. I’ve said it before that a substantial number of employees anywhere would fail at a company if it weren’t for the processes that they put in place to help them succeed and so we’re very focused on our processes.

We’re very focused on updating our processes. We’re very focused on client feedback that revolves around our process because likewise with new technology we also have to make sure you are providing a new type of service. You don’t want to have a 2016 technology and your service model in stuck in 2001 and so you really or you are onboarding a piece and so you have to continue to innovate across the board. It’s not just the software, it’s the process, it’s the setup, it’s R&D it’s everything.

You have to continue to innovate across the board and we’ve really gotten a lot of experience in continuing to do that, be good at recruiting. And a lot of that comes from leveraging our own tools internally to be able to make those things happen.

Jim MacDonald

And just a quick follow-up to that, do you try to maintain a client contact so that people aren’t seeing new faces all the time?

Chad Richison

Well, definitely. You want to give the client the best experience that, that client can have. And I believe that starts off with a great technology. I can remember when I used to do first sales calls myself, I actually sold our first 400 deals here at Paycom where I was teaching people what the Internet was, and kind of plug it in for them.

And so even from back then, you go in with your plan and you want to have very good, you want a very good technology solution. And we’ve just continue to innovate that along the way. So it’s something we’ve experienced in the past as far as continuing to grow these departments overtime and I see as just continuing that.

Jim MacDonald

Great, thanks very much.

Operator

Your next question comes from the line of John Byun with UBS. Your line is now open.

John Byun

Hi, thank you. Just wanted to kind of go back to the FLSA little bit. In terms of the government and compliance module, given that you’ve added more functionality; would you be increasing the price for that? And is there any way to get a sense for how that's price relative to other core modules?

Chad Richison

At this time the functionality is within the government compliance tool. We did put in there. So clients of ours that have current government compliance, they have it available for them today, and we are working with them.

We do have a large number of clients that aren't set up on government compliance, we're looking at bringing that to them as well as adding it to each prospect that comes in. I mean, this is almost a have to have now for companies to start with us moving forward.

That’s not to say that they absolutely have to buy it from us, but it wouldn’t make a lot of sense I wouldn’t think for a product with this type of impact for a client to actually on board our service without it. And so but it’s still optional for them.

John Byun

Okay. And then in terms of the potential impact, is there any way to think about the seasonality or timing? I mean, should there be some market increase in the Q4 or would you really more spread out?

Chad Richison

I mean, you do have a mandate right now, December 1. So that is something that’s out there, that all companies need to be compliant by then. And then you’re going to have the ongoing aspect of management continuing on. And so I mean, if there is a point where people want to jump on, it’s that, you might have some people jump on after they get their first DoL compliant. It just really depends.

John Byun

Okay, that's helpful. One last question. You're getting increasing success of market and just wondering if you are seeing work in ultimate more often as you move up and in what situations do you do notably better than them when you do see them?

Chad Richison

Well, we see them more often because we have more reps and more - in more cities. We’re going to see them more often because we have more at-bats and obviously, they’re in that market. But I would say, we’ve been hearing of where day in especially ultimate on a continual basis for a long time, across the board, whether we’re above the 2,000 employees range, or whether we’re in mid-market.

So I think that we’ve all kind of existed and we all kind of have our focus, but we all really exist in similar markets as far as and ultimate we do have crossover. And so we’re going to see them quite a bit. I think we’ve been very successful with onboarding and converting businesses from all of our competitors.

John Byun

Great, thanks very much.

Operator

Your next question and last question comes from the line of Ryan MacDonald with Wunderlich Securities. Your line is now open.

Ryan Macdonald

Hi, guys, congrats on the great quarter. Just kind of piggybacking off of the last question there. As we're talking about this new FLSA toolkit, last year you saw, I think in the fourth quarter, you saw kind of an early pull through of revenues or new customers adopting the solution based on ACA.

Do you think given the December 1 deadline or cutoff date for the FLSA or the new regulations, is there a potential for that? Or at least what are you seeing in the pipeline as we're going to the third quarter here? How is that reflected, if at all, in guidance for the third quarter?

Chad Richison

Yes. I mean, I would say this. One, as far as guidance even though deals that would start December 1, you’re going to get that 1/12 of the total annualized value for that on this - for December. So a major impact in the very last month, I don’t know, but as far as on boards, we are trying our best to make sure we have several people. And let people know that December 1 go live date for this.

And it’s very important for them to have this information and be able to be utilizing these tools. Whether or not, that means a lot of companies convert very quickly to something. It is a little different than ACA and that standpoint, just because ACA did have the Forms filing piece to it where you’re going to get caught quick.

This might be a situation where you might actually make a decision just give everybody the $47,000 salary. So, that you've abided by the rules but then you go back and realize that had you used good analytics and made some of them hourly, because their overtime would've put them over that, you find that - you make the decision save yourself $280,000 just by managing it.

And so someone wants to get compliant, they just raise everybody to $47,000 and make everybody hourly. But I believe in the mid-market especially, and definitely upper mid-market people that are lot more strategic than one comes to their cost and so.

We’re going to be doing everything we can to educate both clients and prospects alike on what’s coming and how we can make substantial impact on mitigating their exposure, as well as reducing their operating costs.

Ryan Macdonald

Okay. And then shifting to hiring trends, when you look at what you're hiring plan was for this year and what you've done thus far and looking to the back half of the year, can you talk about, would you say you are on plan, ahead of plan, maybe a little bit behind in terms of your ideas for what you are going to add in terms of sales headcount. As we look at the back half of the year here, can you talk about what your additional hiring plans are and maybe potential mix between, say, outside sales and client relations?

Chad Richison

Sure. We give employee count updates once a year. I can’t tell you just having been here for now 19 years that from a hiring perspective, you’re up, you’re down, you’re up, you’re down, you’re up, you’re down and then you always end up where you need to be.

So for us, we continue that throughout the year and really being methodical on when we bring people on, we’re fortunate in a couple of ways in that as we sailed deals they start. We have a pretty quick start dates. And so as we sell deals we start and so we had a little bit of notice but often times we don’t have enough notice in the pipeline necessarily to just run out and hire people and get them trained.

And so, often times you have to train those people, which Craig was talking about ahead of, which can inflate sometimes our gross margin. You've to hire and train those people ahead of then being able to catch the business and the revenue follows later.

Sometimes when the revenues follows quicker than what you have actually added employees, sometimes you can get upside down a little bit where you need to take staff and get them trained and going quickly. And so it's kind of something in our business, at least, that you’re always managing. But we’re also fortunate and that, the business comes an incremental overtime and stays with us. And so it allows us to be able to do that.

Ryan Macdonald

All right, thanks a lot. Congrats again.

Operator

And there are no further questions in the queue at this time. I would now like to turn the call back over to Paycom's CEO, Chad Richison.

Chad Richison

I'd like to thanks, everyone, for joining us on today’s call. We had an excellent second quarter and we’re energized for the second half of the year. I want to remind everybody, we’ll be presenting at the Pacific Crest Technology Conference in Vail on Monday - Tuesday August, 9 and also at the Canaccord Conference in Boston on August 10.

Thank you all and we’ll be speaking with you soon.

Operator

This concludes today's conference call. You may now disconnect.

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