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Back in May, I was bullish on Paycom Software (NYSE:PAYC) noting that while the stock was not in the bargain bin that it had some of the best S&M efficiency in the SaaS space and solid growth ahead. In a more recent earnings preview, I said I expected another moderate beat and raise for the company, but said that investors will be looking for any change in language about the macroeconomy’s impact on the stock. With the stock crashing after earnings, let’s take a closer look at the name.
Q2 Results
For its most-recent quarter, PAYC saw a 26.6% jump in total revenue to $401.1 million from $316.9 million the prior year. Recurring revenue climbed an identical 26.6% to $395.5 million. Analysts were expecting total revenue of $398.4 million.
Adjusted net income was $94.3 million, an increase of 29.2% from $73.0 million a year ago. Adjusted EPS rose 28.6% to $1.62 per share, topping the consensus by 2 cents.
Adjusted EBITDA rose 30.9% to $156.6 million from $119.6 million a year ago. The company generated $105.9 million in operating cash flow in the quarter.
Adjusted gross margin was 84.0% compared to 84.6% a year ago.
One area of like to look at with SaaS companies is their sales and marketing efficiency. However, because of the revenue boost in Q1 that PAYC sees due to processing W-2, bonus paychecks, and Affordable Care Act form filings, Q2 is always seasonally lower than Q1. Overall, the quarter was similar to prior Q2s with regard to S&M efficiency, and its trailing 12-month payback of just under one and a half years remains very strong.
PAYC S&M Efficiency (FInBox)
The company noted that it recently launched in Canada, increasing its international expansion efforts. It said as it expands its international reach that it will now be able to go after companies with more than 10,000 employees, as it continues to move up market.
PAYC also launched two new tools in the quarter - Everyday and the Client Action Center. The former gives employees the option to be paid early without fees and is designed for lower-wage employees in certain industries. The latter is an intuitive dashboard within the Paycom mobile app.
The company ended the quarter with cash of $537 million and debt of only $29 million. It also held an average daily balance of $2.2 billion for clients, which it is able to earn interest off of before it is disbursed.
Overall, this was one of the smallest earnings and revenue beats by PAYC over the past couple of years. The quarter was still solid, with revenue growth of over 26%. Notably, some of those revenue gains do come from higher interest rates, as the company is a beneficiary of rising rates, saying it earns approximately $5 million annually for every 25 basis point increase.
Outlook
Looking ahead, PAYC guided for Q3 total revenue of between $410-412 million. That represents growth of about 23% at the midpoint.
It is looking for Q3 EBITDA of between $156-158 million. At the time analysts were expecting revenue of $412 million and EBITDA of $156.7 million.
For the full year, the company forecast total revenue of between $1.715-$1.717 billion. That’s up from prior guidance of $1.713-1.715 billion. The consensus at the time was for revenue of $1.71 billion.
It projected adjusted EBITDA to be between $722-724 million. PAYC was previous looking for full-year adjusted EBITDA of between $717-719 million. The consensus was $718.1 million at the time.
Asked about demand on its Q2 call, CEO Chard Richison said:
“Demand for us is still very strong. Especially with outside sales and new bookings, we're booking larger deals. We're booking $2 million deals, $3 million deals. We hadn't booked those before. So outside sales is strong and up year-over-year. Inside sales, which sells a small business -- or smaller emerging businesses below 50 employees, is also up year-over-year. We do have a metric within our business model that sells that's down year-over-year, and that's our CRR sales. The CRR group upsells current clients. And this group has been down year-over-year. And honestly, that's because we've remained very disciplined in converting our client base to Beti. You had that first group that came on, and then we've been out selling the others. It's a lot of work for our CRR with very little revenue opportunity for them. So we've actually given compensation accelerators to incentivize the group to sell it, but it's still a smaller revenue product or billing item for us. So while self-inflicted, I mean, we are having CRR's focus on Beti. And that cost us $15 million to $20 million in bookings this year. But again, we're doing the accelerator commission for the CRRs to make up for the lower revenue. …. So while Beti is a small revenue amount for Paycom, it produces strong employee and employer advocates, which produce more leads for our outside sales group and with less than 5% of the market, we'll recapture the delayed opportunities in due time.”
Management said it wasn’t seeing any macro issues, and noted that upmarket demand was particularly strong.
Investors were clearly not enthused by PAYC’s guidance, sending the stock down -18.8% the following session. The guidance wasn’t awful, but when a stock has a robust valuation, expectations tend to be high. The company said it is not seeing any changes in the macro environment, and indicated that its guidance was more of a reflection to dedicating resources converting clients to its new Beti product, which is only a small revenue uplift. However, it does think the product helps differentiate it and makes it overall stickier. This could hurt its S&M efficiency temporarily as it increases compensation to its sales rep to convert clients over to Beti without a big revenue lift.
Valuation
SaaS companies are generally valued based on a sales multiple given their high gross margins and the companies wanting to pump money back into sales and marketing to grow.
On that front, PAYC is valued at a P/S ratio of about 9.7x based on the 2023 consensus for revenue of $1.72 billion. Based on the 2024 sales consensus of $2.07 billion, it trades at a P/S multiple of 8.0x.
On an EV/EBITDA multiple it trades at 22.1x the 2023 consensus of $732.2 million and 18.6x the 2024 consensus of $869 million.
In the past, the company has often traded at over 10x LTM sales. However, growth is slowing from around 30% a year to around 20-25% over the next two years.
Conclusion
While PAYC didn’t put up its best quarter of all time, the investor reaction to its results seems like an overreaction to me. The company still has some of the best sales & marketing efficiency in the SaaS space and is still growing solidly. Meanwhile, it is solidly profitable, and being pretty attractively valued off of EBITDA metrics.
Now the company may be benefiting from high interest rates, so a sudden reversal in Fed policy could be a risk, but currently there doesn’t seem to be any indication of that happening with Fed Chair Jerome Powell still signaling that rates will remain higher for longer. I continue to rate PAYC a “Buy” with a target of $360+, which is around 10x P/S multiple on 2024 numbers and 23.5x 2024 EBITDA, which seems reasonable given its over 20% revenue growth rate.
