Paycom Software, Inc. (NYSE:PAYC) Q4 2022 Earnings Call Transcript

Paycom Software, Inc. (NYSE:PAYC) Q4 2022 Earnings Call Transcript February 7, 2023

Operator: Good afternoon, and thank you for attending today’s Paycom Software Fourth Quarter and Full Year 2022 Results Conference Call. My name is Daniel, and I will be your moderator for today’s call. . It is now my pleasure to hand the conference over to our host, James Samford, Head of Investor Relations. James, the floor is yours.

James Samford: Thank you, and welcome to Paycom’s earnings conference call for the fourth quarter and full year 2022. 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.

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 Richison, Paycom’s President and Chief Executive Officer. Chad?

Chad Richison: Thanks, James, and thank you to everyone joining our call today. We ended 2022 with very strong results, and I’d like to thank all of our employees for the consistent hard work and execution that drove 4 consecutive quarters of revenue growth of 30% or more over the respective prior year periods. I’ll spend a few minutes on the highlights of our fourth quarter and our full year 2022 results and high-level expectations for 2023. Following that, Craig will review our financials and our guidance, and then we will take questions. Our 2022 fourth quarter revenue of approximately $371 million came in very strong, up 30% year-over-year, bringing our full year 2022 revenue to $1.375 billion, also up 30% year-over-year.

Fourth quarter adjusted EBITDA also came in very strong at $164 million, representing an adjusted EBITDA margin of 44% bringing our full year 2022 adjusted EBITDA to $580 million, representing an adjusted EBITDA margin of 42%. The sum of our 2022 revenue growth rate and adjusted EBITDA margin resulted in us hitting the Rule of 72. With our full year 2023 guidance, we are once again starting the year strong with outlook for a solid Rule of 65. As a reminder, we guide to what we can see based on our existing recurring revenue, new business sales and anticipated new starts in the near term. I’m pleased with the momentum we are carrying into the new year. On the product front, 2022 was a very strong year for Paycom benefiting from our first full year of rolling out Beti, our differentiated employee self-service payroll solution.

We are seeing strong demand trends that position us to deliver another year of rapid profitable growth in 2023. We are leading an industry transformation by making payroll and HCM processes more efficient for both employees and businesses by eliminating manual tasks, improving accuracy and reducing liability exposure caused when payroll and HCM is done in accurately. With Beti, employees are doing their own payroll by interfacing directly with their data and a self-service, easy-to-use software. A recent study conducted by Ernst & Young found that the average organization has a 20% in accuracy rate when it comes to payrolls, which results in lost revenue, hours wasted correcting errors and increased exposure to potential lawsuits and fines.

Each of these mistakes cost an average of $291 and could cost upwards of $705 for unentered nonproductive time errors. So you can see how costly these errors become over time. In fact, over the course of the year, a 1,000-employee company could potentially incur almost $1 million in unnecessary costs, correcting common payroll mistakes. Beti automates the payroll processes to deliver perfect payroll and employees are empowered to identify and correct errors ahead of time so that everybody wins. Our marketing plan in 2022 continued to perform well, delivering strong demo leads throughout the year as we spend aggressively on advertising. At the same time, our deliberate investments in marketing are delivering high-margin revenues and we saw improving operating leverage in the sales and marketing throughout 2022.

Photo by Markus Spiske on Unsplash

We continue to be pulled upmarket in 2022 with the fastest-growing revenue segment of our business coming from clients with greater than 2,000 employees. We are seeing increasing demand from larger organizations that are recognizing the opportunity to simplify their HCM needs. And Paycom is well positioned to benefit from this trend. With only approximately 5% of the TAM today, there’s still plenty of runway ahead for us to expand our market share. Paycom received national recognition from several organizations in 2022. As a workplace, we were named One of America’s Most Trusted Companies, as well as Best Company for Women, and we received a Top Workplace in Oklahoma award for a tenth consecutive year. These awards are a testament to our hard work, our thriving corporate culture and our client focus.

As of December 31, 2022, our headcount stood at over 6,300 employees, up 18% and year-over-year as we continue to have great success attracting and retaining high-quality talent to further bolster our future growth. Additionally, I want to congratulate the 2022 Paycom Jim Thorpe Award winner, Travis Hodges Tomlinson from Texas Christian University. This award recognizes the most outstanding defensive back in college football and memorializes Jim Thorpe, who is one of the greatest all-around athletes in history. Jim Thorpe also happened to be an Oklahoman. To sum up, our focus on the employee experience and client ROI continue to fuel our strong results and we are executing well. I’m very excited about the long list of new innovative opportunities we will be pursuing in 2023 and beyond.

I’d like to thank our employees for helping to make 2022 such a strong year and we are set up for another great year in 2023. With that, I’ll turn the call over to Craig for a review of our financials and guidance. Craig?

Craig Boelte: Before I review our fourth quarter and full year results for 2022 and our outlook for the first 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 ended the year with very strong results with full year 2022 revenue of $1.375 billion, up 30.3% compared to 2021. Fourth quarter results were excellent, with total revenues of $370.6 million, representing growth of 30% over the comparable prior year period. Our revenue growth was driven by strong demand, new business wins and adoption of recent new product offerings. Within total revenues, recurring revenue was $364 million for the fourth quarter of 2022 representing 98% of total revenues for the quarter and growing 30% from the comparable prior year period.

We ended 2022 with approximately 36,600 clients, representing a growth rate of 8% compared to 2021. On a parent company grouping basis, we ended the year with roughly 19,100 clients, also up 8% compared to 2021. Total number of employee records increased 14% year-over-year in 2022 to 6.5 million. Paycom’s annual revenue retention rate in 2022 was 93%, which was consistent with our recent 4-year average of 93% and up more than 200 basis points from the prior 4-year period average of 91%. Total adjusted gross profit for the fourth quarter was $312.5 million, representing an adjusted gross margin of 84.3%. For the full year 2022, our adjusted gross margin was 84.9%. Adjusted sales and marketing expense for the fourth quarter of 2022 was $87.3 million or 23.5% of revenues.

Our marketing strategy in 2022 has been very effective at driving high-quality demo leads with the revenue generated from prior period investments, we saw a 100 basis point improvement in adjusted sales and marketing expense as a percentage of revenues for the year. We plan to continue to invest in marketing in Q1 and throughout 2023. Adjusted R&D expense was $36.6 million in the fourth quarter of 2022 or 9.9% of total revenues. Adjusted total R&D costs, including the capitalized portion, were $51.8 million in the fourth quarter of 2022 compared to $44 million in the prior year period. We have a very strong pipeline of product development opportunities in 2023 that we believe will create tremendous value for our clients and for Paycom. Adjusted EBITDA was $163.9 million in the fourth quarter of 2022 or 44.2% of total revenues compared to $109.6 million in the fourth quarter of 2021 or 38.4% and of total revenues.

For the full year 2022, adjusted EBITDA was $579.7 million or 42.2% of total revenues compared to $419.3 million or 39.7% of total revenues in 2021, representing over 240 basis points of margin expansion. Our GAAP net income for the fourth quarter was $80 million or $1.38 per diluted share versus $48.7 million or $0.84 per diluted share in the prior year period based on approximately 58 million shares in both periods. For the full year 2022, our GAAP net income was $281.4 million, or $4.84 per diluted share, up 44% year-over-year. Non-GAAP net income for the fourth quarter of 2022 was $100.2 million or $1.73 per diluted share versus $64.4 million or $1.11 per diluted share in the prior year period. For the full year 2022, our non-GAAP net income was $357.2 million or $6.14 per diluted share versus $260.4 million or $4.48 per diluted share in the prior year period, up 37% year-over-year.

For Q1 and full year 2023, we anticipate our effective income tax rate to be approximately 28% on a GAAP basis and approximately 26% on a non-GAAP basis. Turning to the balance sheet. We ended the year with a very strong balance sheet, including cash and cash equivalents of $401 million and total debt of $29 million. During 2022, we repurchased approximately 365,000 shares for a total of nearly $100 million. Through December 31, 2022, Paycom has repurchased nearly 4.7 million shares since 2016 for a total of nearly $590 million, and we currently have $1.1 billion remaining in our buyback program. Cash from operations was $365 million in 2022, representing an increase of 14.3%. The new requirement in 2022 to capitalize instead of expense R&D costs resulted in approximately $27 million in additional income tax payments that would have been deferred under previous law.

This impacted both our operating cash flow and free cash flow as compared to 2021. The average daily balance of funds held on behalf of clients was approximately $2.1 billion in the fourth quarter of 2022. For 2023, we anticipate stock compensation to be approximately $120 million. On the capital expenditure front, we’re in full construction of our fifth building in Oklahoma City, and we now estimate total CapEx as a percent of revenues to be approximately 12% in 2023. Now let me turn to guidance. For fiscal 2023, we expect revenue in the range of $1.7 billion to $1.702 billion or approximately 24% year-over-year growth at the midpoint of the range. We expect adjusted EBITDA in the range of $700 million to $702 million, representing an adjusted EBITDA margin of approximately 41% at the midpoint of the range.

Once again, we are starting the year’s guidance at the Rule of 65. For the first quarter of 2023, we expect total revenues in the range of $443 million to $445 million, representing a growth rate over the comparable prior year period of approximately 26% at the midpoint of the range. We expect adjusted EBITDA for the first quarter in the range of $210 million to $212 million, representing an adjusted EBITDA margin of approximately 48% at the midpoint of the range. 2022 was a very strong year for Paycom, reflecting the strength of prior year investments and consistent execution. We will continue to invest in talent, marketing, innovation, customer service and geographic expansion to meet the strong demands we are experiencing. With that, we will open the line for questions.

Operator?

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Q&A Session

Operator: The first question comes from the line of Raimo Lenschow of Barclays.

Raimo Lenschow : Two questions. Chad, can you talk a little bit about what you’re seeing on there in terms of end demand, obviously, the markets are nervous, the kind of data points about SMB coming in that they might be weaker on some of the players in the other segments of the software market. So just talk a little bit about what you’re seeing. We’re also looking at the numbers, your renewals came in at 93 versus 94. Just kind of just paint a picture for us a little bit there. And then one for Craig, if you think about the new year and investments, like how do you think balance that kind of seeing other guys be nervous about the economy and your investment approach for the year? Just talk a little bit about the flexibility there.

Chad Richison: Yes, I’ll start off. I mean our go-to-market remains very strong. We continue to have very strong book sales, and we’ve been selling Beti across the board. New clients that come in have about 50% of their employees doing their own payroll within the first 2 months of using Beti. And so that continues to be successful. From 2015 to 2018, we had a retention rate of anywhere from 91% to 92%, was 91% for 3 of those years and 92% for 1 of those years. For the last 4 years, from 2019 through 2022, we’ve had a retention rate of 93% for 3 of the years and 94% of one of those years. There’s often rounding at play as you look through that. But what I will also say is with clients who have Beti, we have a much, much higher retention rate across our base. And I would expect retention to continue to rise as a larger percent of our current client base deploys Beti.

Craig Boelte : Yes, Raimo on the plan for 2023, we’ve given our guidance on our adjusted EBITDA. And it’s still a very strong guide on that as we’re looking at 41%. So we — as I mentioned in the prepared remarks, we’re going to continue to spend on the marketing side, the R&D side and then in the service side as well. And really, the marketing is the one area where we can pull leverage. We don’t have any long-term commitments out there. So that is an area where we could pull levers if we needed to.

Operator: The next question comes from Samad Samana of Jefferies.

Samad Samana : Great. I guess first one, Chad, did I hear you say — I think you said you had just north of 6,300 employees. I think that’s high teens growth over the prior year. I’m just curious how we should think about the hiring in context of it’s slightly slower than it was in 2021. I’m just curious, is it that we’re — should you expect just productivity to increase? Maybe what the exit rate on that growth rate is and just how we think about the hiring trends for Paycom itself?

Chad Richison: Yes. I mean, we hired what we look to hire last year. I believe our growth was around 18% in hiring. We definitely have a more efficient client. I’ve been talking about for quite some time, who we kind of have the haves and the have-nots when you look across our client base with those clients that have already deployed Beti and are getting strong usage out of it. We’re just — we’re having to do less for them. I mean we’re having to fix less things. We’re having to do less adjustments, and so they’re just much more efficient. And so we don’t need as many people when people are using Beti. That said, we had a very healthy growth in our employment last year. And so I believe we had success with that.