Earnings Call: Q3 2014

Nov 4, 2014

Hello, and welcome to the Paycom Third Quarter Fiscal twenty fourteen Results Teleconference. All participants will be in listen only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. At this time, I'd like to turn the conference over to Mr. Craig Belte, Chief Financial Officer of Paycom. Mr. Belte, you may begin. 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. When we believe any forward looking statements we have made are reasonable, actual results could differ materially because the 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 filed with the Securities and Exchange Commission on April 15, 2014. You should refer to and consider these factors when relying on such forward looking information. 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 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 also located on our website at www.paycom.com. I will now turn the call over to Chad Richison, Paycom's President and Chief Executive Officer. Chad? Thanks, Craig, and welcome to everyone joining us today for the call. We had strong financial results for the Q3 of 2014. Our total revenues of $36,600,000 grew 42% from the comparable prior year period. Highlighting our success, annualized new recurring revenue or ANRR was a record $14,900,000 in the Q3 of 2014, up 52% from the comparable prior year period. As a reminder, ANRR is the annualized amount of the 1st full month of already onboarded new recurring revenue and we view it as a robust indicator of our future revenue. Our ANRR growth is a testament to both our new client wins and also our ongoing success in bringing on larger clients. It reflects the growing demand for our industry leading software solution. We've made great progress so far in 2014, checking off several of our goals as we strive to become the leader in the payroll and human capital management industry. From our 5 new sales teams to our ongoing application introductions and enhancements and our initial public offering, our momentum is strong and growing. We are taking active steps to ensure that this momentum is sustained through the Q4 and beyond. Regarding our cloud based SaaS solution, we are relentless in our efforts to ensure that our solution remains best in class. We continue to drive our software development in the Q3 of 2014 with adjusted R and D increasing approximately 100% on a year over year basis. Our software efforts are helping drive our results. We continue to see examples of clients turning to Paycom when competing offerings lack the functionality and ease of use our solution has. I'd like to spend a few minutes discussing an upcoming enhancement to our solution that we believe will drive substantial value to our current and future clients and also drive growth for Paycom. As you know, the Affordable Care Act or ACA was a transformative piece of legislation in this country. The requirements imposed on individuals and organizations are significant. At Paycom, we quickly realized that our clients had many questions about how to obtain and maintain compliance with the ACA. Our early responses made Paycom a trusted resource for the ACA in the payroll and human capital management industry. We've been a leader for some time in providing education and timely information to our clients and HR professionals alike. More and more businesses are turning to Paycom for expertise in navigating the ACA. In addition to being a trusted resource of ACA information, we also provide solutions. And because of our proprietary SaaS platform, we're able to change and update our applications to meet the ever changing employer mandates. In fact, I'm pleased to share with you that this Thursday, we are releasing an industry leading ACA solution. This comprehensive solution will encompass robust functionality, empowering employers to navigate one of the single largest changes to the healthcare system our country has ever seen. Paycom's new and existing clients that utilize our payroll, time and attendance, benefit administration and HR management applications have the resources they need to be fully compliant with all ACA employer mandated requirements. With this functionality, the clients will be able to deploy the information needed in order to remain ACA compliant. We believe our answer to the ACA mandate is unparalleled. This upcoming development is just one of the ways that our R and D investments are resulting in innovation. Paycom is helping HR professionals evolve into a strategic role and become a valued resource to the C suite. In our experience, we are seeing that potential clients cannot find the functionality they require with competing offerings. If you want an easy way to do it all, including a full service payroll option, Paycom is the best solution. This value proposition is resonating with current and prospective clients as evidenced by our 52% ANRR revenue growth. I would like to share with you a few examples of some new client wins from the Q3 that illustrate the breadth of the appeal of the Paycom SaaS solution. These new clients held from very different industries and geographies indicating the broad success we are experiencing in the marketplace. First, we signed a parking solution provider with nearly 2,000 employees, converting them from one of our large competitors. This client had been maintaining 5 separate systems. They were excited to switch to Paycom as they were looking for an innovative partner that can grow alongside them. Next, we added a restaurant chain with multiple locations and close to 2,000 employees. This client had been handling their payroll and HR needs with an in house solution. The risk mitigation and clear benefits from automation were appealing to this client. Finally, we were excited to bring a regional health insurance provider with over 1500 employees onto the Paycom solution. This company was utilizing 1 of the other SaaS provider solutions and was having issues with maintaining and integrating disparate data and systems. We are particularly proud of this last deal as it was generated by 1 of the 5 new sales teams we recently launched beginning of this year. And this shows how quickly our teams can get up to speed. In addition to our leading SaaS solution, our go to market strategy is one of the keys to our success. The success of our sales organization continues to improve as we become more seasoned and as word spreads regarding the power of our solution. As an example, our Tulsa, Oklahoma team is on pace to achieve nearly 2,500,000 in ANRR this year. This achievement is even more remarkable when you consider that the city of Tulsa has a population of approximately 440,000. When you compare that to a city like New York, where we currently have a single sales team just now reaching maturity, we believe the runway for adding new teams to current cities is long and the potential for growth of mature teams is also substantial. We also have had consistent success with our new sales teams. We are continuing that trend and are laying the groundwork for additional new sales team launches soon. We have deployed our office group to sign leases and they are setting up office space for the new sales teams we will be announcing very soon. It is our strategy to deploy as many sales teams as we can to provide a platform for our future growth. We will do this while also sustaining our current growth and just as importantly remaining profitable. And on a more personal note, I want to mention that I've spent some time visiting our sales teams around the country. I am pleased to report that the excitement level in the field is strong and growing. Our sales associates recognize that they are armed with a highly compelling solution and are in front of a sizable opportunity consisting of 1,000 of potential clients, all of whom can benefit from the capabilities of the Paycom solution. We are continuing to ensure our sales team members have the most powerful ammunition as evidenced by our upcoming ACA offering as well as several other enhancements to our solution. In conclusion, our forward progress continued in the Q3 of 2014. Clients are embracing our solution with enthusiasm. Our 42% revenue growth as well as our outperformance in ANRR with 52% growth is evidence of this success. Additionally, our software development productivity was impressive. We are optimistic as we look to execute against our opportunity for continued growth and to lead the payroll and human capital management industries with our cutting edge cloud based solution. We continue to believe that our ability to provide a comprehensive human capital management offering created and hosted off a flexible single database architecture is a key differentiator for Paycom. With that, I will now turn the call over to Craig to discuss our financial results. Thanks, Chad. Before I review our fiscal Q3 results and our outlook for the Q4 and fiscal 2014, I would like to remind everyone that my comments related to certain financial measures will be on a non GAAP basis. Adjusted EBITDA and non GAAP net income are non GAAP financial measures that exclude stock based compensation and other non recurring charges, including transaction expenses related to our initial public offering. A reconciliation of our GAAP to non GAAP results is included in a table on our press release. As Chad highlighted, we saw continued robust growth in the 3rd quarter. Total revenues were $36,600,000 representing year over year growth of 41.7% from the comparable prior year period. While our growth was primarily driven by new client additions by our mature sales teams, we're also starting to see additions from our more recently opened sales teams. Additionally, we continue to increase the average revenue per client as we continue to onboard larger clients. Within total revenues, recurring revenues was $35,900,000 representing 98% of total revenues for the quarter and growing 42.4% from the comparable prior year period. ANRR was $14,900,000 up from $9,800,000 in the same period last year and representing 52% growth from the comparable prior year period. Total adjusted gross profit for the Q3 was $30,200,000 representing an adjusted gross margin of 82.4%. This compares to 79.3% in the Q3 of 2013. As we have detailed in prior calls, our cost of revenue consists largely of hosting and support costs along with employee related expenses for client support and ACH fees. The sequential improvement in gross margin was largely driven by cost disciplines across most of the inputs that make up our total cost of sales. While we recognize the gross margin improvement for the Q3 of 2014, we also recognize the need to stay ahead of the growth on a staffing basis. We invested heavily at the beginning of the year to account for new sales team growth. And as Chad mentioned, we are preparing for new sales teams in the upcoming months. And we will meet to staff appropriately to handle the anticipated new business. As such, we expect overall gross margin to be similar to historic levels going forward. Turning to operating expenses. As a reminder, we pay commission to our sales reps based solely on new sales at the time of their 1st monthly billing cycle. This is a one time commission pay, which we recoup over the life of the client relationship. For the 3rd quarter, total adjusted administrative expenses were $25,400,000 This compares to $18,000,000 in the Q3 of 2014. As Chad mentioned, we are continuing to increase our software development staff. We continue to invest heavily in technology with adjusted research and development expense increasing 100.6% from the comparable prior year period. Adjusted EBITDA was $6,600,000 or 18 percent of revenue compared to $3,800,000 or 14.6 percent of revenue in the Q3 of 2013. From time to time, you will see variability in our adjusted EBITDA margin as we continue to invest for growth. Regarding the Q3 of 2014, we are starting to absorb cost of new sales teams. Non GAAP net income was $2,700,000 or $0.05 per diluted share based on 53,000,000 shares versus a breakeven net income or 0 per diluted share based on 46,000,000 shares in the year ago period. Turning to the balance sheet. We ended the quarter with cash and cash equivalent of $18,500,000 and debt of 27,200,000 dollars As a reminder, this debt represents the financing on our corporate headquarters. With that, let me turn to guidance for the Q4 and for fiscal 2014. For the Q4 of 2014, we expect total revenues in the range of $40,000,000 to $41,000,000 representing a growth rate of 30 3.7% at the midpoint. We expect adjusted EBITDA in the range of $5,500,000 to 6,500,000 dollars representing an adjusted EBITDA margin of 14.8 percent at the midpoint. For fiscal 2014, we expect total revenue to be between $147,000,000 to $148,000,000 or 37.1 percent year over year growth at the midpoint. We expect adjusted EBITDA in the range of $25,000,000 to $26,000,000 representing an adjusted EBITDA margin of 17.3% at the midpoint. In summary, our momentum continued into the Q3 and we anticipate ongoing success through the rest of the year as we leverage our investments in R and D and sales and marketing and strive to deliver revenue growth. With that, we will open up the line for questions. Operator? Our first question comes from Raimo Lenschow at Barclays. Hi, guys. This is Harry for Raimo. Thanks for taking the question and congrats on a good quarter. I have a couple of questions. I guess I would just start off by asking, how are you guys what kind of traction are you seeing and success are you seeing with your non payroll modules? Thanks for the question, Harry. This is Chad. We do see it as one solution as we've discussed earlier. The longer we've had a module out, the more success we have not only selling it, but also implement it in increased use. So we continue to drive all products or all modules into the client base. And good client feedback and from a competitive standpoint otherwise happy clients? Yes. I mean, you have to continuously develop the modules. I mean, as you put them out initially, I mean, version 7 is always better than version 1. We've learned a lot over the years in how we've released these modules. We've taken a lot of knowledge from that in the past and we continue to work on all modules. And can you guys give a little bit of an update on your plans for new offices that you've talked about a little bit in the past? Yes. So our goal is to continue to penetrate both existing cities as well as open new cities with sales teams. As I mentioned in the past, we do take existing sales managers who are proven. We relocate them to a new city or in a current city where we're going to add a new team, as I mentioned earlier, like a city like New York. And then we backfill them with an up and coming sales executive who's ready to be in management. We've identified several managers who are ready to relow as well as several backfills to be able to backfill those positions. And as I mentioned in the call earlier, we are currently we have deployed our office sales team setup group. We are in the process of negotiating leases and getting those prepared to be able to launch sales teams. Got it. And the 5 new sales teams that you guys added this quarter, were those existing city expansions or new cities? So we did not add 5 sales teams this quarter. Those are the 5 sales teams added earlier in this year Q1 of this year. They are doing well. And we did have at least one of the examples I mentioned of 1 of our current sales did come from one of those new sales teams, but they're trending nicely. Got it. Great. Thanks. All right. Thank you. The next question comes from Richard Davis at Canaccord. Hey, thanks very much. So 2 kind of just pretty straightforward questions. 1, when we've kind of talked to companies or customers that use your product, ease of use always kind of comes out as a key factor. And I know it's about the back end database, but is there anything on the front end that you're doing to make it easier to use because it's always ease of use is always kind of a neat thing. So just more on the software development side of the house. And then you talked about kind of adding people. The second question would be is are you because when I talk to a lot of companies like, man, it's hard to find people. You guys are doing a good job on that. Could you just kind of triangulate around finding good people? I mean, obviously, you're doing a good job there. Would you help me out on that? Thanks. Sure. Okay. So on the first question, it's really, I think, understanding not only why prospects buy, but also how they're going to use innovation. It's no it's being able to sit down and watch people actually use the system. We're users of our own system. We do actually invite clients in. We watch them use the system. And we're active in soliciting as well as documenting client feedback to make ease of use a key. The easier a system is to use, the more they're going to use it and the stronger overall solution we've provided. As far as good people, a lot of what Paycom and a lot of what we've done in the past is hire good people and give them the proper training and support they need to grow. And so from that, we're able to find good educated people that want to come in and be a part of our organization. And so really for us, it's finding good people that care, who are educated and wish to be a part of this team. And then from there, we give them the tools to do the proper training and support as well as management needed to grow their career. Excellent. Great. Thank you so much. Thank you. The next question comes from Brandon Barnickel at Pacific Crest Securities. Thanks so much. Chad, I'm interested in your commentary on the ACA solutions. And I'm curious as to what people are doing now otherwise and what your competitors are even trying to offer in place of this given how much it is changing? Yes. So and I appreciate you stating that the fact that ACA is it actually is still changing and there's still regs that we're looking for. A part of the ACA goes into effect 2015 with reports due 2016. There's a piece of it that goes into effect in 2016 for 2017 and then even another in 2018. And even the range changes for who complies with what piece as far as the payer play component. And so we've done a couple of things. Number 1, it's important to mention that a lot of the information needed comes out of both a time and attendance system, because ACA is really based on hours worked to identify who those are, who are full time employee and full time employees, so that we know which employers are even eligible. As well as there's a component for making the health care affordable. And in that case, you need to know how much an employee's premium is as far as what they're responsible to pay, coupled with how much the employee makes. And so and then there's documentation of this, including the notice of the exchange from the beginning and that's notifying employees that they're even eligible for the ACA. And so with the Paycom system, we were actually able to take 3 of our modules that we have currently. And really, if clients have already implemented our time and attendance benefit administration and have our document storage system and onboarding process, they're really able to take that and there's very little they're going to need to do to be able to maintain it because we're able to grab the information from the same system and provide the reporting. Now for those clients that may not have all of those systems and maybe they haven't chosen to implement those systems yet, we have developed a system that's actually coming out Thursday, which will allow them to input the information that does not currently exist because they're not using that piece of the system. That will grab the pertinent data that we do have out of payroll and allow them to comply with the ACA mandate. Regardless of which path someone chooses, at the end of the day, Paycom will be helping clients with their Form 1095 for employees, which will be due in February 2016 for everything done through for the year of 2015 as well as the employer copy 1094. And so there's a lot of moving parts. There's if you don't play, you're penalized and there's payments and there's collecting money for that and remitting it to the IRS. We're still waiting on regs on that even for who that's remitted to and how that's remitted. So anyway, I'll stop there. But there's a lot going on with ACA and we feel like what we're providing strong. Great. That was helpful color. And Chad, and maybe this is more a question for Craig. The ANRR was impressive at 52% year on year growth. We only have limited numbers going back. When was the last time you guys saw that kind of growth level? I mean that's definitely one of the largest growth year over year that we've seen in the past. As we reported last quarter, we were in the 40% range on that. So this was a very impressive quarter for growth. And you highlighted some of the reasons why it was better in terms of the additional products. But in terms of how we think about it, the growth trending, should we be thinking of this more as a 50% versus a 40% type grower? It can have some variability from quarter to quarter based on when deals come on. But the 50% growth rate was a very impressive number for this quarter and we look forward to continuing to bring on new business. Terrific. Thanks guys. Thank you. Our next question comes from Brad Reback at Stifel. Hey, guys. Thanks a lot. On the ACA solution, will the gross margin on that product be similar to the rest of your portfolio? Yes. I mean, I would say, I mean, for sure it will be similar to the rest of our portfolio. I mean, payroll is the hardest thing we do, as far as keeping up with all the tax laws and what have you. And payroll has other components involved, depending on which state we're filing taxes with and what they'll actually accept. We're going to we're learning a lot more about ACA as far as how it's deposited and penalties may be deposited and how it's all filed and reconciled. But we would expect this to be a high gross margin product as we've developed it to be. Great. And just one follow-up unrelated. Any reason to think that you won't have more sales teams added in 2015 than you did in 2014? Thanks. Well, that's a loaded question there. We're definitely always trying to accelerate our growth in all areas. And as opportunities present itself, I mean, we're looking to capture them. Right now, we're talking with our existing sales management staff to identify who's ready to relocate and start these new teams and then be able to actually backfill them with a strong bench we have ready to do that. And so as we've identified these people, we'll start opening these cities. But we do believe we're ready to begin opening several here very soon. Great. Thanks a lot. All right. All right. Well, thanks everybody. I want to thank everybody for participating in today's call and we look forward to speaking to everyone again next quarter. Thank you. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.