Paycor HCM - Q1 2023

Transcript

Operator (participant)

Ladies and gentlemen, thank you for standing by, and welcome to Paycor's first quarter fiscal year 2023 earnings call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star then zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the call over to Rachel White, Vice President of Investor Relations. Please go ahead, ma'am.

Rachel White (VP of Investor Relations)

Good afternoon, and welcome to Paycor's earnings call for the first quarter of fiscal year 2023, which ended on September 30th. On the call with me today are Raul Villar Jr., Paycor's Chief Executive Officer, and Adam Ante, Paycor's Chief Financial Officer. Our financial results can be found in our press release issued today, which is available on the investor relations section of our website. Today's call is being recorded, and a replay will be available on our website following the conclusion of the call.

Statements made in this call include forward-looking statements related to our financial results, products, customer demand, operations, impact of COVID-19 on our business, and other matters. These statements are subject to risks, uncertainties, and assumptions and are based on management's current expectations as of today and may not be updated in the future.

Therefore, these statements should not be relied upon as representing our views as of any subsequent date. We also will refer to certain non-GAAP financial measures and key business metrics to provide additional information to investors. Definitions of non-GAAP measures and key business metrics and a reconciliation of non-GAAP to GAAP measures is provided in our press release on our website. With that, I'll turn the call over to Raul.

Raul Villar Jr. (CEO)

Thank you, Rachel, and thank you all for joining us to discuss Paycor's fiscal first quarter results. Revenue growth reached 28%, the highest level in over five years as we expand our go-to-market motion. We also continue to scale our operations and delivered more than 500 basis points of margin improvement year-over-year. Based on this strong momentum, we are once again raising our guidance, which Adam will cover in more detail.

We are executing against our go-to-market strategy and continue to make significant progress expanding our sales coverage and growing PEPPM. Competitive dynamics have been consistent, demand remains strong, and we had our best Q1 on record. We continue to target increasing sales headcount over 20% for the fiscal year. With established sellers in all Tier 1 markets today, our ongoing focus is on expanding coverage in Tier 1 markets.

With the opportunity to more than triple our sales team, we have significant runway to add sellers for the foreseeable future. While it's still early, we are really pleased with how both the Bengals and Pac-12 sports sponsorships are increasing brand awareness and ongoing new business development. Paycor's modern open platform is purpose-built for leaders and configured by industry, a combination that continues to win in the market. A recent Gartner survey identified leader and manager effectiveness as a top priority among CHROs for 2023.

This quarter, we are excited to announce two key differentiators for leaders, the COR Leadership Framework and Talenya's award-winning candidate sourcing technology. The COR Leadership Framework empowers organizations to transform frontline managers into effective leaders. The framework is built on the understanding that effective leaders focus on coaching employees, optimizing performance, and retaining top talent.

We provide organizations with the means to evaluate the efficacy of their frontline leaders and the tools and thought leadership needed to improve leader performance. We continue to add leapfrogging innovation to our HCM suite and are thrilled to have acquired Talenya's intelligent candidate sourcing technology to enhance our industry-leading talent solution.

The AI-powered recruiting technology will be unified into our platform, making it easier for frontline leaders to find skilled and diverse talent quickly and at significantly lower costs. Talenya's solution stands out in that it is fully automated and easy for frontline leaders to use. In today's war for talent, Talenya not only sources candidates that are actively looking to change jobs, but more impressively, passive candidates that are not actively seeking a new role.

The technology will also help companies execute against their DE&I strategy by placing an emphasis on diverse candidates that are often overlooked by traditional recruiting systems. This acquisition builds on our successful track record of rapidly integrating best-in-class point solutions that provide a competitive advantage and expand our PEPPM opportunity. These advancements showcase the versatility of our product strategy. Our modern platform enables us to select whether to build, buy, or partner to add valuable functionality, options that are increasingly valuable as we focus on leapfrogging technology to further differentiate Paycor in the market. As further proof of our product differentiation, we earned the Platinum 2022 TITAN Business Awards in the business intelligence solution category for Paycor Analytics.

We are increasingly focused on providing leaders with intelligent analytics that deliver valuable insights to drive business performance. For example, predictive resignation provides leaders with insights to identify the top drivers of employee resignation and potential at-risk employees to help prevent turnover. In addition, we provide many analytics that are critical to helping our key industries manage time and labor, such as overtime or schedule analysis by tenure.

In September, we published our first ESG report describing Paycor's commitment to sustainable business practices and ongoing efforts to address material ESG topics. I am particularly pleased we increased the representation of females in leadership and ethnic diversity among our associates by 8% and 13% respectively, and reduce our Scope 1 and Scope 2 emissions by 14% year-over-year.

We are incredibly proud Paycor won 2022 Top Workplaces Culture Excellence Awards in diversity, equity and inclusion practices, innovation, and compensation and benefits categories by Energage. This is the second consecutive year Paycor has been recognized for DE&I excellence. Over the past fiscal year, Paycor has continued to advance its DE&I strategy, enhance associate rewards, expand benefit options, and drive innovation. In terms of the labor market, dynamics remain unchanged.

Nonfarm payrolls have slowly risen to pre-COVID levels. Job openings remain at elevated levels and the labor market continues to be tight. Modest changes in unemployment or job openings are unlikely to materially impact our business as most of our revenue growth is derived from new logo additions and the market is still very early in adopting modern cloud-based HCM solutions.

Plus, HCM is highly defensible as our value proposition is mission critical to attracting, paying, and retaining great talent. Lastly, I would like to thank all the amazing Paycorians who are the foundation of these amazing results. With that, I'll turn the call over to Adam to discuss our financial results and guidance.

Adam Ante (CFO)

Thanks, Raul. I'll review our first quarter results, then share our outlook for the second quarter and fiscal year. As a reminder, my comments related to financial measures are on a non-GAAP basis. Total revenue for the quarter was $118 million, increasing 28% year-over-year, our highest on record. Excluding the impact of interest income, recurring revenue grew by 24%. We exceeded the top end of our revenue guidance by 4% and significantly outperformed our adjusted operating income guidance through diligent investment management. Revenue growth was primarily driven by new business and cross sales, PEPPM expansion, strong execution of pricing initiatives, and growth of our partner program. Pricing initiatives include conversion of clients to our newest product bundles and continued higher adoption of our bundles at the point of sale.

The number of employees on our platform increased to more than 2.3 million, up 10% over the prior year. Our average customer size increased to 78 employees at the end of Q1, compared to 73 a year ago as we continue to focus our investment in the mid-market and accelerate growth among clients with more than 100 employees. Net retention trended favorably, benefiting from price initiatives and continued cross sales.

Adjusted gross profit margin improved to 66.3% versus 65.2% a year ago. Adjusted gross margin excluding depreciation and amortization was 76.8%, an increase of nearly 2 points year-over-year. The expansion was a result of increased scale across our support team and lower third-party costs. Sales and marketing expense was $40 million or 34% of revenue, slightly below 35% a year ago.

Based on the continued demand and attractive returns we're seeing, we continue to invest in our sales expansion strategy and marketing programs to drive new business growth and capture market share, primarily in tier one markets. On a gross basis, we invested $19 million in R&D or 16% of revenue, slightly lower than 17% a year ago and in line with our long-term targets. Our team continues to efficiently add new functionality through organic development, partnerships, and best-in-class product touch points that create value for our clients and expand our PEPPM opportunity. G&A expense was $18 million or 15% of revenue, down from 18% in the first quarter of 2022. We intend to progressively drive G&A down as a percentage of revenue as we scale the business, consolidate our facilities footprint, and anniversary public company costs.

While our primary objective remains sustainable 20%+ revenue growth, we intend to steadily expand margins as we scale the business. This quarter, we increased operating income to $10.4 million or an 8.8% profit margin, more than double the 3.7% last year. The greater than 500 basis point expansion enabled us to deliver adjusted EBITDA margins of 24%, and when combined with our 28% revenue growth, exceed the rule of 50 this quarter. Shifting to the balance sheet and cash flow, this quarter free cash flow was a -$30 million compared to a negative $24 million last year. The first quarter tends to have the largest use of cash due to the timing of our annual bonus payment.

In addition, this quarter we made our first naming rights payment, which covered the full year and will be made quarterly moving forward. However, we plan to be free cash flow positive for the full fiscal year and going forward. We ended the quarter with $98 million in cash and no debt. This quarter, we generated $4 million of interest income on average client funds of approximately $920 million. As overnight rates began benefiting from recent Fed rate increases, our overall effective rate more than tripled to 178 basis points this quarter, compared to 52 basis points last quarter.

Interest income exceeded our expectations as overnight rates reflected Fed fund raises faster and more completely. Turning to our outlook for fiscal 2023, we continue to be positive about the momentum in the business, strong demand environment, and Paycor's leadership position in the HCM market. The labor market has remained tight, and while we continue to closely monitor the macro environment, we have not seen any material impact to our business.

Our guidance assumes these trends continue for the remainder of the year. While we are enthusiastic about integrating Talenya's innovative technology into our platform and expanding our PEPPM opportunity, we expect it to be immaterial to the financials this fiscal year. We generated about 180 basis points of interest income in the first quarter and expect that rate to increase further in the second quarter.

At today's rates, we anticipate interest income will be in the range of $20 million-$24 million for the full year on average client fund balances of just under $1 billion. We currently plan to reinvest about half of interest income into either accelerate our product roadmap or expanding our marketing programs to support our sales expansion. For the second quarter, we expect total revenue of between $126 million and $128 million or 24% growth at the high end of the range, and adjusted operating income of between $12.5 million and $13.5 million. For the full year, we expect revenue of $528 million-$534 million or 24% growth at the top end of the range, and we anticipate adjusted operating income of $65 million-$68 million.

In summary, we continue to deliver strong top-line growth while expanding profitability. We are winning share in the SMB segment through our differentiated platform focused on leaders and industries. Our team is laser focused on execution, Tier 1 market penetration, and continued PEPPM expansion. With less than 2% share of our $29 billion total addressable market, we have significant runway for continued growth and remain enthusiastic about the trajectory of the business. With that, we'll open the call for questions. Operator?

Operator (participant)

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star and then one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star and then two if you would like to remove a question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please while we poll for questions. Our first question is from Gabriela Borges of Goldman Sachs. Please go ahead.

Speaker 7

Hi, this is Kevin on for Gabriela. Thanks for taking my question. I wanted to ask about ramping of sellers hired last fiscal year. What are you seeing in terms of early trends in terms of the time they're at ramp, particularly in the Tier 1 markets? Thanks.

Adam Ante (CFO)

Yeah. Hey, thanks. We're seeing, you know, what we like to track is we like to track those sellers on a cohort basis and look at the sellers who've been here for four quarters or five quarters to compare them to previous cohorts. You know, it's still really early, but we're adding closer to 70+ sellers in each of those cohorts and they continue to perform, you know, like they have historically. We'd love to always, you know, there's always room for improvement, but we've seen good performance out of those larger cohorts that we've been hiring more recently for sure.

Speaker 7

That's helpful. Then Adam, can you talk a bit about the levers for gross margin expansion going forward, particularly as you broaden the HCM suite and as PEPPM continues to increase?

Adam Ante (CFO)

One of the things that we see is that when you add additional products and when clients are buying more products from us, they're more effective and the gross margin increases. For new products like our talent management solution, you just don't have to put the same level of service in terms of calls and callbacks to management and service operations that you do with payroll. Payroll is the largest part of our service and service operations.

When we add these additional products, it really helps to drive additional margin. As well as we continue to go into the larger segments out of the micro segment, we do see that those clients, you know, they tend to buy a little bit more. They tend to be more effective in the way that they use the product. The margins tend to come out a little bit better. That's gonna be the primary driver.

Speaker 7

Great. Thank you.

Operator (participant)

Our next question is from Terry Tillman of Truist Securities. Please go ahead.

Speaker 8

Great. Thanks so much for taking the questions. This is Robert Gion for Terry. Hoping to get a little more detail and an update into the micro segment. Can you remind us on the mix of business there, is that segment a hold steady or perhaps becoming small from growth with bigger mid-market customers? And how are you all thinking about the segment in terms of overall economic sensitivity? And then I have one follow-up. Thanks.

Adam Ante (CFO)

Yeah. I mean, it's really just not material that marginal moves in that micro segment. It represents about 5% of our total portfolio in terms of revenue. We have seen that that's slowed down in terms of the growth of the companies in that segment as we are intentionally, you know, not investing quite as much in that under-10 segment. But we do continue to drive revenue growth actually in that segment. It's held fairly steady in terms of that, you know, 5% of total revenue or so. I'd say in terms of the sensitivity, we do expect that sort of in the larger ends, you know, the micro segment and then the large enterprise segment is where we would see maybe more sensitivity to macro changes.Again, it's just so marginal in terms of its overall impact on our portfolio. Even large swings wouldn't really impact us.

Speaker 8

Makes sense. Thanks. Then just as a quick follow-up. Last quarter, I believe y'all mentioned strong growth, across industries, particularly in the restaurant and food services segments. Is that momentum still continuing, or have, any other specific verticals taken more of the spotlight this quarter? Thanks.

Adam Ante (CFO)

I mean, that trend has continued. It is sort of dependent on, we don't seasonally adjust our hiring or employee count, so you do see slightly more growth in sort of the seasonal peaks and whatnot. Those trends have continued and they have performed sort of outsized and in line with what you'd see in the broader market as well as hiring has continued to be tight in the labor market more broadly.

Speaker 8

Great. Thanks so much.

Operator (participant)

Our next question is from Bryan Bergin of Cowen. Please go ahead.

Speaker 9

Hey, it's actually Jared on for Bryan tonight. In terms of the Q2 adjusted gross margin, if you remove flow there, it looks like it was flat year-over-year. Was that in line with your expectations, and what are you expecting for the full year for adjusted gross margin?

Adam Ante (CFO)

Yeah. We haven't guided to adjusted gross margin on a full-year basis, but we actually did drive some expansion if you back out interest income and look at it on a recurring basis. We did still drive some expansion across the board, so across adjusted gross margin as well as adjusted operating income. Again, I really think the best metric to look at for our gross margin is excluding depreciation and amortization. We drove multiple points of expansion there, even without the benefit of interest income. That's, you know, that is our long-term goal is to continue to drive expansion across the business. Like I said, we haven't guided specifically to gross margin improvement, but we're gonna continue to look at that as an opportunity.

Speaker 9

Okay, great. In terms of that updated full year flow revenue guidance, does that include the most recent Fed funds rate hike from today or any additional rate assumptions there?

Adam Ante (CFO)

No, it includes the 75 basis points from today, and it doesn't include any potential future raises.

Speaker 9

Great. Thank you.

Adam Ante (CFO)

Thanks, Jared.

Operator (participant)

Our next question is from Mark Murphy of JPMorgan. Please go ahead.

Ari Jacobson (Senior Associate)

Hey, guys. Thanks for taking the question. This is Ari on from Mark Murphy. Just a quick question on Talenya. It looks like an interesting acquisition. In terms of the focus of the company there, is that kind of focused towards any particular customers, maybe frontline workers, blue collar, white collar, et cetera?

Raul Villar Jr. (CEO)

Yeah, it primarily today focused on professional services. I think, you know, we'll continue to leverage that in our professional services and healthcare verticals. I think over time, we'll be able to also identify more use cases for, you know, hourly employees to identify hourly employees more effectively.

Ari Jacobson (Senior Associate)

Got it. Thanks. In terms of the NRR, you guys said that kind of moved favorably. Any commentary on gross retention? Is that something you guys expect to improve as you guys move up market?

Adam Ante (CFO)

Yeah. Yeah. I mean, I definitely think that we expect gross retention to continue to improve. It's been relatively stable, and, you know, for some time now, and even while we've been driving net retention improvements. Those have been continuing and remain strong, coming into 2023 now.

Ari Jacobson (Senior Associate)

Got it. Thank you.

Operator (participant)

Our next question is from Bhavin Shah of Deutsche Bank. Please go ahead.

Bhavin Shah (Director and Software Equity Research Analyst)

Great. Thanks for taking my question. A couple quick ones for me. Just first on the sales front, I mean, you guys talked about adding another 20% growth in sellers. How should we think about the linearity of sales hires over the course of the year? And what does the hiring environment look like today in terms of finding talent?

Raul Villar Jr. (CEO)

Yeah. We map out hiring. We obviously will hire the majority of the people in the first half of this fiscal year that are in our planned budget growth. That will enable us to get some minor contribution in the fourth quarter, but to have those people fully ramped up for FY 2024. We've seen no issues identifying, recruiting and hiring sales associates. We feel really good about our staffing position in sales today.

Bhavin Shah (Director and Software Equity Research Analyst)

That's very helpful. Then just on your, some of your recent sponsorships, you kind of noted increasing top of funnel. What types of customers and prospective customers are you able to bring in? Are there certain types of size clusters? Are they more regional focused? Any kind of additional insight there, and kind of how are you thinking about this kind of avenue of marketing going forward?

Raul Villar Jr. (CEO)

Yeah, I think there's two key elements to consider. First is just overall brand awareness. Obviously, we're still trying to build brand awareness nationally as we expand our sales coverage. In the first quarter alone, we had more digital impressions, over 1 trillion, than we did all of last year as a company. I think the sponsorships are serving their purpose and really creating, you know, air cover for our sales team as we continue to build awareness and expand coverage. As far as the actual conversion, I think what we've done a great job of is leveraging both, you know, the both sponsorships with game day activations.

What we're doing is, you know, we're seeing significant presence by bringing, you know, large prospects and influence centers to, you know, the activities, and that's, you know, proven to be a winning formula for us. We're really optimistic about the opportunity to continue to drive bookings growth based on these sponsorships. Our early indicators are really favorable and we're excited to finish both the Pac-12 football season and the Bengals season. We're leveraging both home games and away games for the Bengals, so it's more than just a Midwestern influence, and I think that's been exciting for us as they've had games this year, you know, in New York and Dallas and some of the large Tier 1 markets that we're trying to further penetrate within.

Bhavin Shah (Director and Software Equity Research Analyst)

Makes kind of sense. A quick follow-up on that for Adam in terms of the cash flow dynamics. If I'm clear, you had an annual payment this year, and then every other year it'll be more quarterly or are there still quarterly payments to be paid this fiscal year?

Adam Ante (CFO)

No, we made the payment for the first full year for the fiscal year already. Beginning in 2024, they will be quarterly going forward.

Bhavin Shah (Director and Software Equity Research Analyst)

Perfect. That's what I thought. I just wanted to clarify. Thank you guys for taking my questions.

Adam Ante (CFO)

Yep.

Bhavin Shah (Director and Software Equity Research Analyst)

Yeah.

Operator (participant)

Our next question is from Scott Berg of Needham. Please go ahead.

Scott Berg (Managing Director and Senior Research Analyst)

Hi, Raul and Adam. Thanks for taking my questions. Congrats on a good quarter. I guess I wanted to start on the sales environment. As you look back at the new sales in the quarter, is there any difference in, I don't know, maybe the composition of those deals in Q1 this year versus last year, maybe customer size, types of modules they're buying, et cetera, that might kind of highlight an environment that may or may not be changing?

Raul Villar Jr. (CEO)

No, the environment, Scott, has been really steady. We're seeing consistent production, you know, in our Tier 1 markets from our broker partners and our industry go-to-market strategy. Nothing has changed. We're still running the same plays and winning at an outsized rate in all markets. We feel really good about our go-to-market motion and that no macro impacts whatsoever in the size of our deals or the number of modules people are purchasing at point of sale.

Scott Berg (Managing Director and Senior Research Analyst)

Got it. Helpful. A follow-up question on your sales investments for this year. Obviously, a big focus for the company the last two years is putting new sales heads in these Tier 1 cities. How do you think about cross-sells or up-sells over time, you know, in staffing, maybe a further staffing a team or headcount in that area versus just adding new heads going after for a net new logo acquisition?

Raul Villar Jr. (CEO)

Yeah. We have a centralized team that handles cross-selling, and we continue to invest in that team, and continue to drive cross-selling against the legacy base. Obviously, our new clients, you know, are coming aboard, you know, with two or three modules attached already. A lot of it is cross-selling back into the legacy base, or following up, as an example, you know, when we are fully unified with Talenya, we'll be able to cross-sell Talenya into the entire, you know, client base of 30,000. We are with you. We're continuing to invest in a cross-selling team, and we're seeing really good results there. I think you'll see us continue to generate somewhere between 15% and 20% of our bookings will come from cross-sells.

Scott Berg (Managing Director and Senior Research Analyst)

Great. That's all I have. Thanks for taking my questions.

Raul Villar Jr. (CEO)

Thanks a lot, Scott.

Operator (participant)

We have reached the end of the question and answer session. I would like to turn the call back over to Raul Villar for closing comments. Please go ahead.

Raul Villar Jr. (CEO)

Thank you again for joining us tonight. We're enthusiastic about the accelerated momentum in the business and look forward to connecting with you again soon. As always, feel free to reach out if you have any questions, and have a great night.

Operator (participant)

Ladies and gentlemen, that concludes today's conference. Thank you for joining us. You may now disconnect your lines.