Paycor HCM, Inc. (NASDAQ:PYCR) Q3 2023 Earnings Call Transcript May 12, 2023

Operator: Ladies and gentlemen thank you for standing by and welcome to Paycor’s Third Quarter Fiscal Year 2023 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note this conference is being recorded. I would now like to turn the call over to Rachel White, Vice President of Investor Relations.

Rachel White: Good afternoon and welcome to Paycor’s earnings call for the third quarter of fiscal year 2023, which ended on March 31st. 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 on this call include forward-looking statements related to our financial results, products, customer demand, operations, 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: Thank you, Rachel and thank you all for joining us to discuss Paycor’s fiscal third quarter results. As employee engagement nationwide dropped to the lowest level in nearly a decade, we are seeing robust demand for our modern and differentiated HCM suite that enables leaders to more effectively coach, optimize, and retain their people. With these essential talent tools, our customers are improving the core strength of their critical frontline leaders and increasing their employee retention by 10%. Revenue grew 32% this quarter as we continue to make great progress expanding our sales coverage and increasing PEPM. This also marks the fourth consecutive quarter of margin expansion delivering over 400 basis points of improvement year-over-year while investing in capabilities that further differentiate Paycor in the market.

Paycor’s strong results are evidence of consistent execution across the enterprise. We continue to expand our go-to-market capabilities seller headcount growth remains on track for 20%. Win rates remain high average deal size continues to expand and we are pleased to report another record third quarter for bookings. These efforts are underpinned by investments in brand awareness lead generation and broker relationships that drive sales opportunities. We are thrilled with the acquisition of Verb, a people development platform incorporating behavioral science and proprietary microlearning content to create best-in-class workplace training. The acquisition will enhance Paycor’s mission of empowering leaders by providing them with learning tools to develop their associates with personalized development pathways.

Like our other recent acquisitions we plan to fully integrate Verb’s innovative technology into our HCM suite and increase PEPM leveraging our broad distribution channel. We expect the integrated offering to be available as part of our talent management bundle in the first half of fiscal year 2024. Within our talent management bundle we recently completed the integration of our new AI-driven recruiting technology Paycor Smart Sourcing. We continue to see strong demand for this solution with more than 600 customers scheduled for activation. Building on Paycor’s initial artificial intelligence innovation Paycor Smart Sourcing and predictive resignation, we introduced our existing natural language processing and sentiment analysis engines into performance reviews and provide frontline leaders real-time feedback on the language they’re using in evaluation to foster more humanized engaging work culture.

We will continue to leverage AI in our platform to efficiently empower leaders like using generative AI to aid the recruiting process by generating job descriptions along with several other exciting innovations on our product roadmap. Furthermore, we continue to lead the industry with the most extensive network of partners, deep two-way integrations, and API connectivity points to meet our clients’ unique business needs. In the last year, we added over 100 partners to our ecosystem to expand our reach and provide new capabilities and value for our customers. Lastly, we are proud that Paycor was recognized for its modern and differentiated platform with six Titan Business Intelligence Awards for our best-in-class talent management solution, Paycor Smart Sourcing, and insightful analytics that help frontline leaders optimize business decisions.

I would like to thank the entire Paycor team for these amazing results. With that, I’ll turn the call over to Adam to discuss our financial results and guidance.

Adam Ante: Thanks, Raul. I’ll discuss our third quarter results and outlook for the remainder of the fiscal year. As a reminder, my comments related to financial measures are on a non-GAAP basis. We delivered another strong quarter with total revenues of $161 million, a 32% increase year-over-year and recurring revenue growth of 23% over the prior year, marking the sixth straight quarter of achieving our 20%-plus target and a testament to the consistent execution from our team. Our revenue growth continues to be driven by new business wins and cross-sells, growing the number of employees on our platform to nearly $2.4 million, up 7% over the prior year with more than 30,000 customers. As we shift our portfolio upmarket and focus our resources on clients with greater than 100 employees, our average customer size continues to increase, now at 79 employees per customer, up from 75 last year.

Aligned with this intentional strategic shift, we continue to see moderation in employee growth in the micro segment, while the number of employees in the mid-market and enterprise segments increased 9% year-over-year. This past quarter, our clients’ employment level was essentially flat over the prior quarter, in line with our expectations and prior guidance. As a reminder, organic employment levels among our existing customer base have typically only impacted revenue growth by one point or two outside of an anomaly like COVID. All in, net retention continues to trend favorably with benefits from cross-sales and pricing increases, marginally offset by relative softness in our customers’ organic hiring. Effective PEPM increased 15% year-over-year to just over $21 for the quarter.

PEPM growth is comprised of three primary drivers, including cross-sales, pricing initiatives and higher bundle adoption at the point of sale. This quarter, PEPM growth also benefited from strong form filing revenue, some of which we believe was pulled forward from the fourth quarter. We’re also pleased with the progress we’ve made expanding our partner program, made possible by the investments in our interoperability engine. New incremental partner revenue streams, such as income and employment verification services and other software partnerships are expanding services to our clients and will increasingly contribute to our revenue growth into next year. In addition to the consistent revenue growth, we have also demonstrated steady margin expansion.

Adjusted gross profit margin excluding depreciation and amortization improved to 80.7%, nearly 300 basis points higher than last year, as we continue to scale. Sales and marketing expense was $46 million or 29% of revenue, in line with our long-term targets and we continue to invest as we expand our sales team nationally. On a gross basis, we invested $22 million in R&D or 14% of revenue, a similar level to last year 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 tuck-ins that create value for our clients and expand our PEPM opportunity. G&A expense was $19 million or 11.9% of revenue, down nearly 300 basis points from 14.6% in the third quarter of ’22.

We have made significant progress scaling and driving down G&A as a percentage of revenue. Year-to-date, G&A expense as a percentage of recurring revenue is more than 150 basis points lower than last year. Adjusted operating income increased nearly 60% to $39 million, with margins of 24%, up more than 400 basis points from 20% last year, while continuing to expand investments in sales and marketing and R&D. Shifting to the balance sheet and cash flow. We generated $24 million of adjusted free cash flow, a net spend of $9 million year-to-date. We remain on track to deliver our plan to be free cash flow positive for the full fiscal year. At the close of the quarter, our cash balance increased to $83 million with no debt. This quarter, we generated interest income of just under $11 million on average client funds of approximately $1.2 billion, yielding an effective rate of just over 370 basis points.

The majority of our client funds remain in overnight accounts, which are capturing Fed fund rates, faster and more completely. Our outlook on the HCM demand environment remains positive. The labor market remains tight as nonfarm payables continue to increase though growth has moderated. Job openings are at elevated levels and workforce participation remains well. Similar to last quarter, our guidance assumes no material change in the broader demand environment or labor market, which has been fairly consistent and flat organic employee growth among existing customers for the balance of the year. Please keep in mind that we had a really strong fourth quarter last year, compared to our two-year recurring revenue CAGR of 21% through the second quarter and we are not anticipating the same outsized form filing benefit that we had this third quarter.

Separately, while we are enthusiastic about the acquisition of Verb, it will be immaterial to our operations today. With these factors in mind, we are once again raising our guidance for fiscal ’23. For the fourth quarter, we expect total revenues of between $135 million and $137 million or 24% growth at the high end of the range and adjusted operating income of between $13 million and $14 million. For the full year, we expect revenues of $548 million to $550 million or 28% growth at the top end of the range and we anticipate adjusted operating income of $80 million to $81 million. With respect to interest income, we expect our effective rate to increase marginally in the fourth quarter. And at today’s rates, we anticipate interest income will be in the range of $30 million to $32 million for the full year on average client funds balances of just over $1 billion.

We remain on track to reinvest about one-third of our interest income and temporary programs to accelerate our product road map, expand marketing programs and invest in scaling the business. In summary, our modern HCM platform that empowers frontline leaders to improve employee engagement and retention is resonating with customers. Our team continues to execute. We’ve demonstrated margin expansion as we scale the business and believe there is significant runway for further growth. As a mission-critical applications still early in its transition to the cloud, we believe in the durability of the category and our opportunity to continue capturing share within the expanding $32 billion HCM market. With that, we will open the call for questions.

Operator?

Q&A Session

Operator: Thank you. [Operator Instructions] Our first question comes from Mark Murphy with JPMorgan. Please state your question.

Operator: Our next question comes from Gabriela Borges with Goldman Sachs.

Operator: Your next question comes from Samad Samana with Jefferies.

Operator: Your next question comes from Bhavin Shah with Deutsche Bank. Please state your question.

Operator: Your next question comes from Terry Tillman with Truist Securities.

Operator: Your next question comes from Bryan Bergin with TD Cowen. Please state your question.

Operator: Your next question comes from Scott Berg with Needham. Please state your question.

Q – Scott Berg: Got it. Helpful. And then from a follow-up question, as we all are getting these over the last 30, 60, 90 days. Help us understand, what you think the impact would be from these newer generative AI solutions on the HCM space. I think there’s a lot of opportunity. I’ve been sniffing around this for the last couple of weeks, but I don’t think the average investor really looks at HCM as maybe a space or a sector that can benefit from these technologies. How do you all have a kind of viewpoint, on those opportunities?

Q – Scott Berg: Great. That’s all I have. Thanks for taking my questions.

Operator: Your next question comes from Brad Reback with Stifel. Please state your question.

Operator: Your next question comes from Brian Peterson with Raymond James. Please go ahead.

Operator: Your next question comes from Mark Marcon with Baird. Please state your question.

Operator: And our next question comes from Kevin McVeigh with Credit Suisse. Please state your question.

Operator: Your next question comes from Daniel Jester with BMO Capital Markets. Please go ahead.

Operator: And our next question comes from Robert Simmons with D.A. Davidson. Please state your question.

Operator: Your next question comes from Steve Enders with Citi. Please state your question.

Operator: Your next question comes from Jackson Ader with SVB MoffettNathanson. Please proceed with your question.

Operator: Our next question comes from Matt Pfau with William Blair. Please state your question.

Operator: Thank you. There are no further questions at this time, so I’ll hand the floor to Raul Villar, for closing remarks.

Raul Villar: Thank you, again for joining our conference call this evening. I would like to take this opportunity to thank our associates for contributing to these excellent results. We are encouraged by the underlying fundamentals of the business and remain focused on executing our strategy. We look forward to connecting with you at the J.P. Morgan Global Technology, Media and Communications Conference in Boston and Baird Global Consumer, Technology and Services Conference in New York over the coming weeks. Have a great night, everyone and happy birthday, to my sister Melissa.

Operator: Thank you. And that concludes today’s conference. All parties may disconnect. Have a good evening.