Earnings Call Transcript - ASUR Q3 2020

Operator, Operator

Good afternoon and welcome to Asure’s Third Quarter 2020 Earnings Conference Call. Joining us for today’s call are Asure’s CEO, Pat Goepel; CFO, John Pence; Vice President of HR, Cheryl Trbula, and Jay Powers. After the speakers’ remarks, there will be a question and answer session. I would now like to turn the call over to Cheryl for introductory remarks. Please go ahead.

Cheryl Trbula, Vice President of HR

Thank you, operator. Good afternoon, everyone, and thank you for joining us for Asure’s third-quarter 2020 earnings call. After the market close, we released our financial results. The earnings materials are available on the SEC's website and our Investor Relations website at investor.asuresoftware.com, where you will also find the investor presentation. This teleconference is also being broadcast over the internet and will be archived and available on our IR website. During our call today, we will reference non-GAAP financial measures, which we believe to be useful to investors and exclude the impact of certain items. A description and timing of these items along with a reconciliation of non-GAAP measures to their most comparable GAAP measure can be found in our earnings release. Today's call will also contain forward-looking statements that refer to future events and involve some risks. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. Finally, I would like to remind everyone that this call will be recorded and it will be made available for replay via a link in the Investor Relations section of our website. With that, I would like to turn the call over to Pat Goepel, CEO. Pat?

Pat Goepel, CEO

Thank you, Cheryl. And thank you for all of you being on the call today. We'd like to welcome everybody to our third quarter earnings 2020 call. I appreciate your interest, whether you're an employee, a client, investor, analyst, or other interested third party. I will start today's call with an update on some key metrics and our response to COVID-19 before reviewing business highlights for the third quarter and recent changes to our senior leadership team. Let’s review our financial results and then I'll take questions. In the third quarter, small business new bookings grew by over 100% year-over-year. Revenue was also better than expected, and we generated positive free cash flow. Our key metrics benefited from a backdrop of gradually improving economic conditions, including higher employment levels and increased business activity. We also onboarded many high-quality caliber sales reps; our number of sales reps increased to 64 from 33 at the beginning of the year. We're delighted with how quickly these new reps have become productive. While hiring these exceptional reps sooner than expected led to higher sales expenses in the quarter, non-GAAP EBITDA was still at or above expectations. So we view the early hire of extraordinary sales reps as a very attractive trade-off that we expect to benefit organic growth in the second half of 2020, 2021, and beyond. In May and August, we provided updates to our business as we were responding to the impacts of COVID-19. We also talked about the headwinds in our key metrics at that time. While the pandemic continues to impact our top line, resulting in unfavorable year-over-year comparisons, we have experienced a steady increase in paid employees, as well as an increase in sales leads and sales productivity in the quarter. We usually do not provide detailed monthly metrics, but this year to help our investors understand the impact of COVID and how they've been trending as the economy recovers, we are making an exception. The pandemic has impacted our key metrics in three ways. Looking at our 10,000 customers, approximately 1,050 paused in March. Since that time, over 600 returned at the end of June, and about 900 at the end of August, and we've retained that level through October. Essentially, about one and a half percent of our base or 150 clients continue to be paused. Over 50,000 indirect customers that Asure services through resellers have experienced similar trends. Second, on our payroll control, or what we call same-store sales, which track national unemployment rates, it was down 14% year-over-year in Q2, but improved to down about 9% in Q3. This provides a sense of the headwinds. In normal times, payroll control usually is a tailwind, increasing about 2% to 3% year-over-year. Lastly, new sales bookings were pressured as many small businesses are focused on surviving and adjusting their business models instead of changing payroll providers, even if it's a pain point, but this pressure has been offset by our investments in sales and products. Demonstrating this point, we began 2020 with 33 sales reps, and we now have 64. Most of those new hires are very experienced and bringing strong referral relationships, ramping quickly in the quarter. Small business bookings, where most of these reps focus, increased more than 100% year-over-year in the third quarter, pointing to higher product adoption; over 95% of new customers bundle human capital management products with payroll. Additionally, new sales units and starts are exceeding losses every month since July. We expect this to drive organic growth as national employment levels gradually return to pre-COVID levels. It is important to note that we also hired human capital management developers and client service people to meet the changing requirements for small businesses. Some of the new products that we recently rolled out include simple payroll entry and essential HR. Adopting new COVID compliance requirements has also been a major initiative in 2020. I've been in this industry for a long time. There have been more payroll changes and tax filing changes in the last six months than in the past decade. We continue to be a valuable business partner to our small business clients during the pandemic, providing them with information to navigate complicated changes in legislation. Our solutions have proven invaluable to clients in adapting to the new environment of a remote workforce as they begin to reopen and get back to business. Our COVID-19 resource center and webinars, in particular, have benefited tens of thousands of small business attendees since their launch in the first and second quarters. During the third quarter, we hosted our Annual Retailer Conference; this well-attended virtual event featured more than 25 training sessions over two days. Representatives from many of our existing 200-plus retailers participated, along with new prospects. We're extremely proud of our employees' level of commitment to our customers and their excellent execution during these unprecedented times. I can't thank them enough for rising to the challenge. Approximately 90% of our workforce continues to work remotely as we're committed to ensuring our employees' safety. Our investments in back-office technology over the past couple of years have made this transition possible. While small businesses have experienced unprecedented economic headwinds due to the COVID-19 pandemic, we will never stop providing our clients with the service, technology, and support they need to survive the crisis and thrive when it's over. As such, we continue to make progress on strategic initiatives, including product innovation and go-to-market investments while controlling expenses. These go-to-market investments resulted in strong new business bookings in the second and third quarters. Still, as expected, a high employment rate and a 150 basis point cut in rates continue to adversely impact Asure’s results in the third quarter, albeit to a lesser extent than in the second quarter. As an essential small business, Asure remains committed to helping our 60,000 small business clients grow in this challenging environment. We remain optimistic about our long-term strategy and expect to be well positioned once the macro environment and our clients' operations normalize. Shifting to a couple of leadership and board changes, we announced in the earnings release that John Pence has been appointed CFO, replacing Jay Powers. John has 28 years of leadership experience in accounting, finance, and operations at a variety of both publicly traded and privately held technology companies that have served both large and small businesses. Most recently, he served as CFO of a leading HR benefits provider and helped them direct the successful exit for the company's investors. We also announced that Jay Powers resigned as CFO due to family health matters; Jay will leave after a transition to John in the next couple of weeks. Additionally, independent board member Charlie Lathrop is resigning due to health reasons, effective December 31. We're delighted to welcome John to the Asure leadership team; he brings a strong track record of success leading high-performing finance organizations in technology companies. While we're disappointed about Jay and Charlie's departure from Asure because of their outstanding backgrounds and valuable contributions, our thoughts and prayers are with Jay and Charlie and their families during this difficult time. Next, I'll cover the financial results, then Jay and John will say a few words before turning over to Q&A. Turning over to our third quarter highlights. For comparison purposes, we've provided a recap of the 2019 revenue numbers that exclude the workspace business, non-strategic customer clients, and non-core HCM business as we exited December 2019. As usual, all the non-revenue financial figures discussed today are non-GAAP unless I state them as GAAP, and you will find a reconciliation from GAAP to non-GAAP results and recap revenue numbers in today's press release. During the quarter, small business bookings increased more than 100%. We increased our sales representatives to 64 at the end of October, up 94% from the 33 we began the year with. They will be impactful in the fourth quarter of 2020 and into 2021. We are encouraged by the strong momentum with new business bookings and continue to manage costs effectively, as demonstrated by positive free cash flow this quarter. Although revenue, gross profit, and adjusted EBITDA year-over-year declines are still being driven by the pandemic-related lower check volumes, these declines have improved substantially over the last two quarters. We remain confident about our financial and competitive position and look forward to a gradual return to more normal operating conditions. Revenue for the third quarter decreased 10% to $16 million from an adjusted $17.9 million in Q3 of last year. Recurring revenue represented 95% of total revenue in Q3, compared to an adjusted 96% in Q3 of 2019. Next, I'll discuss our profitability metrics. Q3 non-GAAP gross profit was $10.3 million, equating to a non-GAAP gross margin of 64.3%. This compares to $11.6 million of gross margin of 65.2% in Q3 of 2019. We continue to be laser-focused on gross margin. We're taking actions to drive improvement. Interest on client funds exceeded $180,000 in the third quarter, down from $460,000 in the third quarter of 2019. We expect 2020 levels of interest on client funds to be between $900,000 and $1 million. Q3 non-GAAP EBITDA was $1 million, down from $3 million in the third quarter of 2019. In the third quarter of 2020, our non-GAAP effective tax rate guidance is still at zero percent as we feel this more accurately measures our expectation for actual performance. Net operating loss carryforward stands at $34 million. We generated $2.4 million of cash from operations, less $1 million of property, plant, and equipment and software capitalization, resulting in $1.4 million of free cash flow for the quarter. Shifting gears to our balance sheet, cash and cash equivalents were $12.9 million at quarter end. As of September 30, 2020, we had $23.7 million in gross debt, which are the amounts payable for our term loan and our seller notes. This is down $10.2 million from $33.9 million at the end of Q2 2020. The PPP loan represents $8.9 million in gross debt; while we expect this to be forgiven, we expect the Small Business Administration to grant that decision sometime in the second quarter of 2021. Our total deferred revenue at our balance sheet as of September 30, including both short-term and long-term combined, was $3.7 million, down from $4 million in the second quarter of 2020. Our days sales outstanding for Q3 was 29 days, up from 23 days in the year-ago quarter. As for forward guidance, although we expect the tailwinds on recurring revenue to continue improving, we think it's prudent to wait for John to be on board before revisiting or returning to providing guidance. Given the economic uncertainty with the election, stimulus, and COVID, we just think that makes a lot of sense for us. To provide a sense of the forward revenue growth trajectory on Slide 19 of the investor deck, we show how, after adjusting for non-strategic customer contracts exited in 2019, the second quarter of 2020 troughed at a negative 13% year-over-year decline in revenue, primarily due to COVID, and improved to a 5% decline in the third quarter. In the fourth quarter and into 2021, we expect this trajectory of revenue growth improvement to continue because, number one, new customer starts are outpacing customer losses; two, our new sales reps continue to ramp to full quota; three, U.S. employment continues to improve; and four, easy year-over-year comparisons begin in 2021. Before turning our call over to Q&A, Jay and John would like to say a few words. Jay, perhaps you can go first.

Jay Powers, CFO

Hey Pat, thank you. I'd like to thank you and the Board for the opportunity to serve as Chief Financial Officer. I believe it's in my best interest to resign so I can focus on my family health matters. Thank you so much.

Pat Goepel, CEO

Thank you, Jay. We appreciate your hard work and diligence in your role.

John Pence, CFO

Despite the unfortunate personal situation that caused the opportunity to become available, I'm excited to join Asure's experienced leadership team. Asure is uniquely positioned as a leading SaaS HCM provider for 60,000 small businesses, and I'm eager to help the company build on the foundation established by Pat and his team and continue its plans for double-digit organic and inorganic growth.

Pat Goepel, CEO

Thanks, Jay, and thank you, John. With that, we'll open it up for questions. Operator?

Operator, Operator

Your first question comes from Ryan Meyers with Lake Street Capital. Your line is open.

Ryan Meyers, Analyst

Hi, guys. Thanks for taking my question. First one for me, so when we look at the strong bookings number, how much of that would you attribute to the overall economic recovery? And then how much would you attribute to the sales force expansion?

Pat Goepel, CEO

No, it's a good question. It's probably a little bit of both. I do think we were able to really acquire and onboard about 20 sales reps early. Our experienced sales reps have been in the industry, so they definitely came with strong contacts. We were able to hit the ground running. I do think in the second quarter, there was some pent-up demand in the sense that businesses were trying to figure out if they were operational, and then in the third quarter, they settled down and said, okay, we don't like the pandemic, but we know how to operate. We did get some sales. Now, pivoting forward, I'm really excited about the fourth quarter and first quarter of 2021, where we have improving conditions, we have those 20 sales reps with a quarter now underneath their belts, and the pipeline is really strong. So we're selling a lot for January 2021 right now, and I feel really good about how we’re positioned.

Ryan Meyers, Analyst

Okay. That's kind of a good segue to my next question. Can you give us some insight on what you're seeing so far from customers here in the fourth quarter, and how the bookings have been tracking?

Pat Goepel, CEO

Yeah. I think from a business perspective, the pandemic is one factor, but you also have the election and the potential for a third wave. However, from a customer perspective, people are saying, hey, I’ve got to deal with this one way or the other. I think we're getting a little bit more return to normalcy. You do have different industries pushing. If we get a stimulus, obviously that will help, but you can't count on that. What I would say is our pipeline and growth has been strong. We feel good about where we're positioned, and I think people are returning to the normalcy of buying habits and adapting to the ambiguity of the pandemic. That being said, policy changes are unpredictable, but we need to control what we can control. If we keep selling and starting more customers than we lose in a month, then we're going to be in good shape going forward.

Ryan Meyers, Analyst

Okay. That's good to hear. And then lastly, how are you thinking about sales hires for the fourth quarter here and into 2021?

Pat Goepel, CEO

Yeah, so in 2021, we’ll position our sales headcount around 75. We have about 64 right now. We'll hire some in the fourth quarter and in the first quarter to get ready for the 2021 season. We see this as a good opportunity to gain market share, stay close to our customers, and grow. We feel optimistic about our competitive products and the rollout of our new products. We think right now is the time to grow, and I believe you’ll see us aim for a total of about 75 sales reps in 2021.

Ryan Meyers, Analyst

Awesome. Thanks for the help.

Pat Goepel, CEO

Thank you. And thanks for the call.

Operator, Operator

Your next question comes from the line of Derrick Wood with Cowen. Your line is open.

Derrick Wood, Analyst

Great, thanks for taking my questions. Nice to speak with you, Pat, and everyone else. I know you entered the year focusing on the sale of space and reinvesting sales capacity and other things back on the HCM side, so congrats on starting to see the dividends from that. I wanted to ask, as you onboard all these new reps, will the focus be more on cross-selling the base or generating new customers?

Pat Goepel, CEO

Derrick, the first focus is that we have a lot of momentum selling to new customers. We have benefit providers, CPAs, and banks actively looking to engage us in books of business and growth opportunities. We're taking advantage of that strength in the marketplace. Some of our competitors are competing aggressively, notably benefit brokers trying to steal record keeping, while we are working with benefit providers for mutual growth. From a cross-sell perspective, as we roll out our new products, we expect the attach rate for our new sales to increase, and as companies logically evolve, we'll look to cross-sell those opportunities to drive attach rates for all our customers. So initially, our primary progress is in acquiring new customers and new books of business.

Derrick Wood, Analyst

Yes, that makes sense. And Pat, you pointed out that 95% of new customers tend to buy a bundle. So, what's the most frequently adopted HCM module with payroll? What should we think about, at least initially, regarding the average deal size uplift when you bundle versus a standalone payroll?

Pat Goepel, CEO

The average bundle per unit from a pricing perspective is about 50%. We see time&attendance, HR consulting, and bundles, especially during the pandemic, where clients look for extensive HR advice on layoffs, hiring, and navigating through payroll tax regulations. They're increasingly seeking our guidance in those areas, leading to greater adoption of bundled services.

Derrick Wood, Analyst

Okay. Last question for me, just on the kind of back-office investments you've made—what expectations do you have for yield from that? I'm thinking of three aspects: easier M&A onboarding, cross-selling, and better sales and marketing efficiencies. From a revenue synergy perspective, is there anything you would call out since you've made those investments?

Pat Goepel, CEO

That's a great question, Derrick. We're currently going through our planning cycle and completing it this quarter. Looking at it, I believe we could double the size of our company while continuing to drive down costs. We're focused on our general and administrative spend, as we believe the people, processes, and technology are in place to double without adding significant costs. Product innovation and our web product deployment, like simple payroll entry and essential HR rolled out last quarter, set the stage for a more streamlined customer experience. We can expect an uptick in our gross margins over the next couple of years as we streamline our processes and enhance efficiency, aiming for gross margins exceeding 70%. Currently, we’re looking at a 3% annual rise as we achieve those targets.

Derrick Wood, Analyst

Makes a lot of sense. Okay, thanks.

Pat Goepel, CEO

Thank you, Derrick.

Operator, Operator

Your next question comes from the line of Ryan MacDonald with Needham. Your line is open.

Ryan MacDonald, Analyst

Hi, thanks for taking my question. Pat, I guess my first one is for you. You've indicated that about 900 or so of the thousand clients shut down have returned. What should we expect for the 100 to 150 clients that remain paused? Do we need to wait for stimulus to get those back online? Or are those customers putting insurance on hold?

Pat Goepel, CEO

Ryan, that's a good thought. We cover that topic in our daily calls, and I would say, generally speaking, those clients have either likely moved on or may return with a stimulus. Based on what I perceive, those 150 or so may not come back. If they do great, we keep in touch with them and have done that, but I'm viewing it that way. On the positive side, per data from the U.S. Chamber of Commerce, customer formations and new businesses are snapping back to an all-time high in the fourth quarter. We're focused on capturing our share of these businesses onboarding in the fourth quarter as we look towards 2021. We're assisting clients managing COVID and ensuring they have the necessary data to return to us promptly.

Ryan MacDonald, Analyst

Super helpful. You mentioned the reseller conference during the quarter. Could you share some insights into how your resellers are viewing their business health and their market outlook, and how we should think about expanding the reseller network as a growth driver for 2021?

Pat Goepel, CEO

Yes, Ryan, our focus has been twofold. First, we had a banner year last year acquiring and onboarding more resellers. This year, these resellers, which generally range from small to mid-size businesses, are dealing with various challenges, notably with PPP. We're working closely with them, assisting their end clients in resuming regular processing. Their metrics mirror ours, showing they lost about 10-10.5% early in the year due to pauses, but they're regaining customers now, varying by region. Looking into 2021 for our reseller network, we plan continued positive growth, engaging these resellers to promote multiple products, ultimately helping drive profitable add-on products for their existing customers. Our focus is to grow the network while facilitating their client recovery efforts.

Ryan MacDonald, Analyst

Great, thanks a lot.

Pat Goepel, CEO

Thanks, you.

Operator, Operator

Your next question comes from the line of Jeff Van Rhee with Craig-Hallum. Your line is open.

Jeff Van Rhee, Analyst

Thanks for taking my questions. Pat, on the bookings number, I believe last quarter you indicated bookings were up 21% year-over-year, and I want to clarify the 100% you're mentioning now—are those apples to apples? Do you have a corresponding number from last quarter?

Pat Goepel, CEO

Yeah, definitely. We're down about 10% in overall bookings. However, we were up over 100% in the SMB segment. We faced a tough comparison in our reseller area due to several large resellers and competitive issues, including attacks on one of our significant competitors. So, overall, our bookings are down 10%, but the direct market showed over 100% improvement.

Jeff Van Rhee, Analyst

That’s helpful. Regarding the resellers, you've mentioned your plans to deepen penetration beyond payroll into additional offerings like time and attendance and HR. Given you have existing relationships, what does that look like? Would these be new clients, or are these existing ones? What is currently in the market regarding time and attendance and HR?

Pat Goepel, CEO

Firstly, SwipeClock does an excellent job in that space, along with other competitors in the market. In some cases, we will be displacing their services, but considering our product strategy for web deployment, we've rolled out simple payroll entry to facilitate moving to the web. Once clients are on the web platform, essential HR provides a foundation of HR services they may not have had previously. With clients on essential HR, they can seamlessly upgrade to advanced HR via a dropdown menu. We have migrated many consulting services online and will continue to bundle payroll offerings, light HR, and consulting services, thereby creating an attractive offering for our clients. We're optimistic about the traction for these bundled products, and we've already had over 100 clients using essential HR, indicating growth potential in that area.

Jeff Van Rhee, Analyst

Very helpful. Lastly, I believe you mentioned the payroll tax management acquisition. Was there any revenue contribution in the quarter from that? I don't recall specifics.

Pat Goepel, CEO

We didn't provide exact figures for that. However, if you look from the second quarter to the third quarter, revenue increased from $14.1 million to $16 million. I would estimate that slightly less than half of that increase came from the payroll tax management acquisition, with the remainder coming from organic growth—approximately what you should expect.

Jeff Van Rhee, Analyst

Thanks, Pat. That’s very helpful.

Pat Goepel, CEO

Thank you. I appreciate it.

Operator, Operator

Your next question comes from the line of Vincent Colicchio with Barrington Research. Your line is open.

Vincent Colicchio, Analyst

Yeah, Pat. I was hoping you could provide an update on how far along you are in terms of actions taken to improve gross margins.

Pat Goepel, CEO

I believe, looking ahead into 2021, we will see an improvement of a couple of percentage points. The product developments we rolled out this past quarter and initiatives like simple payroll and essential HR will lead to a more seamless experience. We've made considerable progress in our AWS transitions and are optimizing that for efficiency. The first phase was to lift and shift to AWS, and next, we're working on increasing efficiency. I am pleased with some of the leadership in each area who have started to benchmark their efficiencies, creating opportunities for improvements. Our objective is to reach over 70% gross margin in this business, and achieving a 3% rise annually is certainly a feasible target.

Vincent Colicchio, Analyst

Thanks for that insight. One more question— SG&A kicked up in the quarter. Was that mainly tied to the new sales hires?

Pat Goepel, CEO

Yes, we accelerated hiring sales personnel because we recognized the opportunity to bring experienced reps on board. This led to the majority of our increased SG&A costs during the quarter.

Vincent Colicchio, Analyst

Thank you, Pat.

Pat Goepel, CEO

Thank you, Vince.

Operator, Operator

As there are no further questions at this time, presenters, you may proceed.

Pat Goepel, CEO

First of all, I'd like to thank everybody for joining the call. I'm really excited about the business. I bought Asure stock with my own money recently. We have an Investor Relations Deck from Pages 13 to 19. We believe that the second quarter was our trough. We understand that with COVID, there's some uncertainty. However, we're focused on selling and acquiring more customers than we lose, leading to long-term profitability. The investment in salespeople is a solid strategy, and we feel very optimistic as we look into 2021. Thank you for your time and involvement as shareholders, employees, clients, or participants on this call. We'll see you in the first quarter of 2021. Thank you.

Operator, Operator

Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day. You may all disconnect.