Paycom Software Inc

NYSE:PAYC

Earnings Call Analysis

Strong Financial Performance in Q3 2024

Paycom reported an impressive third-quarter revenue of $452 million for 2024, marking an 11% increase from the prior year. The company's recurring revenue comprised $445 million, a notable 12% year-over-year growth, which accounted for about 98% of total revenues. This growth in recurring income underlines the strength of Paycom's business model, characterized by high customer retention and loyalty.

Profitability and Margin Insights

For Q3 2024, GAAP net income stood at $73 million, translating to $1.31 per diluted share. Non-GAAP net income was recorded at $93 million or $1.67 per share. The adjusted EBITDA reached $171 million with a margin of 38%, exceeding expectations largely due to increased revenues and enhanced operational efficiencies. With ongoing investments in automation, Paycom anticipates an adjusted EBITDA range for Q4 2024 of between $184.5 million to $191.5 million.

Guidance Highlights and Revenue Projections

As a result of its robust third-quarter performance, Paycom has raised its guidance for fiscal 2024. The company now expects total revenues in the range of $1.866 billion to $1.873 billion, indicative of approximately 10% year-over-year growth at the midpoint. Adjusted EBITDA is also projected between $745 million and $752 million, maintaining an adjusted EBITDA margin of roughly 40%.

Capital Strength and Shareholder Returns

Paycom's balance sheet remains strong, ending the quarter with cash and cash equivalents totaling $326 million and boasting no debt. The company's strategy includes returning capital to shareholders, as evidenced by the repurchase of around 300,000 shares totaling $44 million during Q3. Furthermore, the Board has approved a quarterly dividend of $0.375 per share, payable in mid-December, alongside continuous stock buyback programs.

Innovative Automations Driving Client Value

Paycom continues to invest heavily in automation, particularly through its flagship product, GONE, which automates time-off decision-making. This has resulted in significant time savings for managers, with users reportedly saving about 200 hours weekly with the system. In addition, Paycom’s internal AI-enhanced capabilities have improved response times by 25%, showcasing the operational efficiencies derived from technological integration.

Market Position and Future Growth Strategy

Despite strong growth, Paycom currently serves less than 5% of its addressable market. The company views this as a substantial opportunity for expansion. By focusing on automation and ROI-driven client solutions, Paycom is poised to enhance its market presence, which is crucial as it develops a more comprehensive international footprint.

Competitive Landscape and Sales Performance

The company's sales momentum has been buoyed by system automations, enabling Paycom's sales force to meet the evolving needs of its clients effectively. September marked an all-time high in sales, reflecting strong performance tied to a robust demand for automated solutions, especially amid increasing competitive pressures.

Outlook Amid Economic Conditions

Looking ahead, Paycom is navigating challenges posed by potential interest rate cuts, which could affect its float revenue. Management estimates that each 25 basis point cut could reduce float revenue by about $6 million annually. However, the ongoing automation initiatives and market demand should help counterbalance these pressures, while improvements in efficiency may drive further margin expansion.

Earnings Call Transcript 2024-Q3

[Operator]

Good afternoon. My name is Elliot, and I will be your conference operator today. At this time, I would like to welcome everyone to Paycom's Third Quarter 2024 Financial Results Conference Call. [Operator Instructions] I'd now like to turn the call over to James Samford, Head of Investor Relations. You may begin.

[James Samford, executive]

Thank you, and welcome to Paycom's earnings conference call for the third quarter of 2024. Certain statements made on this call that are not historical facts, including those related to our future plans, objectives and expected performance, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements represent our outlook only as of the date of this conference call.

While we believe any forward-looking statements made on this call are reasonable, actual results may differ materially because the statements are based on our current expectations and subject to risks and uncertainties. These risks and uncertainties are discussed in our filings with the SEC, including our most recent annual report on Form 10-K. You should refer to and consider these factors when relying on such forward-looking information.

Any forward-looking statement made speaks only as of the date on which it is made, and we do not undertake and expressly disclaim any obligation to update or alter our forward-looking statements, whether as result of new information, future events or otherwise, except as required by applicable law. Also during today's call, we will refer to certain non-GAAP financial measures, including adjusted EBITDA, non-GAAP net income and certain adjusted expenses.

We use these non-GAAP financial measures to review and assess our performance and for planning purposes. A reconciliation schedule showing GAAP versus non-GAAP results is included in the press release that we issued after the close of the market today, and is available on our website at investors.paycom.com. I will now turn the call over to Chad Richison, Paycom's CEO and President. Chad?

[Chad Richison, executive]

Thanks, James, and thank you to everyone joining our call today. I'd like to discuss how Paycom's automation continues to transform our industry, then I'll review some recent client wins and industry recognition. Before turning it over to Craig, who will review our financials and guidance before taking questions. We are investing in our highly differentiated automation platform that is delivering ROI for our clients.

20 years ago, user buyers bought the Paycom system because they wanted to do more for themselves. And today, people buy Paycom because they wanted to do more for them without the need for day-to-day involvement in the software. We already have the most automated system in the industry, and we are rapidly moving towards full solution automation, driving even more ROI for our clients.

Our award-winning solution, GONE, is just 1 example of how Paycom simplifies tasks through automation. GONE was recently named a top HR product by HR Executive Magazine, and for good reason. GONE is the industry's first fully automated time off solution that decisions all-time off requests. Before GONE, nearly all time off decisions were unmanaged.

A recent Forrester study found that GONE can generate an ROI up to 800%. By automating time off decisions, individual managers save nearly a week of unproductive hours annually. The study found that on average, companies using GONE saved nearly 5 weeks of unproductive time in the areas of HR, finance and accounting every year. Without GONE, 10% of an organization's labor cost goes substantially unmanaged, resulting in increased costs from overpayments, errors and scheduling, staffing shortages and operational disruption.

One example of a client utilizing GONE is an auto dealership with nearly 500 employees spread across multiple locations. GONE saved this client approximately 200 hours of unproductive time per week while ensuring a consistent time-off request process [indiscernible] management across the organization. With GONE, this client reports having reduced decision fatigue among managers and team leaders. Not only is GONE automating mundane tasks, it is also having a positive impact on employees.

BETI continues to be a differentiator, and clients using it are experiencing its benefits. We recently onboarded a 1,000-employee hospital organization with over 20 locations. Utilizing BETI, this bilingual workforce has already reduced their payroll processing by 85%. This organization also appreciates that their managers benefit greatly from Manager on-the-Go, which consolidated their managerial task into a single app, streamlining approvals, PA management, applicant tracking and more. This client currently boasts a 99.7% DDX score, reflecting the user-friendly power of Paycom software for their organization.

Our development teams have been focused on automating tasks across the platform that are easily adopted by our client base. Because of this focus, both this quarter and throughout the year, we've launched more products and enhancements than any time in our company's history. There are several examples of automation we recently launched that are having a big impact on HR and recruiting departments.

One such automation is our physician management enhancement that automates reporting structure and hierarchy changes needed due to individual employee changes such as promotions and transfers or large-scale organizational changes such as an acquisition or restructure. Another example of automation is how we enhanced our recruiting module. The advances in our recruiting product have dramatically increased the application completion rates and significantly reduced time to fill. What was already a very fast time to apply process has now been reduced by 50%.

Internally, we developed and deployed an AI agent for our service team. This technology utilizes our own knowledge-based semantic search model and enables us to provide service to help our clients more quickly and consistently than ever before. The AI agent continually improves over time and is having an impact on helping our clients achieve even more value out of their relationship with Paycom. By utilizing our own AI agent, we were able to connect our clients to the right solution faster, improving our immediate response rates by 25% without any additional human interaction.

As a result of our continued focus on solution automation, ROI achievement, world-class service, we also increased our Net Promoter Score 24 points year-over-year. On the sell side, we are seeing continued momentum, particularly with our outside sales reps. System automation matters more to business than ever before, and our sales force is delivering on the market's needs, which is driving our goals.

We still have less than 5% of the addressable market. We remain focused on executing strategies that will produce extremely high ROI and automation for our clients while continuing to differentiate our solution to automation. Finally, I'm pleased that Paycom was recognized as one of the best employers for tech workers by Forbes and one of the world's best companies overall by Time Magazine.

These testaments showcase our culture and the impact our technology is having on workforces all over the globe. We are executing on our 2024 plan, and I'm very pleased with the progress. Our success in 2024 will set the foundation for future growth. With that, let me turn it over to Craig. Craig?

[Craig Boelte, executive]

Thanks, Chad. Before I review our third quarter 2024 results and our outlook for the fourth quarter and full year 2024, I'd like to remind everyone that my comments related to certain financial measures will be on a non-GAAP basis. We delivered solid third quarter results, with revenue and adjusted EBITDA coming in above expectations.

Third quarter revenue of $452 million increased 11% over the comparable prior year period. Within total revenues, recurring revenue was $445 million for the third quarter of 2024, representing 98% of total revenues for the quarter and growing nearly 12% from the comparable prior year period. GAAP net income in the quarter was $73 million or $1.31 per diluted share based on approximately 56 million shares. Non-GAAP net income for the third quarter was $93 million or $1.67 per diluted share.

Third quarter adjusted EBITDA of $171 million or 38% margin was better than expected, primarily due to revenue upside and our continued focus on automation. We expanded our investments in the area of AI, automation and international expansion, resulting in a 20% increase in adjusted R&D expense to $55 million in the third quarter of 2024. Adjusted total R&D costs, including the capitalized portion, were $84 million in the third quarter of 2024 compared to $69 million in the prior year period.

Our tax rate in the third quarter came in higher than expected, largely due to onetime discrete items recorded in the quarter primarily related to return to provision adjustments. For Q4 and the full year 2024, we anticipate our effective income tax rate to be approximately 28% and 24%, respectively, on a GAAP basis. We estimate Q4 and full year 2024 non-GAAP effective tax rate to be 27%. For the fourth quarter of 2024, we expect stock-based compensation expense to be approximately $27 million.

Turning to the balance sheet. We ended the quarter with a very strong balance sheet, including cash and cash equivalents of $326 million and no debt. The average daily balance of funds held on behalf of clients was approximately $2.3 billion in the third quarter of 2024, up approximately 10% year-over-year. During the third quarter, we repurchased approximately 300,000 shares for $44 million. Since July 1 of last year, we have repurchased approximately 2.3 million shares representing nearly 4% of total shares outstanding, and we have $1.49 billion remaining on our buyback authorization.

During the third quarter of 2024, we paid approximately $21 million in cash dividends, and earlier this week, the Board approved our next quarterly dividend of $0.375 per share payable in mid-December. Now let me turn to guidance. Following solid Q3 results and our expectations for the fourth quarter, our revenue guidance range for fiscal 2024 increases to $1.866 billion to $1.873 billion or approximately 10% year-over-year growth at the midpoint of the range.

We are raising our expected adjusted EBITDA range to $745 million to $752 million, representing an adjusted EBITDA margin of 40% at the midpoint of the range. For the fourth quarter of 2024, we expect total revenues in the range of $477 million to $484 million, representing a growth rate over the comparable prior year period of approximately 11% at the midpoint of the range. We expect adjusted EBITDA for the fourth quarter in the range of $184.5 million to $191.5 million, representing an adjusted EBITDA margin of approximately 39% at the midpoint of the range.

Overall, Q3 was a good quarter, with better-than-expected revenue and significant adjusted EBITDA upside. We have an attractive high-margin recurring business model, a solid balance sheet with no debt and strong cash flows. We will continue to focus on strengthening our competitive position through automation and delivering even more value to our clients through ROI achievement.

With that, we will open the line for questions. Operator?

[Operator]

[Operator Instructions] Your first question comes from the line of Raimo Lenschow with Barclays.

[Raimo Lenschow, analyst]

Perfect. Congrats on a great solid quarter. Chad, if you think about like the reporting season so far for the payroll names, it does speak towards more of a stabilization or like a really stable market, and everyone is still hoping for like some sort of recovery.

What are you seeing out there in terms of like end demand, et cetera? Like how does the pipeline evolve? Like how are the [indiscernible] conversations going at the moment? Do you have any kind of more color there, please? And then for Craig, any comment on float and how you think about float going into next year?

[Chad Richison, executive]

Yes. So I mean the demand is strong out there. I mean we have an automated solution, and more and more people are looking to automate. We continue to get stronger. In fact, last month was our largest sales month, September, both for this year as well as over the history of our company. So we continue to get stronger in sales, and that's been important to us to continue to move the product into the market, so that clients can experience the ROI that can be derived from the fully automated solution.

[Craig Boelte, executive]

Yes. I would say, Raimo, on the float revenue, for every 25 basis point cut, it could impact us as much as $6 million on an annualized basis. And we've already seen 50 basis point cut, maybe a couple more this year. So as we're looking into next year, that's going to be something that's going to impact us. And then -- but we're starting to also look at layering in some more longer term on that float balances.

[Operator]

Your next question comes from the line of Samad Samana with Jefferies.

[Samad Samana, analyst]

Maybe first one, Chad, for you. Interesting to hear about using AI in the customer service organization. I'm curious if that's technology that Paycom has built or if you're using a third party, and how you're thinking about that translating into like the savings on the cost to serve side, and do you think that, that can be something that can be monetized as a feature at some point as well? And then I have a follow-up for Craig after.

[Chad Richison, executive]

Yes. So that's internal. We built it ourselves, and we've been using it. And so it gets better and better as we mentioned on the call. It's sped up our process by 25% as far as being able to connect clients to the solution quicker, whether that be a configuration question, a tax question or what have you. And so that's really been helpful to us, and it continues to do more and more from that perspective. And I'll let Craig answer.

[Samad Samana, analyst]

Great. And then, Craig, maybe just as a follow-up. When I think about the acceleration, it was good to see that. Have we turned the corner on the CRR cross-sell headwinds and any associated BETI headwinds? And should we think about the fourth quarter guidance as a good starting point for 2025 now that we've started to see a reacceleration?

[Chad Richison, executive]

I mean there's still benefits being gained by clients that utilize BETI. I mean even when you look at our tax resolutions this year versus last year same time, they're down 1/3. So BETI is still driving efficiencies amongst those clients as far as CRRs. They continue to help clients achieve the full value of the software, and they're continuing to do well.

But in order to sell a client an additional product, you really have to make sure that they're utilizing and having success with the products that they've currently purchased. And so we have a lot of CRRs that have got their clients in the right solution. We have a lot of them well over plan and their quotas now.

[Operator]

Your next question comes from the line of Mark Marcon with Baird.

[Mark Marcon, analyst]

Really nice to see the acceleration with regards to recurring revenue. Chad, you mentioned several things, but I'm wondering if you can talk a little bit about the drivers behind that acceleration. To what extent is it increased module uptake for things like GONE relative to some of the improvements that have been made with regards to kind of the sales go-to-market and training that you've implemented recently? And then I've got a follow-up.

[Chad Richison, executive]

Sure. I mean I would say that GONE definitely helps sales because of its automation. GONE isn't priced separately, so it's included in one of the modules that most all of our clients already have. So GONE is just a way to automate that module fully. And then that also is helping sales, like I kind of said on the call. I mean 20 years ago, people bought our system so that they could do more with it. Today, people buy our systems so that it can do more for them without their involvement.

I mean, 20 years ago, I'd go to a fantasy football draft and do the draft and then set my lineup. Maybe 1 week, I'm playing 2 kickers on accident. Today, people can go and have that draft, set it on auto draft and set it on auto lineup. They're usually ones that win the season. And so that's really the concept of our system. If you set it up right, it's going to automate everything for you. And Paycom has the best case scenario for usage in our industry, and it's getting more and more clients to that. And we have a lot of success with that, obviously, in our go-to-market with new clients.

[Mark Marcon, analyst]

Great. And then any comment with regards to just kind of the sales process and the sales training?

[Chad Richison, executive]

Yes, sales is doing really well. I mean unit counts, as I mentioned last time, continue to be elevated. Go-to-market, they continue to sell more than we have in the past. And as I mentioned yesterday or earlier last month, September was our largest sales month we've had to date and ever.

[Operator]

Your next question comes from the line of Brian Schwartz with Oppenheimer.

[Brian Schwartz, analyst]

Chad, I had a follow-up on the AI agent or the AI technology that you're developing. Do you see an opportunity in the future to productize what you're developing internally, maybe like in your -- in future versions of your recruiting product or other products in your platform?

[Chad Richison, executive]

We -- I mean I would say this isn't the only area in which we're using AI. We have it in several products that we both have released and will be releasing. And so there's definitely opportunities to monetize AI. As far as this particular solution, it's really helping us on the back end and helping our client as well. So I think we're going to see results and benefits from that in other areas of efficiency across the board within our own organization.

[Brian Schwartz, analyst]

And then one question for Craig. Just in terms of the EBITDA upside in the quarter, it was a much bigger beat than we've seen in previous quarters. Just wanted to ask you about the expense profile. Did any expenses slip into Q4? Or is that just primarily from the upside in the top line?

[Craig Boelte, executive]

Yes. I mean it was primarily from the upside in the top line. I mean, there were a couple of things that kind of impacted the beat. I mean some of them were at the corporate level, and then some of the marketing may be a little bit of timing. But other than that, just efficiencies throughout.

[Operator]

Your next question comes from the line of Joshua Reilly with Needham.

[Joshua Reilly, analyst]

All right. You mentioned in the press release moving towards a full solution automation. How should investors think about this period right now where you've kind of been aggressively making some changes to the platform behind the scenes? Is this something that you think is largely complete at the end of '24 or sometime in '25? And are the implications that we should be thinking about from our end is that the EBITDA margins can potentially move up as we move past that kind of elevated period of investment?

[Chad Richison, executive]

Well, I mean automations do drive efficiencies. I mean there's no doubt about that across the board. We're also very ambitious because we only have 5% of the market, and so there are certain areas we want to capture. I mean I would just say about automation, since our founding, we focused on innovating for our clients and differentiating ourselves from our competitors by delivering that maximum ROI, which is good for everyone. And so we've doubled down on innovation to include the full automation. And the softwares used in our industry will look different in a couple of years, and we're the ones who are building it.

[Joshua Reilly, analyst]

Got it. And then just following back up on the client utilization of modules that have already been sold. It seemed like the last couple of quarters, you've been monitoring that pretty carefully yourself. Are you seeing any change in terms of making the effort with the cross-sell team to get the utilization higher? Or is it still kind of consistent with what it's been in the last few quarters?

[Chad Richison, executive]

Yes, it's continuing to go up in a good way. Sometimes utilization isn't always reflected in time spent in the system. Oftentimes, the best way to utilize our system is to set it up and leave it alone so that it can actually do the work for you, and we're having a lot more of that where people trust the system. I mean we can make 20 decisions today and help us configure something in a way that it will fully automate 4,000 decisions you would otherwise be making every day. And so, so much of what we bring to market is about doing that.

[Operator]

Your next question comes from the line of Steve Enders with Citi.

[Steven Enders, analyst]

Great. I guess maybe to start, I just want to ask a little bit on the 4Q guide and the outlook here. I mean I think kind of [indiscernible] to beat here, but it doesn't look like the full amount kind of rolled through to the year. So can you help us maybe think about what's maybe happening in Q4 that's leading to a little bit of the change in the guide or some of the puts and takes that we should be thinking about for Q4?

[Craig Boelte, executive]

Yes. So as we look to Q4 and in the full year, we narrowed the range, we increased the bottom end and narrowed the range some. Q4 is the one that is the hardest to predict based on the number of bonus runs that you have and other type of off-cycle runs, as well as we had a 50 basis point cut in the interest rate, and potentially a couple of more as we're looking to the end -- towards the end of the year. But that's really what I would say as it relates to the -- as we were thinking the guidance for Q4 and full year.

[Steven Enders, analyst]

Okay. And so is it -- the factors going into it. It's primarily changes on the [indiscernible] assumption side that there isn't, I guess, other changes being accounted for in the outlook?

[Craig Boelte, executive]

Not that I would really call out. I mean more interest rate cuts on that.

[Operator]

Your next question comes from the line of Kevin McVeigh with UBS.

[Kevin McVeigh, analyst]

Great. In terms of the EBIT to beat, you talked about revenue and some automation. Is there any way to think about like how much was the revenue upside as opposed to automation? And as you think about that automation initiative, how much of that is kind of through the organization, and how much more is there to go, I guess, in terms of maybe not necessarily numbers, but percentages, whether it's on the front end or back end. Is there any way to frame that a little bit?

[Chad Richison, executive]

Yes. I mean I think there's a lot of automation to go. I mean in the perfect world, the system would just work for you as you look at it. You wouldn't even have to log in. So I mean, I think there's a lot of automation to go. We're a company that eats our own cooking, so of course, automation is going to impact us in our back office as well to the positive. So automation, it's fun. It's fun to do. It's fun to actually watch a client enact it and be able to trust the system and what it can do for them because that's really what it's about is the return on investment that they're achieving and being able to do something that they couldn't do anywhere else.

[Kevin McVeigh, analyst]

That's helpful. And then with the commentary on that September, the largest sales month ever, is there any way to -- how much of that is kind of white space as opposed to competitive takeaway? What drives -- is that kind of just incremental BETI adoption? Or just because obviously it's a really, really nice [indiscernible] point?

[Chad Richison, executive]

Yes. So that's going to be our bookings. So that's going to be pretty much new business, new logo adds that's going to be the overwhelming majority of it. Of course, all of those will have BETI as well. But that's, that number.

[Operator]

Your next question comes from the line of Jason Celino with KeyBanc.

[Devin Au, analyst]

This is actually Devin on for Jason today. I just want to double click on the outperformance in the quarter on the revenue side. Would you attribute the beat there just mainly on new logo strength in the quarter? Was it stronger back-to-base motion? Or did you see maybe perhaps better retention among employees within your customers? Just more color there would be helpful.

[Craig Boelte, executive]

It's primarily going to be just new logo adds. I mean that's the overwhelming majority of our new revenue is going to be new logo ads.

[Devin Au, analyst]

Got it. That's helpful. And then just one more for me. Just curious how the new cohort of sales rep, I believe you guys added 60-plus new sales rep last quarter. Just curious how those have been ramping versus expectations.

[Chad Richison, executive]

Yes, very well. I mean we have a very strong sales model, a very strong go to market. I would say that our sales reps are very fired up about the product that they're selling and what can be delivered to our clients. And they've been very well as reflected by both the starts number and unit numbers that we gave both last quarter and giving some comment on bookings this quarter.

[Operator]

Your next question comes from the line of Arvind Ramnani with Piper Sandler.

[Arvind Ramnani, analyst]

I just wanted to see if you could comment on sort of BETI adoption, particularly with sort of the cohort of customers who were kind of slow to adopt. I mean you definitely had some customers who were slow to adopt BETI. Have they -- has that adoption increased between that core of folks who were slow to adopt?

[Chad Richison, executive]

Yes. So we definitely are still meeting clients where they live to help them achieve value through the products that they utilize from us, whether they have BETI or not. But you do continue to have clients that see the value of BETI and continue to implement it as well. And of course, all new clients have been coming on with BETI now for about 3 years.

[Arvind Ramnani, analyst]

Yes. Terrific. And then can you provide a bit of an update on some of the progress on the international markets? And I know it's much smaller, but any details around that would be helpful.

[Chad Richison, executive]

Yes. So we're in 4 countries right now, native of us having developed payroll. But our global HCM actually encompasses all countries, and we continue to build that product out as well. So we're doing well in that. And now we -- Craig had a comment.

[Craig Boelte, executive]

Yes. I mean we recently added a manufacturing company with locations all over the world, and they had a native payroll in U.S., Canada and Mexico. So we're seeing more and more companies, primarily U.S. with multinational operations, adopt that.

[Operator]

Your next question comes from the line of Bhavin Shah with Deutsche Bank.

[Bhavin Shah, analyst]

Just first, I guess for Chad, going back to our earlier comments, just back to the CR team, where are they in terms of helping clients achieve full value for that software? Like what percentage of the base have you gone through and have optimized their spend with Paycom?

[Chad Richison, executive]

Yes. I mean I would say CRRs is that's one of the groups that is helping clients achieve full value. But if I'm a CRR and I have a quota, and it's my job to go out there and help clients make sure they have all the products necessary to reach full ROI, there are certain products I want to sell them. But in order to sell them those products, I have to make sure they're utilizing the current products that they have. And so where a CRR is going to be involved in that is during that process. But whether a CRR is out there or not working with an individual client, we at Paycom continue to do that. We do have service individuals that focus on helping clients make sure they're configured the right way to get full usage and value for the systems that they've purchased.

[Bhavin Shah, analyst]

Got it. Craig, just on gross margins, they compressed this quarter at similar levels to what we saw last quarter, even when I take into consideration higher depreciation costs. Can you just give us a sense like what else might be impacting gross margin? How much of it is kind of industry pricing dynamics or needing to hire more customer support reps or anything else? And when should that stabilize going forward?

[Craig Boelte, executive]

Yes. So some of the pressure on the gross margin was the new building we brought online, really at the end of second quarter. So we had a full quarter of the cost of that new building. And so it's not just a depreciation, but some of the other allocations of some headcount, some corporate headcount and things like that. So some of that went into the gross margins, and then some of it's also headcount as well, just client service headcount. As the margins get too high, we may be a little understaffed, and so we're in a good place staffing-wise on that group.

[Operator]

Your next question comes from the line of Daniel Jester with BMO.

[Unknown Analyst]

This is [ Kyle Everest ] on for Dan Jester. Can you talk about the capital spending trends and how you expect that will evolve next year? And then secondly, on segment performance, was there anything to call out in terms of upmarket versus downmarket performance during the quarter?

[Craig Boelte, executive]

Yes. I mean I'll cover the capital spending trends. I mean, obviously, we're going to spend for growth first. And so definitely going to invest there either in sales and marketing. And then also on the R&D front, that's one of the line items that's continued to grow some. After that, we're looking at the stock buybacks. We've done some stock buybacks this quarter that you guys have seen as well as dividends.

[Chad Richison, executive]

And from segment performance, up or downmarket, no change on that. We're seeing strength in both.

[Craig Boelte, executive]

Yes. One thing I would say also on the capital spend, we finished that big building this year, so we would expect maybe CapEx next year to trend down a little bit, probably below 10%.

[Operator]

This concludes the question-and-answer session of today's call. I'll now turn the call back over to Mr. Chad Richison for closing remarks.

[Chad Richison, executive]

All right. I want to thank everyone for joining our call today, and I want to thank our employees for all their hard work and commitment to Paycom's success. We look forward to seeing investors at several conferences this quarter, including the UBS Conference in Phoenix in early December and the Barclays Conference in San Francisco in mid-December. Thank you. Operator, you may disconnect.

[Operator]

This concludes today's conference call. You may now disconnect.