Paycom Software, Inc. — Q3 2017 Form 10-Q
Business and period: Paycom provides cloud-based human capital management software as a service, including payroll, time and labor, talent, and HR applications. This unaudited quarterly report covers the three and nine months ended September 30, 2017, compared with the same 2016 periods.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $101.3m | $77.3m | $319.0m | $241.3m |
| Recurring revenue | $99.5m | $75.9m | $313.8m | $237.3m |
| Operating income | $11.4m | $0.6m | $59.2m | $45.3m |
| Net income | $14.1m | $6.2m | $53.9m | $35.2m |
| Diluted EPS | $0.24 | $0.10 | $0.91 | $0.59 |
| Gross margin | 82.4% | 80.9% | 83.4% | 84.0% |
| Operating margin | 11.3% | 0.8% | 18.5% | 18.7% |
Revenue increased 31% in Q3 and 32% year to date, driven by new clients, sales-office maturation, cross-selling applications, tax-form filing activity, larger clients, and client employee growth. Q3 operating income rose substantially from a low prior-year comparison; nine-month operating income increased 31%. Q3 net income also benefited from a $2.7m income tax benefit. For the nine months, the effective tax rate was 8.3%, versus 20.9% in 2016, primarily reflecting excess tax benefits from stock-award vesting.
Adjusted EBITDA, a non-GAAP measure, was $30.7m in Q3 2017 versus $18.2m, and $105.2m for the first nine months versus $73.8m. The filing cautions that this measure is not a substitute for GAAP results.
Cash flow, liquidity, and debt
- Cash and cash equivalents were $66.6m at September 30, 2017, compared with $60.2m at December 31, 2016. Management said available cash should cover working-capital and capital-expenditure needs for at least 12 months.
- For the first nine months, operating cash flow was $92.4m, compared with $74.4m in 2016. Capital expenditures were $42.9m, mainly related to headquarters construction.
- Reported investing cash flow was $22.6m and financing cash flow was negative $108.6m. Investing and financing totals were materially affected by client funds movements: $792.7m of funds held for clients were matched by a $792.7m client-funds obligation at quarter-end.
- Total debt, including current maturities, was $34.4m, up from $29.8m at year-end, including $5.3m outstanding on a construction loan. The company reported compliance with loan covenants.
- The company spent $47.5m on repurchases during the first nine months, including $28.1m of cash used for employee tax withholding on vested restricted shares. A subsequent board authorization provided for up to an additional $75m of repurchases.
Changes, outlook, and risks
- Operating expenses rose 17% in Q3 and 33% year to date, reflecting continued hiring, sales and marketing investment, research and development, and facility-related depreciation. Nine-month stock-based compensation expense increased to $31.8m from $18.9m.
- Management said gross margins may fluctuate with seasonality and hiring trends, but expected them to remain relatively consistent. It expects ongoing investment in sales teams, product development, and infrastructure; R&D expense is expected to rise in dollars, with its rate of increase anticipated to moderate over time.
- Revenue and margins are seasonal: first-quarter payroll tax-form processing generally lifts results. The filing warns historical seasonal performance may not predict future results.
- Hurricanes in Texas and Florida disrupted prospecting, client conversions, and some implementations in August and September. Management was still evaluating possible fourth-quarter effects; no quantified impact was provided.
- Paycom expected to adopt the revenue-recognition standard on January 1, 2018 using the full retrospective method. It anticipated a material effect on accounting for certain sales commissions and implementation costs, which would generally be deferred and amortized over an average ten-year customer relationship. Management expected the implementation-revenue impact to be minimal. The lease standard was expected to materially affect the balance sheet, but its impact had not been quantified.
- The company disclosed ordinary-course legal proceedings whose outcomes are uncertain and could adversely affect results. It reported no material change in previously disclosed risk factors, no material off-balance-sheet arrangements, and effective disclosure controls.
Important facts for investors to verify
- How much of continued revenue growth comes from new clients and cross-selling versus client employee growth, and whether hurricane-related delays affect Q4.
- How recurring revenue, seasonality, and margins develop in subsequent quarters.
- The sustainability of the unusually low year-to-date effective tax rate and the effect of future share-award vesting tax benefits.
- The scale of stock-based compensation, related share withholding and repurchases, and resulting shareholder dilution.
- The final retrospective impact of the revenue-recognition adoption, especially deferred contract-acquisition and implementation costs.