Paycom Software, Inc. — 2014 Form 10-K
Reporting period: Fiscal year ended December 31, 2014. The filing also reports fourth-quarter results for the three months ended December 31, 2014; amounts below are in U.S. dollars unless stated otherwise.
Business context and reporting period
Paycom provides cloud-based human capital management software on a software-as-a-service basis, spanning payroll, HR, time and labor, talent acquisition and talent management. Payroll was the principal revenue source, and clients had no long-term commitments and could generally cancel with 30 days’ notice.
Paycom completed its IPO in April 2014 and reorganized as a Delaware corporation effective January 1, 2014. Prior-period financial statements were retrospectively presented following the reorganization. The company reported 12,775 clients, 1.6 million people in client data, and a 91% average annual revenue retention rate for the three years ended 2014.
Key financial metrics
| Metric | FY 2014 | FY 2013 |
|---|---|---|
| Revenue | $150.9 million | $107.6 million |
| Recurring revenue | $148.2 million | $105.6 million |
| Gross profit / gross margin | $123.6 million / approximately 82% | $86.7 million / approximately 81% |
| Operating income / margin | $15.7 million / 10.4% | $9.5 million / 8.8% |
| Net income | $5.7 million | $0.6 million |
| Operating cash flow | $22.3 million | $17.0 million |
| Cash and cash equivalents at year-end | $25.1 million | $13.4 million |
| Long-term debt, including current portion | $27.0 million | $82.0 million |
| Working capital, as defined by the company | $16.8 million | $(4.0) million |
Revenue grew 40% year over year. Cost of revenue was $27.3 million; sales and marketing was $63.5 million, research and development $4.3 million, and general and administrative expense $35.5 million. Adjusted EBITDA, a non-GAAP measure, was $27.0 million versus $19.9 million; GAAP net income was $5.7 million.
Funds held for clients were $660.6 million and the matching client funds obligation was also $660.6 million. These client funds are not equivalent to cash available for general corporate use. Investing cash outflow of $219.1 million primarily reflected the $204.8 million increase in client funds; financing cash inflow of $208.5 million included a matching increase in client fund obligations.
Fourth-quarter performance and changes
Q4 2014 revenue was $44.0 million, compared with $30.3 million in Q4 2013, an increase of approximately 45%. Operating income was $4.8 million, versus an operating loss of $1.1 million; net income was $2.5 million, versus a net loss of $2.0 million. Results are affected by payroll-related seasonality, including unscheduled payroll runs near year-end.
For the full year, gross margin increased approximately one percentage point. Operating income improved despite substantial hiring and expansion spending: sales and marketing expense rose 49%, R&D expense 102%, and G&A expense 24%. Net income also reflected a $4.0 million loss on early debt repayment, while interest expense fell to $3.4 million from $9.3 million.
Outlook, risks and unusual items
- Management expected revenue growth from new clients, expansion into existing markets, additional applications sold to current clients, and growth in clients’ employee counts. It planned eight to twelve additional sales offices over the following two years and expected gross margin to improve gradually as higher-margin non-payroll applications grew. The filing does not provide a specific quantified revenue or earnings forecast.
- The April 2014 IPO generated approximately $62.8 million net proceeds; proceeds and about $3.3 million of existing cash were used to repay related-party notes bearing 10% and 14% interest. At year-end, the remaining $27.0 million bank term loan carried a fixed 4.75% rate, matured in 2021, was secured by headquarters property, and included a debt-coverage covenant. Paycom reported compliance at year-end.
- A trademark lawsuit brought by National Financial Partners alleged infringement and sought damages and injunctive relief concerning Paycom’s logo. Paycom disputed the allegations; potential damages, injunction or rebranding exposure could not be reliably determined. The filing also notes other ordinary-course legal proceedings.
- Principal operating risks include client retention and new-client acquisition, competition and pricing pressure, reliance on payroll revenue, rapid growth and hiring, cybersecurity or data-center disruption, privacy and regulatory requirements, and the possibility that clients’ payroll funding fails to clear after employee or tax payments have been made.
- The company is controlled by major stockholders and used NYSE controlled-company governance exemptions. The follow-on offering closed in January 2015 and consisted of shares sold by existing stockholders; Paycom received no proceeds.
Important facts for investors to verify
- Whether client growth, 91% revenue retention and adoption of non-payroll applications continued, and how much revenue remained dependent on payroll processing.
- Whether spending on sales expansion and product development translated into durable operating-margin and cash-flow improvement.
- How much reported cash is freely available after distinguishing company cash from client funds and related obligations.
- Debt-covenant headroom, planned headquarters or other capital spending, and any need for additional borrowing.
- Developments and potential financial or branding consequences of the NFP trademark litigation.
- Effects of restricted-stock vesting, the concentrated ownership structure and controlled-company governance exemptions on dilution and shareholder rights.