Paycom Software, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. Paycom provides cloud-based human capital management software on a Software-as-a-Service basis. Amounts below are in U.S. dollars; financial statement figures are in millions unless otherwise noted. Prior-year comparatives were recast for adoption of ASC 606.
Financial results and key metrics
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total revenue | $128.8 | $98.2 | $282.7 | $217.7 |
| Recurring revenue | $126.6 | $96.4 | $278.5 | $214.3 |
| Operating income | $43.0 | $18.8 | $94.1 | $71.3 |
| Net income | $35.7 | $20.0 | $76.9 | $53.7 |
| Diluted EPS | $0.61 | $0.34 | $1.31 | $0.91 |
| Gross margin | Approximately 84% | Approximately 82% | Approximately 84% | Approximately 84% |
- Q2 revenue grew 31% year over year; recurring revenue grew 31%. Six-month revenue grew 30%, with recurring revenue up 30%.
- Q2 operating margin was 33.4% versus 19.1%; net margin was 27.7% versus 20.4%. Six-month operating margin was 33.3% versus 32.7%; net margin was 27.2% versus 24.7%.
- Six-month cash provided by operating activities was $100.4 million, up from $55.3 million. Purchases of property and equipment were $31.9 million, versus $21.9 million. Reported investing and financing cash flows are significantly affected by matching client funds and client obligations.
- At June 30, cash and cash equivalents were $46.1 million. Funds held for clients of $1,089.2 million were matched by a $1,089.2 million client funds obligation and are not general-purpose liquidity.
- Total debt carrying value was $35.3 million. The company had $24.5 million of remaining capacity under its term credit agreement and an undrawn $50 million revolving facility. Stockholders’ equity was $329.7 million.
Material changes and drivers
- Management attributed recurring revenue growth to new clients, improved productivity in mature sales offices, sales offices opened in 2017, cross-selling applications, customer employee growth in favorable economic conditions, higher interest earned on client funds, and, for the six-month period, tax-form processing growth.
- Operating income grew faster than revenue in Q2. General and administrative expense fell 19% year over year, principally because Q2 stock-based compensation was lower; Q2 2017 included market-based award vesting. For the six-month period, stock-based compensation expense rose to $27.0 million from $16.3 million, primarily following issuance and accelerated vesting of market-based awards in Q1 2018.
- Sales and marketing, research and development, and general and administrative costs increased over the six-month period, reflecting personnel growth and compensation. Research and development expense rose 48% to $22.0 million; some software development costs were capitalized.
- ASC 606 adoption was retrospective and increased stockholders’ equity by $103.4 million as of January 1, 2016. Management said revenue timing and amounts were not materially affected; the principal change was capitalization and amortization of certain contract acquisition and implementation costs. The company reported $197.4 million of deferred contract costs at June 30.
Outlook, risks, and unusual items
- No quantified revenue or earnings guidance is provided. Management expects gross margins to remain relatively consistent, while noting quarterly variation from seasonality and hiring. Q1 is generally stronger because of annual payroll-form processing.
- Management expects research and development spending to increase in absolute dollars and as a percentage of revenue, with the rate of increase expected to decline over time as the business scales. The company opened four sales offices in the first half and plans further geographic expansion.
- The fourth headquarters building was completed in Q2. The company expected land, design, and other preliminary spending for a new Grapevine, Texas operations facility in the second half of 2018, with construction-related capital expenditures expected to begin in 2019.
- Management said existing cash and operating cash flows should cover working capital and capital expenditure needs for at least 12 months. It also cautioned that payroll seasonality, labor-market conditions, growth investments, and the ability to attract and retain clients and employees could affect results.
- The term and revolving credit agreements require a minimum fixed-charge coverage ratio of 1.25:1 and maximum funded debt-to-EBITDA ratio of 2.0:1; the company reported compliance at June 30. A swap mitigates some variable-rate exposure; its fair-value gains contributed $0.3 million in Q2 and $1.1 million in the first half to other income.
- The board authorized an additional $100 million of repurchases in February. During the first half, the company repurchased 576,710 shares at an average $103.82 per share, including shares withheld for employee tax obligations; $77.5 million remained available at June 30.
- Various legal proceedings are ongoing in the ordinary course; the company said their outcomes are uncertain and could potentially have a material adverse effect. Management reported no material changes to the risk factors in its 2017 Form 10-K, no material off-balance-sheet arrangements, and effective disclosure controls.
Important facts for investors to verify
- Assess how much growth is attributable to customer and application adoption versus interest earned on client funds and seasonal tax-form revenue.
- Track deferred contract cost capitalization, amortization, and recoverability, along with the effects of ASC 606 on comparisons and reported margins.
- Evaluate recurring stock-based compensation, particularly market-based vesting events, their effect on GAAP earnings, and the resulting dilution.
- Monitor cash generation separately from client funds movements, planned Grapevine facility expenditures, and share repurchases.
- Review debt covenant headroom, interest-rate exposure, and developments in the disclosed legal proceedings.