Paycom Software, Inc. — 2019 Form 10-K
Business context and period. Paycom provides cloud-based human capital management software, including payroll, time and labor, talent management and HR applications. This annual report covers the fiscal year ended December 31, 2019; selected fourth-quarter figures are also reported. Paycom operates as one reporting segment. All amounts below are U.S. dollars.
Financial performance and position
| Metric | 2019 | 2018 | Change |
|---|---|---|---|
| Revenue | $737.7 million | $566.3 million | +30% |
| Operating income | $226.2 million | $173.7 million | +30% |
| Net income | $180.6 million | $137.1 million | +32% |
| Diluted EPS | $3.09 | $2.34 | +32% |
| Operating cash flow | $224.3 million | $184.8 million | +21% |
| Cash and cash equivalents at year-end | $133.7 million | $45.7 million | — |
| Long-term debt, including current portion | $32.6 million | $34.4 million | — |
- Gross margin was approximately 85%, versus 84% in 2018; operating margin was 30.6% in both years, and net margin was 24.5% versus 24.2%.
- Recurring revenue was $724.4 million, up 30%, and represented 98.2% of total revenue. Implementation and other revenue was $13.2 million, up 46%.
- Capital expenditures, reported as purchases of property and equipment, were $92.9 million, compared with $59.9 million. Investing cash outflow was $219.5 million, driven also by movements in investments of client funds. Financing cash flow included a $695.0 million increase in client funds obligation.
- Funds held for clients were $1.663 billion, matched by a $1.663 billion client funds obligation. These funds are held to meet client-related obligations and should not be treated as unrestricted company liquidity.
- At year-end, the company had a $75 million revolving credit facility, with no borrowings outstanding; availability could increase to $125 million subject to conditions. Management said cash and operating cash flow should cover working capital and capital expenditure needs for at least 12 months.
Fourth-quarter snapshot
Fourth-quarter 2019 revenue was $193.4 million, compared with $150.3 million in fourth-quarter 2018 (about 29% growth). Operating income was $60.3 million versus $43.4 million, and net income was $45.4 million versus $31.4 million. These quarterly figures are unaudited.
Material changes and management commentary
- Management attributed revenue growth to new-client additions and productivity at mature sales offices, sales of additional applications to existing clients, new offices, higher average interest rates on client funds, strong tax-form filing activity and a modest price increase for some clients in March 2019.
- Annual revenue retention improved to 93% from 92% in 2018. The client count rose to 26,527 from 23,533; sales teams increased to 50 from 49.
- Operating expenses rose 30% to $511.4 million. Research and development expense increased 58% to $73.1 million, and general and administrative expense increased 32% to $127.5 million. Management cited increased staffing, growth investment and higher regulatory and compliance-related accounting and legal costs.
- Stock-based compensation expense increased 30% to $47.3 million, in part because market-based restricted shares vested early in 2019 after enterprise-value thresholds were reached. The company also reported a $1.4 million loss from the interest-rate swap’s fair-value change, versus a $0.7 million gain in 2018.
- Management expects gross margins to remain relatively consistent, while noting quarterly variation from seasonality and hiring. It expects research and development spending to increase in dollars and as a share of revenue, with the rate of increase potentially moderating over time. The filing does not provide a clear numerical revenue or earnings outlook for 2020.
Outlook, risks and unusual items
- Revenue is seasonal: first-quarter revenue and margins are generally higher due to annual payroll and ACA-related filings; fourth-quarter revenue can benefit from unscheduled payroll runs. Paycom estimated ACA application and filing revenue would be about 4% of projected 2020 revenue if employer reporting requirements remained in place.
- Key risks include cybersecurity or data privacy incidents, service or data-center outages, changing privacy and employment regulations, competition and pricing pressure, and the ability to recruit and train sales and technical personnel. The filing also identifies potential money-transmitter regulation; Paycom stated it was required to register as a money services business in one jurisdiction.
- Client payroll and tax funds create liquidity and operational exposure: client transfers may fail or be reversed after Paycom has made payments. Funds held for clients are also exposed to investment, interest-rate, credit and liquidity risks.
- Debt is secured by the headquarters property and subject to financial and other covenants; Paycom reported compliance at year-end. A floating-to-fixed interest-rate swap offsets part of the term-loan rate exposure, but its fair-value changes are recognized in earnings.
- The company began construction of an expanded Texas operations facility and purchased adjacent Oklahoma City land for $19.2 million. It reported no off-balance-sheet arrangements expected to have a material effect and said pending ordinary-course legal matters were not expected to have a material adverse effect, while noting outcomes remain uncertain.
- Auditors issued unqualified opinions on the financial statements and internal controls. The critical audit matter concerned the estimated ten-year client relationship period used to amortize deferred contract costs and recognize deferred implementation revenue.
Important facts for investors to verify
- Whether client retention, new-client growth and application adoption continue to support recurring revenue growth.
- How much of reported cash and cash-flow movement is attributable to client funds, versus cash available for corporate use.
- Whether ACA reporting requirements, and the estimated 4% contribution to projected 2020 revenue, remain applicable.
- The scale and timing of facility and technology investment, and the effect of rising R&D and stock-based compensation costs on margins.
- The assumptions supporting the ten-year client relationship estimate, given its importance to deferred costs, revenue recognition and the auditor’s critical audit matter.
- Compliance with debt covenants and the potential impact of data-security, privacy, money-services regulation and payroll-funding risks.