Paycom Software, Inc. — 2014 Q3 Form 10-Q
Reporting period: Three and nine months ended September 30, 2014. Financial statements are unaudited. Dollar amounts below are in millions unless noted. Paycom provides cloud-based human capital management software, primarily payroll and tax management, on a SaaS basis.
Financial performance and position
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $36.6 | $25.8 | $106.9 | $77.3 |
| Recurring revenue | $35.9 | $25.2 | $105.0 | $75.8 |
| Operating income | $4.7 | $1.8 | $10.9 | $10.6 |
| Net income (loss) | $2.7 | $(0.4) | $3.2 | $2.6 |
| Diluted EPS | $0.05 | $(0.01) | $0.06 | $0.05 |
| Operating cash flow | Not presented quarterly | $13.3 | $12.1 |
- Growth and margins: Revenue increased 41.7% in Q3 and 38.2% year to date. Gross margin was approximately 82.5% in Q3 and 81.5% for the nine months, versus 79.3% and 80.7%, respectively, in 2013. Operating margin was 12.8% in Q3 versus 7.1%; year-to-date it was 10.2% versus 13.7%. Net margin was approximately 7.4% in Q3 and 3.0% year to date.
- Expenses: Nine-month operating expenses rose 43.8%, faster than revenue, principally reflecting sales-force expansion, commissions, office growth, R&D hiring and public-company costs. Sales and marketing expense increased 53.0% year over year.
- Cash and liquidity: Cash and cash equivalents were $18.5 at September 30, up from $13.4 at December 31, 2013. Management said cash should cover working-capital and capital-expenditure needs for at least 12 months. Operating cash flow was $13.3 for the first nine months. Investing cash flow included a $62.1 decrease in client funds held, offset in financing by the same decrease in the client funds obligation; these are client payroll-tax funds, not ordinary available liquidity.
- Debt and investment: Outstanding debt was $27.2, consisting of a fixed-rate 4.75% bank loan maturing in 2021, secured by headquarters property. The company reported compliance with its loan covenants at quarter-end. Capital expenditures for property and equipment were $11.9 year to date, versus $6.2 in 2013.
Material changes and unusual items
- The April 2014 IPO generated approximately $64.3 of net proceeds for the company. Proceeds and about $3.3 of existing cash were used to repay related-party notes bearing 10% and 14% interest. The company also consolidated bank borrowings into its 2021 loan.
- Year-to-date results include a $4.0 loss on early debt repayment/write-off of debt issuance costs. Lower interest expense partly offset that charge. The company’s corporate reorganization also changed its tax status; the higher 2014 effective tax rate reflects taxation as a C corporation.
- Shares outstanding increased with the reorganization and IPO; period-end common shares were 51.1 million. Dilution and the increase in the share base are relevant to per-share comparisons.
Outlook, management commentary and risks
- Management attributed growth to mature sales offices, new clients, sales of additional HCM applications and larger clients. It operated 31 sales teams in 20 states, opened five offices in the first nine months, and said it believed annual new-office openings could rise to four to six beginning in 2015.
- Management expects growth to generally track labor-market improvement, recurring revenue from non-payroll HCM applications to increase, and gross margin to improve gradually over time. It also anticipates rising R&D expense and capital expenditures as the business expands. These are forward-looking expectations, not guarantees.
- Paycom does not require long-term client commitments. Management cited failure to generate sufficient revenue and operating cash flow as a potential threat to liquidity and business objectives.
- A trademark dispute with National Financial Partners concerning Paycom’s logo was pending. The company intended to defend the case; a loss could entail damages or require a logo or brand change. A separate patent dispute was settled and dismissed with prejudice in July 2014. The filing notes other ordinary-course legal proceedings and potential material adverse effects from their resolution.
- A prior debt-coverage covenant noncompliance at December 31, 2013 had been addressed through a lender waiver; the refinanced loan was reported covenant-compliant at September 30, 2014. Management reported effective disclosure controls and no material changes in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether recurring-revenue growth and new-client/application sales continue to support revenue growth as sales and marketing spending rises.
- Whether margins and cash generation improve, particularly given year-to-date operating expenses growing faster than revenue and substantial capital investment.
- The company’s cash available apart from client funds, future debt-service and covenant position, and the effect of loan restrictions.
- Progress and potential financial or branding consequences of the National Financial Partners trademark litigation.
- How share dilution, the one-time debt repayment charge and the post-reorganization tax structure affect reported and per-share earnings.