Paycom Software, Inc. — Q2 2017 Form 10-Q
Business and period: Paycom provides cloud-based human capital management software on a SaaS basis. This unaudited report covers the quarter and six months ended June 30, 2017; comparisons are with the same 2016 periods. Amounts below are in millions except per-share data.
Key financial results
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Revenue | $98.2 | $73.9 | $217.7 | $164.0 |
| Recurring revenue | $96.4 | $72.5 | $214.3 | $161.4 |
| Operating income | $9.1 | $16.0 | $47.8 | $44.7 |
| Net income | $14.2 | $10.4 | $39.8 | $29.0 |
| Diluted EPS | $0.24 | $0.18 | $0.67 | $0.49 |
| Operating cash flow | Not reported by quarter | Not reported by quarter | $55.3 | $54.6 |
- Revenue rose 33% in both the quarter and first half. Recurring revenue represented about 98% of revenue.
- Q2 operating margin declined to 9.3% from 21.6%; first-half operating margin was 21.9% versus 27.3%. Management reported first-half gross margin of approximately 84%, compared with 85% in 2016.
- Q2 net income increased despite lower operating income, primarily because of a $5.3 million income-tax benefit, versus $5.5 million tax expense in Q2 2016. The 2017 benefit reflects an $8.2 million discrete excess tax benefit from share-based awards. First-half effective tax rate was 16.1%, versus 34.6%.
- First-half cash from operations was $55.3 million. Capital expenditures for property and equipment were $21.9 million. Cash and cash equivalents were $68.1 million at June 30, versus $60.2 million at year-end 2016.
- Total debt, including the current portion, was $34.6 million; net of current maturities, long-term debt was $33.5 million. Debt increased from $29.8 million at year-end, including $5.3 million drawn under a construction loan. The company reported compliance with loan covenants.
Changes, outlook, and notable items
- Revenue growth reflected new clients, sales-office expansion, sales of additional applications, tax-form filing activity, larger clients, and customer employee growth. Paycom opened two sales offices in Q2 and another in July; it reported 45 sales teams across 25 states.
- Expenses grew faster than revenue in Q2: total operating expenses increased 54%, including increases in sales and marketing, R&D, and general and administrative costs. Management attributed growth largely to hiring and expansion, and expects continued investment in sales, product development, and infrastructure.
- Stock-based compensation was $13.8 million in Q2 and $17.5 million in the first half, versus $3.3 million and $4.6 million, respectively, in 2016. This included compensation associated with restricted-stock vesting triggered by enterprise-value milestones. Adjusted EBITDA and non-GAAP net income were also presented; they are non-GAAP measures and are not substitutes for GAAP results.
- Management said cash on hand should cover working-capital and capital-expenditure needs for at least 12 months. It expects capital expenditures and investment activity to increase with growth, and expects gross margins to remain relatively consistent over time, subject to quarterly fluctuations. The filing provides no numeric revenue or earnings guidance.
- Cash-flow comparisons are affected by client payroll-tax funds: funds held for clients and the matching client-funds obligation were each $787.0 million at June 30. The first-half investing cash inflow and financing outflow included matching $71.2 million changes in these balances, which fluctuate with payroll timing.
- The company repurchased 460,159 shares for $30.2 million in the first half, including shares withheld to cover employee taxes; the related tax-withholding cash outflow was $15.0 million. The repurchase authorization was extended through January 2019.
- Paycom had not completed its assessment of the revenue-recognition standard effective January 1, 2018; it expected material changes to accounting for certain contract acquisition and fulfillment costs. The company also anticipated that the new lease standard would materially affect its balance sheet.
- Ordinary-course legal proceedings could have a material adverse outcome, though no specific matter or amount is identified here. Management reported effective disclosure controls and no material changes to internal control during the quarter.
Investor verification points
- Assess the drivers and sustainability of 33% revenue growth, including new-client additions, application uptake, and employee growth at existing clients.
- Separate underlying operating trends from the Q2 tax benefit and unusually high stock-based compensation; review the vesting terms and future compensation expense.
- Track operating-margin pressure, hiring and expansion costs, capital spending, and the timing and eventual financing of headquarters construction.
- Distinguish corporate liquidity from client funds held for payroll taxes, and review repurchase spending alongside cash generation and debt.
- Follow implementation of the new revenue and lease accounting standards and developments in legal proceedings.