Paycom Software, Inc. — Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015. Paycom provides cloud-based human capital management software on a Software-as-a-Service basis. Financial statements are unaudited; comparisons are with the three months ended March 31, 2014 unless otherwise noted. Amounts below are in millions except per-share data.
Financial performance and position
| Metric | Q1 2015 | Q1 2014 / comparison |
|---|---|---|
| Total revenue | $55.2 | $37.0; up 49% |
| Recurring revenue | $54.4 | $36.5; up 49% |
| Gross profit / margin | $46.9 / approximately 85% | $30.1 / approximately 81% |
| Operating income / margin | $10.5 / 19.1% | $3.1 / 8.5% |
| Net income / margin | $6.0 / 10.9% | $1.1 / 2.9% |
| Diluted earnings per share | $0.11 | $0.02 |
| Operating cash flow | $13.1 | $1.7 |
| Cash and cash equivalents, March 31 | $35.7 | $25.1 at December 31, 2014 |
| Long-term debt, including current portion, March 31 | $26.5 | $27.0 at December 31, 2014 |
Sales and marketing expense was $21.2 million, research and development $1.9 million, and general and administrative expense $12.0 million. Adjusted EBITDA, a company-defined non-GAAP measure, was $13.6 million versus $6.6 million; non-GAAP net income was $6.7 million versus $1.6 million.
Client funds held and the corresponding client funds obligation were each $591.6 million at March 31, 2015, down from $660.6 million at year-end. These matched balances relate to payroll-tax processing and are not ordinary operating liquidity. Investing cash flow of $66.9 million chiefly reflected the $69.0 million decrease in client funds held; financing cash outflow of $69.5 million chiefly reflected the matching decrease in the client funds obligation. Capital expenditures were $2.5 million.
Material changes and business trends
- Revenue growth reflected client additions, particularly in mature sales offices, more tax filings, sales of additional applications to existing clients, and higher average revenue per client as Paycom served larger clients.
- Annualized new recurring revenue, a company-defined indicator based on the first full month of revenue from new clients and additional applications, was $20.2 million, compared with $12.6 million. Sales teams increased to 36 from 31; five sales offices opened during the quarter.
- Operating expenses rose 32%, less than revenue growth of 49%. Management attributed improved gross margin partly to vendor-cost reductions negotiated in 2014. Sales and marketing costs rose with sales staffing, commissions, and office expansion; public-company accounting, compliance, and insurance costs contributed to higher general and administrative expense.
- Interest expense declined to $0.3 million from $2.1 million, following repayment of related-party notes with IPO proceeds in 2014. Other income fell to $0.03 million from $0.8 million.
- A January 2015 follow-on offering sold 6.4 million shares by existing stockholders at $22.50 per share; Paycom received no proceeds.
Outlook, risks, and unusual items
- Management stated existing cash was expected to meet working-capital and capital-expenditure needs for at least the next 12 months. No quantified revenue or earnings guidance was provided. Management anticipated continued investment in capital expenditures and operations, and a gradual increase in research and development expense.
- Paycom planned an approximately $14 million headquarters expansion, expected to be completed by mid-2016. A May 13, 2015 construction loan permits borrowing up to the lesser of $11 million or 80% of appraised construction value; there were no borrowings at signing. The loan carries construction-period variable interest and converts to an 84-month term loan upon specified conditions. Management expected to borrow approximately $11 million within 18 months.
- Existing debt was a $26.5 million bank term loan due in 2021 at a fixed 4.75% rate, secured by headquarters property and certain personal property. Paycom reported compliance with its covenants at March 31, 2015. The later construction loan has additional financial and restrictive covenants.
- A trademark and unfair-competition lawsuit brought by National Financial Partners Corp. alleges infringement related to Paycom’s logo and seeks injunctive relief and damages, potentially including treble damages. Paycom denied the material allegations and said it would vigorously defend the case; it stated that outcome and potential liability could not be predicted. The filing reported a preliminary-injunction hearing in May 2015 and a trial scheduled for February 2016.
- Management identified growth dependence on new-client acquisition, geographic expansion, additional application sales, and labor-market conditions. It also noted that failure to generate sufficient revenue and cash flow or raise capital could harm liquidity and business objectives. Other legal matters may also have adverse effects; their outcomes were uncertain.
- On May 5, 2015, stockholders approved an employee stock purchase plan and an annual incentive plan. Management was also negotiating a local incentive package of up to approximately $1.2 million for headquarters-related job creation.
- Management concluded disclosure controls and procedures were effective as of March 31, 2015 and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the 49% revenue growth and higher annualized new recurring revenue translated into sustained client additions, retention, and recurring growth.
- How expenses—especially sales and marketing, research and development, and public-company costs—affect margins as the business scales.
- The composition and timing of the $13.1 million operating cash flow, including the $4.3 million benefit from income-tax working-capital changes; distinguish operating cash from client funds movements.
- Funding, cost, schedule, borrowing, and covenant implications of the headquarters expansion and construction loan.
- Developments and potential financial or branding consequences of the trademark litigation and other contingencies.
- The assumptions and exclusions in Paycom’s non-GAAP measures when comparing them with GAAP results or other companies.