Paycom Software, Inc. — Q3 2023 Form 10-Q
Business context and reporting period. Paycom provides cloud-based human capital management software, including payroll, HR, time and labor, talent management and related services. This unaudited quarterly report covers the three and nine months ended September 30, 2023; comparisons are with the corresponding 2022 periods unless stated otherwise. Amounts below are in U.S. dollars; financial statement figures are shown in millions except per-share data.
Financial performance
| Metric | Q3 2023 | Q3 2022 | Change | Nine months 2023 | Nine months 2022 |
|---|---|---|---|---|---|
| Revenue | $406.3 | $334.2 | +21.6% | $1,259.1 | $1,004.6 |
| Recurring revenue | $398.8 | $328.2 | +21.5% | $1,237.7 | $987.8 |
| Operating income | $96.9 | $74.3 | +30.5% | $344.6 | $272.8 |
| Net income | $75.2 | $52.2 | +44.2% | $259.0 | $201.4 |
| Diluted EPS | $1.30 | $0.90 | +44.4% | $4.46 | $3.46 |
| Gross margin | Approx. 83% | Approx. 84% | Down 1 point | Approx. 84% | Approx. 85% |
Operating margin was 23.8% in Q3 2023 versus 22.2% a year earlier, and 27.4% for the first nine months versus 27.2%. Net margin was 18.5% and 15.6% for the respective Q3 periods, and 20.6% and 20.1% for the nine-month periods. Management attributed revenue growth mainly to new clients, mature sales-office productivity, sales of additional applications and higher interest earned on client funds. Q1 tax-form filing activity also contributed to nine-month growth.
- Cash flow: Nine-month operating cash flow was $350.6 million, up from $236.6 million. Investing used $135.6 million, including $135.7 million of property and equipment purchases. Financing used $437.7 million, including the net decrease in client funds obligation, $43.4 million in dividends paid and share repurchases. Operating cash flow less property and equipment purchases was approximately $214.9 million; this is a simple calculation, not a company-defined free-cash-flow measure.
- Liquidity and debt: September 30 cash and cash equivalents were $484.0 million. Funds held for clients were $1.899 billion, substantially matched by a $1.902 billion client funds obligation and not equivalent to corporate cash available for general use. Long-term debt was $29.0 million. The revolving credit commitment was increased to $1.0 billion; the company reported covenant compliance.
- Balance sheet and capital returns: Total assets were $3.856 billion and stockholders’ equity was $1.421 billion. Deferred contract costs totaled approximately $757.5 million, up from $664.4 million at December 2022. During the first nine months, Paycom repurchased 303,401 shares at an average $288.77 per share and paid $43.4 million in dividends.
Material changes and unusual items
- Revenue growth exceeded expense growth in Q3, supporting higher operating margin. However, reported gross margin declined about one percentage point in both the quarter and nine-month comparison.
- Operating costs rose with staffing and growth. Nine-month sales and marketing increased 22.6%, research and development 32.1%, and general and administrative 19.1%. Stock-based compensation was $96.4 million for nine months, up 36%.
- Other income benefited from corporate cash interest income of $6.5 million in Q3 and $17.9 million in the first nine months. Paycom also recorded a $1.2 million loss on extinguishment of debt after terminating an undrawn delayed-draw term-loan facility.
- Cash flows reflect client payroll and tax funds moving through the business; the timing of client receipts and payments can materially affect reported investing and financing flows.
- In July, Paycom increased revolving commitments from $650 million to $1.0 billion, terminated its $750 million delayed-draw term facility without borrowing, and amended its credit agreement in preparation for a planned Paycom Client Trust and Paycom National Trust Bank.
Outlook, management commentary and risks
- No specific revenue, earnings or other numerical full-year guidance is provided in the filing. Management said existing cash, operating cash flow and available liquidity should be sufficient for operations, capital expenditures, dividends and opportunistic repurchases for at least the next 12 months.
- Management expects gross margins to remain relatively consistent, while noting seasonal and hiring-related fluctuations. Revenue is seasonal, with first- and fourth-quarter recurring revenue generally higher than other quarters.
- Management expects research and development expense to continue increasing in absolute dollars and as a percentage of revenue, while anticipating that its rate of increase will decline over time. Beti is designed to reduce payroll errors, billable corrections and unscheduled payroll runs; Paycom said it has experienced and expects continued revenue reductions from those activities.
- The current headquarters expansion is estimated to cost $70 million to $75 million, with construction expected to finish in Q1 2024. Paycom also has escalating arena naming-rights payments, reaching $6.1 million annually by 2035.
- Risks highlighted include cybersecurity and data privacy incidents, third-party security exposure, changing regulations, competition, macroeconomic and labor-market conditions, international expansion, and regulation or potential liability associated with background checks. Paycom disclosed that a third-party business partner had experienced a cyberattack that resulted in unauthorized access to data relating to certain clients, employees and company records.
- Paycom is involved in ordinary-course legal matters. It said current pending matters are not expected to have a material adverse effect, while acknowledging that outcomes are uncertain and could be material. The board may modify, suspend or cancel the dividend policy.
Important facts for investors to verify
- How much recurring-revenue growth came from client additions and application sales versus interest earned on client funds, and how sensitive that interest contribution is to rates.
- Whether continued Beti adoption reduces correction and unscheduled-payroll revenue, and how that trade-off affects client retention and growth.
- Whether cost growth, stock-based compensation and capitalized software spending remain consistent with revenue growth and margin trends.
- That client funds and related obligations are restricted to payroll and tax purposes; assess corporate liquidity separately from those balances.
- Progress on the planned trust and trust bank, the headquarters expansion, and cybersecurity controls following the disclosed third-party incident.