Paycom Software, Inc. — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020. Paycom provides cloud-based human capital management software, including payroll, HR, time and labor, and talent applications. Financial statement amounts below are in millions, except per-share data.
Financial performance and liquidity
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Revenue | $181.6 | $169.3 | $424.0 | $369.3 |
| Recurring revenue | $178.0 | $166.0 | $416.4 | $362.9 |
| Operating income | $26.6 | $52.9 | $115.8 | $115.4 |
| Net income | $28.6 | $48.8 | $91.6 | $96.0 |
| Diluted EPS | $0.49 | $0.83 | $1.57 | $1.64 |
| Operating cash flow | — | $107.5 | $122.8 | |
| Adjusted EBITDA (non-GAAP) | $61.2 | $69.4 | $179.1 | $172.7 |
- Revenue increased 7% in Q2 and 15% year to date. Recurring revenue represented about 98% of revenue in both periods.
- Reported gross margin was approximately 84% in Q2 versus 85% a year earlier, and 86% year to date versus 85%. Operating margin fell to 14.6% from 31.2% in Q2; year-to-date operating margin was 27.3% versus 31.2%.
- Q2 net income declined 41%; year-to-date net income declined 5%. Q2 included an income tax benefit of $1.9 million, compared with a $3.6 million tax provision in Q2 2019. The six-month effective tax rate was 20.4%, versus 16.1%.
- Cash and cash equivalents were $113.5 million at June 30, down from $133.7 million at year-end 2019. Funds held for clients of $1,033.5 million were matched by a client funds obligation of the same amount and should be distinguished from corporate liquidity.
- Debt was $31.8 million carrying value, including $1.8 million current; the $75 million revolving facility was undrawn. The company reported compliance with debt covenants. The term loan matures in 2025.
- Operating cash flow was $107.5 million. The $787.9 million decrease in cash, cash equivalents and restricted cash largely reflected movements in client funds; it is not equivalent to a comparable decline in unrestricted corporate cash.
Material changes versus prior comparable periods
- Revenue growth from new clients, maturing sales offices, sales of additional applications, and strong Q1 tax-form processing was partly offset by client employee headcount reductions and lower interest earned on client funds.
- Q2 operating expenses rose 33% to $155.0 million. Sales and marketing increased 35% and R&D increased 30%, reflecting higher investment; general and administrative expense rose 49%, including higher stock-based compensation and employee-related costs.
- Q2 stock-based compensation expense was $21.2 million versus $5.6 million a year earlier. For the six months it was $37.0 million, broadly similar to $36.7 million in 2019. Adjusted EBITDA declined in Q2 but increased for the first six months.
- Capital expenditures were $52.5 million for the first six months, up from $34.7 million, including investment in the Grapevine, Texas operations facility.
- Repurchases and employee tax-withholding share settlements used cash. The company repurchased 295,227 shares during the six months at an average $227.35 per share; $174.8 million remained available under the $250 million authorization at June 30.
Outlook, commentary, and risks
- Management gave no specific numerical revenue or earnings guidance in the provided filing. It expected pandemic-related headcount declines, lower interest rates, and CARES Act Social Security tax deferrals to weigh on recurring revenue while those conditions persisted. Management expected net income to remain pressured through the rest of 2020 by these factors and continued investment.
- Management said demand remained high and expressed confidence in the business and product offering. It planned continued significant marketing investment and expected R&D expense to increase in absolute dollars as the platform develops.
- COVID-19 had reduced client employee counts and temporarily delayed implementation for a limited number of new clients. As of June 30, 96% of Paycom employees worked remotely; virtual selling could affect client acquisition or lengthen sales cycles. The full pandemic impact was uncertain.
- Interest earned on client funds faced pressure from lower rates and no Q2 year-over-year growth in average client funds. The company also identified seasonality: Q1 revenue and margins are generally higher due to payroll-form processing.
- An SEC inquiry, ongoing since 2019, concerns whether certain clients were charged for applications already included in their charges, as well as books and records and internal controls. Paycom identified fewer than 250 affected clients (about 0.5% of its client base), refunded approximately $2.5 million, and said the matter had not materially affected prior-period results. The inquiry’s outcome and timing were uncertain.
- Other risks include cybersecurity and privacy, competition, recruiting and retention, growth execution, and ordinary-course legal proceedings. Management reported disclosure controls effective and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether client headcount, new-client implementation timing, and Social Security tax deferrals continue to affect recurring revenue and client-fund balances.
- How much of operating expense growth—especially marketing, R&D, and stock-based compensation—continues, and whether revenue growth converts into operating income.
- The SEC inquiry’s status, any further client refunds, and any resulting regulatory, accounting, or control consequences.
- Corporate cash and liquidity excluding client funds, alongside construction spending, buybacks, and the undrawn revolving facility.
- The effect of lower interest rates on client-fund interest revenue and the interest-rate swap’s fair-value changes.