Paycom Software, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. Paycom provides cloud-based human capital management software on a software-as-a-service basis. Financial amounts below are in millions unless stated otherwise; prior-year results have been recast for adoption of ASC 606.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Change | Nine months 2018 | Nine months 2017 | Change |
|---|---|---|---|---|---|---|
| Revenue | $133.3 | $101.3 | 32% | $416.0 | $319.0 | 30% |
| Recurring revenue | $130.8 | $99.5 | 31% | $409.3 | $313.8 | 30% |
| Operating income | $36.2 | $22.0 | 65% | $130.3 | $93.3 | 40% |
| Net income | $28.8 | $20.9 | 38% | $105.7 | $74.6 | 42% |
| Diluted EPS | $0.49 | $0.35 | — | $1.80 | $1.26 | — |
| Gross margin | 83% | 82% | +1 percentage point | 84% | 83% | +1 percentage point |
Q3 operating margin was 27.2%, compared with 21.7%; net margin was 21.6%, compared with 20.6%. Nine-month operating and net margins were 31.3% and 25.4%, respectively, versus 29.2% and 23.4%.
Cash flow, balance sheet and capital allocation
- Nine-month operating cash flow was $145.8 million, compared with $92.0 million a year earlier. Investing activities provided $143.1 million and financing activities used $249.9 million. Cash increased $39.0 million during the period.
- Cash and cash equivalents were $85.0 million at September 30, 2018, versus $46.1 million at December 31, 2017. Funds held for clients of $1,089.2 million are matched by a client funds obligation of the same amount and should not be treated as unrestricted company liquidity.
- Total debt was $34.8 million, including $1.8 million current; the company reported $24.5 million of remaining term-loan borrowing capacity. Its $50 million revolving facility was undrawn. Management said cash and operating cash generation should cover working capital and capital needs for at least 12 months.
- The term loan is secured by the headquarters property and matures in 2025. The company reported compliance with debt covenants. A rate swap fixes the rate on a portion of the debt; its fair-value gain was $0.3 million in Q3 and $1.4 million for the nine months.
- The company repurchased 607,158 shares during the first nine months for an aggregate $63.0 million, including shares withheld for employee tax obligations. $74.4 million remained available under the plan at September 30.
Changes, outlook and risks
- Growth in recurring revenue reflected new-client additions, productivity gains in mature sales offices, developing sales offices, additional applications sold to existing clients, higher interest earned on client funds, and—year to date—tax-form filing activity. No client represented more than 0.5% of nine-month revenue.
- Expenses rose with hiring, sales-office expansion, marketing, research and development, and technology investment. A new national advertising campaign launched late in Q3; management expected related sales and marketing expense to increase into Q4. R&D expense was expected to continue increasing in absolute dollars and as a share of revenue, with the rate of increase expected to moderate over time.
- Management expected gross margins to remain relatively consistent, while noting quarterly variability from seasonality and hiring. Payroll-form processing makes Q1 revenue and margins generally higher; historical seasonal results may not predict future performance. The filing provides no numerical revenue or earnings guidance.
- The fourth headquarters building entered service in June 2018, increasing depreciation. The company expected Q4 spending on land and design for a new Grapevine, Texas operations facility, with construction spending expected to begin in 2019. It opened four sales offices during the first nine months of 2018.
- ASC 606 was adopted retrospectively from January 1, 2018. The company said the change did not materially affect revenue timing or amount; it primarily changed accounting for certain sales commissions and implementation costs by capitalizing and amortizing them. Adoption increased stockholders’ equity by $103.4 million as of January 1, 2016, and prior periods were recast.
- A new risk disclosure addresses possible money-transmitter or money-services-business regulation. Paycom reported it had recently been required to register as a money services business in one jurisdiction; further regulatory determinations could require licensing or changes to operations and could result in penalties or other adverse effects. Ordinary-course legal proceedings were also disclosed, with outcomes uncertain.
- Management reported effective disclosure controls as of September 30 and no material changes in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether recurring-revenue growth, client additions, application sales and sales-office productivity continue to support growth.
- How hiring, advertising, R&D spending and depreciation affect margins, particularly as seasonality changes across quarters.
- Cash generation and capital needs after headquarters spending, the planned Texas facility, and share repurchases; distinguish corporate cash from client funds.
- Debt covenant compliance, term-loan draw capacity and exposure to interest-rate changes, including the swap’s impact on reported income.
- Any additional money-transmitter licensing requirements, regulatory actions or material developments in legal proceedings.
- The effect of capitalized contract acquisition and fulfillment costs under ASC 606 on reported expenses, assets and period-to-period comparability.