Paycom Software, Inc. — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. Unaudited results. Paycom provides cloud-based human capital management software on a subscription basis.
Financial performance
Amounts below are in millions, except per-share data and percentages.
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Revenue | $73.9 | $49.0 | $164.0 | $104.2 |
| Recurring revenue | $72.5 | $47.8 | $161.4 | $102.2 |
| Operating income | $16.0 | $10.8 | $44.7 | $21.3 |
| Net income | $10.4 | $5.9 | $29.0 | $11.9 |
| Diluted EPS | $0.18 | $0.10 | $0.49 | $0.21 |
| Operating margin | 21.6% | 22.1% | 27.3% | 20.5% |
| Net margin | 14.1% | 12.1% | 17.7% | 11.4% |
- Q2 revenue rose 51% year over year; recurring revenue rose 52%. Six-month revenue rose 57%, with recurring revenue up 58%.
- Six-month gross margin was approximately 85%, compared with 84% a year earlier. Management expects gross margins to remain relatively consistent from quarter to quarter rather than continue improving at the historical pace.
- Q2 operating income increased 48%, while operating margin declined 0.5 percentage points as expenses grew slightly faster than revenue. For the first half, operating income more than doubled and operating margin expanded 6.8 percentage points.
- First-half sales and marketing expense rose 41%, research and development 114%, and general and administrative expense 38%. Management cited increased staffing and sales commissions as principal drivers.
- First-half adjusted EBITDA was $55.6 million versus $26.8 million; non-GAAP net income was $31.9 million versus $12.7 million. These are company-defined non-GAAP measures and are not substitutes for GAAP results.
Cash flow, liquidity and debt
- First-half operating cash flow was $54.6 million, up from $22.8 million. It included $12.1 million of cash benefit from income-tax-related working capital changes and $4.8 million of stock-based compensation expense.
- Cash and cash equivalents were $80.9 million at June 30, 2016, compared with $50.7 million at year-end 2015. Management said available cash should cover working capital and capital expenditures for at least the next 12 months.
- Funds held for clients were $1,034.3 million, matched by a $1,034.3 million client funds obligation. Their $337.6 million increase drove most of the period’s investing and financing cash flows; these balances vary with client payroll calendars and should be distinguished from corporate liquidity.
- Capital expenditures for property and equipment were $24.3 million in the first half, versus $4.9 million a year earlier, including ongoing headquarters construction.
- Debt totaled $29.3 million at June 30, including a $25.4 million fixed-rate term note at 4.75% and $3.9 million drawn on a construction loan. The company reported covenant compliance. The filing reports $5.0 million outstanding on that construction loan when it converted to a term loan on August 1, after the period end.
- In June, Paycom repurchased 85,129 shares for $3.5 million at an average $41 per share under a $50 million, 24-month authorization; $46.5 million remained available at June 30.
Outlook, changes and notable items
- Growth was attributed mainly to new clients in mature sales offices, additional applications sold to existing clients, application enhancements, improved client training and higher sales-representative productivity. First-half revenue also benefited from more client tax-form filings, including sales of Enhanced ACA applications.
- Paycom opened six sales offices in the first half and reported 42 sales teams across 24 states. No client accounted for more than 0.5% of first-half revenue. Management plans further U.S. sales-office expansion and expects capital expenditures and investment activity to rise as the business grows.
- The filing provides no numerical revenue or earnings guidance. Management said results for the interim period are not necessarily indicative of full-year results.
- After quarter end, market-based restricted-stock awards vested, triggering approximately $15.8 million of compensation cost: $12.0 million on July 28 and $3.8 million on August 1. Tax withholding led to shares being held as treasury stock.
- On August 2, Paycom entered a new headquarters construction loan allowing up to $28.6 million of borrowing, subject to collateral appraisal, with a 30-month construction term and potential conversion to an 84-month term loan. The existing $5.0 million construction balance had converted on August 1 to a 78-month loan at 3.44% fixed interest.
- The company changed its policy in Q2 to record interest earned on client funds in recurring revenue rather than other income. Management said the effect was immaterial and did not restate prior periods.
- Risks include ordinary-course legal proceedings that could have a material adverse outcome and evolving sales, use and other tax rules that may increase costs or create liabilities. The filing reports no off-balance-sheet arrangements and no material change to previously disclosed risk factors other than the tax-risk disclosure.
Most important facts for investors to verify
- Whether rapid revenue growth continues and whether expense growth, particularly in sales, R&D and stock compensation, affects margins.
- The composition and timing of client funds and obligations, given their large matched balances and significant effect on reported cash flows.
- The cash and borrowing requirements of headquarters expansion, including utilization and terms of the new construction facility.
- The timing and income-statement effect of restricted-stock vesting and related tax withholding; first-half stock-based compensation was materially higher than in 2015.
- Execution of the sales-office expansion and the $50 million repurchase authorization, alongside covenant compliance and tax or legal contingencies.