Paycom Software, Inc. — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; unaudited. Paycom provides cloud-based human capital management software as a service, including payroll, time and labor, talent acquisition and HR applications. Unless otherwise noted, financial amounts below are in millions.
Financial performance and position
| Metric | Q1 2016 | Q1 2015 / comparison |
|---|---|---|
| Total revenue | $90.1 | $55.2; up 63% |
| Recurring revenue | $88.9 | $54.4; up 64% |
| Gross margin | Approximately 87% | Approximately 85% |
| Operating income / margin | $28.7 / 31.8% | $10.5 / 19.1% |
| Net income | $18.6 | $6.0; up 210% |
| Diluted EPS | $0.31 | $0.11 |
| Operating cash flow | $29.9 | $13.1 |
| Cash and cash equivalents at quarter-end | $72.1 | $50.7 at Dec. 31, 2015 |
| Long-term debt, including current portion | $25.6 | $25.7 at Dec. 31, 2015 |
Revenue growth reflected new clients, particularly in mature sales offices, sales of additional applications to existing clients, Enhanced ACA, and more client tax-form filings. Operating expenses rose 37% to $61.4 million, including higher sales and marketing, research and development, and administrative spending. The effective tax rate declined to 34.61% from 41.45%, primarily due to the Section 199 deduction and research and development tax credit.
Cash flow from investing was a use of $437.3 million, largely because funds held for clients increased $428.9 million; financing cash flow included an equal $428.9 million increase in the client funds obligation. These client funds are held to meet payroll-tax obligations and are not equivalent to unrestricted operating liquidity. Property and equipment purchases were $8.4 million. Management said existing cash should cover working capital and capital expenditure needs for at least 12 months.
At March 31, funds held for clients were $1,125.6 million, matched by a $1,125.6 million client funds obligation. The $25.6 million term note bears fixed interest of 4.75%, matures in May 2021 and is secured by headquarters property. Paycom reported compliance with its loan covenants. It had no borrowings under its separate construction loan.
Material changes and operating developments
- Operating margin improved to 31.8% from 19.1%, while gross margin increased by about two percentage points. Management expects gross margins to remain relatively consistent rather than continue improving at the historical rate.
- Sales and marketing expense increased 35%, research and development expense increased 107%, and general and administrative expense increased 27%. Management cited increased staffing and sales commissions; it expects gradual increases in R&D staffing costs.
- Paycom had 42 sales teams in 24 states and opened six sales offices during the quarter.
- Capital spending included continued construction of a headquarters building, estimated to cost approximately $15.7 million, with completion expected by mid-2016. The company said it was funding the expansion from cash reserves.
Outlook, risks and unusual items
- The filing provides no specific full-year revenue or earnings guidance. Management estimated Enhanced ACA would contribute approximately 5% of 2016 revenue and cautioned that it may be a less significant growth driver in future periods as ACA implementation sales normalize.
- Management identified growth opportunities in new-client acquisition, geographic expansion and cross-selling applications, while noting that results may correlate with labor-market conditions. It may increase investment in sales and marketing, acquisitions, technology and services.
- Risks include the ability to attract and retain clients, forecast revenue and manage growth-related spending; changing tax rules for internet-delivered services; and ordinary-course legal proceedings whose outcomes are uncertain. The filing says there were no material changes to previously disclosed risks except for the added tax-law risk.
- Operating cash flow benefited from a $13.3 million change in income taxes, net, and was partly offset by a $6.9 million decrease in accrued commissions and bonuses. Consider these working-capital movements when assessing cash generation.
- Stock-based compensation was $1.2 million in operating cash flow adjustments; Adjusted EBITDA also adds back stock-based compensation. On April 15, 2016, Paycom issued 847,928 restricted shares to employees under its incentive plan, with time- and market-based vesting.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether recurring revenue growth, new-client additions and cross-selling continue as Enhanced ACA becomes a smaller growth contributor.
- Whether the improved operating margin is sustainable as sales, R&D and administrative staffing and spending increase.
- How much operating cash flow reflects durable earnings versus tax-related and other working-capital timing effects; distinguish unrestricted cash from client funds.
- Progress and final cost of the headquarters expansion, and whether any construction-loan borrowing becomes necessary.
- Potential effects of evolving state and local tax rules, legal proceedings and the April 2016 restricted-stock awards on costs, dilution and results.