Paycom Software, Inc. — FY 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. This is an annual filing; Q4 figures are identified separately where available. Paycom provides cloud-based, subscription HCM software spanning payroll, HR, time and labor, and talent applications. Payroll is required to access its other applications. The company reported 17,817 clients and 2,075 employees at year-end.
Financial performance and liquidity
| Metric | FY 2016 | FY 2015 | Change |
|---|---|---|---|
| Revenue | $329.1 million | $224.7 million | +47% |
| Operating income | $58.0 million | $34.4 million | +68% |
| Net income | $43.8 million | $20.9 million | +109% |
| Diluted EPS | $0.74 | $0.36 | +106% |
| Operating cash flow | $99.0 million | $43.0 million | +130% |
- Recurring revenue was $323.5 million, or 98.3% of total revenue. Revenue growth reflected new clients, sales-office maturation and expansion, cross-selling, larger clients and growth in clients’ employee counts; ACA filing activity also contributed.
- Gross margin was approximately 84%, essentially unchanged from 2015. Operating margin rose to 17.6% from 15.3%; net margin increased to 13.3% from 9.3%.
- Cash and cash equivalents were $60.2 million at year-end, versus $50.7 million. Working capital, using the company’s stated definition, was $31.9 million versus $37.3 million.
- Total debt was $29.8 million, including $1.1 million current and $28.7 million long-term. The company had no borrowings under its $28.6 million construction facility at year-end and reported compliance with loan covenants.
- Investing cash outflow was $205.1 million, primarily reflecting a $161.5 million increase in client funds held and $43.8 million of capital expenditures. Client funds held and the corresponding client funds obligation were each $858.2 million; these matched balances are not equivalent to unrestricted cash or operating liquidity.
Fourth-quarter results
Q4 2016 revenue was $87.8 million, up approximately 35% from $65.1 million in Q4 2015. Operating income was $12.7 million versus $6.2 million, and net income was $8.6 million versus $5.2 million. Q4 2016 diluted EPS was $0.15, compared with $0.09. Revenue was seasonally supported by year-end unscheduled payroll runs.
Material changes and unusual items
- Research and development expense increased 143% to $21.0 million; capitalized software development costs increased to $8.8 million from $4.3 million. Sales and marketing expense increased 29% to $119.3 million, while general and administrative expense rose 44% to $69.0 million.
- Non-cash stock-based compensation increased to $22.5 million from $3.0 million, mainly due to restricted stock awards and vesting tied to market-based targets. This materially affects comparisons of reported and adjusted earnings.
- The effective tax rate fell to 23% from 38%, primarily because early adoption of ASU 2016-09 resulted in $7.0 million of excess tax benefits recognized in the income-tax provision.
- From April 1, 2016, interest earned on client funds was classified as recurring revenue rather than other income; this change affects revenue and other-income comparability.
- The company repurchased 1.12 million shares for approximately $50.0 million in 2016, including shares withheld to cover employee taxes. A further $50.0 million authorization was announced in February 2017.
Outlook, risks and contingencies
- Management stated that existing cash should cover working-capital and capital-expenditure needs for at least 12 months, and expects gross margins to remain relatively consistent. It planned 10 to 14 additional sales offices over the following two years; no formal revenue or earnings guidance is provided in the filing.
- Management estimated that ACA application and filing revenue could represent approximately 5% of projected 2017 revenue if requirements remained in place. Under a hypothetical repeal or modification eliminating further ACA-related collections after March 1, 2017, approximately 3% of projected 2017 revenue would be lost. The filing notes substantial uncertainty following the January 2017 executive order concerning the ACA.
- Key risks include client retention and cross-selling, competition and pricing pressure, hiring and managing rapid growth, service interruptions or cyberattacks, data-center continuity, regulatory and privacy changes, and client-fund settlement or investment risks. Payroll funds may need to be advanced if client transfers fail to clear.
- Legal matters arise in the ordinary course. Management did not expect current matters to have a material adverse effect, but stated outcomes are uncertain. No off-balance-sheet arrangements were reported.
- New revenue-recognition guidance, expected to be adopted January 1, 2018, was expected to materially affect accounting for certain contract acquisition and fulfillment costs. Lease-accounting changes were expected to materially affect the balance sheet.
- The financial statements received an unqualified audit opinion, and management and the auditor reported effective internal control over financial reporting as of December 31, 2016.
Important facts for investors to verify
- Whether client, employee and revenue growth—and 91% annual revenue retention—continue as sales offices mature and the company pursues larger clients.
- How much reported earnings growth reflects operating performance versus the $22.5 million of stock-based compensation and the $7.0 million tax benefit.
- The recurring contribution and durability of ACA-related revenue, and the effects of any legislative changes.
- Cash generation and capital spending after separating operating cash from client funds held and matching obligations; also monitor debt covenants and construction borrowing.
- The timing and financial-statement effects of adopting the new revenue-recognition and lease-accounting standards.