Paycom Software, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017. Unaudited results are compared with Q1 2016. Paycom provides cloud-based human capital management software on a software-as-a-service basis.
Financial performance
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Total revenue | $119.5 million | $90.1 million | +33% |
| Recurring revenue | $117.9 million | $88.9 million | +33% |
| Operating income | $38.7 million | $28.7 million | +35% |
| Net income | $25.6 million | $18.6 million | +38% |
| Diluted EPS | $0.43 | $0.31 | +39% |
| Adjusted EBITDA (non-GAAP) | $46.7 million | $33.0 million | +42% |
Gross margin was approximately 86%, versus 87% in the prior-year quarter. Operating margin improved to 32.4% from 31.8%; net margin increased to 21.4% from 20.6%. Recurring revenue represented 98.7% of total revenue.
Revenue growth reflected new client additions, sales offices opened in 2016, additional applications sold to existing clients, strong tax-forms filing activity, larger clients, and client employee-headcount growth attributed partly to favorable economic conditions. No client represented more than 0.5% of revenue.
Cash flow, liquidity and debt
- Cash and cash equivalents were $92.9 million at March 31, 2017, up from $60.2 million at year-end. Management said cash should cover working-capital and capital-expenditure needs for at least 12 months.
- Operating cash flow was $40.2 million, compared with $29.9 million in Q1 2016. The 2017 result included a $17.3 million increase in net income taxes payable; operating cash flow also reflected $25.6 million of net income.
- Capital expenditures for property and equipment were $9.1 million. Cash flows from investing and financing included offsetting $92.7 million increases in funds held for clients and the corresponding client-funds obligation.
- Total debt, including current maturities, was $31.5 million. The principal term loans carried fixed rates of 4.75% and 3.4%; a $2.0 million construction-loan balance carried a floating rate with a 4.0% floor. The company reported compliance with loan covenants.
- Funds held for clients were $951.0 million and were matched by a $951.0 million client-funds obligation. These balances relate to payroll and tax processing and should be distinguished from corporate cash and ordinary liquidity.
Material changes and outlook
- Operating expenses rose 32% to $80.8 million. Sales and marketing increased 29%, research and development increased 76%, and general and administrative increased 17%; employee-related costs and stock-based compensation were important contributors.
- Stock-based compensation was $3.7 million, versus $1.4 million. The company reported $35.6 million of unrecognized compensation cost for unvested post-IPO restricted stock, expected to be recognized over a weighted-average two years.
- Management expected gross margins to remain relatively consistent, while noting quarterly fluctuation from seasonality and hiring. It expected R&D expense to increase with hiring, but remain relatively constant as a percentage of revenue annually.
- No specific revenue or earnings guidance was provided. Management said capital expenditures and investment activity were expected to increase as the business grows, and that it may accelerate spending on sales and marketing, acquisitions, technology, and services.
- Paycom opened a Milwaukee sales office in April, bringing its network to 43 sales teams in 25 states, and planned further U.S. sales-office expansion.
- The company extended its stock repurchase authorization by up to an additional $50 million through January 2019; it repurchased no shares in Q1.
Risks, contingencies and unusual items
- The company was assessing adoption of the new revenue-recognition standard, effective for it January 1, 2018. It expected a material effect on accounting for certain contract acquisition and fulfillment costs, including deferral and amortization over client relationships (estimated average life of 10 years); the impact on implementation-revenue recognition remained under evaluation.
- Management described ongoing ordinary-course legal proceedings but did not quantify potential exposure; it said an adverse resolution could materially affect results, financial condition, or cash flows.
- Interest-rate sensitivity analysis indicated a 100-basis-point rate change was not expected to have a material effect on results or financial condition. The company noted that investment income and security values remain sensitive to rates.
- Effective tax rate declined to 33.48% from 34.61%, primarily due to increased Section 199 deductions and research and development tax credits.
- On April 26, 2017, after quarter-end, the company granted 607,605 restricted shares with time- and market-based vesting conditions.
Important facts for investors to verify
- Whether recurring-revenue growth and client additions continue, including the contribution from additional applications and new sales offices.
- How operating costs, stock-based compensation, and margins evolve as the company expands its workforce and sales footprint.
- The composition and sustainability of operating cash flow, particularly the contribution from income taxes payable and other working-capital movements.
- The distinction between corporate liquidity and client funds, and the company’s construction spending, debt balances, and covenant compliance.
- The eventual effects of the 2018 revenue-recognition adoption on commission and implementation costs and revenue timing.
- Any material developments in legal proceedings, and the terms and effects of subsequent restricted-stock grants and the repurchase authorization.