Paycom Software, Inc. quarterly report, Q2 FY2023

Paycom Software, Inc. — Q2 2023 Form 10-Q

Reporting period: Three and six months ended June 30, 2023. Paycom provides cloud-based human capital management software as a service, including payroll and related HR applications. Figures below are in U.S. dollars; financial statement amounts are in millions unless otherwise noted.

Financial performance

Metric	Q2 2023	Q2 2022	Six months 2023	Six months 2022
Revenue	$401.1	$316.9	$852.8	$670.4
Operating income	$87.3	$72.3	$247.7	$198.6
Net income	$64.5	$57.4	$183.8	$149.3
Diluted EPS	$1.11	$0.99	$3.17	$2.57
Operating cash flow	Not separately provided	Not separately provided	$252.0	$169.0

Q2 revenue rose 26.6% year over year; recurring revenue increased 26.6% to $394.5 million and accounted for 98.4% of revenue. Six-month revenue increased 27.2%.
Q2 operating margin was 21.8%, versus 22.8% a year earlier; net margin was 16.1%, versus 18.1%. Management reported gross margins of approximately 83% versus 84% in Q2 and 84% versus 85% for the first half.
Six-month operating cash flow was $252.0 million. Investing activities used $83.4 million, principally including $83.4 million of property and equipment purchases; financing activities used $234.4 million, including a $201.6 million net decrease in the client funds obligation and $21.7 million of dividends paid. The resulting decrease in cash, cash equivalents and restricted cash was $65.7 million.
At June 30, cash and cash equivalents were $536.5 million, while funds held for clients were $2.002 billion and the corresponding client funds obligation was $2.006 billion. Client funds are held to meet client payroll and tax obligations and are not equivalent to unrestricted corporate cash.
Long-term debt was $29.0 million. The company had $1.0 billion of revolving commitments following a July 28, 2023 amendment; the facility had $29.0 million drawn at quarter-end. The company said it was in compliance with credit covenants.
Non-GAAP adjusted EBITDA was $156.6 million for Q2 and $377.1 million for the first half, compared with $119.6 million and $289.7 million, respectively, in 2022. These are company-defined supplemental measures, not GAAP earnings.

Changes versus prior comparable periods

Q2 net income grew 12.5%, slower than revenue growth, as operating expenses rose 28.3% and the effective tax burden increased. For the first half, net income grew 23.1%.
Management attributed revenue growth mainly to new clients, productivity and efficiency gains in mature sales offices, sales of additional applications to existing clients, and higher interest earned on client funds. Higher interest rates and a higher average client-funds balance contributed to recurring revenue growth.
Expense growth reflected increased staffing and employee-related costs, higher sales and marketing spending, continued product development, and greater depreciation and amortization. Stock-based compensation rose 46% in Q2 to $35.4 million.
Other income was $6.2 million in Q2, primarily from income on corporate funds, compared with $0.9 million in Q2 2022. The first-half effective tax rate increased to 28.9% from 25.5%, attributed to lower excess tax benefits from stock compensation and reduced R&D credits.

Outlook, risks and notable items

The filing provides no quantitative revenue or earnings guidance. Management expects gross margins to remain relatively consistent over future periods, while noting quarter-to-quarter seasonality. It expects R&D expense to increase as the business grows, with the rate of increase expected to moderate over time.
Management said existing cash, operating cash generation and available liquidity should be sufficient for operations, capital expenditures and dividends for at least 12 months. It expects to fund longer-term needs primarily through operating cash flows and, as needed, financing.
Management cited growth opportunities from new-client acquisition, geographic expansion, larger enterprise clients and selling additional applications. Results are sensitive to client employee counts, labor-market conditions, retention, application adoption and interest income on client funds.
The company highlighted cybersecurity and data privacy threats, including risks involving third-party providers; competition and technology changes; hiring and growth-management challenges; international expansion risks; regulatory changes; and seasonality. It disclosed ordinary-course legal matters, noting outcomes are uncertain; it did not identify a specific pending matter as expected to have a material adverse effect.
A quarterly dividend policy was adopted in May 2023. A $0.375-per-share dividend was paid in June, and another $0.375 dividend was declared in July for payment in September, subject to board approval and the company’s ability to continue the policy. The board may modify or discontinue dividends.
The company estimated $70–$75 million for its Oklahoma City headquarters expansion, with construction expected to finish in Q1 2024. It also has escalating arena naming-rights payments, reaching $6.1 million annually in 2035.
On July 28, 2023, after quarter-end, the company increased revolving credit commitments from $650 million to $1.0 billion, terminated an undrawn $750 million delayed-draw term loan facility, and amended the credit agreement in preparation for a planned Client Trust and Trust Bank.
The company reported effective disclosure controls as of June 30, 2023, with no material changes in internal control over financial reporting during the quarter.

Important facts for investors to verify

How much of recurring revenue growth is attributable to core client and application expansion versus interest income on client funds.
Whether expense growth, stock-based compensation and declining year-over-year operating and gross margins affect profitability as revenue scales.
The distinction between corporate cash and restricted client funds, and the operating, regulatory and financial implications of the proposed Client Trust and Trust Bank.
Execution and cost of the headquarters expansion, plus capital spending and cash-flow trends as investments continue.
Cybersecurity and third-party data incidents, international expansion risks, legal contingencies and the sustainability of the dividend and repurchase plans.