Paycom Software, Inc. — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020; unaudited. Paycom provides cloud-based human capital management software, including payroll and HR applications. Unless stated otherwise, figures below are in millions of dollars.
Financial performance
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Revenue | $196.5 | $175.0 | $620.5 | $544.3 |
| Recurring revenue | $192.7 | $171.4 | $609.1 | $534.3 |
| Operating income | $34.0 | $50.6 | $149.9 | $165.9 |
| Net income | $27.5 | $39.2 | $119.1 | $135.2 |
| Diluted EPS | $0.47 | $0.67 | $2.04 | $2.31 |
| Operating cash flow | — | — | $174.3 | $176.4 |
Q3 revenue increased 12% year over year, while operating income fell 33% and net income fell 30%. For the first nine months, revenue rose 14%, operating income declined 10%, and net income declined 12%. Gross margin was approximately 84% in Q3 2020 versus 85% in Q3 2019, and approximately 85% for both nine-month periods. Operating margin fell to 17.4% from 28.9% in Q3 and to 24.2% from 30.5% for the nine months.
Cash and cash equivalents were $156.4 million at September 30, compared with $133.7 million at year-end 2019. Funds held for clients were $1.522 billion and were matched by an equal client funds obligation; these client funds are not ordinary corporate liquidity. Total debt carrying value was $31.3 million, including $1.8 million current; the $75 million revolving facility was undrawn. The company reported compliance with debt covenants. Nine-month investing cash outflow was $197.8 million and financing cash outflow was $219.9 million, including client-fund movements, client-fund investment purchases, capital expenditures and share repurchases.
Drivers and material changes
- Revenue growth reflected new-client additions, sales-office productivity and maturation, additional applications sold to existing clients, and strong first-quarter tax-form filing activity.
- COVID-19-related client workforce reductions weighed on per-employee recurring revenue. Lower interest rates, limited growth in average client funds and clients’ CARES Act Social Security tax deferrals also reduced interest earned on client funds and constrained recurring revenue growth.
- Operating expenses grew faster than revenue: total operating expenses increased 31% in Q3. Sales and marketing rose 32%, general and administrative 57%, and research and development 11%. Higher advertising, personnel costs and stock-based compensation were important contributors.
- Q3 stock-based compensation expense was $19.5 million, versus $4.5 million a year earlier; nine-month expense was $56.5 million versus $41.1 million. Management attributed the quarterly increase largely to the timing of market-based award vesting in the prior-year comparison and the nine-month increase to more awards and higher grant-date fair values.
- Repurchased 344,216 shares during the first nine months at an average $227 per share, including shares withheld for employee tax obligations. As of September 30, $172 million remained under the $250 million authorization.
Outlook, risks and unusual items
The filing gives no numerical revenue or earnings guidance. Management expected pandemic-related recurring-revenue pressure and increased investment levels to negatively affect net income through the remainder of 2020, while expressing confidence in the business and continued demand. It planned continued significant marketing investment and expected R&D expense to rise as the platform develops. Management said gross margins were expected to remain relatively consistent, subject to seasonality and hiring trends.
COVID-19 remained a key uncertainty: 95% of employees worked remotely at quarter-end, business travel was suspended, and sales meetings were virtual. Management noted possible effects from further client headcount reductions, business failures, implementation delays, remote-work costs and longer or less effective virtual sales cycles. First-quarter seasonality generally lifts revenue and margins due to annual payroll tax-form processing; quarterly comparisons should be viewed in that context.
The SEC had an ongoing inquiry into books and records and internal controls concerning whether some clients were charged extra for applications for which they were already being charged. Paycom identified fewer than 250 affected clients, about 0.5% of its client base at December 31, 2019, and had refunded approximately $2.5 million through the filing date. The company said the issue had not materially affected prior-period results but could not predict the inquiry’s timing, scope or outcome. Other ordinary-course legal proceedings also carry inherent uncertainty.
Other notable items: the interest-rate swap had a $3.0 million liability at quarter-end and fair-value changes affected reported other income or expense. On October 22, 2020, after quarter-end, Paycom’s enterprise value crossed a specified threshold, triggering vesting of 40,146 market-based restricted shares. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Key facts for investors to verify
- Whether client employment levels, implementation timing and average funds held for clients recover, and how those trends affect recurring revenue and interest income.
- Whether sales and marketing, R&D and stock-based compensation growth moderates enough to support operating-margin recovery.
- Developments in the SEC inquiry, client refunds and any resulting legal, regulatory or control implications.
- Cash generation and capital needs after separating corporate cash from client funds, and the pace of facility spending and repurchases.
- Seasonality and the effect of management’s non-GAAP adjustments; reported GAAP net income and cash flows remain important alongside adjusted EBITDA and non-GAAP net income.