Paycom Software, Inc. — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019. Paycom provides cloud-based human capital management software, including payroll, HR, time and labor, and talent applications. Amounts below are in U.S. dollars; financial statement amounts are in millions unless noted.
Financial performance and position
- Q2 revenue: $169.3 million, up 31% year over year. Recurring revenue was $166.0 million, up 31%; implementation and other revenue was $3.3 million, up 51%.
- Q2 profitability: Gross margin was approximately 85% versus 84%. Operating income was $52.9 million, up 23%, with a 31.2% operating margin versus 33.4%. Net income was $48.8 million, up 37%; diluted EPS was $0.83 versus $0.61.
- First-half results: Revenue was $369.3 million, up 31%; operating income was $115.4 million, up 23%; net income was $96.0 million, up 25%. Diluted EPS was $1.64 versus $1.31. Gross margin was approximately 85% versus 84%.
- Cash flow, six months: Operating cash flow was $122.8 million, compared with $99.9 million. Capital expenditures were $34.7 million. Cash flows were affected by client-fund timing: financing cash flow was positive $119.7 million, including a $159.0 million net increase in the client funds obligation.
- Liquidity: Cash and cash equivalents were $94.8 million at June 30, 2019, versus $45.7 million at year-end. Funds held for clients of $1,126.8 million were matched by a $1,126.8 million client funds obligation; these client funds are not ordinary corporate liquidity.
- Debt and facilities: Long-term debt, including current portion, was $33.5 million. No revolver borrowings were outstanding; the revolving facility was increased to $75 million and extended to April 2022, with potential capacity up to $125 million subject to conditions. The company reported compliance with debt covenants.
- Other key items: Operating lease liabilities totaled $27.0 million after adopting the new lease standard. Adjusted EBITDA, a non-GAAP measure, was $69.4 million in Q2 and $172.7 million for the first half; reported net income remains the GAAP measure.
Changes versus prior comparable periods
- Management attributed revenue growth to new clients, maturing sales offices, additional applications sold to existing clients, higher interest earned on client funds, and strong first-quarter tax-form filing activity.
- Operating expenses grew faster than revenue: Q2 operating expenses increased 36%, including sales and marketing up 31%, R&D up 56%, and G&A up 45%. This reduced Q2 operating margin despite higher gross margin.
- First-half stock-based compensation expense rose to $36.7 million from $27.0 million, primarily reflecting restricted stock issuance and accelerated vesting of market-based awards in Q1. The related tax benefits contributed to a lower first-half effective tax rate of 16.1%, versus 19.6%.
- Cash flow presentation now includes restricted cash under ASU 2016-18; this presentation change did not affect income or balance sheet amounts. The company also adopted lease accounting in January 2019.
Outlook, commentary, and risks
- No specific numerical revenue or earnings guidance is provided in the supplied filing text. Management said it expects gross margins to remain relatively consistent, while noting quarterly fluctuations from seasonality and hiring trends.
- Management expects continued investment in sales, R&D, personnel, and facilities. Construction began on an expanded operations facility in Grapevine, Texas; the company said existing cash and operating cash flow should meet working-capital and capital-expenditure needs for at least the next 12 months.
- Revenue is seasonal: first-quarter revenue and margins are generally higher because of payroll tax-form processing. Management cautioned that historical seasonal results are not necessarily predictive.
- Privacy and data-protection compliance are material risks. The filing describes a lawsuit alleging violations of Illinois biometric privacy law related to fingerprint scans from leased time clocks; Paycom said it believes the suit is without merit and intends to defend it. Legal outcomes remain uncertain.
- The interest-rate swap was not designated as a hedge; fair-value changes affect reported earnings. Paycom recorded a $0.8 million Q2 loss and $1.4 million first-half loss on the swap. The filing also identifies interest-rate exposure and potential risks from evolving privacy regulation.
- The company reported no material off-balance-sheet arrangements and no material changes to other previously disclosed risk factors, apart from the privacy-related disclosure.
Important facts for investors to verify
- Whether 31% revenue growth and strong recurring-revenue performance continue, particularly given monthly client contracts and labor-market sensitivity.
- Whether expense growth, especially R&D, G&A, and stock-based compensation, moderates enough to support operating margins.
- The distinction between corporate cash and client funds, and the effect of payroll-calendar timing on reported cash flows.
- Progress, cost, and funding needs for the Grapevine facility and other planned growth investments.
- Developments in the biometric privacy lawsuit and the company’s broader compliance with privacy and data-protection laws.
- Use of non-GAAP adjusted EBITDA and non-GAAP net income alongside GAAP results, including the impact of stock compensation and swap valuation changes.