Business context and reporting period
Paycom Software, Inc. filed this Form 10-K for the fiscal year ended December 31, 2017. The company provides cloud-based human capital management software on a SaaS basis, with payroll as the required foundation for its other applications. The filing also reports unaudited fourth-quarter results.
At year-end Paycom reported 20,591 clients (11,111 using parent-company grouping), 45 sales teams, and a 91% annual revenue retention rate. It operates as one reporting segment.
Financial results and liquidity
| Metric | FY 2017 | FY 2016 | Change |
|---|---|---|---|
| Revenue | $433.0 million | $329.1 million | +32% |
| Operating income | $78.6 million | $58.0 million | +36% |
| Net income | $66.8 million | $43.8 million | +52% |
| Diluted EPS | $1.13 | $0.74 | +53% |
| Operating margin | 18.2% | 17.6% | +0.6 percentage points |
| Gross margin | Approximately 83% | Approximately 84% | Down approximately 1 point |
Recurring revenue was $425.4 million, 98.2% of total revenue, and grew 31%. Management attributed growth to new clients, sales-office maturation, additional applications sold to existing clients, tax-form filing activity, and client employee growth.
For Q4 2017, revenue was $114.0 million versus $87.8 million in Q4 2016; operating income was $19.4 million versus $12.7 million; and net income was $12.9 million versus $8.6 million. Revenue is seasonal, with first-quarter strength from annual forms processing and typically higher fourth-quarter activity from unscheduled payroll runs.
Operating cash flow was $130.6 million, compared with $99.0 million in 2016. Investing cash flow was negative $290.3 million, substantially reflecting the increase in client funds held and $59.4 million of property and equipment purchases, including headquarters construction. Financing cash flow was $145.7 million. Cash and cash equivalents declined to $46.1 million from $60.2 million.
Client funds held were $1.089 billion and were matched by a $1.089 billion client funds obligation; these funds are held to meet client payroll and tax obligations and should not be viewed as unrestricted corporate liquidity. Working capital, as defined by the company, was $16.7 million.
Year-end long-term debt was $35.3 million, including $0.9 million current. In December 2017, Paycom refinanced prior facilities with a secured term credit agreement, with up to $60 million available; $24.5 million of capacity remained at year-end. The loan matures in 2025 and is secured by headquarters property. A swap was entered into to fix the rate on a portion of the debt; the filing states the effective rate was 4.0%. The company reported compliance with its financial covenants. A separate $50 million revolving facility, expandable to $100 million subject to conditions, was entered into in February 2018 and was undrawn when the filing was submitted.
Material changes versus the prior comparable period
- Revenue increased 32%; operating income and net income grew faster, and operating margin improved to 18.2% from 17.6%.
- Operating expenses rose with hiring and expansion. Sales and marketing increased 26%, research and development 45%, and general and administrative 33%.
- Non-cash stock-based compensation increased to $38.5 million from $22.5 million, primarily reflecting market-based restricted-stock awards and their vesting.
- The effective tax rate fell to 13% from 23%, primarily because of excess tax benefits on share-based awards. The Tax Cuts and Jobs Act prompted a $0.4 million deferred-tax remeasurement charge; management expected the lower federal corporate rate to benefit future earnings and operating cash flow.
- Investing outflows increased alongside client-fund balances and construction spending. Cash decreased despite higher operating cash flow, in part amid repurchases and employee tax-withholding payments.
Outlook, management commentary, risks, and unusual items
Management planned to open 10 to 14 additional sales offices over the next two years and continued to target larger clients, geographic expansion, and sales of additional applications. It expected growth to continue increasing headcount, personnel costs, research and development, and general operating expenses, while pursuing efficiencies. The filing does not provide a clear numerical FY 2018 revenue or earnings forecast.
Management estimated that Enhanced ACA and ACA-form filing revenue would represent approximately 5% of projected 2018 revenue if ACA reporting requirements remained in place. Modification or repeal of those requirements could reduce this revenue. Management also cited possible positive effects from stronger hiring and wage trends following the Tax Act, while noting the impact was uncertain.
Key risks include cybersecurity or privacy breaches; data-center outages or service defects; changing employment, tax, and privacy regulation; competition and pricing pressure; retaining clients and staff while managing rapid growth; and the possibility that clients’ payroll funds fail to settle after Paycom has paid employees or tax authorities. Client agreements generally may be canceled on 30 days’ notice. The company also highlighted ACA uncertainty, seasonality, debt covenants, and exposure to interest-rate changes.
Unusual items included $0.9 million of debt-extinguishment and related early repayment costs and a $0.6 million loss from the interest-rate swap’s fair-value change. Paycom repurchased 1,238,577 shares in 2017 for an aggregate cost of $89.7 million, including shares withheld for employee tax obligations. It paid no cash dividends. Management said pending legal matters were not currently believed to create material exposure, while acknowledging outcomes remain uncertain. The auditor issued unqualified opinions on the financial statements and internal control over financial reporting.
Most important facts an investor should verify
- Whether client growth, retention, and adoption of additional applications sustain revenue growth, particularly as new sales offices mature.
- How much reported cash flow and balance-sheet growth relates to client funds, which are offset by corresponding obligations and are not freely available for general corporate use.
- Capital spending and share repurchases relative to operating cash flow, including the effect of restricted-stock withholding taxes and dilution from stock-based compensation.
- Debt borrowing, covenant headroom, the terms and use of the revolving facility, and the swap’s interest-rate protection.
- The continuing contribution of ACA-related services and the implementation effects of the new revenue-recognition standard, which the company expected to adopt retrospectively in 2018.