Paycom Software, Inc. — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019; filed October 31, 2019. Unaudited results. Paycom provides cloud-based human capital management software, primarily through recurring payroll and related services. Amounts below are in millions except per-share data.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $175.0 | $133.3 | $544.3 | $416.0 |
| Recurring revenue | $171.4 | $130.8 | $534.3 | $409.3 |
| Operating income | $50.6 | $36.2 | $165.9 | $130.3 |
| Net income | $39.2 | $28.8 | $135.2 | $105.7 |
| Diluted EPS | $0.67 | $0.49 | $2.31 | $1.80 |
| Gross margin | 85% | 83% | 85% | 84% |
| Operating margin | 28.9% | 27.2% | 30.5% | 31.3% |
| Net margin | 22.4% | 21.6% | 24.8% | 25.4% |
- Q3 revenue grew 31%, operating income 39%, and net income 36% year over year. Nine-month revenue increased 31%, operating income 27%, and net income 28%.
- For the nine months, operating cash flow was $176.4 versus $145.8. Capital expenditures were $71.1; operating cash flow less those purchases was approximately $105.3.
- Cash and cash equivalents were $108.1 at September 30, compared with $45.7 at year-end 2018. Funds held for clients were $835.9, matched by a $835.9 client funds obligation; these client balances are not ordinary available liquidity. Total cash, cash equivalents and restricted cash was $909.3.
- Debt was $33.1, including $1.8 current; no revolver borrowings were outstanding. The $75.0 revolving facility can be increased to $125.0, subject to conditions. The company reported compliance with debt covenants.
- Total assets were $1.592 billion and stockholders’ equity $474.9 million at September 30, 2019.
Material changes and management commentary
- Revenue growth reflected new clients, maturing sales offices, sales of additional applications to existing clients, and increased interest income on client funds. Strong first-quarter tax-form filing activity also supported nine-month growth.
- Operating expenses rose 28% in Q3 and 32% for the nine months. R&D expense increased 70% in Q3 and 64% year to date, reflecting employee-related costs and ongoing product development. Nine-month stock-based compensation expense rose to $41.1 from $31.5, including costs from market-based awards vesting in Q1.
- Nine-month net income margin declined to 24.8% from 25.4%, despite improved gross margin; operating margin also decreased to 30.5% from 31.3%. In Q3, both operating and net margins improved year over year.
- Investing cash outflow was $78.1, including $71.1 of property and equipment purchases. Financing cash outflow was $175.4, influenced by a $131.9 decrease in the client funds obligation and $42.2 of tax-withholding payments on vested restricted stock. The reported $77.2 decrease in cash, cash equivalents and restricted cash reflects client-fund timing as well as business activity.
Outlook, risks and unusual items
- The filing provides no numerical full-year revenue or EPS guidance. Management expected available cash and operating cash generation to cover working-capital and capital-expenditure needs for at least 12 months, and expected gross margins to remain relatively consistent, subject to seasonality and hiring trends.
- Management expected R&D spending to continue increasing in dollars and as a share of revenue, while anticipating a slower rate of increase over time as the business scales. Growth plans included more sales offices and construction of an expanded Grapevine, Texas operations facility; the company also purchased adjacent Oklahoma City land for $19.2 million in August.
- Revenue and margins are seasonal: first-quarter payroll-form processing generally lifts results, so historical periods may not predict future performance. Growth also depends on winning new clients, retaining clients, selling more applications, employee counts at client companies, and labor-market conditions. Interest earned on client funds is sensitive to rates.
- Privacy and data-protection regulation is a stated risk. A biometric time-clock lawsuit alleging violations of Illinois law remained pending after plaintiffs filed a third amended complaint on October 22, 2019; Paycom said it believed the suit lacked merit and intended to defend it. The filing also notes ordinary-course legal proceedings with uncertain outcomes.
- On October 28, 2019, the company amended CEO Chad Richison’s employment agreement to permit certain outside activities and waived specified forfeiture and repayment provisions affecting 5,323,907 restricted shares. Investors may wish to review the filed amendment and waiver.
- Lease accounting adoption in 2019 recognized $26.8 of operating lease liabilities at September 30. Management reported effective disclosure controls and no material changes to internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether recurring revenue growth and client retention/application adoption remain strong, and how much growth comes from new clients versus existing clients and interest income.
- Expense growth, particularly R&D, sales and marketing, and stock-based compensation, relative to revenue growth and margins.
- Capital spending and construction commitments, and the distinction between available corporate cash and restricted/client funds.
- Debt terms, covenant headroom, interest-rate exposure, and the impact of swap fair-value changes on reported earnings.
- The status and potential financial or reputational impact of the biometric privacy litigation and other data-security/privacy risks.
- The governance and compensation implications of the CEO agreement amendment and waiver involving 5.3 million restricted shares.