Paycom Software, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. Paycom provides cloud-based human capital management software, including payroll and related HR applications. Comparisons below are to Q1 2017, recast where applicable for the new revenue accounting standard.
Financial performance
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Revenue | $153.9 million | $119.5 million | +29% |
| Recurring revenue | $151.9 million | $117.9 million | +29% |
| Gross margin | Approximately 85% | Approximately 86% | Down about 1 percentage point |
| Operating income | $51.0 million | $52.5 million | Down about 3% |
| Net income | $41.2 million | $33.7 million | +22% |
| Diluted EPS | $0.70 | $0.57 | Up |
| Operating cash flow | $57.7 million | $40.2 million | +$17.4 million |
Net income increased despite slightly lower operating income, primarily reflecting a lower effective tax rate: 20.92%, compared with 33.48% in Q1 2017, following the federal corporate tax rate reduction. Q1 is typically seasonally strong due to annual payroll tax-form processing; management cautions that seasonal results are not necessarily indicative of later quarters.
Cash, debt and liquidity
- Cash and cash equivalents were reported at $68.1 million as of March 31, 2018. Management said existing cash was expected to cover working capital and capital expenditure needs for at least 12 months.
- Long-term debt was approximately $35.3 million, under a secured term loan maturing in 2025. An additional $24.5 million remained available under the term credit agreement at quarter-end.
- A new $50 million revolving credit facility, expandable to $100 million subject to conditions, was undrawn at March 31, 2018 and matures in 2020. The company reported compliance with its financial covenants.
- Operating cash flow was $57.7 million; investing cash flow was negative $24.7 million and financing cash flow negative $11.0 million. Cash-flow movements include substantial client payroll funds: $1.089 billion of funds held for clients was matched by an equal client-funds obligation, and should not be treated as available operating liquidity.
- Capital expenditures were $9.1 million. The company repurchased 169,146 shares for $16.9 million, including shares withheld to cover employee tax obligations.
Changes, outlook and risks
- Revenue growth reflected strong tax-form filing activity, new clients, sales offices maturing, sales of additional applications to existing clients, and customer employee growth. Paycom opened a Salt Lake City sales office during the quarter and a Rochester office in April; it reported 47 sales teams in 26 states.
- Operating expenses rose substantially, notably from stock-based compensation. Q1 compensation expense was $23.4 million versus $3.4 million in the prior-year period, principally due to market-based restricted shares vesting after share-value targets were reached. This materially affected reported operating income.
- Management expects gross margins to remain relatively consistent, while noting quarterly seasonal and hiring-related variation. It expects research and development expense to increase as the business grows, with the rate of increase expected to moderate over time. No specific revenue or earnings guidance was provided in this filing.
- On January 1, 2018, Paycom adopted ASC 606 using the full retrospective method. Revenue timing and amounts were not materially affected; capitalization of certain contract acquisition and implementation costs was the principal impact. Prior periods were recast, including a $103.4 million cumulative stockholders’ equity adjustment as of January 1, 2016.
- The company’s interest-rate swap generated a $0.8 million gain in Q1, recognized in earnings because it was not designated as a hedge. The swap mitigates some variable-rate exposure on the term debt. Paycom also expects adoption of lease accounting in 2019 to significantly increase reported assets and liabilities.
- Paycom disclosed ordinary-course legal proceedings that could have an adverse effect, but gave no clear estimate of potential loss. It reported no material changes to the risk factors in its 2017 Form 10-K and no material off-balance-sheet arrangements.
Investor verification points
- Confirm the sustainability of 29% revenue growth, including client additions, cross-selling, tax-form processing and customer employee growth.
- Assess operating income and margins excluding the unusual market-based share-vesting expense, while also considering the dilution and economic cost of stock compensation.
- Separate operating liquidity from client funds held for payroll and taxes; verify capital spending, repurchases and construction funding against cash generation.
- Review debt-facility availability, covenant headroom, interest-rate exposure and the potential balance-sheet effect of the 2019 lease standard.
- Monitor seasonality, sales-office expansion costs, legal contingencies and the effect of the retrospective ASC 606 recast when comparing periods.