PAYCOM SOFTWARE, INC. You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the audited and unaudited consolidated financial statements (prepared in accordance with accounting principles generally accepted inthe United States ("U.S. GAAP")) and related notes included elsewhere in this Annual Report on Form 10-K (this "Form 10-K"). The following discussion contains forward-looking statements that are subject to risks and uncertainties. See Part I "Special Note Regarding Forward-Looking Statements" for a discussion of the uncertainties, risks, and assumptions associated with those statements. Actual results could differ materially from those discussed in or implied by forward-looking statements as a result of various factors, including those discussed below and elsewhere in this Form 10-K, particularly in the section entitled "Risk Factors." Unless we state otherwise or the context otherwise requires, the terms "we," "us," "our" and the "Company" refer toPaycom Software, Inc. and its consolidated subsidiaries. All amounts presented in tables, other than per share amounts, are in thousands unless otherwise noted.
Overview
We are a leading provider of comprehensive, cloud-based human capital management
("HCM") software delivered as Software-as-a-Service. We provide functionality
and data analytics that businesses need to manage the complete employment
lifecycle, from recruitment to retirement. Our solution requires virtually no
customization and is based on a core system of record maintained in a single
database for all HCM functions, including talent acquisition, time and labor
management, payroll, talent management and human resources management
applications. Our user-friendly software allows for easy adoption of our
solution by employees, enabling self-management of their HCM activities in the
cloud, which reduces the administrative burden on employers and increases
employee productivity.
We generate revenues from (i) fixed amounts charged per billing period plus a
fee per employee or transaction processed and (ii) fixed amounts charged per
billing period. We do not require clients to enter into long-term contractual
commitments with us. Our billing period varies by client based on when each
client pays its employees, which may be weekly, bi-weekly, semi-monthly or
monthly. Our revenues are primarily generated through our sales force that
solicits new clients and our client relations representatives who sell new
applications to existing clients.
Our continued growth depends on attracting new clients through further
penetration of our existing markets and geographic expansion into new markets,
targeting a high degree of client employee usage across our solution, and
introducing new applications to our existing client base. We believe our ability
to continue to develop new applications and to improve existing applications
will enable us to increase revenues in the future, and the number of our new
applications adopted by our clients has been a significant factor in our revenue
growth.
Throughout our history, we have built strong relationships with our clients. As
the HCM needs of our clients evolve, we believe that we are well-positioned to
expand the HCM spending of our clients and we believe this opportunity is
significant. To be successful, we must continue to demonstrate the operational
and economic benefits of our solution, as well as effectively hire, train,
motivate and retain qualified personnel.
Growth Outlook, Opportunities and Challenges
As a result of our significant growth and geographic expansion, we are presented
with a variety of opportunities and challenges. Our payroll application is the
foundation of our solution, and all of our clients are required to utilize this
application in order to access our other applications. Consequently, we have
historically generated the majority of our revenues from our payroll
applications, although our revenue mix has evolved and will continue to evolve
as we develop and add new non-payroll applications to our solution. We believe
our strategy of focusing on increased employee usage is key to long-term client
satisfaction and client retention. Client adoption of new applications and
client employee usage of both new and existing applications have been
significant factors in our revenue growth, and we expect the continuation of
this trajectory will depend, in part, on the introduction of applications to our
existing client base that encourage and promote more employee usage. Moreover,
in order to increase revenues and continue to improve our operating results, we
must also attract new clients. We intend to obtain new clients by (i)
continuing to leverage our salesforce productivity within markets where we
currently have existing sales offices, (ii) expanding our presence in
metropolitan areas where we currently have an existing sales office through
adding sales teams or offices, thereby increasing the number of sales
professionals within such markets, and (iii) opening sales offices in new
metropolitan areas.
Our target client size range is 50 to 5,000 employees. While we continue to
serve a diversified client base ranging in size from one employee to many
thousands of employees, the average size of our clients has grown significantly
as we have organically grown our operations, increased the number of
applications we offer and experienced traction with larger companies. Our
solution requires no adjustment to serve larger clients. We believe larger
employers represent a substantial opportunity to increase the number of
potential clients and to increase our revenues per client, with limited
incremental cost to us. Because we charge our clients on a per employee basis
for certain services we provide, any increase or decrease in the number of
employees at our clients will have a positive
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--------------------------------------------------------------------------------or negative impact, respectively, on our results of operations. We expect the changes in certain factors affecting our performance will correlate with improvement or deterioration in the labor market.
Based on our total revenues, we have grown at a 35% compound annual growth rate fromJanuary 1, 2016 throughDecember 31, 2019 . Growing our business has resulted in, and will continue to result in, substantial investments in sales professionals, operating expenses, system development and programming costs and general and administrative expenses, which have and will continue to increase our expenses. Specifically, our revenue growth and geographic expansion drive increases in our employee headcount, which in turn precipitates an increase in (i) salaries and benefits, (ii) stock-based compensation expense and (iii) facility costs related to the expansion of our corporate headquarters, operations facilities and additional sales office leases. We believe the challenges of managing the ever-changing complexity of payroll and human resources will continue to drive companies to turn to outsourced providers for help with their HCM needs. The HCM industry historically has been driven, in part, by legislation and regulatory action, including COBRA, changes to the minimum wage laws or overtime rules, and legislation from federal, state or municipal taxation authorities. The implementation of the Affordable Care Act (the "ACA") is an example of legislation that has created demand in the HCM industry. We generate ACA-related revenues (i) on an annual basis in connection with processing and filing Forms 1094 and 1095 on behalf of clients and (ii) from clients who have purchased our Enhanced ACA application as part of the fixed, bundled price charged per billing period. While we generally do not track our revenues on an application-by-application basis (because applications are often sold in various groupings and configurations for a single price), we estimate that, if the ACA is not modified or repealed, revenues from our Enhanced ACA application and ACA forms filings business will represent approximately 4% of total projected revenues for the year endingDecember 31, 2020 . For the years endedDecember 31, 2019 , 2018 and 2017, our gross margins were approximately 85%, 84% and 83%, respectively. Although our gross margins may fluctuate from quarter to quarter due to seasonality and hiring trends, we expect our gross margins will remain relatively consistent in future periods.
Key Metrics
In addition to the
Year Ended December 31,
2019 2018 2017
Key performance indicators:
Clients 26,527 23,533 20,591
Clients (based on parent company grouping) 13,581 12,754 11,111
Sales teams 50 49 45
Annual revenue retention rate 93 % 92 % 91 %
• Clients. When we calculate the number of clients at period end, we treat
client accounts with separate taxpayer identification numbers (or, in
certain circumstances, separate client codes) as separate clients, which
often separates client accounts that are affiliated with the same parentorganization. We track the number of our clients to provide an accurate
gauge of the size of our business. Unless we state otherwise or the
context otherwise requires, references to clients throughout this Form
10-K refer to this metric.
• Clients (based on parent company grouping). When we calculate the number
of clients based on parent company grouping at period end, we combine
client accounts that have identified the same person(s) as their
decision-maker regardless of whether the client accounts have separate
taxpayer identification numbers (or, in certain circumstances, separate
client codes), which often combines client accounts that are affiliated
with the same parent organization. We track the number of our clients
based on parent company grouping to provide an alternate measure of the
size of our business and clients.
• Sales Teams. We monitor our sales professionals by the number of sales
teams at period end. Each team consists of a sales manager and
approximately six to eight sales professionals. Certain larger
metropolitan areas can support more than one sales team. We believe thenumber of sales teams is an indicator of potential revenues for future
periods.
• Annual Revenue Retention Rate. Our annual revenue retention rate tracks
the percentage of revenues that we retain from our existing clients. We
monitor this metric because it is an indicator of client satisfaction and
revenues for future periods.
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Components of Results of Operations
Sources of Revenues
Revenues are comprised of recurring revenues, and implementation and other revenues. We expect our revenues to increase as we introduce new applications, expand our client base and renew and expand relationships with existing clients. As a percentage of total revenues, we expect our mix of recurring revenues, and implementation and other revenues to remain relatively constant.
Recurring Revenues
Recurring revenues include fees for our talent acquisition, time and labor management, payroll, talent management and HR management applications as well as fees charged for form filings and delivery of client payroll checks and reports. These revenues are derived from (i) fixed amounts charged per billing period plus a fee per employee or transaction processed or (ii) fixed amounts charged per billing period. We do not require clients to enter into long-term contractual commitments with us. Our billing period varies by client based on when each client pays its employees, which may be weekly, bi-weekly, semi-monthly or monthly. Because recurring revenues are based, in part, on fees for use of our applications and the delivery of checks and reports that are levied on a per-employee basis, our recurring revenues increase as our clients hire more employees. Recurring revenues are recognized in the period services are rendered. Recurring revenues include revenues relating to the annual processing of payroll forms, such as Form W-2 and Form 1099, and revenues from processing unscheduled payroll runs (such as bonuses) for our clients. Because payroll forms are typically processed in the first quarter of the year and many of our clients are subject to ACA form filing requirements in the first quarter, first quarter revenues and margins are generally higher than in subsequent quarters. We anticipate our revenues will continue to exhibit this seasonal pattern related to ACA form filings for so long as the ACA (or replacement legislation) includes employer reporting requirements. In addition, we often experience increased revenues during the fourth quarter due to unscheduled payroll runs for our clients that occur before the end of the year. Therefore, we expect the seasonality of our revenue cycle to decrease to the extent clients utilize more of our non-payroll applications. Recurring revenues also include interest earned on funds held for clients. We collect funds from clients in advance of either the applicable due date for payroll tax submissions or the applicable disbursement date for employee payment services. These collections from clients are typically disbursed from one to 30 days after receipt, with some funds being held for up to 120 days. We typically invest funds held for clients in money market funds, demand deposit accounts, commercial paper and certificates of deposit until they are paid to the applicable tax or regulatory agencies or to client employees. We expect interest earned on funds held for clients will increase as we introduce new applications, expand our client base and renew and expand relationships with existing clients. The amount of interest we earn from the investment of client funds is also impacted by changes in interest rates.
Implementation and Other Revenues
Implementation and other revenues are comprised of implementation fees for the deployment of our solution and other revenues from sales of time clocks as part of our time and attendance services. Non-refundable implementation fees are charged to new clients at inception and upon the addition of certain incremental applications for existing clients. These fees range from 10% to 30% of the annualized value of the transaction. Implementation revenues are recognized as deferred revenue and amortized into income over the life of the client, which is estimated to be ten years, and other revenues are recognized upon shipment of time clocks. Implementation and other revenues comprised approximately 1.8% and 1.6% of our total revenues for the years endedDecember 31, 2019 and 2018, respectively.
Cost of Revenues
Cost of revenues consists of expenses related to hosting and supporting our
applications, hardware costs, systems support and technology and depreciation
and amortization. These costs include employee-related expenses (including
non-cash stock-based compensation expenses) and other expenses related to client
support, bank charges for processing ACH transactions, certain implementation
expenses, delivery charges and paper costs. They also include our cost for time
clocks sold and ongoing technology and support costs related to our systems. The
amount of depreciation and amortization of property and equipment allocated to
cost of revenues is determined based upon an estimate of assets used to support
our operations.
Administrative Expenses
Administrative expenses consist of sales and marketing, research and
development, general and administrative and depreciation and amortization. Sales
and marketing expenses consist primarily of employee-related expenses for our
direct sales and marketing staff (such as the amortization of commissions and
bonuses and non-cash stock-based compensation expenses), marketing expenses and
other related costs. Research and development expenses consist primarily of
employee-related expenses (including non-cash stock-based compensation expenses)
for our development staff, net of capitalized software costs for internally
developed software. We expect to grow our research and development efforts as we
continue to broaden our payroll and HR solution offerings and extend our
technological solutions by investing in the development of new applications and
enhancements for existing applications. General and
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administrative expenses consist of employee-related expenses for finance and
accounting, legal, human resources and management information systems personnel
(including non-cash stock-based compensation expenses), legal costs,
professional fees and other corporate expenses. Depreciation and amortization
expenses consist of (i) the amount of depreciation and amortization of property
and equipment allocated to administrative expenses (based upon an estimate of
assets used to support our selling, general and administrative functions) and
(ii) amortization of intangible assets.
Interest Expense
Interest expense includes interest on debt related to our corporate headquarters and settlements related to an interest rate swap we entered into in connection with such debt. We capitalize interest incurred for indebtedness related to construction in progress.
Other Income, net
Other income, net includes interest earned on our own funds, any gain or loss on the sale or disposal of fixed assets, costs associated with the early repayment of debt and any unrealized gain or loss related to our interest rate swap.
Provision for Income Taxes
Our consolidated financial statements include a provision for income taxes incurred for the anticipated tax consequences of the reported results of operations using the asset and liability method. Under this method, we recognize deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial reporting and tax basis of assets and liabilities, as well as for any operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using the tax rates expected to apply to taxable income for the years in which those tax assets and liabilities are expected to be realized or settled. We recognize a valuation allowance to reduce deferred tax assets to the net amount we believe is more likely than not to be realized. Results of Operations The following table sets forth selected consolidated statements of income data and such data as a percentage of total revenues for each of the periods indicated, as well as year-over-year changes with respect to each line item. Refer to the Annual Report on Form 10-K for the year ended December 31, 2018, filed with the SEC on February 14, 2019, for a discussion of results for the year endedDecember 31, 2017 . Year Ended December 31, % change 2019 2019 2018 vs. 2018 Revenues Recurring$ 724,428 98.2%$ 557,255 98.4% 30% Implementation and other 13,243 1.8% 9,081 1.6% 46% Total revenues 737,671 100.0% 566,336 100.0% 30% Cost of revenues Operating expenses 89,336 12.1% 76,231 13.5% 17% Depreciation and amortization 20,411 2.8% 14,532 2.5% 40% Total cost of revenues 109,747 14.9% 90,763 16.0% 21% Administrative expenses Sales and marketing 179,286 24.3% 143,881 25.4% 25% Research and development 73,080 9.9% 46,247 8.2% 58% General and administrative 127,534 17.3% 96,605 17.1% 32% Depreciation and amortization 21,800 3.0% 15,125 2.7% 44% Total administrative expenses 401,700 54.5% 301,858 53.4% 33% Total operating expenses 511,447 69.4% 392,621 69.4% 30% Operating income 226,224 30.6% 173,715 30.6% 30% Interest expense (940 ) (0.1%) (766 ) (0.1%) 23% Other income, net 803 0.1% 1,762 0.3% -54% Income before income taxes 226,087 30.6% 174,711 30.8% 29% Provision for income taxes 45,511 6.1% 37,646 6.6% 21% Net income$ 180,576 24.5%$ 137,065 24.2% 32% 31
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Revenues The increase in total revenues for the year endedDecember 31, 2019 from the year endedDecember 31, 2018 was primarily the result of (i) the addition of new clients and productivity and efficiency gains in mature sales offices, which are offices that have been open for at least 24 months, (ii) higher average interest rates earned on funds held for clients, (iii) the strong performance of our tax forms filing business, (iv) the sale of additional applications to our existing clients, (v) contributions from new sales offices that were progressing toward maturity or reached maturity during 2019 and (vi) the modest price increase implemented for a portion of our clients inMarch 2019 . The increase in implementation and other revenues for the year endedDecember 31, 2019 from the year endedDecember 31, 2018 was primarily the result of the increased recognition of non-refundable conversion fees that are charged to new clients to offset the expense of new client set-up. These fees are deferred and recognized ratably over the ten-year estimated life of our clients.
Expenses
Cost of Revenues
During the year endedDecember 31, 2019 , operating expenses increased from the prior year by$13.1 million primarily due to a$7.1 million increase in expenses attributable to growth in the number of operating personnel, as well as a$4.6 million increase in shipping fees and a$1.4 million increase in automated clearing house fees, both of which related to the increase in revenues. Additionally, depreciation and amortization expense increased$5.9 million , or 40%, primarily due to the development of additional technology and purchases of other related fixed assets.
Administrative Expenses
Sales and marketing
During the year endedDecember 31, 2019 , sales and marketing expenses increased from the prior year by$35.4 million due to a$25.6 million increase in employee-related expenses, including commissions, bonuses and non-cash stock-based compensation, and a$9.8 million increase in marketing and advertising expense. The increase in employee-related expenses included a$0.4 million increase in non-cash stock-based compensation expense.
Research and development
During the year ended
As we continue the ongoing development of our platform and product offerings, we generally expect research and development expenses (exclusive of stock-based compensation) to continue to increase, particularly as we hire more personnel to support our growth. While we expect this trend to continue on an absolute dollar basis and as a percentage of total revenues, we also anticipate the rate of increase to decline over time as we leverage our growth and realize additional economies of scale. As is customary for our business, we also expect fluctuations in research and development expense as a percentage of revenue on a quarter-to-quarter basis due to seasonal revenue trends, the introduction of new products, the amount and timing of research and development costs that may be capitalized and the timing of onboarding new hires and restricted stock vesting events. Expenditures for software developed or obtained for internal use are capitalized and amortized over a three-year period on a straight-line basis. The nature of the development projects underway during a particular period directly impacts the timing and extent of these capitalized expenditures and can affect the amount of research and development expenses in such period. The table below sets forth the amounts of capitalized and expensed research and development costs for the years endedDecember 31, 2019 and 2018: Year Ended December 31, % Change 2019 2018 2019 vs 2018 Capitalized portion of research and development$ 30,412 $ 22,013
38%
Expensed portion of research and development 73,080 46,247
58%
Total research and development costs
52% General and administrative During the year endedDecember 31, 2019 , general and administrative expenses increased by$30.9 million from the prior year due to a$21.3 million increase in employee-related expenses, which included a$7.7 million increase in non-cash stock-based compensation expense, and a$9.6 million increase in accounting and legal expenses related to regulatory and compliance matters. 32 --------------------------------------------------------------------------------
Non-Cash Stock-Based Compensation Expense
Year Ended December 31 , % Change
2019 2018 2019 vs 2018
Non-cash stock-based compensation
expense:
Operating expenses $ 4,376 $ 4,041 8%
Sales and marketing 7,955 7,510 6%
Research and development 5,428 3,013 80%
General and administrative 29,509 21,847 35%
Total non-cash stock-based
compensation expense $ 47,268 $ 36,411 30%
During the year ended December 31, 2019 , our non-cash stock-based compensation
expense increased $10.9 million from the prior year primarily due to the
issuance and subsequent accelerated vesting of restricted stock subject to
market-based vesting conditions during the first quarter of 2019, which exceeded
expenses associated with the accelerated vesting of restricted stock subject to
market-based vesting conditions in 2018.
Depreciation and Amortization
During the year endedDecember 31, 2019 , depreciation and amortization expense increased from the prior year primarily due to the development of additional technology and purchases of other related fixed assets.
Interest Expense
The increase in interest expense for the year endedDecember 31, 2019 was due to the timing of construction of our expanded operations facility and our fourth headquarters building, which resulted in less capitalized interest in 2019.
Other Income, net
The decrease in other income, net for the year ended
Provision for Income Taxes
The provision for income taxes is based on a current estimate of the annual effective income tax rate adjusted to reflect the impact of discrete items. Our effective income tax rate was 20% and 22% for the years endedDecember 31, 2019 and 2018, respectively. The lower effective income tax rate for the year endedDecember 31, 2019 primarily resulted from an increase in excess tax benefits from stock-based compensation related to vesting events, which was partially offset by changes in tax legislation that increased non-deductible expenses.
Liquidity and Capital Resources
Our principal sources of capital and liquidity are our operating cash flow and cash and cash equivalents. Our cash and cash equivalents are comprised primarily of demand deposit accounts, money market funds and certificates of deposit. Additionally, we maintain a senior secured revolving credit facility (the "Facility"), which can be accessed as needed to supplement our operating cash flow and cash balances. The Facility provides us the ability to borrow funds in the aggregate principal amount of$75.0 million , which may be increased up to$125.0 million , subject to obtaining additional lender commitments and certain approvals and satisfying certain other conditions. We believe our existing cash and cash equivalents and cash generated from operations will be sufficient to meet our working capital and capital expenditure needs over at least the next 12 months.
We have historically funded our operations from cash flows generated from operations, cash from the sale of equity securities and debt financing. Although we have funded most of the costs for construction projects at our corporate headquarters and other facilities from available cash, we have incurred indebtedness for a portion of these costs. Further, all purchases under our stock repurchase plans were paid for from available cash.
Term Credit Agreement. As ofDecember 31, 2019 , our indebtedness consisted solely of term loans (the "Term Loans") made under a senior secured term credit agreement (as amended from time to time, the "Term Credit Agreement") among the Company, certain of our subsidiaries,JPMorgan Chase Bank, N.A .,Bank of America, N.A . andKirkpatrick Bank . Our obligations under the Term Loans are secured by a mortgage and first priority security interest in our headquarters property. The Term Loans mature onSeptember 7, 2025 and bear interest, at our option, at either (a) a prime rate plus 1.0% or (b) an adjusted LIBOR rate for the interest period in effect for such Term Loan plus 1.5%. 33 -------------------------------------------------------------------------------- Under the Term Credit Agreement, we are required to comply with certain financial and non-financial covenants, including maintaining a fixed charge coverage ratio of not less than 1.25 to 1.0 and a funded indebtedness to EBITDA ratio of not greater than 2.0 to 1.0. Additionally, the Term Credit Agreement contains customary affirmative and negative covenants, including covenants limiting our ability to, among other things, grant liens, incur debt, effect certain mergers, make investments, dispose of assets, enter into certain transactions including swap agreements and sale and leaseback transactions, pay dividends or distributions on our capital stock, and enter into transactions with affiliates, in each case subject to customary exceptions for a credit agreement of this size and type. As ofDecember 31, 2019 , we were in compliance with all covenants set forth in the Term Credit Agreement. Interest Rate Swap Agreement. In connection with entering into the Term Credit Agreement, we also entered into a floating-to-fixed interest rate swap agreement to limit the exposure to interest rate risk related to the Term Loans (the "Interest Rate Swap Agreement"). The Interest Rate Swap Agreement, which has a maturity date ofSeptember 7, 2025 , provides that we will receive quarterly variable interest payments based on the LIBOR rate and will pay interest at a fixed rate. We have elected not to designate this interest rate swap as a hedge and, as such, changes in the fair value of the derivative instrument are recognized in our consolidated statements of income. For the years endedDecember 31, 2019 and 2018, we recognized a loss of$1.4 million and a gain of$0.7 million , respectively, for the change in fair value of the interest rate swap, which is included in Other income, net in the consolidated statements of income. Revolving Credit Agreement. OnFebruary 12, 2018 , we entered into a senior secured revolving credit agreement (the "Revolving Credit Agreement") withJPMorgan Chase Bank, N.A . andBank of America, N.A . that provided for the Facility in the aggregate principal amount of$50.0 million (the "Revolving Commitment"), which could be increased to up to$100.0 million , subject to obtaining additional lender commitments and certain approvals and satisfying certain other conditions. The Facility includes a$5.0 million sublimit for swingline loans and a$2.5 million sublimit for letters of credit. The Facility was scheduled to mature onFebruary 12, 2020 . OnApril 15, 2019 , we entered into the First Amendment to Revolving Credit Agreement (the "First Amendment"). Pursuant to First Amendment,Wells Fargo Bank, N.A . was added as a lender and the Revolving Commitment was increased to$75.0 million , which may be further increased to$125.0 million subject to obtaining additional lender commitments and certain approvals and satisfying other conditions and the scheduled maturity date of the Facility was extended toApril 15, 2022 . Borrowings under the Facility will generally bear interest at a prime rate plus 1.0% or, at our option, an adjusted LIBOR rate for the interest period in effect for such borrowing plus 1.5%, in each case subject to certain conditions set forth in the Revolving Credit Agreement. As ofDecember 31, 2019 , we did not have any borrowings outstanding under the Facility. Stock Repurchase Plan and Withholding Shares to Cover Taxes. InMay 2016 , our Board of Directors authorized a stock repurchase plan allowing for the repurchase of shares of our common stock in open market transactions at prevailing market prices, in privately negotiated transactions or by other means in accordance with federal securities laws, including Rule 10b5-1 programs. Since the initial authorization of the stock repurchase plan, our Board of Directors has amended and extended the stock repurchase plan from time to time. Most recently, onNovember 20, 2018 , we announced that our Board of Directors authorized the repurchase of up to an additional$150.0 million of our common stock. Our stock repurchase plan may be suspended or discontinued at any time. The actual timing, number and value of shares repurchased depends on a number of factors, including the market price of our common stock, general market and economic conditions, the shares withheld for taxes associated with the vesting of restricted stock and other corporate considerations. During the year endedDecember 31, 2019 , we withheld 219,764 shares to satisfy tax withholding obligations with respect to the delivery of vested shares of restricted stock to certain employees. Our payment of the taxes on behalf of those employees resulted in a cash expenditure of$42.5 million and, as such, we generally subtract the amounts attributable to such withheld shares from the aggregate amount available for future purchases under our stock repurchase plan. As ofDecember 31, 2019 , there was$119.4 million available for repurchases. The stock repurchase plan will expire onNovember 19, 2020 .
Cash Flow Analysis
Our cash flows from operating activities have historically been significantly impacted by profitability, implementation revenues received but deferred, our investment in sales and marketing to drive growth, and research and development. Our ability to meet future liquidity needs will be driven by our operating performance and the extent of continued investment in our operations. Failure to generate sufficient revenues and related cash flows could have a material adverse effect on our ability to meet our liquidity needs and achieve our business objectives. As our business grows, we expect our capital expenditures and our investment activity to continue to increase. We are currently focused on the ongoing construction of our newTexas operations facility inGrapevine, Texas . Capital expenditures related to the construction of the facility began in the second quarter of 2019. OnAugust 5, 2019 , we purchased 107.5 acres of land adjacent to our corporate headquarters inOklahoma City for$19.2 million . While there are no immediate plans for development, we expect a portion of this land will be utilized to facilitate our growth in the future. Depending on certain growth opportunities, we may choose to accelerate investments in sales and marketing, acquisitions, technology and services. Actual future capital requirements will depend 34
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on many factors, including our future revenues, cash from operating activities and the level of expenditures in all areas of our business.
As part of our payroll and payroll tax filing services, we collect funds from our clients for federal, state and local employment taxes, which we remit to the appropriate tax agencies. We invest these funds in money market funds, demand deposit accounts, commercial paper and certificates of deposit from which we earn interest income during the period between their receipt and disbursement. Our cash flows from investing and financing activities are influenced by the amount of funds held for clients, which can vary significantly from quarter to quarter. The balance of the funds we hold depends on our clients' payroll calendars, and therefore such balance changes from period to period in accordance with the timing of each payroll cycle. Our cash flows from financing activities are also affected by the extent to which we use available cash to purchase shares of common stock under our stock repurchase plan as well as restricted stock vesting events that result in net share settlements and the Company paying withholding taxes on behalf of certain employees.
The following table summarizes the consolidated statements of cash flows for the
years ended
Years Ended December 31,
2019 2018(1) Change %
Net cash provided by (used in):
Operating activities $ 224,263 $ 184,817 21%
Investing activities (219,545 ) (49,417 ) 344%
Financing activities 650,672 (247,796 ) -363%
Change in cash, cash equivalents,
restricted cash and restricted cash
equivalents $ 655,390 $ (112,396 ) -683%
(1)Amounts have been adjusted to reflect the adoption of Accounting Standards
Update No. 2016-18, "Statement of Cash Flows (Topic 230): Restricted Cash (a
consensus of the FASB Emerging Issues Task Force )." See Note 2 for a summary of
reclassifications and adjustments.
Operating Activities
Cash provided by operating activities for the year endedDecember 31, 2019 primarily consisted of payments received from our clients and interest earned on funds held for clients. Cash used in operating activities primarily consisted of personnel-related expenditures to support the growth and infrastructure of our business. These payments included costs of operations, advertising and other sales and marketing efforts, IT infrastructure development, product research and development and security and administrative costs. Compared to the year endedDecember 31, 2018 , our operating cash flows for the year endedDecember 31, 2019 were positively impacted by the growth of our business.
Investing Activities
Cash flows used in investing activities for the year endedDecember 31, 2019 increased from the prior year period due to an$86.3 million decrease in proceeds from maturities of short-term investments from funds held for clients, a$50.8 million increase in purchases of short-term investments from funds held for clients and a$33.0 million increase in cash used for purchases of property and equipment, which was primarily related to the purchase of land adjacent to our corporate headquarters. Financing Activities Cash flows from financing activities for the year endedDecember 31, 2019 decreased from the prior year period primarily due to the impact of$816.4 million of changes in client funds obligation, which is due to the timing of receipts from our clients and payments made to our clients' employees and applicable taxing authorities on their behalf. Additionally, cash flows from financing activities were positively impacted by a$105.2 million decrease in repurchases of common stock. These cash flows provided by financing activities were partially offset by a$22.3 million increase in withholding taxes paid related to net share settlements and a$0.9 million increase in payments on long-term debt.
Contractual Obligations
Our principal commitments primarily consist of long-term debt and leases for
office space. We disclose our long-term debt in Note 6 and our commitments and
contingencies in Note 12 in our consolidated financial statements included
elsewhere in this Form 10-K.
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As of
Payments Due by Period
Less More
than 1-3 3-5 than
Total 1 Year Years Years 5 Years
Net term notes to bank due
September 7, 2025 $ 32,838 $ 1,775 $ 3,550 $ 3,550 23,963
Interest on term notes to bank
due September 7, 2025 6,241 1,302 2,378 2,088 473
Operating lease obligations 34,850 11,081 15,166 8,155 448
Total 73,929 14,158 21,094 13,793 24,884
We plan to continue to lease additional office space to support our growth. In
addition, many of our existing lease agreements provide us with the option to
renew. When applicable, our future operating lease obligations include payments
due during any renewal period provided for in the lease where the lease imposes
a penalty for failure to renew.
The contractual commitment amounts in the table above are associated with
agreements that are enforceable and legally binding and that specify all
significant terms, including fixed or minimum services to be used, fixed minimum
or variable price provisions, and the approximate timing of the transaction.
Obligations under contracts that we can cancel without a significant penalty are
not included in the table above.
Off-Balance Sheet Arrangements
As ofDecember 31, 2019 , we did not have any off-balance sheet arrangements that have or are reasonably likely to have an effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that may be material to investors.
Critical Accounting Policies and Estimates
Our consolidated financial statements and accompanying notes have been prepared in accordance withU.S. GAAP. The preparation of these consolidated financial statements requires us to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses, and related disclosures. On an ongoing basis, we continually evaluate our estimates and assumptions believed to be reasonable under current facts and circumstances. Actual amounts and results may materially differ from these estimates made by management under different assumptions and conditions. Certain accounting policies that require significant management estimates, and are deemed critical to our results of operations or financial position, are described below. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our consolidated financial condition and results of operations.
Revenue Recognition
Revenues are recognized when control of the promised goods or services is transferred to our clients in an amount that reflects the consideration we expect to be entitled to for those goods or services. Substantially all of our revenues are comprised of revenue from contracts with clients. Sales and other applicable taxes are excluded from revenues. Recurring revenues are derived primarily from our talent acquisition, time and labor management, payroll, talent management and HR management applications as well as fees charged for form ?lings and delivery of client payroll checks and reports. Talent acquisition includes our applicant tracking, candidate tracker, background check, on-boarding, e-verify and tax credit services applications. Time and labor management includes time and attendance, scheduling/schedule exchange, time-off requests, labor allocation, labor management reports/push reporting and geofencing/geotracking. Payroll includes our payroll and tax management, Paycom Pay, expense management, garnishment management and GL Concierge applications. Talent management includes our employee self-service, compensation budgeting, performance management, executive dashboard and Paycom learning and course content applications. HR management includes our document and task management, government and compliance, bene?ts administration, COBRA administration, personnel action forms, surveys and enhanced ACA applications. The performance obligations related to recurring revenues are satisfied during each client's payroll period, with the agreed-upon fee being charged and collected as part of our processing of the client's payroll. Recurring revenues are recognized at the conclusion of processing of each client's payroll period, when each respective payroll client is billed. Collectability is reasonably assured as the fees are collected through an automated clearing house as part of the client's payroll cycle or through direct wire transfer, which minimizes the default risk.
The contract period for substantially all contracts associated with these revenues is one month due to the fact that both we and the client have the unilateral right to terminate a wholly unperformed contract without compensating the other party by providing 30
36
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days' notice of termination. Our payroll application is the foundation of our
solution, and all of our clients are required to utilize this application in
order to access our other applications. For clients who purchase multiple
applications, due to the short-term nature of our contracts, we do not believe
it is meaningful to separately assess and identify whether or not each
application potentially represents its own, individual, performance obligation
as the revenue generated from each application is recognized within the same
month as the revenue from the core payroll application. Similarly, we do not
believe it is meaningful to individually determine the standalone selling price
for each application. We consider the total price charged to a client in a given
period to be indicative of the standalone selling price, as the total amount
charged is within a reasonable range of prices typically charged for our goods
and services for comparable classes of client groups.
Implementation and other revenues consist of nonrefundable upfront conversion
fees which are charged to new clients to offset the expense of new client set-up
as well as revenues from the sale of time clocks as part of our employee time
and attendance services. Although these revenues are related to our recurring
revenues, they represent distinct performance obligations.
Implementation activities primarily represent administrative activities that
allow us to fulfill future performance obligations for our clients and do not
represent services transferred to the client. However, the nonrefundable upfront
fee charged to our clients results in an implied performance obligation in the
form of a material right to the client related to the client's option to renew
at the end of each 30-day contract period. Further, given that all other
services within the contract are sold at a total price indicative of the
standalone selling price, coupled with the fact that the upfront fees are
consistent with upfront fees charged in similar contracts that we have with
clients, the standalone selling price of the client's option to renew the
contract approximates the dollar amount of the nonrefundable upfront fee. The
nonrefundable upfront fee is typically included on the client's first invoice,
and is deferred and recognized ratably over the estimated renewal period (i.e.
ten-year estimated client life).
Revenues from the sale of time clocks are recognized when control is transferred
to the client upon delivery of the product. We estimate the standalone selling
price for the time clocks by maximizing the use of observable inputs such as our
specific pricing practices for time clocks.
Goodwill is not amortized, but we are required to test the carrying value of goodwill for impairment at least annually, or earlier if, at the reporting unit level, an indicator of impairment arises. The estimates and assumptions about future results of operations and cash flows made in connection with the impairment testing could differ from future actual results of operations and cash flows. If impairment exists, a write-down to fair value is recorded. Our business is largely homogeneous and, as a result, goodwill is associated with one reporting unit. We have selectedJune 30 as our annual goodwill impairment testing date. We elected to perform a qualitative analysis of the fair value of our goodwill and determined there was no impairment as ofJune 30, 2019 . For the years endedDecember 31, 2019 , 2018 and 2017, there were no indicators of impairment. Intangible assets with definite lives are amortized on a straight-line basis over their estimated useful lives.
Impairment of Long-Lived Assets
Long-lived assets, including intangible assets with finite lives, are reviewed for impairment when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized for the amount by which the carrying amount of the asset exceeds the estimated fair value of the asset. We have determined that there is no impairment of long-lived assets for the years endedDecember 31, 2019 , 2018 and 2017.
Market-Based Restricted Stock Awards
We measure non-cash stock-based compensation expense based on the fair value of
the award on the date of grant. We determine the fair value of stock awards
issued by using a Monte Carlo simulation model. This model considers various
subjective assumptions as inputs, and represent our best estimates, which
involve inherent uncertainties and the application of our judgment as it relates
to market volatilities, the historical volatility of our stock price, risk-free
rates and expected life. The valuation model also incorporates exercise and
forfeiture assumptions based on an analysis of historical data. Determining
these assumptions is subjective and complex, and therefore, a change in the
assumptions utilized could impact the calculation of the fair value of our
market-based stock awards and the associated compensation expense. Refer to Note
11 in the notes to our consolidated financial statements for further information
regarding our stock-based compensation awards.
37
--------------------------------------------------------------------------------Recent Accounting Pronouncements
Refer to Note 2 in the notes to the consolidated financial statements for a full description of recent accounting pronouncements.
Non-GAAP Financial Measures
Management uses adjusted EBITDA and non-GAAP net income as supplemental measures to review and assess the performance of our core business operations and for planning purposes. We define (i) adjusted EBITDA as net income plus interest expense, taxes, depreciation and amortization, non-cash stock-based compensation expense, certain transaction expenses that are not core to our operations (if any) and the change in fair value of our interest rate swap and (ii) non-GAAP net income as net income plus non-cash stock-based compensation expense, certain transaction expenses that are not core to our operations (if any) and the change in fair value of our interest rate swap, all of which are adjusted for the effect of income taxes. Adjusted EBITDA and non-GAAP net income are metrics that provide investors with greater transparency to the information used by management in its financial and operational decision-making. We believe these metrics are useful to investors because they facilitate comparisons of our core business operations across periods on a consistent basis, as well as comparisons with the results of peer companies, many of which use similar non-GAAP financial measures to supplement results underU.S. GAAP. In addition, adjusted EBITDA is a measure that provides useful information to management about the amount of cash available for reinvestment in our business, repurchasing common stock and other purposes. Management believes that the non-GAAP measures presented in this Form 10-K, when viewed in combination with our results prepared in accordance withU.S. GAAP, provide a more complete understanding of the factors and trends affecting our business and performance. Adjusted EBITDA and non-GAAP net income are not measures of financial performance underU.S. GAAP, and should not be considered a substitute for net income, which we consider to be the most directly comparableU.S. GAAP measure. Adjusted EBITDA and non-GAAP net income have limitations as analytical tools, and when assessing our operating performance, you should not consider adjusted EBITDA or non-GAAP net income in isolation, or as a substitute for net income or other consolidated statements of income data prepared in accordance withU.S. GAAP. Adjusted EBITDA and non-GAAP net income may not be comparable to similar titled measures of other companies and other companies may not calculate such measures in the same manner as we do. 38 -------------------------------------------------------------------------------- The following tables reconcile net income to adjusted EBITDA, net income to non-GAAP net income and earnings per share to non-GAAP net income per share on a basic and diluted basis. Refer to our Annual Report on Form 10-K for the year ended December 31, 2018, filed with the SEC on February 14, 2019, for a presentation of the 2017 amounts: Year Ended December 31, 2019 2018 Net income to adjusted EBITDA: Net income$ 180,576 $ 137,065 Interest expense 940 766 Provision for income taxes 45,511 37,646 Depreciation and amortization 42,211 29,657 EBITDA 269,238 205,134
Non-cash stock-based compensation expense 47,268 36,411 Change in fair value of interest rate swap 1,375
(667 )
Adjusted EBITDA $ 317,881 $ 240,878
Year Ended December 31,
2019 2018
Net income to non-GAAP net income:
Net income $ 180,576 $ 137,065 Non-cash stock-based compensation expense 47,268 36,411 Change in fair value of interest rate swap 1,375
(667 )
Income tax effect on non-GAAP adjustments (24,647 ) (16,197 ) Non-GAAP net income
$ 204,572 $ 156,612 Earnings per share, basic$ 3.14 $ 2.37 Earnings per share, diluted$ 3.09 $ 2.34
Non-GAAP net income per share, basic
Weighted average shares outstanding:
Basic 57,561 57,711
Diluted 58,395 58,582
Year Ended December 31,
2019 2018
Earnings per share to non-GAAP net income
per share, basic:
Earnings per share, basic $ 3.14 $ 2.37
Non-cash stock-based compensation expense 0.82
0.63
Change in fair value of interest rate swap 0.02 (0.01 )
Income tax effect on non-GAAP adjustments (0.43 ) (0.28 )
Non-GAAP net income per share, basic $ 3.55 $ 2.71
Year Ended December 31,
2019 2018
Earnings per share to non-GAAP net income
per share, diluted:
Earnings per share, diluted $ 3.09 $ 2.34
Non-cash stock-based compensation expense 0.81
0.62
Change in fair value of interest rate swap 0.02 (0.01 )
Income tax effect on non-GAAP adjustments (0.42 ) (0.28 )
Non-GAAP net income per share, diluted $ 3.50 $ 2.67
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