PAYCOM SOFTWARE, INC. This Management's Discussion and Analysis of Financial Condition and Results of Operations is intended to provide a reader of our financial statements with a narrative from the perspective of our management on our financial condition, results of operations, liquidity, and certain other factors that may affect our future results. The following discussion and analysis should be read in conjunction with (i) the accompanying unaudited consolidated financial statements and notes thereto for the three and nine months endedSeptember 30, 2021 , (ii) the audited consolidated financial statements and notes thereto for the year endedDecember 31, 2020 included in our Annual Report on Form 10-K (the "Form 10-K") filed with theSecurities and Exchange Commission (the "SEC") onFebruary 18, 2021 and (iii) the discussion under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Form 10-K. Except for certain information as ofDecember 31, 2020 , all amounts herein are unaudited. 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.
Forward-Looking Statements
The following discussion contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are any statements that look to future events and include, but are not limited to, statements regarding our business strategy; anticipated future operating results and operating expenses, cash flows, capital resources, dividends and liquidity; trends, opportunities and risks affecting our business, industry and financial results; future expansion or growth plans and potential for future growth; our ability to attract new clients to purchase our solution; our ability to retain clients and induce them to purchase additional applications; our ability to accurately forecast future revenues and appropriately plan our expenses; market acceptance of our solution and applications; our expectations regarding future revenues generated by certain applications; our ability to attract and retain qualified employees and key personnel; future regulatory, judicial and legislative changes; how certain factors affecting our performance correlate to improvement or deterioration in the labor market; our plan to open additional sales offices and our ability to effectively execute such plan; the sufficiency of our existing cash and cash equivalents to meet our working capital and capital expenditure needs over the next 12 months; our ability to relocate ourTexas operations facility within an expected timeframe; our plans regarding our capital expenditures and investment activity as our business grows, including with respect to our newTexas operations facility and research and development; the expected impact on our consolidated financial statements of new accounting pronouncements; our plans to repurchase shares of our common stock through a stock repurchase plan; our expected income tax rate for future periods; and the impact of the novel coronavirus (COVID-19) pandemic on our business, results of operations, cash flows, financial condition and liquidity. In addition, forward-looking statements also consist of statements involving trend analyses and statements including such words as "anticipate," "believe," "could," "estimate," "expect," "will," "intend," "may," "might," "plan," "potential," "should," "would," and similar expressions or the negative of such terms or other comparable terminology. Forward-looking statements are neither historical facts nor assurances of future performance, and are based only on our current beliefs, expectations and assumptions regarding the future of our business, future plans and strategies, projections, anticipated events and trends, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and many of which are outside of our control. Therefore, you should not rely on any of these forward-looking statements. Important factors that could cause our actual results and financial condition to differ materially from those indicated in the forward-looking statements include, among others, the following:
• changes in laws, including proposed tax legislation, government regulations
and policies and interpretations thereof;
• the possibility of security vulnerabilities, cyberattacks and network
disruptions, including breaches of data security and privacy leaks, data
loss, and business interruptions;
• the impact of the COVID-19 pandemic on the U.S. economy, including
reductions in employment levels, business disruptions resulting from
government-mandated mitigation measures and an increase in business
failures;
• our compliance with data privacy laws and regulations;
• our ability to develop enhancements and new applications, keep pace with
technological developments and respond to future disruptive technologies;
• our ability to compete effectively;
• fluctuations in our financial results due to factors beyond our control;
• our ability to manage our rapid growth and organizational change effectively;
• the possibility that clients may not be satisfied with our deployment or
technical support services, or that our solution fails to perform properly;
• our dependence on our key executives;
• our ability to attract and retain qualified personnel, including software
developers and skilled IT, sales, marketing and operational personnel;
• the possibility that the Affordable Care Act may be modified, repealed or
declared unconstitutional;
• our failure to develop and maintain our brand cost-effectively;
20
--------------------------------------------------------------------------------
• seasonality of certain operating results and financial metrics; • our failure to adequately protect our intellectual property rights; • our reliance on relationships with third parties; and
• the other factors set forth in Part I, Item 1A, "Risk Factors" of the Form
10-K, Part II, Item 1A, "Risk Factors" of this Form 10-Q and our other
reports filed with the
Forward-looking statements are based only on information currently available to
us and speak only as of the date of this Form 10-Q and are subject to business
and economic risks. We do not undertake any obligation to update or revise the
forward-looking statements to reflect events that occur or circumstances that
exist after the date on which such statements were made, except to the extent
required by law.
Overview
We are a leading provider of a comprehensive, cloud-based human capital
management ("HCM") solution 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. We serve a diverse client base in terms of size and industry. None of
our clients constituted more than one-half of one percent of our revenues for
the nine months ended September 30, 2021 . 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. We also plan to open additional sales offices in the future and leverage
virtual sales meetings to further expand our market presence.
Our principal marketing efforts include national and local advertising
campaigns, email campaigns, social and digital media campaigns, search engine
marketing methods, tradeshows, print advertising and outbound marketing
including personalized direct mail campaigns. In addition, we generate leads and
build recognition of our brand and thought leadership with relevant and
informative content, such as white papers, blogs, podcast episodes and webinars.
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 revenue 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 sales force 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 10,000 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 gained traction with larger companies. We believe
larger employers
21
--------------------------------------------------------------------------------
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 of our clients will
have a positive or negative impact, respectively, on our results of operations.
As discussed in more detail below, client headcount fluctuations are
particularly relevant in light of the ongoing COVID-19 pandemic. Generally, we
expect that changes in certain factors affecting our performance will correlate
with improvement or deterioration in the labor market.
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. Those 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. As we introduce
new applications, expand our client base and renew and expand relationships with
existing clients, we expect our average funds held for clients balance and,
accordingly, interest earned on funds held for clients, will increase; however,
the amount of interest we earn can be positively or negatively impacted by
changes in interest rates. Even if our average funds held for clients balance
increases, the impact of significantly lower average interest rates could
partially offset the impact of such increased balance and, as a result, have a
negative impact on recurring revenue growth.
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 increased and will continue to increase our expenses. Specifically, our
revenue growth and geographic expansion drive increases in our employee
headcount, which in turn precipitates increases in (i) salaries and benefits,
(ii) stock-based compensation expense and (iii) facility costs related to the
expansion of our corporate headquarters and 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.
Our revenues are seasonal in nature. Recurring revenues include revenues
relating to the annual processing of payroll forms, such as Form W-2, Form 1099,
and Form 1095, 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, first quarter revenues and margins are generally
higher than in subsequent quarters. These seasonal fluctuations in revenues can
also have an impact on gross profits. Historical results impacted by these
seasonal trends should not be considered a reliable indicator of our future
results of operations. For the three months ended September 30, 2021 and 2020,
our total gross margins were approximately 83% and 84%, respectively. For the
nine months ended September 30, 2021 and 2020, our total gross margins were
approximately 85%. Although our gross margins may fluctuate from quarter to
quarter due to seasonality and hiring trends, we expect that our gross margins
will remain relatively consistent in future periods.
22
--------------------------------------------------------------------------------Impact of the COVID-19 Pandemic
Beginning inFebruary 2020 , we took various actions in order to minimize the risk of COVID-19 to our employees, our clients, and the communities in which we operate. InMarch 2020 , we prohibited all business-related travel until further notice and began transitioning our employees to work-from-home arrangements. During the third quarter of 2021, we transitioned the majority of our employees back to our offices, with a large contingent temporarily utilizing alternating schedules between work-from-home and on-site arrangements. Our sales employees have been conducting meetings with current and prospective clients virtually sinceMarch 2020 , but as prospective clients begin to take meetings in-person, we expect our sales process would transition to include a combination of virtual and in-person meetings. We are permitting a limited amount of business travel, and will continue to actively monitor the situation. We may take further actions that alter our business operations as may be required by federal, state or local authorities or that we determine are in the best interests of our employees and clients. Business continuity and safety will continue to guide our return-to-office plans. The COVID-19 pandemic has disrupted the operations of our clients and client prospects and may continue to do so for an indefinite period of time. Across many industries, temporary and permanent business closures as well as business occupancy limitations have resulted in significant layoffs and employee furloughs since lateMarch 2020 . Because we charge our clients on a per-employee basis for certain services we provide, decreases in headcount at our clients as of the onset of the pandemic negatively impacted our recurring revenue beginning in the second quarter of 2020, and we expect that our recurring revenue in future periods will continue to be negatively impacted by such headcount reductions until employment levels among such client base return to pre-pandemic levels. Further, at the onset of the COVID-19 pandemic, a limited number of new clients temporarily delayed service implementation. BetweenAugust 2019 andMarch 2020 , theFederal Open Market Committee reduced the target range for short-term interest rates several times, with the most significant rate cut occurring inMarch 2020 to support the economy and potentially reduce the impacts of the COVID-19 pandemic. Due to significantly lower average interest rates during the first nine months of 2021, as compared to the first nine months of 2020, interest earned on funds held for clients for the three and nine months endedSeptember 30, 2021 decreased from the comparable prior year periods, which had a negative effect on recurring revenue growth. Demand for our solution remains high and, despite the economic challenges brought on by the COVID-19 pandemic, we remain confident in the overall health of our business, the strength of our product offerings, and our ability to continue to execute on our strategy. Prior to the COVID-19 pandemic, our sales force historically traveled frequently to sell our solution. The remote work environment has presented a unique opportunity for our sales force, in that each sales employee is able to meet virtually with a greater number of client prospects in a given day than he or she would if conducting in-person meetings. Internally, all applications within the Paycom solution, and more specifically Employee Self-Service®, Manager on-the-Go®, Documents and Checklists, Ask Here and our enhanced Learning Management System, were instrumental in our ability to seamlessly manage and communicate with our remote workforce. As many clients transitioned their workforces to work-from-home arrangements, we believe they too recognized the benefits of these applications and our focus on employee usage, as well as the strengths and advantages of our single database solution. In contrast, we believe the remote work environment has exposed the weaknesses and disadvantages arising from the combination of disparate systems offered by some of our competitors. We will continue to aggressively invest in sales and marketing and in research and development to drive future growth and expand our market share. OnNovember 4, 2021 , theDepartment of Labor's Occupational Safety and Health Administration released an emergency temporary standard requiring private employers with 100 or more employees to mandate vaccination or weekly testing and masking for their unvaccinated employees. We are evaluating the impact this standard may have on our business and results of operations, including any potential impact it may have on our employees or the employees of our clients. We are unable to estimate the full impact that the COVID-19 pandemic could have on our business and results of operations in the future due to numerous uncertainties, including the severity of the disease, the duration of the outbreak, the emergence of different COVID-19 variants, actions that may be taken by governmental authorities, the impact to the business of our clients and other factors identified in Part I, Item 1A "Risk Factors" in our Form 10-K that was filed with theSEC onFebruary 18, 2021 . Further, while our revenue and earnings are relatively predictable, the effect of the ongoing COVID-19 pandemic may not be fully reflected in our results of operations and overall financial performance until future periods. 23 --------------------------------------------------------------------------------
Results of Operations
The following table sets forth consolidated statements of income data and such data as a percentage of total revenues for the periods presented:
Three Months Ended September 30, Nine Months Ended September 30,
2021 2020 % Change 2021 2020 % Change
Revenues
Recurring $ 251,306 98.1 % $ 192,664 98.0 %
30.4%
4,888 1.9 % 3,868 2.0 % 26.4% 13,873 1.8 % 11,378 1.8 % 21.9%
Total revenues 256,194 100.0 % 196,532 100.0 % 30.4% 770,538 100.0 % 620,487 100.0 % 24.2% Cost of revenues Operating expenses 34,766 13.6 % 24,278 12.3 %
43.2% 92,612 12.0 % 71,651 11.5 % 29.3%
Depreciation and
amortization 7,914 3.1 % 6,634 3.4 % 19.3% 22,751 3.0 % 18,865 3.0 % 20.6%
Total cost of
revenues 42,680 16.7 % 30,912 15.7 % 38.1% 115,363 15.0 % 90,516 14.5 % 27.5%
Administrative
expenses
Sales and marketing 69,745 27.2 % 62,146 31.6 % 12.2% 200,485 26.0 % 173,228 27.9 % 15.7%
Research and
development 31,077 12.1 % 21,772 11.1 % 42.7% 84,012 10.9 % 65,171 10.5 % 28.9%
General and
administrative 59,980 23.4 % 40,516 20.6 % 48.0% 160,234 20.8 % 121,487 19.6 % 31.9% Depreciation and amortization
9,407 3.7 % 7,150 3.6 % 31.6% 25,503 3.3 % 20,209 3.3 % 26.2%
Total administrative
expenses 170,209 66.4 % 131,584 66.9 % 29.4% 470,234 61.0 % 380,095 61.3 % 23.7% Total operating expenses
212,889 83.1 % 162,496 82.6 % 31.0% 585,597 76.0 % 470,611 75.8 % 24.4% Operating income
43,305 16.9 % 34,036 17.4 % 27.2% 184,941 24.0 % 149,876 24.2 % 23.4%
Interest expense - 0.0 % - 0.0 % 0.0% - 0.0 % (19 ) 0.0 % -100.0%
Other income
(expense), net 244 0.1 % 246 0.1 % -0.8% 1,019 0.1 % (522 ) -0.1 % -295.2%
Income before income
taxes 43,549 17.0 % 34,282 17.5 % 27.0% 185,960 24.1 % 149,335 24.1 % 24.5%
Provision for income
taxes 13,170 5.1 % 6,800 3.5 % 93.7% 38,687 5.0 % 30,249 4.9 % 27.9%
Net income $ 30,379 11.9 % $ 27,482 14.0 % 10.5% $ 147,273 19.1 % $ 119,086 19.2 % 23.7%
Revenues
The increase in total revenues for the three and nine months ended September 30,
2021 compared to the same periods in 2020 was primarily the result of 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, and the
sale of additional applications to our existing clients. In addition, our tax
forms filing business in the first quarter of 2021 contributed to the increase
in total revenues for the nine months ended September 30, 2021 as compared to
the same period in 2020. The COVID-19 pandemic has resulted in, and may continue
to result in, headcount fluctuations across our client base. Because we charge
our clients on a per-employee basis for certain services we provide, the drivers
of revenue for the three and nine months ended September 30, 2021 described
above were impacted by the headcount fluctuations within our client base. The
negative effects on our client revenue of lower headcount resulting from the
pandemic were more than offset by headcount additions from new clients and
modestly improved headcount levels among our pre-pandemic client base throughout
the third quarter of 2021. Significantly lower average interest rates during the
nine months ended September 30, 2021 as compared to the nine months ended
September 30, 2020 , had a negative effect on recurring revenue growth for the
three and nine months ended September 30, 2021 . We expect that the foregoing
adverse macroeconomic factors may continue to have a negative effect on
recurring revenues in future periods for so long as such conditions persist.
The increase in implementation and other revenues for the three and nine months
ended September 30, 2021 from the same periods in 2020 was primarily the result
of increased non-refundable upfront conversion fees collected from the addition
of new clients. These fees are deferred and recognized ratably over the ten-year
estimated life of our clients.
Expenses
Cost of Revenues
During the three months endedSeptember 30, 2021 , operating expenses increased from the comparable prior year period by$10.5 million due to a$7.3 million increase in employee-related expenses primarily attributable to growth in the number of operating personnel, a$2.2 million increase in shipping and supplies fees and a$1.0 million increase in automated clearing house fees in connection with the increase in revenues. Depreciation and amortization expense increased$1.3 million from the comparable prior year period, primarily due to the development of additional technology and purchases of other fixed assets. 24 -------------------------------------------------------------------------------- During the nine months endedSeptember 30, 2021 , operating expenses increased from the comparable prior year period by$21.0 million due to a$14.1 million increase in employee-related expenses primarily attributable to growth in the number of operating personnel, a$4.5 million increase in shipping and supplies fees and a$2.4 million increase in automated clearing house fees in connection with the increase in revenues. Depreciation and amortization expense increased$3.9 million from the comparable prior year period, primarily due to the development of additional technology and purchases of other fixed assets. Administrative Expenses Sales and Marketing During the three months endedSeptember 30, 2021 , sales and marketing expenses increased from the comparable prior year period by$7.6 million due to an$8.8 million increase in employee-related expenses, including commissions and bonuses, which was partially offset by a$1.2 million decrease in marketing and advertising expense. During the nine months endedSeptember 30, 2021 , sales and marketing expenses increased from the comparable prior year period by$27.3 million due to a$22.0 million increase in employee-related expenses, including commissions and bonuses, and a$5.3 million increase in marketing and advertising expense attributable to increased spending across most components of our marketing program. Based on positive results from our advertising campaigns, we plan to continue to make significant investments in our marketing program and may adjust spending levels in future periods as we see opportunities for returns on our investments. Research and Development
During the three and nine months 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 three and nine months endedSeptember 30, 2021 and 2020: Three Months Ended September 30, Nine Months Ended September 30, 2021 2020 % Change 2021 2020 % Change Capitalized portion of research and development$ 13,157 $ 11,727 12%$ 39,160 $ 32,448 21% Expensed portion of research and development 31,077 21,772 43% 84,012 65,171 29% Total research and development costs$ 44,234 $ 33,499 32%$ 123,172 $ 97,619 26%
General and Administrative
During the three months endedSeptember 30, 2021 , general and administrative expenses increased$19.5 million from the comparable prior year period primarily due to a$10.2 million increase in non-cash stock-based compensation and a$10.1 million increase in employee-related expenses, which were partially offset by a$0.8 million decrease in accounting and legal expenses. During the nine months endedSeptember 30, 2021 , general and administrative expenses increased$38.7 million from the comparable prior year period primarily due to a$22.7 million increase in non-cash stock-based compensation and a$19.2 million increase in employee-related expenses, which were partially offset by a$3.2 million decrease in accounting and legal expenses. 25 --------------------------------------------------------------------------------
Non-Cash Stock-Based Compensation Expense
The following table presents the non-cash stock-based compensation expense that
is included within the specified line items in our consolidated statements of
income:
Three Months Ended September 30, Nine Months Ended September 30,
2021 2020 % Change 2021 2020 % Change
Non-cash stock-based
compensation expense
Operating expenses $ 1,256 $ 1,227 2% $ 3,381 $ 4,158 -19%
Sales and marketing 3,417 3,829 -11% 10,567 10,795 -2%
Research and development 1,827 2,115 -14% 5,394 7,270 -26%
General and
administrative 22,491 12,331 82% 57,022 34,308 66%
Total non-cash
stock-based compensation
expense $ 28,991 $ 19,502 49% $ 76,364 $ 56,531 35%
During the three and nine months ended September 30, 2021 , our non-cash
stock-based compensation expense increased $9.5 million and $19.8 million ,
respectively, from the comparable prior year periods due to an increase in both
the number of employees who received awards and the grant date fair value
associated with the issuances in 2021. Also contributing to the increase in our
non-cash stock-based compensation expense was the accelerated vesting of
restricted stock subject to market-based vesting conditions.
Depreciation and Amortization
During the three and nine months endedSeptember 30, 2021 , depreciation and amortization expense increased from the comparable prior year periods primarily due to the development of additional technology and purchases of other related fixed assets. Interest Expense The decreases in interest expense for the three and nine months endedSeptember 30, 2021 , as compared to the comparable prior year periods, were due to the timing of construction of our expanded operations facility inGrapevine, Texas , which resulted in a higher capitalization rate of interest in 2021.
Other Income (Expense), net
The changes in other income (expense), net for the three and nine months endedSeptember 30, 2021 was primarily due to the increase in the fair value of our interest rate swap as compared to the comparable prior year periods.
Provision (Benefit) for Income Taxes
The provision (benefit) 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 20.8% and 20.3% for the nine months endedSeptember 30, 2021 and 2020, respectively. The higher effective income tax rate for the nine months endedSeptember 30, 2021 is primarily related to a decrease in excess tax benefits from stock-based compensation as compared to the nine months endedSeptember 30, 2020 .
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 consist 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 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 ongoing 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 ofSeptember 30, 2021 , 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 . All Term Loans were used to finance construction projects at our corporate headquarters. Our obligations under the Term Loans are secured by a mortgage and first priority security interest in our corporate 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%. 26
-------------------------------------------------------------------------------- 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 ofSeptember 30, 2021 , 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 receive quarterly variable interest payments based on the LIBOR rate and 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 three and nine months endedSeptember 30, 2021 , we recorded gains of$0.2 million and$0.9 million , respectively, for the change in fair value of the interest rate swap, and for the three months endedSeptember 30, 2020 , we recorded a gain of$0.1 million and for the nine months endedSeptember 30, 2020 , we recorded a loss of$1.6 million , for the change in fair value of the interest rate swap. The change in fair value of the interest rate swap is included in Other income (expense), 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 the 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. The scheduled maturity date of the Facility was also 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 ofSeptember 30, 2021 , 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 and authorized new stock repurchase plans from time to time. Most recently, inMay 2021 , our Board of Directors authorized the repurchase of up to$300.0 million of our common stock. As ofSeptember 30, 2021 , there was$270.7 million available for repurchases under our stock repurchase plan. 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, shares withheld for taxes associated with the vesting of restricted stock and other corporate considerations. The current stock repurchase plan will expire onMay 13, 2023 . During the nine months endedSeptember 30, 2021 , we repurchased an aggregate of 155,575 shares of our common stock at an average cost of$393.05 per share, all of which were shares withheld to satisfy tax withholding obligations for certain employees upon the vesting of restricted stock. Our payment of the taxes on behalf of those employees resulted in an aggregate cash expenditure of$61.1 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. 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 completing the construction of our newTexas operations facility inGrapevine, Texas . Capital expenditures related to the construction of the facility began in the second quarter of 2019. OnNovember 3, 2021 , we signed a construction contract for a fifth building at ourOklahoma City headquarters. We estimate that the total cost of the project will be between$60 million and$70 million and construction will take approximately two years to complete. In addition, we have purchased the naming rights to the downtown 27 --------------------------------------------------------------------------------Oklahoma City arena that is home to theOklahoma City Thunder National Basketball Association franchise. Under the terms of the naming rights agreement, we have committed to make payments escalating annually from$4.0 million in 2021 to$6.1 million in 2035. The payments are due in the fourth quarter of each year. Upon the conclusion of the initial term, the agreement may be extended upon the mutual agreement of both parties for an additional five-year period. 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 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
nine months ended
Nine Months Ended September 30,
2021 2020 % Change
Net cash provided by (used in):
Operating activities $ 229,637 $ 174,328 32%
Investing activities (63,978 ) (197,767 ) -68%
Financing activities 1,283,999 (219,891 ) 684%
Change in cash, cash equivalents, restricted
cash and restricted cash equivalents $ 1,449,658 $ (243,330 ) 696%
Operating Activities
Cash provided by operating activities for the nine months ended September 30,
2021 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 nine months ended September 30, 2020 , our operating cash
flows for the nine months ended September 30, 2021 were positively impacted by
the growth of our business.
Investing Activities
Cash flows used in investing activities for the nine months ended September 30,
2021 decreased from the comparable prior year period due to an $101.4 million
increase in proceeds from maturities of short-term investments from funds held
for clients and a $47.1 million decrease in purchases of short-term investments
from funds held for clients. This decrease was slightly offset by a $13.2
million increase in purchases of property and equipment as well as a $1.5
million increase in purchases for intangible assets related to the naming rights
agreement.
Financing Activities
Cash flows provided by financing activities for the nine months ended September
30, 2021 increased from the comparable prior year period primarily due to the
impact of a $1,486.9 million change related to the 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 as well as
a $52.0 million decrease in common stock repurchases. The increase in cash flows
provided by financing activities was slightly offset by a $35.1 million increase
in the withholding taxes paid related to net share settlements.
Contractual Obligations
Our principal commitments primarily consist of long-term debt and leases for office space. As discussed within "Note 5.Goodwill and Intangible Assets, Net", we have entered into a naming rights agreement pursuant to which we have committed to pay an annual fee escalating annually from$4.0 million in 2021 to$6.1 million in 2035 in exchange for arena naming rights and other 28 -------------------------------------------------------------------------------- associated benefits. Outside of the naming rights agreement, there have been no material changes to our contractual obligations disclosed in the contractual obligations section of Management's Discussion and Analysis of Financial Condition and Results of Operations in the Form 10-K that was filed with theSEC onFebruary 18, 2021 . For additional information regarding our naming rights agreement, leases, long-term debt and our commitments and contingencies, see "Note 5. Leases", "Note 6. Long-Term Debt, Net" and "Note 12. Commitments and Contingencies" in the Form 10-K and "Note 5.Goodwill and Intangible Assets, Net", "Note 6. Long-Term Debt, Net" and "Note 12. Commitments and Contingencies" in the notes to our unaudited consolidated financial statements included elsewhere in this Form 10-Q.
Off-Balance Sheet Arrangements
As ofSeptember 30, 2021 , 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 with generally accepted accounting principles inthe United States of America ("U.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 evaluate our estimates and assumptions to ensure that management believes them to be reasonable under the then-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 discussed in the critical accounting policies and estimates section of Management's Discussion and Analysis of Financial Condition and Results of Operations in the Form 10-K. There have been no material changes to the critical accounting policies disclosed in the Form 10-K.
Adoption of Accounting Pronouncements
Discussion of our recently adopted accounting pronouncements can be found in Note 2 in this Form 10-Q.
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-Q, 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 similarly titled measures of other companies and other companies may not calculate such measures in the same manner as we do. 29 --------------------------------------------------------------------------------
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:
Three Months Ended September 30 ,
Nine Months Ended
2021 2020 2021 2020
Net income to adjusted EBITDA:
Net income $ 30,379 $ 27,482 $ 147,273 $ 119,086
Interest expense - - - 19
Provision for income taxes 13,170 6,800 38,687 30,249
Depreciation and amortization 17,321 13,784 48,254 39,074
EBITDA 60,870 48,066 234,214 188,428
Non-cash stock-based compensation
expense 28,991 19,502 76,364 56,531
Change in fair value of interest
rate swap (158 ) (88 ) (863 ) 1,618
Adjusted EBITDA $ 89,703 $ 67,480 $ 309,715 $ 246,577
Three Months Ended September 30, Nine Months Ended September 30,
2021 2020 2021 2020
Net income to non-GAAP net income:
Net income $ 30,379 $ 27,482 $ 147,273 $ 119,086
Non-cash stock-based compensation
expense 28,991 19,502 76,364 56,531
Change in fair value of interest
rate swap (158 ) (88 ) (863 ) 1,618
Income tax effect on non-GAAP
adjustments (5,626 ) (6,332 ) (26,798 ) (22,802 )
Non-GAAP net income $ 53,586 $ 40,564 $ 195,976 $ 154,433
Weighted average shares
outstanding:
Basic 57,935 57,603 57,843 57,609
Diluted 58,190 58,171 58,192 58,312
Earnings per share, basic $ 0.52 $ 0.48 $ 2.55 $ 2.07
Earnings per share, diluted $ 0.52 $ 0.47 $ 2.53 $ 2.04
Non-GAAP net income per share,
basic $ 0.92 $ 0.70 $ 3.39 $ 2.68
Non-GAAP net income per share,
diluted $ 0.92 $ 0.70 $ 3.37 $ 2.65
Three Months Ended September 30, Nine Months Ended September 30,
2021 2020 2021 2020
Earnings per share to non-GAAP net
income per share, basic:
Earnings per share, basic $ 0.52 $ 0.48 $ 2.55 $ 2.07
Non-cash stock-based compensation
expense 0.50 0.34 1.32 0.98
Change in fair value of interest
rate swap - - (0.01 ) 0.03
Income tax effect on non-GAAP
adjustments (0.10 ) (0.12 ) (0.47 ) (0.40 )
Non-GAAP net income per share,
basic $ 0.92 $ 0.70 $ 3.39 $ 2.68
Three Months Ended September 30, Nine Months Ended September 30,
2021 2020 2021 2020
Earnings per share to non-GAAP net
income per share, diluted:
Earnings per share, diluted $ 0.52 $ 0.47 $ 2.53 $ 2.04
Non-cash stock-based compensation
expense 0.50 0.34 1.31 0.97
Change in fair value of interest
rate swap - - (0.01 ) 0.03
Income tax effect on non-GAAP
adjustments (0.10 ) (0.11 ) (0.46 ) (0.39 )
Non-GAAP net income per share,
diluted $ 0.92 $ 0.70 $ 3.37 $ 2.65
30
--------------------------------------------------------------------------------
© Edgar Online, source
