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 management's perspective 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, 2022 , (ii) the audited consolidated financial statements and notes thereto for the year endedDecember 31, 2021 included in our Annual Report on Form 10-K (the "Form 10-K") filed with theSecurities and Exchange Commission (the "SEC") onFebruary 17, 2022 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, 2021 , 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 plans regarding our capital expenditures and investment activity as our business grows, including with respect to research and development and the expansion of our corporate headquarters and other facilities; 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 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:
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changes in laws, government regulations and policies and interpretations thereof;
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the possibility of security vulnerabilities, cyberattacks and network disruptions, including breaches of data security and privacy leaks, data loss, and business interruptions;
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our compliance with data privacy laws and regulations;
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our ability to develop enhancements and new applications, keep pace with technological developments and respond to future disruptive technologies;
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our ability to compete effectively;
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fluctuations in our financial results due to factors beyond our control;
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our ability to manage our rapid growth and organizational change effectively;
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the possibility that clients may not be satisfied with our deployment or technical support services, or that our solution fails to perform properly;
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our dependence on our key executives;
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our ability to attract and retain qualified personnel, including software developers and skilled IT, sales, marketing and operational personnel;
21
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the possibility that the Affordable Care Act may be modified, repealed or declared unconstitutional;
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the impact of the COVID-19 pandemic on the
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our failure to develop and maintain our brand cost-effectively;
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seasonality of certain operating results and financial metrics;
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our failure to adequately protect our intellectual property rights;
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our reliance on relationships with third parties; and
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the other factors set forth in Part I, Item 1A, "Risk Factors" of the Form 10-K
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, 2022 . Our revenues are primarily generated
through our sales force that solicits new clients and our client relations
representatives ("CRRs") 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. In January 2022 , we added new sales teams in Las Vegas , Jacksonville ,
New England and South Jersey , bringing our total to 55 sales teams (including
one team consisting of CRRs and inside sales representatives) located in 28
states. We 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, sponsorships, 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.
22
--------------------------------------------------------------------------------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. For example, in 2021, we launched our industry-first Beti technology, which further automates and streamlines the payroll process by empowering employees to do their own payroll. 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 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,U.S. treasury securities, 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. 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 and generally we expect our first and fourth quarter recurring revenues to be higher than other quarters during the year. Recurring revenues include revenues relating to the annual processing of payroll tax filing forms and ACA form filing requirements, such as Form W-2, Form 1099, and Form 1095 and revenues from processing unscheduled payroll runs (such as bonuses) for our clients. As payroll tax forms are typically processed in the first quarter of the year, first quarter recurring revenues and margins are positively impacted. In addition, unscheduled payroll runs at the end of the year often result in increased recurring revenues in the fourth quarter. 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 endedSeptember 30, 2022 and 2021, our total gross margins were approximately 84% and 83%, respectively. For the nine months endedSeptember 30, 2022 and 2021, 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. 23 --------------------------------------------------------------------------------
Impact of the COVID-19 Pandemic
The COVID-19 pandemic has created uncertainty and impacted the operations of many of our clients and client prospects. Nonetheless, 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. We are monitoring developments related to the pandemic. 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. 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 17, 2022 .
Results of Operations
The following table sets forth certain 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,
2022 2021 % Change 2022 2021 % Change
Revenues
Recurring $ 328,150 98.2 % $ 251,306 98.1 %
30.6%
6,017 1.8 % 4,888 1.9 % 23.1% 16,762 1.7 % 13,873 1.8 % 20.8%
Total revenues 334,167 100.0 % 256,194 100.0 % 30.4% 1,004,610 100.0 % 770,538 100.0 % 30.4%
Cost of revenues
Operating
expenses 44,169 13.2 % 34,766 13.6 % 27.0% 122,265 12.2 % 92,612 12.0 % 32.0% Depreciation and amortization
10,935 3.3 % 7,914 3.1 % 38.2% 31,405 3.1 % 22,751 3.0 % 38.0% Total cost of revenues
55,104 16.5 % 42,680 16.7 % 29.1% 153,670 15.3 % 115,363 15.0 % 33.2%
Administrative
expenses
Sales and
marketing 91,114 27.3 % 69,745 27.2 % 30.6% 253,834 25.3 % 200,485 26.0 % 26.6%
Research and
development 40,366 12.1 % 31,077 12.1 % 29.9% 108,774 10.8 % 84,012 10.9 % 29.5% General and administrative
60,693 18.1 % 59,980 23.4 % 1.2% 179,109 17.8 % 160,234 20.8 % 11.8% Depreciation and amortization
12,625 3.8 % 9,407 3.7 % 34.2% 36,378 3.6 % 25,503 3.3 % 42.6%
Total
administrative
expenses 204,798 61.3 % 170,209 66.4 % 20.3% 578,095 57.5 % 470,234 61.0 % 22.9% Total operating expenses
259,902 77.8 % 212,889 83.1 % 22.1% 731,765 72.8 % 585,597 76.0 % 25.0% Operating income 74,265 22.2 % 43,305 16.9 % 71.5% 272,845 27.2 % 184,941 24.0 % 47.5% Interest expense (1,018 ) -0.3 %
- 0.0 % -100.0% (1,587 ) -0.2 % - 0.0 % -100.0%
Other income
(expense), net 2,041 0.6 % 244 0.1 % 736.5% 4,331 0.4 % 1,019 0.1 % 325.0%
Income before
income taxes 75,288 22.5 % 43,549 17.0 % 72.9% 275,589 27.4 % 185,960 24.1 % 48.2% Provision for income taxes
23,135 6.9 % 13,170 5.1 % 75.7% 74,151 7.3 % 38,687 5.0 % 91.7% Net income
$ 52,153 15.6 %$ 30,379 11.9 % 71.7%$ 201,438 20.1 %$ 147,273 19.1 % 36.8% Revenues The increase in total revenues for the three and nine months endedSeptember 30, 2022 compared to the same periods in 2021 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, the performance of our tax forms filing business in the first quarter contributed to the increase in total revenues for the nine months endedSeptember 30, 2022 as compared to the same period in 2021. The COVID-19 pandemic has resulted in, and may continue to result in, headcount fluctuations across our client base. Additionally, rising interest rates and a higher average funds held for clients balance during the three and nine months endedSeptember 30, 2022 as compared to the same periods in 2021, resulted in increased interest earned on funds held for clients, which had a positive impact on recurring revenue. The increase in implementation and other revenues for the three and nine months endedSeptember 30, 2022 from the same periods in 2021 was primarily the result of the 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. 24 --------------------------------------------------------------------------------
Expenses Cost of Revenues During the three months endedSeptember 30, 2022 , operating expenses increased from the comparable prior year period by$9.4 million due to an$8.6 million increase in employee-related expenses primarily attributable to growth in the number of operating personnel and a$0.7 million increase in automated clearing house fees in connection with the increase in revenues. Depreciation and amortization expense increased$3.0 million from the comparable prior year period, primarily due to the development of additional technology and purchases of other fixed assets. During the nine months endedSeptember 30, 2022 , operating expenses increased from the comparable prior year period by$29.7 million due to a$24.6 million increase in employee-related expenses primarily attributable to growth in the number of operating personnel, a$2.9 million increase in shipping and supplies fees and a$2.2 million increase in automated clearing house fees in connection with the increase in revenues. Depreciation and amortization expense increased$8.7 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, 2022 , sales and marketing expenses increased from the comparable prior year period by$21.4 million due to a$16.6 million increase in employee-related expenses, including commissions and bonuses, and a$4.8 million increase in marketing and advertising expense attributable to increased spending across most components of our marketing program. During the nine months endedSeptember 30, 2022 , sales and marketing expenses increased from the comparable prior year period by$53.3 million due to a$41.1 million increase in employee-related expenses, including commissions and bonuses, and a$12.2 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, 2022 and 2021: Three Months Ended Nine Months Ended September September 30, 30, 2022 2021 % Change 2022 2021 % Change Capitalized portion of research and development$ 16,995 $ 13,157 29%$ 48,835 $ 39,160 25% Expensed portion of research and development 40,366 31,077 30% 108,774 84,012 29% Total research and development costs$ 57,361 $ 44,234 30%$ 157,609 $ 123,172 28% General and Administrative During the three months endedSeptember 30, 2022 , general and administrative expenses increased$0.7 million from the comparable prior year period due to a$1.1 million increase in accounting and legal expenses, which was partially offset by a$0.4 million decrease in employee-related expenses. 25 -------------------------------------------------------------------------------- During the nine months endedSeptember 30, 2022 , general and administrative expenses increased$18.9 million from the comparable prior year period due to a$19.7 million increase in employee-related expenses, which was partially offset by a$0.8 million decrease in accounting and legal expenses.
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
comprehensive income:
Three Months Ended Nine Months Ended
September 30, September 30,
2022 2021 % Change 2022 2021 % Change
Non-cash stock-based
compensation expense
Operating expenses $ 1,396 $ 1,256 11% $ 3,725 $ 3,381 10%
Sales and marketing 5,280 3,417 55% 13,186 10,567 25%
Research and development 3,039 1,827 66% 8,115 5,394 50%
General and administrative 14,777 22,491 -34% 45,789 57,022 -20%
Total non-cash stock-based
compensation expense $ 24,492 $ 28,991 -16% $ 70,815 $ 76,364 -7%
Depreciation and Amortization
During the three and nine months endedSeptember 30, 2022 , 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 increase in interest expense for the three and nine months endedSeptember 30, 2022 , as compared to the comparable prior year periods, is due to the timing and progress of construction of the expansion of our corporate headquarters and our expanded operations facility, which resulted in a lower capitalization rate of interest in 2022. Other Income (Expense), net The change in other income (expense), net for the three and nine months endedSeptember 30, 2022 was primarily due to the realized gain which resulted from the settlement of our interest rate swap agreement.
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 26.9% and 20.8% for the nine months endedSeptember 30, 2022 and 2021, respectively. The increase in the effective income tax rate for the nine months endedSeptember 30, 2022 is primarily related to a decrease of excess tax benefits from stock-based compensation.
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$650.0 million senior secured revolving credit facility (the "July 2022 Revolving Credit Facility"), and a$750.0 million senior secured delayed draw term loan facility (the "July 2022 Term Loan Facility"), which can be accessed as needed to supplement our operating cash flow and cash balances. As ofSeptember 30, 2022 , we have$29.0 million of outstanding borrowings under theJuly 2022 Revolving Credit Facility and no outstanding borrowings under theJuly 2022 Term Loan Facility. 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. We are funding the current building expansion at ourOklahoma City headquarters from available cash. Further, all purchases under our stock repurchase plans were paid for from available cash. We believe our existing cash and cash equivalents, cash generated from operations and available sources of liquidity will be sufficient to maintain operations, make necessary capital expenditures and opportunistically repurchase shares for at least the next 12 months. In addition, based on our strong profitability and continued growth, we expect to meet our longer-term liquidity needs with cash flows from operations and, as needed, financing arrangements. Interest Rate Swap Agreement. InDecember 2017 , we entered into a floating-to-fixed interest rate swap agreement (the "Interest Rate Swap Agreement") to limit our exposure to interest rate risk related to the term loans used to finance construction projects at our corporate headquarters (the "2017 Term Loans"). The Interest Rate Swap Agreement, which had a maturity date ofSeptember 7, 2025 , provided that we received quarterly variable interest payments based on the LIBOR rate and paid interest at a fixed rate. We have 26 -------------------------------------------------------------------------------- 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 comprehensive income. OnAugust 24, 2022 , we terminated the Interest Rate Swap Agreement by settling the contract. The settlement of the interest rate swap contract resulted in a cash receipt of$0.5 million . The realized gain from the settlement of the interest rate swap is included in Other income (expense), net in the consolidated statements of comprehensive income.May 2022 Revolving Credit Agreement. OnMay 4, 2022 , we entered into a credit agreement (the "May 2022 Revolving Credit Agreement") withBank of America, N.A ., as a lender, swingline lender and letters of credit issuer, the lenders from time to time party thereto, andBank of America, N.A ., as the administrative agent, which provided for a senior secured revolving credit facility in the initial aggregate principal amount of up to$250.0 million and the ability to request an incremental facility of up to an additional$100.0 million , subject to obtaining additional lender commitments and certain approvals and satisfying certain other conditions (the "May 2022 Facility"). TheMay 2022 Facility included a$25.0 million sublimit for swingline loans and a$2.5 million sublimit for letters of credit. OnMay 4, 2022 , we borrowed$29.0 million under theMay 2022 Facility to repay the 2017 Term Loans, along with accrued interest, expenses and fees. OnJune 7, 2022 , the aggregate commitments under theMay 2022 Revolving Credit Agreement were increased from$250.0 million to$350.0 million . TheMay 2022 Facility was scheduled to mature onMay 4, 2027 . As discussed below, onJuly 29, 2022 , we entered into theJuly 2022 Credit Agreement (as defined below) and borrowed$29.0 million to repay the outstanding indebtedness under theMay 2022 Facility along with accrued interest, expenses and fees. In connection with the repayment, theMay 2022 Revolving Credit Agreement was terminated onJuly 29, 2022 .July 2022 Credit Agreement. OnJuly 29, 2022 (the "July 2022 Facility Closing Date"), we entered into a new credit agreement (the "July 2022 Credit Agreement") withJPMorgan Chase Bank, N.A ., as a lender, swingline lender and issuing bank, the lenders from time to time party thereto (collectively withJPMorgan Chase Bank, N.A ., the "July 2022 Lenders"), andJPMorgan Chase Bank, N.A ., as the administrative agent. TheJuly 2022 Credit Agreement provides for theJuly 2022 Revolving Credit Facility in the aggregate principal amount of up to$650.0 million , and the ability to request an incremental facility of up to an additional$500.0 million , subject to obtaining additional lender commitments and certain approvals and satisfying certain other conditions. TheJuly 2022 Credit Agreement includes a$25.0 million sublimit for swingline loans and a$6.5 million sublimit for letters of credit. TheJuly 2022 Credit Agreement also provides for theJuly 2022 Term Loan Facility in the aggregate amount of up to$750.0 million . All loans under theJuly 2022 Credit Agreement will mature onJuly 29, 2027 (the "Scheduled Maturity Date"). The borrowings under theJuly 2022 Credit Agreement will bear interest at a rate per annum equal to (i) the Alternate Base Rate ("ABR") plus an applicable margin ("ABR Loans") or (ii) (x) the term Secured Overnight Financing Rate ("SOFR") plus 0.10% (the "Adjusted Term SOFR Rate") or (y) the daily SOFR plus 0.10%, in each case plus an applicable margin ("SOFR Rate Loans"). ABR is calculated as the highest of (i) the rate of interest last quoted by The Wall Street Journal inthe United States as the prime rate in effect, (ii) the federal funds rate plus 0.5% and (iii) the Adjusted Term SOFR Rate for a one-month interest period plus 1.00%; provided that, if the ABR as determined pursuant to the foregoing would be less than 1.00%, such rate shall be deemed to be 1.00%. The applicable margin for ABR Loans is (i) 0.25% if the Company's consolidated leverage ratio is less than 1.0 to 1.0; (ii) 0.50% if the Company's consolidated leverage ratio is greater than or equal to 1.0 to 1.0 but less than 2.0 to 1.0; (iii) 0.75% if the Company's consolidated leverage ratio is greater than or equal to 2.0 to 1.0 but less than 3.0 to 1.0; or (iv) 1.00% if the Company's consolidated leverage ratio is greater than or equal to 3.0 to 1.0. The applicable margin for SOFR Rate Loans is (i) 1.25% if the Company's consolidated leverage ratio is less than 1.0 to 1.0; (ii) 1.5% if the Company's consolidated leverage ratio is greater than or equal to 1.0 to 1.0 but less than 2.0 to 1.0; (iii) 1.75% if the Company's consolidated leverage ratio is greater than or equal to 2.0 to 1.0 but less than 3.0 to 1.0; or (iv) 2.00% if the Company's consolidated leverage ratio is greater than or equal to 3.0 to 1.0. We are required to pay a quarterly commitment fee on the daily amount of the undrawn portion of the revolving commitments under theJuly 2022 Revolving Credit Facility and a quarterly ticking fee on the daily amount of the undrawn portion of theJuly 2022 Term Loan Facility, in each case at a rate per annum of (i) 0.20% if the Company's consolidated leverage ratio is less than 1.0 to 1.0; (ii) 0.225% if the Company's consolidated leverage ratio is greater than or equal to 1.0 to 1.0 but less than 2.0 to 1.0; (iii) 0.25% if the Company's consolidated leverage ratio is greater than or equal to 2.0 to 1.0 but less than 3.0 to 1.0; or (iv) 0.275% if the Company's consolidated leverage ratio is greater than or equal to 3.0 to 1.0. We are also required to pay customary letter of credit fees upon drawing any letter of credit. Under theJuly 2022 Credit Agreement, we are required to maintain as of the end of each fiscal quarter a consolidated interest ratio of not less than 3.0 to 1.0 and a consolidated leverage ratio of not greater than 3.75 to 1.0, stepping down to 3.0 to 1.0 at intervals thereafter. We may make up to ten draws under theJuly 2022 Term Loan Facility at any time during the period from and after theJuly 2022 Facility Closing Date through twelve months after theJuly 2022 Facility Closing Date. Loans under theJuly 2022 Term Loan Facility will amortize in equal quarterly installments commencing with the first full fiscal quarter after the earlier of (x) the date on 27 --------------------------------------------------------------------------------
which the
On theJuly 2022 Facility Closing Date, we borrowed$29.0 million under theJuly 2022 Revolving Credit Facility to repay the outstanding indebtedness under theMay 2022 Facility, along with accrued interest, expenses and fees. The loan bears interest at the Adjusted Term SOFR Rate for the interest period in effect plus 1.25%. In connection with the repayment of theMay 2022 Facility, theMay 2022 Revolving Credit Agreement was terminated onJuly 29, 2022 . 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, inAugust 2022 , our Board of Directors authorized the repurchase of up to$1.1 billion of our common stock. As ofSeptember 30, 2022 , there was$1.1 billion 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 onAugust 15, 2024 . During the nine months endedSeptember 30, 2022 , we repurchased an aggregate of 364,200 shares of our common stock at an average cost of$273.67 per share, including 16,888 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$5.0 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 the expansion of our corporate headquarters. Capital expenditures related to this expansion began in the fourth quarter of 2021. We estimate that the total cost of the project will be between$60 million and$70 million and we expect construction will take approximately two years to complete. In addition, we purchased the naming rights to the downtownOklahoma City arena that is home to theOklahoma City Thunder National Basketball Association franchise. Under the terms of the naming rights agreement, we 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,U.S. treasury securities 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. 28 --------------------------------------------------------------------------------
The following table summarizes the consolidated statements of cash flows for the
nine months ended
Nine Months Ended
2022 2021 % Change
Net cash provided by (used in):
Operating activities $ 236,647 $ 229,637 3%
Investing activities (32,028 ) (63,978 ) 50%
Financing activities (198,871 ) 1,283,999 -115%
Change in cash, cash equivalents, restricted
cash and restricted cash equivalents $ 5,748 $ 1,449,658 -100%
Operating Activities
Cash provided by operating activities for the nine months ended September 30,
2022 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, 2021 , our operating cash
flows for the nine months ended September 30, 2022 were positively impacted by
the growth of our business.
Investing Activities
Cash flows used in investing activities for the nine months ended September 30,
2022 decreased from the comparable prior year period due to a $133.7 million
increase in proceeds from investments from funds held for clients and a $1.5
million decrease in purchases of intangible assets, which were partially offset
by a $98.0 million increase in purchases of investments from funds held for
clients and a $5.3 million increase in purchases of property and equipment.
Financing Activities
Cash flows used in financing activities for the nine months endedSeptember 30, 2022 increased from the comparable prior year period primarily due to the impact of a$1,439.0 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, a$94.7 million increase in common stock repurchases, a$28.0 million increase in payments on long-term debt, and a$6.4 million increase in payment of debt issuance costs. The increase in cash flows used in financing activities was partially offset by a$56.1 million decrease in withholding taxes paid related to net share settlements and$29.0 million in proceeds from the issuance of debt.
Contractual Obligations
Our principal commitments primarily consist of long-term debt, leases for office space and the naming rights agreement. As discussed in "Note 6. Long-Term Debt, Net" and elsewhere in this Form 10-Q, onMay 4, 2022 , we entered into theMay 2022 Revolving Credit Agreement, repaid the 2017 Term Loans and terminated the 2017 Term Credit Agreement. OnJuly 29, 2022 , we entered into theJuly 2022 Credit Agreement and terminated theMay 2022 Revolving Credit Agreement. Outside of the changes related to theMay 2022 Revolving Credit Agreement, repayment of the 2017 Term Loans, termination of the 2017 Term Credit Agreement and changes related to theJuly 2022 Credit 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 17, 2022 . For additional information regarding our naming rights agreement, leases, long-term debt and our commitments and contingencies, see "Note 4.Goodwill and Intangible Assets, Net", "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 13. Commitments and Contingencies" in the notes to our unaudited consolidated financial statements included elsewhere in this Form 10-Q. 29 --------------------------------------------------------------------------------
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.
30
--------------------------------------------------------------------------------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 comprehensive 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.
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
2022 2021 2022 2021
Net income to adjusted EBITDA:
Net income $ 52,153 $ 30,379 $ 201,438 $ 147,273
Interest expense 1,018 - 1,587 -
Provision for income taxes 23,135 13,170 74,151 38,687
Depreciation and amortization 23,560 17,321 67,783 48,254
EBITDA 99,866 60,870 344,959 234,214
Non-cash stock-based compensation
expense 24,492 28,991 70,815 76,364
Change in fair value of interest
rate swap 1,668 (158 ) - (863 )
Adjusted EBITDA $ 126,026 $ 89,703 $ 415,774 $ 309,715
Three Months Ended September 30, Nine Months Ended September 30,
2022 2021 2022 2021
Net income to non-GAAP net income:
Net income $ 52,153 $ 30,379 $ 201,438 $ 147,273
Non-cash stock-based compensation
expense 24,492 28,991 70,815 76,364
Change in fair value of interest
rate swap 1,668 (158 ) - (863 )
Income tax effect on non-GAAP
adjustments (4,882 ) (5,626 ) (15,180 ) (26,798 )
Non-GAAP net income $ 73,431 $ 53,586 $ 257,073 $ 195,976
Weighted average shares
outstanding:
Basic 57,865 57,935 57,949 57,843
Diluted 58,033 58,190 58,193 58,192
Earnings per share, basic $ 0.90 $ 0.52 $ 3.48 $ 2.55
Earnings per share, diluted $ 0.90 $ 0.52 $ 3.46 $ 2.53
Non-GAAP net income per share,
basic $ 1.27 $ 0.92 $ 4.44 $ 3.39
Non-GAAP net income per share,
diluted $ 1.27 $ 0.92 $ 4.42 $ 3.37
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Three Months Ended September 30, Nine Months Ended September 30,
2022 2021 2022 2021
Earnings per share to non-GAAP net
income per share, basic:
Earnings per share, basic $ 0.90 $ 0.52 $ 3.48 $ 2.55
Non-cash stock-based compensation
expense 0.42 0.50 1.22 1.32
Change in fair value of interest
rate swap 0.03 - - (0.01 )
Income tax effect on non-GAAP
adjustments (0.08 ) (0.10 ) (0.26 ) (0.47 )
Non-GAAP net income per share,
basic $ 1.27 $ 0.92 $ 4.44 $ 3.39
Three Months Ended September 30, Nine Months Ended September 30,
2022 2021 2022 2021
Earnings per share to non-GAAP net
income per share, diluted:
Earnings per share, diluted $ 0.90 $ 0.52 $ 3.46 $ 2.53
Non-cash stock-based compensation
expense 0.42 0.50 1.22 1.31
Change in fair value of interest
rate swap 0.03 - - (0.01 )
Income tax effect on non-GAAP
adjustments (0.08 ) (0.10 ) (0.26 ) (0.46 )
Non-GAAP net income per share,
diluted $ 1.27 $ 0.92 $ 4.42 $ 3.37
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