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MarketScreener Homepage  >  Equities  >  Nyse  >  Paycom Software, Inc.    PAYC

PAYCOM SOFTWARE, INC.

(PAYC)
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PAYCOM SOFTWARE : Management's Discussion and Analysis of Financial Condition and Results of Operations (form 10-Q)

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08/06/2020 | 04:15pm EDT
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 six months ended June 30, 2020,
(ii) the audited consolidated financial statements and notes thereto for the
year ended December 31, 2019 included in our Annual Report on Form 10-K (the
"Form 10-K") filed with the Securities and Exchange Commission (the "SEC") on
February 13, 2020 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 of December 31, 2019, all amounts
herein are unaudited. Unless we state otherwise or the context otherwise
requires, the terms "we," "us," "our" and the "Company" refer to Paycom
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 our new Texas
operations facility and research and development; our plans to repurchase shares
of our common stock through a stock repurchase plan; 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," "expect," "intend,"
"may," "might," "plan," "potential," "should," "will," "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:

   •  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;

• changes in laws, 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;


  • 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;


  • our failure to develop and maintain our brand cost-effectively;


  • seasonality of certain operating results and financial metrics;

• the possibility that the Affordable Care Act may be modified or repealed;



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  • 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 SEC.



Forward-looking statements are based only on information currently available to
us and speak only as of the date of this Form 10-Q. 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 comprehensive, cloud-based human capital management
("HCM") software delivered as Software-as-a-Service. We provide functionality
and data analytics that businesses need to manage the complete employment
lifecycle, from recruitment to retirement. Our solution requires virtually no
customization and is based on a core system of record maintained in a single
database for all HCM functions, including talent acquisition, time and labor
management, payroll, talent management and human resources management
applications. Our user-friendly software allows for easy adoption of our
solution by employees, enabling self-management of their HCM activities in the
cloud, which reduces the administrative burden on employers and increases
employee productivity.

We generate revenues from (i) fixed amounts charged per billing period plus a
fee per employee or transaction processed and (ii) fixed amounts charged per
billing period. We do not require clients to enter into long-term contractual
commitments with us. Our billing period varies by client based on when each
client pays its employees, which may be weekly, bi-weekly, semi-monthly or
monthly. 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 six months ended June 30, 2020. 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 to further
expand our presence in the U.S. market.

Our principal marketing efforts include email campaigns, social and digital media, search engine marketing methods, tradeshows and outbound marketing including television and print advertising. 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 since our
initial public offering in April 2014, we are presented with a variety of
opportunities and challenges. Our payroll application is the foundation of our
solution and all of our clients are required to utilize this application in
order to access our other applications. Consequently, we have historically
generated the majority of our revenues from our payroll applications, although
our revenue mix has evolved and will continue to evolve as we develop and add
new non-payroll applications to our solution. We believe our strategy of
focusing on increased employee usage is key to long-term client satisfaction and
client retention. Client adoption of new applications and client employee usage
of both new and existing applications have been significant factors in our
revenue growth, and we expect the continuation of this trajectory will depend,
in part, on the introduction of applications to our existing client base that
encourage and promote more employee usage. Moreover, in order to increase
revenues and continue to improve our operating results, we must also attract new
clients. We intend to obtain new clients by (i) continuing to leverage our
salesforce productivity within markets where we currently have existing sales
offices, (ii) expanding our presence in metropolitan areas where we currently
have an existing sales office through adding sales teams or offices, thereby
increasing the number of sales professionals within such markets, and (iii)
opening sales offices in new metropolitan areas.

Our target client size range is 50 to 5,000 employees. While we continue to
serve a diversified client base ranging in size from one employee to many
thousands of employees, the average size of our clients has grown significantly
as we have organically grown our operations, increased the number of
applications we offer and 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

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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 June 30, 2020 and 2019, our
total gross margins were approximately 84% and 85%, respectively. For the six
months ended June 30, 2020 and 2019, our total gross margins were approximately
86% and 85%, respectively. 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. Nonetheless, as
discussed in further detail below, operational challenges resulting from the
ongoing COVID-19 crisis may negatively impact our gross margins throughout 2020.

Impact of the COVID-19 Pandemic


On March 11, 2020, the World Health Organization declared the COVID-19 outbreak
to be a global pandemic. In response, federal, state and local governments
imposed various restrictions on social and commercial activity to promote social
distancing in an effort to slow the spread of the disease, and many such
restrictions remain in place. Beginning in February 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, and in March 2020, we prohibited all
business-related travel until further notice and began transitioning our
employees to work-from-home arrangements. Our sales employees have been
conducting all meetings with current and prospective clients virtually since
March 2020, and we expect this practice to continue for the foreseeable future.
As of June 30, 2020, 96% of our employees were working remotely. We will
continue to actively monitor the situation and 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.

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 late March 2020. Because we charge our clients on a per-employee
basis for certain services we provide, decreases in headcount at our clients
negatively impacted our recurring revenue 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
our existing 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. As the COVID-19 pandemic continues to create uncertainty
and the potential for ongoing business disruptions, we may experience similar
client-driven delays in service implementation in the future.

In addition, during 2019, interest earned on funds held for clients contributed
to growth in recurring revenue, due to both higher average interest rates and an
increased average funds held for clients balance. Since August 2019, the Federal
Open Market Committee has reduced the target range for short-term interest rates
several times, with the most significant rate cut occurring in

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March 2020 to support the economy and potentially reduce the impacts of the
COVID-19 pandemic. Further, a provision in the Coronavirus Aid, Relief, and
Economic Security Act (the "CARES Act") allows employers to delay the payment of
the employer's share of Social Security taxes to a future date. To the extent
our clients make such election, we are collecting less money from them to hold
and then remit to the appropriate taxing authorities, which adversely affects
our average funds held for clients balance and, consequently, interest earned on
funds held for clients. In the second quarter of 2020, despite the growth in the
number of clients in our base, employee headcount reductions at our clients as
well as clients electing to defer payment of their share of Social Security
taxes under the CARES Act resulted in no growth in our average funds held for
clients balance, relative to the second quarter of 2019. Due to significantly
lower average interest rates in 2020 and, to a lesser extent, the lack of growth
of our average funds held for clients balance, interest earned on funds held for
clients for the three and six months ended June 30, 2020 decreased from the
comparable prior year periods, which had a negative effect on recurring revenue
growth.

Demand for our solutions remains high and, in the second quarter of 2020, we
continued to aggressively invest in sales and marketing and in research and
development to drive future growth and expand our market share. Lower headcount
at our clients and the other pandemic-related factors described above, which had
and may continue to have a negative impact on recurring revenue, combined with
increased sales and marketing and research and development expenses, resulted in
decreases in net income for the three and six months ended June 30, 2020 as
compared to the respective prior year periods. Through the remainder of 2020, we
expect net income to be negatively affected by the impact of the pandemic on our
recurring revenue and our deliberate, increased level of investment to drive the
growth of our business.

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. 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, have been instrumental in our ability to
seamlessly manage and communicate with our remote workforce. As many clients
have also transitioned their workforces to work-from-home arrangements, we
believe they too are recognizing 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 is
exposing the weaknesses and disadvantages arising from the combination of
disparate systems offered by some of our competitors.

Prior to the COVID-19 pandemic, our salesforce historically traveled frequently
to sell our solution. The current remote work environment presents a unique
opportunity for our salesforce, 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. Although we have not experienced
such challenges to date, if clients and client prospects are not as willing or
available to engage via video conference and teleconference, the shift from
in-person to virtual sales meetings could negatively affect our sales efforts,
impede client acquisition and lengthen our sales cycles, which would negatively
impact our business and results of operations and could impact our financial
condition in the future.

Although we currently have some insight with respect to the shorter-term effects
of the COVID-19 pandemic on our business and results of operations, 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, actions
that may be taken by governmental authorities, the impact to the business of our
clients and other factors identified in Part II, Item 1A "Risk Factors" in this
Form 10-Q. 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.

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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 June 30,                                         Six Months Ended June 30,
                               2020                      2019               % Change              2020                      2019               % Change
Revenues
Recurring              $ 177,950        98.0 %   $ 165,998        98.0 %   

7% $ 416,445 98.2 % $ 362,862 98.3 % 15% Implementation and other

                      3,637         2.0 %       3,315         2.0 %      10%             7,510         1.8 %       6,394         1.7 %      17%
Total revenues           181,587       100.0 %     169,313       100.0 %       7%           423,955       100.0 %     369,256       100.0 %      15%
Cost of revenues
Operating expenses        23,257        12.8 %      20,289        12.0 %      15%            47,373        11.2 %      45,065        12.2 %       5%
Depreciation and
amortization               6,301         3.5 %       4,950         2.9 %      27%            12,231         2.9 %       9,492         2.6 %      29%
Total cost of
revenues                  29,558        16.3 %      25,239        14.9 %      17%            59,604        14.1 %      54,557        14.8 %       9%
Administrative
expenses

Sales and marketing 56,064 30.9 % 41,575 24.6 %

  35%           111,082        26.2 %      81,220        22.0 %      37%
Research and
development               21,778        12.0 %      16,775         9.9 %      30%            43,399        10.2 %      35,264         9.6 %      23%
General and
administrative            40,837        22.5 %      27,460        16.2 %      49%            80,971        19.1 %      72,658        19.7 %      11%
Depreciation and
amortization               6,774         3.7 %       5,378         3.2 %      26%            13,059         3.1 %      10,183         2.7 %      28%
Total administrative
expenses                 125,453        69.1 %      91,188        53.9 %      38%           248,511        58.6 %     199,325        54.0 %      25%
Total operating
expenses                 155,011        85.4 %     116,427        68.8 %      33%           308,115        72.7 %     253,882        68.8 %      21%

Operating income 26,576 14.6 % 52,886 31.2 %

  -50%          115,840        27.3 %     115,374        31.2 %       0%
Interest expense              (3 )       0.0 %        (258 )      -0.1 %      -99%              (19 )       0.0 %        (534 )      -0.1 %      -96%
Other income
(expense), net               162         0.1 %        (263 )      -0.2 %     -162%             (768 )      -0.2 %        (363 )      -0.1 %      112%
Income before income
taxes                     26,735        14.7 %      52,365        30.9 %      -49%          115,053        27.1 %     114,477        31.0 %       1%
Provision for income
taxes                     (1,854 )      -1.0 %       3,603         2.1 %     -151%           23,449         5.5 %      18,433         5.0 %      27%
Net income             $  28,589        15.7 %   $  48,762        28.8 %      -41%        $  91,604        21.6 %   $  96,044        26.0 %      -5%





Revenues

The increase in total revenues for the three and six months ended June 30, 2020
compared to the same periods in 2019 was primarily the result of (i) the
addition of new clients and productivity and efficiency gains in mature sales
offices, which are offices that have been open for at least 24 months, (ii)
contributions from new sales offices opened in 2018 and 2019 that are
progressing to maturity and (iii) the sale of additional applications to our
existing clients.  In addition, the strong performance of our tax forms filing
business in the first quarter contributed to the increase in total revenues for
the six months ended June 30, 2020 as compared to the same period in 2019.  The
COVID-19 pandemic has resulted in, and may continue to result in, headcount
reductions 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 six months ended June 30, 2020 described above were partially
offset by the negative impact of headcount reductions within our existing client
base.  Additionally, lower employee headcount at our clients as well as clients
electing the Social Security tax deferral under the CARES Act negatively
impacted our average funds held for clients balance for the three and six months
ended June 30, 2020. Significantly lower average interest rates in the first six
months of 2020 as compared to the same period in 2019, as well as no growth in
the average funds held for clients balance, resulted in a decrease in interest
earned on funds held for clients and, consequently, had a negative effect on
recurring revenue growth for the three and six months ended June 30, 2020. We
expect that the foregoing adverse macroeconomic factors will 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 six months
ended June 30, 2020 from the same periods in 2019 was primarily the result of
the increased recognition of non-refundable upfront conversion fees that are
charged to new clients to offset the expense of new client set up.  These fees
are deferred and recognized ratably over the ten-year estimated life of our
clients.

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Expenses

Cost of Revenues

During the three months ended June 30, 2020, cost of revenues increased from the
comparable prior year period by $4.3 million. Depreciation and amortization
expense increased $1.4 million from the comparable prior year period, primarily
due to the development of additional technology and purchases of other fixed
assets. Additionally, for the three months ended June 30, 2020, as compared to
the same period in 2019, employee-related expenses increased $1.8 million due to
growth in the number of operating personnel, non-cash stock-based compensation
increased $1.4 million, and automated clearing house fees increased $0.1 million
in connection with the increase in revenues. These increases in cost of revenues
were partially offset by a $0.4 million decrease in shipping and supplies fees
during the three months ended June 30, 2020, as compared to the prior year
period, primarily due to the remote work environment.

During the six months ended June 30, 2020, cost of revenues increased from the
comparable prior year period by $5.0 million. Depreciation and amortization
expense increased $2.7 million from the comparable prior year period, primarily
due to the development of additional technology and purchases of other fixed
assets. Additionally, for the six months ended June 30, 2020, as compared to the
same period in 2019, employee-related expenses increased $2.6 million due to
growth in the number of operating personnel, and automated clearing house fees
increased $0.4 million in connection with the increase in revenues. These
increases in cost of revenues were partially offset by a $0.3 million decrease
in non-cash stock-based compensation and a $0.6 million decrease in shipping and
supplies fees during the six months ended June 30, 2020, as compared to the
prior year period.



Administrative Expenses

Sales and Marketing

During the three months ended June 30, 2020, sales and marketing expenses
increased from the comparable prior year period by $14.5 million due to a $14.0
million increase in marketing and advertising expense due to increased spending
across most components of our marketing program and a $1.3 million increase in
non-cash stock-based compensation. These increases in sales and marketing
expenses were partially offset by a $0.7 million decrease in employee-related
expenses primarily related to our current work-from-home mandate.

During the six months ended June 30, 2020, sales and marketing expenses
increased from the comparable prior year period by $29.9 million due to a $21.1
million increase in marketing and advertising expense due to increased spending
across most components of our marketing program, a $6.9 million increase in
employee-related expenses, including commissions and bonuses, and a $1.9 million
increase in non-cash stock-based compensation. Based on positive results from
recent advertising campaigns, we plan to continue to make significant
investments in our marketing program and may increase spending in future periods
as we see opportunities for returns on our investments.

Research and Development


During the three months ended June 30, 2020, research and development expenses
increased from the comparable prior year period due to a $5.0 million increase
in employee-related expenses, including a $2.5 million increase in non-cash
stock-based compensation expense. During the six months ended June 30, 2020,
research and development expenses increased from the comparable prior year
period due to an $8.1 million increase in employee-related expenses, including a
$1.6 million increase in non-cash stock-based compensation expense.

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.

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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 six months ended June 30, 2020 and 2019:



                            Three Months Ended June 30,                           Six Months Ended June 30,
                             2020                  2019           % Change            2020            2019        % Change

Capitalized portion
of research and
development             $        10,975$        6,697        64%               $  20,721$ 15,637         33%
Expensed portion of
research and
development                      21,778               16,775        30%                  43,399       35,264         23%
Total research and
development costs       $        32,753$       23,472        40%               $  64,120$ 50,901         26%


General and Administrative


During the three months ended June 30, 2020, general and administrative expenses
increased $13.4 million from the comparable prior year period primarily due to a
$10.4 million increase in non-cash stock-based compensation and a $5.4 million
increase in employee related expenses. These increases in general and
administrative expenses were partially offset by a $2.4 million decrease in
accounting and legal expenses.

During the six months ended June 30, 2020, general and administrative expenses
increased $8.3 million from the comparable prior year period primarily due to an
$8.9 million increase in employee-related expenses and a $2.2 million increase
in accounting and legal expenses related to regulatory and compliance
matters. These increases in general and administrative expenses were partially
offset by a $2.8 million decrease in non-cash stock-based compensation.

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 June 30,                     

Six Months Ended June 30,

                              2020                 2019          % Change             2020                2019            % Change
Non-cash stock-based
compensation expense
Operating expenses       $         1,733       $        309        461%           $       2,931$       3,205          -9%
Sales and marketing                3,801              2,526        50%                    6,966               5,109          36%
Research and
development                        2,984                505        491%                   5,155               3,551          45%
General and
administrative                    12,700              2,257        463%                  21,977              24,803         -11%
Total non-cash
stock-based
compensation expense     $        21,218$      5,597        279%           $      37,029$      36,668          1%



During the three months ended June 30, 2020, our non-cash stock-based compensation expense increased $15.6 million from the comparable prior year period primarily due to the timing of vesting events for restricted stock subject to market-based vesting conditions during the first quarter of 2019. During the six months ended June 30, 2020, our non-cash stock-based compensation expense increased $0.4 million from the comparable prior year period.

Depreciation and Amortization


During the three and six months ended June 30, 2020, depreciation and
amortization expense increased from the respective 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 six months ended June 30,
2020, as compared to the comparable prior year periods were due to the timing of
construction of our expanded operations facility in Grapevine, Texas, which
resulted in more capitalized interest in 2020.

                                       24

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Other Income (Expense), net

The increase in other income (expense), net for the three months ended June 30,
2020 and the decrease in other income (expense), net for the six months ended
June 30, 2020, was primarily due to the change in the fair value of our interest
rate swap as compared to the three and six months ended June 30, 2019,
respectively.

Provision for Income Taxes


The provision for income taxes is based on a current estimate of the annual
effective income tax rate adjusted to reflect the impact of discrete items. Our
effective income tax rate was 20.4% and 16.1% for the six months ended June 30,
2020 and 2019, respectively. The higher effective income tax rate for the six
months ended June 30, 2020 primarily resulted from a decrease in excess tax
benefits from stock-based compensation related to vesting events as compared to
the six months ended June 30, 2019.

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. Given the rapidly changing market and economic
conditions related to the COVID-19 outbreak, we will continue to evaluate the
nature and extent of the impact to our business, financial position and
liquidity.

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 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 of June 30, 2020, 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.
and Kirkpatrick 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 on September 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%.

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 of June 30, 2020, 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 of September 7, 2025, provides that we will receive quarterly
variable interest payments based on the LIBOR rate and will pay interest at a
fixed rate. We have elected not to designate this interest rate swap as a hedge
and, as such, changes in the fair value of the derivative instrument are
recognized in our consolidated statements of income. For the three and six
months ended June 30, 2020, we recognized a loss of $0.1 million and $1.7
million, respectively, for the change in fair value of the interest rate swap,
which is included in Other income (expense), net in the consolidated statements
of income. For the three and six months ended June 30, 2019, we recognized a
loss of $0.8 million and $1.4 million, respectively, for the change in fair
value of the interest rate swap, which is included in Other income, net in the
consolidated statements of income.

Revolving Credit Agreement. On February 12, 2018, we entered into a senior
secured revolving credit agreement (the "Revolving Credit Agreement") with
JPMorgan Chase Bank, N.A. and Bank 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 on February 12, 2020. On April 15, 2019, we entered into
the First Amendment to Revolving Credit Agreement (the "First
Amendment"). Pursuant to First Amendment, Wells Fargo Bank, N.A. was added as a
lender and the Revolving Commitment was

                                       25

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increased to $75.0 million, which may be further increased to $125.0 million
subject to obtaining additional lender commitments and certain approvals and
satisfying other conditions, and the scheduled maturity date of the Facility was
extended to April 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 of June 30, 2020, we did not have
any borrowings outstanding under the Facility.

Stock Repurchase Plan and Withholding Shares to Cover Taxes. In May 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, in March 2020, our Board of Directors
authorized the repurchase of up to $250.0 million of our common stock. As of
June 30, 2020, there was $174.8 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 on March 12, 2022.

During the six months ended June 30, 2020, we repurchased an aggregate of
295,227 shares of our common stock at an average cost of $227.35 per share,
including 90,157 shares withheld to satisfy tax withholding obligations for
certain employees upon the vesting of restricted common stock. Our payment of
the taxes on behalf of those employees resulted in an aggregate cash expenditure
of $23.1 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 the ongoing
construction of our new Texas operations facility in Grapevine, Texas. Capital
expenditures related to the construction of the facility began in the second
quarter of 2019. 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 well as the duration and extent of
remote work arrangements due to the COVID-19 pandemic.

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 six months ended June 30, 2020 and 2019:


                                            Six Months Ended June 30,
                                             2020                2019             Change %
Net cash provided by (used in):
Operating activities                    $      107,512$     122,768          -12%
Investing activities                          (189,993 )           (46,930 )        305%
Financing activities                          (705,420 )           119,688          -689%
Change in cash, cash equivalents,
restricted cash and restricted cash
equivalents                             $     (787,901 )$     195,526          -503%


                                       26
--------------------------------------------------------------------------------





Operating Activities

Cash provided by operating activities for the six months ended June 30, 2020
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 six months
ended June 30, 2019, our operating cash flows for the six months ended June 30,
2020 decreased primarily due to our increased spending across most components of
our marketing program and the impact of COVID-19 conditions on our revenues.

Investing Activities


Cash flows used in investing activities for the six months ended June 30, 2020
increased from the comparable prior year period due to a $161.5 million increase
in purchases of short-term investments from funds held for clients and a $17.8
million increase in cash used for purchases of property and equipment. The
increase in cash used in investing activities was partially offset by a $36.1
million increase in proceeds from maturities of short-term investments from
funds held for clients.

Financing Activities


Cash flows used in financing activities for the six months ended June 30, 2020
increased from the comparable prior year period primarily due to the impact of a
$788.3 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. Additionally, cash
flows used in financing activities increased by $52.0 million in repurchases of
common stock. These cash flows used in financing activities were partially
offset by a $15.1 million decrease in withholding taxes paid related to net
share settlements and a less than $0.1 million decrease in payments for debt
issuance costs.

Contractual Obligations

Our principal commitments primarily consist of long-term debt and leases for
office space. 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. For
additional information regarding our leases, long-term debt and our commitments
and contingencies, see "Note 5. Leases", "Note 6. Long-Term Debt" and "Note 12.
Commitments and Contingencies" in the Form 10-K and "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 of June 30, 2020, we did not have any off-balance sheet arrangements that had
or were reasonably likely to have an effect on our financial condition, 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 in the 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 adoption of ASU 2018-13 and ASU 2018-15 can be found in Note 2 in this Form 10-Q.


                                       27

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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 under U.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
with U.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 under U.S. GAAP, and should not be considered a substitute for net
income, which we consider to be the most directly comparable U.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 with U.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 June 30,        

Six Months Ended June 30,

                                          2020                 2019              2020               2019
Net income to adjusted EBITDA:
Net income                           $       28,589$       48,762$      91,604$    96,044
Interest expense                                  3                  258                19               534
Provision for income taxes                   (1,854 )              3,603            23,449            18,433
Depreciation and amortization                13,075               10,328            25,290            19,675
EBITDA                                       39,813               62,951           140,362           134,686
Non-cash stock-based compensation
expense                                      21,218                5,597            37,029            36,668
Change in fair value of interest
rate swap                                       131                  833             1,706             1,372
Adjusted EBITDA                      $       61,162$       69,381$     179,097$   172,726




                                         Three Months Ended June 30,            Six Months Ended June 30,
                                          2020                 2019              2020               2019
Net income to non-GAAP net income:
Net income                           $       28,589$       48,762$      91,604$    96,044
Non-cash stock-based compensation
expense                                      21,218                5,597            37,029            36,668
Change in fair value of interest
rate swap                                       131                  833             1,706             1,372
Income tax effect on non-GAAP
adjustments                                 (13,997 )            (11,457 )         (16,470 )         (21,099 )
Non-GAAP net income                  $       35,941$       43,735$     113,869$   112,985
Earnings per share, basic            $         0.50       $         0.85     $        1.59$      1.67
Earnings per share, diluted          $         0.49       $         0.83     $        1.57$      1.64
Non-GAAP net income per share,
basic                                $         0.62       $         0.76     $        1.98$      1.97
Non-GAAP net income per share,
diluted                              $         0.62       $         0.75     $        1.95$      1.93
Weighted average shares
outstanding:
Basic                                        57,568               57,569            57,611            57,464
Diluted                                      58,237               58,410            58,363            58,396


                                       28
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                                        Three Months Ended June 30,           Six Months Ended June 30,
                                         2020                2019              2020               2019
Earnings per share to non-GAAP net
income per share, basic:
Earnings per share, basic            $        0.50$        0.85$       1.59$       1.67
Non-cash stock-based compensation
expense                                       0.37                0.10             0.64               0.64
Change in fair value of interest
rate swap                                        -                0.01             0.03               0.02
Income tax effect on non-GAAP
adjustments                                  (0.25 )             (0.20 )          (0.28 )            (0.36 )
Non-GAAP net income per share,
basic                                $        0.62$        0.76$       1.98$       1.97





                                        Three Months Ended June 30,           Six Months Ended June 30,
                                         2020                2019              2020               2019
Earnings per share to non-GAAP net
income per share, diluted:
Earnings per share, diluted          $        0.49$        0.83$       1.57$       1.64
Non-cash stock-based compensation
expense                                       0.36                0.10             0.63               0.63
Change in fair value of interest
rate swap                                        -                0.01             0.03               0.02
Income tax effect on non-GAAP
adjustments                                  (0.23 )             (0.19 )          (0.28 )            (0.36 )
Non-GAAP net income per share,
diluted                              $        0.62$        0.75$       1.95$       1.93



                                       29

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