PAYCOM SOFTWARE, INC. This Management's Discussion and Analysis of Financial Condition and Results of
Operations is intended to provide a reader of our financial statements with a
narrative from the perspective of our management on our financial condition,
results of operations, liquidity, and certain other factors that may affect our
future results. The following discussion and analysis should be read in
conjunction with (i) the accompanying unaudited consolidated financial
statements and notes thereto for the three months ended
Forward-Looking Statements
The following discussion contains forward-looking statements within the meaning
of the Private Securities Litigation Reform Act of 1995. Forward-looking
statements are any statements that look to future events and include, but are
not limited to, statements regarding our business strategy; anticipated future
operating results and operating expenses, cash flows, capital resources,
dividends and liquidity; trends, opportunities and risks affecting our business,
industry and financial results; future expansion or growth plans and potential
for future growth; our ability to attract new clients to purchase our solution;
our ability to retain clients and induce them to purchase additional
applications; our ability to accurately forecast future revenues and
appropriately plan our expenses; market acceptance of our solution and
applications; our expectations regarding future revenues generated by certain
applications; our ability to attract and retain qualified employees and key
personnel; future regulatory, judicial and legislative changes; how certain
factors affecting our performance correlate to improvement or deterioration in
the labor market; our plan to open additional sales offices and our ability to
effectively execute such plan; the sufficiency of our existing cash and cash
equivalents to meet our working capital and capital expenditure needs over the
next 12 months; our ability to relocate our
Forward-looking statements are neither historical facts nor assurances of future performance, and are based only on our current beliefs, expectations and assumptions regarding the future of our business, future plans and strategies, projections, anticipated events and trends, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and many of which are outside of our control. Therefore, you should not rely on any of these forward-looking statements. Important factors that could cause our actual results and financial condition to differ materially from those indicated in the forward-looking statements include, among others, the following:
• changes in laws, government regulations and policies and interpretations
thereof;
• the possibility of security vulnerabilities, cyberattacks and network
disruptions, including breaches of data security and privacy leaks, data
loss, and business interruptions;
• the impact of the COVID-19 pandemic on the U.S. economy, including
reductions in employment levels, business disruptions resulting from
government-mandated mitigation measures and an increase in business
failures;
• our compliance with data privacy laws and regulations;
• our ability to develop enhancements and new applications, keep pace with
technological developments and respond to future disruptive technologies;
• our ability to compete effectively;
• fluctuations in our financial results due to factors beyond our control;
• our ability to manage our rapid growth and organizational change effectively;
• the possibility that clients may not be satisfied with our deployment or
technical support services, or that our solution fails to perform properly;
• our dependence on our key executives;
• our ability to attract and retain qualified personnel, including software
developers and skilled IT, sales, marketing and operational personnel;
• the possibility that the Affordable Care Act may be modified, repealed or
declared unconstitutional;
• our failure to develop and maintain our brand cost-effectively;
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• seasonality of certain operating results and financial metrics;
• our failure to adequately protect our intellectual property rights;
• our reliance on relationships with third parties; and
• the other factors set forth in Part I, Item 1A, "Risk Factors" of the Form
10-K, Part II, Item 1A, "Risk Factors" of this Form 10-Q and our other
reports filed with the 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 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 three months ended
Our continued growth depends on attracting new clients through further penetration of our existing markets and geographic expansion into new markets, targeting a high degree of client employee usage across our solution, and introducing new applications to our existing client base. We believe our ability to continue to develop new applications and to improve existing applications will enable us to increase revenues in the future, and the number of our new applications adopted by our clients has been a significant factor in our revenue growth. We also plan to open additional sales offices in the future and leverage virtual sales meetings to further expand our presence in the U.S. market.
Our principal marketing efforts include national and local advertising campaigns, email campaigns, social and digital media campaigns, search engine marketing methods, tradeshows, print advertising and outbound marketing including personalized direct mail campaigns. In addition, we generate leads and build recognition of our brand and thought leadership with relevant and informative content, such as white papers, blogs, podcast episodes and webinars.
Throughout our history, we have built strong relationships with our clients. As the HCM needs of our clients evolve, we believe that we are well-positioned to expand the HCM spending of our clients and we believe this opportunity is significant. To be successful, we must continue to demonstrate the operational and economic benefits of our solution, as well as effectively hire, train, motivate and retain qualified personnel.
Growth Outlook, Opportunities and Challenges
As a result of our significant revenue growth and geographic expansion, we are presented with a variety of opportunities and challenges. Our payroll application is the foundation of our solution and all of our clients are required to utilize this application in order to access our other applications. Consequently, we have historically generated the majority of our revenues from our payroll applications, although our revenue mix has evolved and will continue to evolve as we develop and add new non-payroll applications to our solution. We believe our strategy of focusing on increased employee usage is key to long-term client satisfaction and client retention. Client adoption of new applications and client employee usage of both new and existing applications have been significant factors in our revenue growth, and we expect the continuation of this trajectory will depend, in part, on the introduction of applications to our existing client base that encourage and promote more employee usage. Moreover, in order to increase revenues and continue to improve our operating results, we must also attract new clients. We intend to obtain new clients by (i) continuing to leverage our sales force productivity within markets where we currently have existing sales offices, (ii) expanding our presence in metropolitan areas where we currently have an existing sales office through adding sales teams or offices, thereby increasing the number of sales professionals within such markets, and (iii) opening sales offices in new metropolitan areas.
Our target client size range is 50 to 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
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represent a substantial opportunity to increase the number of potential clients and to increase our revenues per client, with limited incremental cost to us. Because we charge our clients on a per employee basis for certain services we provide, any increase or decrease in the number of employees of our clients will have a positive or negative impact, respectively, on our results of operations. As discussed in more detail below, client headcount fluctuations are particularly relevant in light of the ongoing COVID-19 pandemic. Generally, we expect that changes in certain factors affecting our performance will correlate with improvement or deterioration in the labor market.
We collect funds from clients in advance of either the applicable due date for payroll tax submissions or the applicable disbursement date for employee payment services. Those collections from clients are typically disbursed from one to 30 days after receipt, with some funds being held for up to 120 days. We typically invest funds held for clients in money market funds, demand deposit accounts, commercial paper and certificates of deposit until they are paid to the applicable tax or regulatory agencies or to client employees. As we introduce new applications, expand our client base and renew and expand relationships with existing clients, we expect our average funds held for clients balance and, accordingly, interest earned on funds held for clients, will increase; however, the amount of interest we earn can be positively or negatively impacted by changes in interest rates. Even if our average funds held for clients balance increases, the impact of significantly lower average interest rates could partially offset the impact of such increased balance and, as a result, have a negative impact on recurring revenue growth.
Growing our business has resulted in, and will continue to result in, substantial investments in sales professionals, operating expenses, system development and programming costs and general and administrative expenses, which have increased and will continue to increase our expenses. Specifically, our revenue growth and geographic expansion drive increases in our employee headcount, which in turn precipitates increases in (i) salaries and benefits, (ii) stock-based compensation expense and (iii) facility costs related to the expansion of our corporate headquarters and operations facilities and additional sales office leases.
We believe the challenges of managing the ever-changing complexity of payroll and human resources will continue to drive companies to turn to outsourced providers for help with their HCM needs. The HCM industry historically has been driven, in part, by legislation and regulatory action, including COBRA, changes to the minimum wage laws or overtime rules, and legislation from federal, state or municipal taxation authorities.
Our revenues are seasonal in nature. Recurring revenues include revenues
relating to the annual processing of payroll forms, such as Form W-2, Form 1099,
and Form 1095, and revenues from processing unscheduled payroll runs (such as
bonuses) for our clients. Because payroll forms are typically processed in the
first quarter of the year, first quarter revenues and margins are generally
higher than in subsequent quarters. These seasonal fluctuations in revenues can
also have an impact on gross profits. Historical results impacted by these
seasonal trends should not be considered a reliable indicator of our future
results of operations. For the three months ended
Impact of the COVID-19 Pandemic
Beginning in
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
Between
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Demand for our solution remains high and despite the economic challenges brought on by the COVID-19 pandemic, we remain confident in the overall health of our business, the strength of our product offerings, and our ability to continue to execute on our strategy. Prior to the COVID-19 pandemic, our sales force historically traveled frequently to sell our solution. The current remote work environment presents a unique opportunity for our sales force, in that each sales employee is able to meet virtually with a greater number of client prospects in a given day than he or she would if conducting in-person meetings. Internally, all applications within the Paycom solution, and more specifically Employee Self-Service®, Manager on-the-Go™, Documents and Checklists, Ask Here and our enhanced Learning Management System, 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. We will continue to aggressively invest in sales and marketing and in research and development to drive future growth and expand our market share.
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 I, Item 1A
"Risk Factors" in our Form 10-K that was filed with the
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 March 31,
2021 2020 % Change
Revenues
Recurring $ 267,774 98.4 % $ 238,495 98.4 % 12%
Implementation and other 4,424 1.6 % 3,873 1.6 % 14%
Total revenues 272,198 100.0 % 242,368 100.0 % 12%
Cost of revenues
Operating expenses 29,073 10.7 % 24,116 10.0 % 21%
Depreciation and amortization 7,200 2.6 % 5,930 2.4 % 21%
Total cost of revenues 36,273 13.3 % 30,046 12.4 % 21%
Administrative expenses
Sales and marketing 62,761 23.1 % 55,018 22.7 % 14%
Research and development 24,711 9.1 % 21,621 8.9 % 14%
General and administrative 46,191 17.0 % 40,134 16.6 % 15%
Depreciation and amortization 7,716 2.8 % 6,285 2.6 % 23%
Total administrative expenses 141,379 52.0 % 123,058 50.8 % 15%
Total operating expenses 177,652 65.3 % 153,104 63.2 % 16%
Operating income 94,546 34.7 % 89,264 36.8 % 6%
Interest expense - 0.0 % (16 ) 0.0 % 100%
Other income (expense), net 629 0.2 % (930 ) -0.4 % 168%
Income before income taxes 95,175 34.9 % 88,318 36.4 % 8%
Provision for income taxes 30,559 11.2 % 25,303 10.4 % 21%
Net income $ 64,616 23.7 % $ 63,015 26.0 % 3%
Revenues
The increase in total revenues for the three months ended
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ended
The increase in implementation and other revenues for the three months ended
Expenses
Cost of Revenues
During the three months ended
Administrative Expenses Sales and Marketing
During the three months ended
Research and Development
During the three 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 months ended
Three Months Ended March 31,
2021 2020 % Change
Capitalized portion of research and
development $ 12,295 $ 9,746 26%
Expensed portion of research and
development 24,711 21,621 14%
Total research and development costs
General and Administrative
During the three months ended
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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 March 31,
2021 2020 % Change
Non-cash stock-based compensation
expense
Operating expenses $ 995 $ 1,198 -17%
Sales and marketing 3,511 3,165 11%
Research and development 1,567 2,171 -28%
General and administrative 17,508 9,277 89%
Total non-cash stock-based
compensation expense $ 23,581 $ 15,811 49%
During the three months ended
Depreciation and Amortization
During the three months ended
Interest Expense
The decrease in interest expense for the three months ended
Other Income (Expense), net
The change in other income (expense), net for the three months ended
Provision for Income Taxes
The provision for income taxes is based on a current estimate of the annual
effective income tax rate adjusted to reflect the impact of discrete items. Our
effective income tax rate was 32.1% and 28.7% for the three months ended
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
We have historically funded our operations from cash flows generated from operations, cash from the sale of equity securities and debt financing. Although we have funded most of the costs for ongoing construction projects at our corporate headquarters and other facilities from available cash, we have incurred indebtedness for a portion of these costs. Further, all purchases under our stock repurchase plans were paid for from available cash.
Term Credit Agreement. As of
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
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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
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
Revolving Credit Agreement. On
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
Stock Repurchase Plan and Withholding Shares to Cover Taxes. In
During the three months ended
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
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,
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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
three months ended
Three Months Ended March 31,
2021 2020 % Change
Net cash provided by (used in):
Operating activities $ 89,457 $ 82,030 9%
Investing activities 7,455 (183,629 ) 104%
Financing activities 685,369 (279,011 ) 346%
Change in cash, cash equivalents, restricted
cash and restricted cash equivalents $ 782,281 $ (380,610 ) 306%
Operating Activities
Cash provided by operating activities for the three months ended
Investing Activities
Cash flows provided by investing activities for the three months ended
Financing Activities
Cash flows provided by financing activities for the three months ended
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 that
was filed with the
Off-Balance Sheet Arrangements
As of
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Critical Accounting Policies and Estimates
Our consolidated financial statements and accompanying notes have been prepared
in accordance with generally accepted accounting principles in
Certain accounting policies that require significant management estimates, and are deemed critical to our results of operations or financial position, are discussed in the critical accounting policies and estimates section of Management's Discussion and Analysis of Financial Condition and Results of Operations in the Form 10-K. There have been no material changes to the critical accounting policies disclosed in the Form 10-K.
Adoption of Accounting Pronouncements
Discussion of our recently adopted accounting pronouncements can be found in Note 2 in this Form 10-Q.
Non-GAAP Financial Measures
Management uses adjusted EBITDA and non-GAAP net income as supplemental measures
to review and assess the performance of our core business operations and for
planning purposes. We define (i) adjusted EBITDA as net income plus interest
expense, taxes, depreciation and amortization, non-cash stock-based compensation
expense, certain transaction expenses that are not core to our operations (if
any) and the change in fair value of our interest rate swap and (ii) non-GAAP
net income as net income plus non-cash stock-based compensation expense, certain
transaction expenses that are not core to our operations (if any) and the change
in fair value of our interest rate swap, all of which are adjusted for the
effect of income taxes. Adjusted EBITDA and non-GAAP net income are metrics that
provide investors with greater transparency to the information used by
management in its financial and operational decision-making. We believe these
metrics are useful to investors because they facilitate comparisons of our core
business operations across periods on a consistent basis, as well as comparisons
with the results of peer companies, many of which use similar non-GAAP financial
measures to supplement results under
Adjusted EBITDA and non-GAAP net income are not measures of financial
performance under
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 March 31,
2021 2020
Net income to adjusted EBITDA:
Net income $ 64,616 $ 63,015
Interest expense - 16
Provision for income taxes 30,559 25,303
Depreciation and amortization 14,916 12,215
EBITDA 110,091 100,549
Non-cash stock-based compensation expense 23,581 15,811
Change in fair value of interest rate swap (656 ) 1,575
Adjusted EBITDA $ 133,016 $ 117,935
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Three Months Ended March 31,
2021 2020
Net income to non-GAAP net income:
Net income $ 64,616 $ 63,015
Non-cash stock-based compensation expense 23,581 15,811
Change in fair value of interest rate swap (656 ) 1,575
Income tax effect on non-GAAP adjustments (1,633 ) (2,473 )
Non-GAAP net income $ 85,908 $ 77,928
Weighted average shares outstanding:
Basic 57,740 57,655
Diluted 58,394 58,440
Earnings per share, basic $ 1.12 $ 1.09
Earnings per share, diluted $ 1.11 $ 1.08Non-GAAP net income per share, basic $ 1.49 $ 1.35 Non-GAAP net income per share, diluted $ 1.47 $ 1.33
Three Months Ended March 31,
2021 2020
Earnings per share to non-GAAP net income per
share, basic:
Earnings per share, basic $ 1.12 $ 1.09
Non-cash stock-based compensation expense 0.41 0.27
Change in fair value of interest rate swap (0.01 ) 0.03
Income tax effect on non-GAAP adjustments (0.03 ) (0.04 )
Non-GAAP net income per share, basic $ 1.49 $ 1.35
Three Months Ended March 31,
2021 2020
Earnings per share to non-GAAP net income per
share, diluted:
Earnings per share, diluted $ 1.11 $ 1.08
Non-cash stock-based compensation expense 0.40 0.27
Change in fair value of interest rate swap (0.01 ) 0.03
Income tax effect on non-GAAP adjustments (0.03 ) (0.05 )
Non-GAAP net income per share, diluted $ 1.47 $ 1.33
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