PAYCOR HCM, INC. The following discussion and analysis summarizes the significant factors affecting our unaudited condensed consolidated operating results, financial condition, liquidity, and cash flows as of and for the periods presented below. The following discussion and analysis should be read in conjunction with our unaudited condensed consolidated financial statements and the related notes thereto included elsewhere in this report as well as management's discussion and analysis and audited consolidated financial statements included in our most recent Annual Report on Form 10-K. This discussion and analysis reflects our historical results of operations and financial position. The discussion contains forward-looking statements that are based on the beliefs of management, as well as assumptions made by, and information currently available to, our management. Actual results could differ materially from those discussed in or implied by forward-looking statements because of various factors, including those discussed elsewhere in this report, particularly "Note Regarding Forward-Looking Statements" and other important factors disclosed previously under Item 1A. "Risk Factors" in our most recent Annual Report on Form 10-K and in our other filings with theSecurities and Exchange Commission ("SEC"). Unless we state otherwise or the context otherwise requires, the terms "we," "us," and "our" and similar references refer to the Company and its consolidated subsidiaries. Overview We are a leading provider of human capital management ("HCM") software. Our solutions target small and medium-sized businesses with 10-1,000 employees. Our unified, cloud-native platform is built to empower leaders by producing actionable, real-time insights to drive workforce optimization. Our comprehensive suite of solutions enables organizations to streamline administrative workflows and achieve regulatory compliance while serving as the single, secure system of record for all employee data. Our highly flexible, scalable, and extensible platform is augmented by industry-specific domain expertise and offers award-winning ease-of-use with an intuitive user experience and deep third-party integrations. As ofSeptember 30, 2022 , approximately 29,900 customers across all 50 states trust us to empower their leaders to build winning teams. Our Business Model Our revenue is almost entirely recurring in nature and largely attributable to the sale of Software-as-a-Service ("SaaS") subscriptions to our cloud-native HCM software platform. We typically generate revenue from customers on a per-employee-per-month ("PEPM") basis whereby our revenue is derived from the number of employees of a given customer, and the amount, type, and timing of products provided to a customer with respect to their employees. As a result, we increase our recurring revenue as we add more customers, and as our customers add more employees and purchase more product modules. Our highly recurring revenue model provides significant visibility into our future operating results. Recurring and other revenues are primarily revenues derived from the provision of our payroll, workforce management, HR-related cloud-based computing services and nonrefundable implementation fees, which represented approximately 97% of total revenue for the three months endedSeptember 30, 2022 . In addition, we earn interest income on funds held for clients. We have developed a robust organic sales and marketing engine and broad referral network of health insurance and retirement benefits brokers. We market and sell our solutions through a direct sales force, which is organized into field and inside sales teams based on customer size, geography, and industry. Our highly efficient and multi-pronged go-to-market strategy is a key driver of our growth.
The table below sets forth selected results of operations for the three months
ended
Three Months Ended
September 30,
(in thousands) 2022 2021
Total Revenue $ 118,303 $ 92,732
Loss from Operations $ (33,390) $ (52,269)
Operating Margin (28.2) % (56.4) %
Adjusted Operating Income* $ 10,413 $ 3,392
Adjusted Operating Income Margin* 8.8 % 3.7 %
Net Loss $ (29,052) $ (42,036)
21-------------------------------------------------------------------------------- *Adjusted Operating Income and Adjusted Operating Income Margin are non-U.S. GAAP ("non-GAAP") financial measures. See Non-GAAP Financial Measures below for a definition of our non-GAAP measures and reconciliations to the most closely comparableU.S. GAAP measures.
Impact of Adverse Macroeconomic Conditions
Although certain macroeconomic conditions initially caused by the novel
coronavirus pandemic ("COVID-19 pandemic") have dissipated or improved, such as
employee headcount, the ongoing effects of inflation, supply chain disruptions
and labor shortages are expected to continue to impact our and our customers'
businesses for the foreseeable future. Our business and financial performance
may be unfavorably impacted in future periods if a significant number of our
customers are unable to continue as viable businesses or if they significantly
reduce headcount, there is a reduction in business confidence and activity, a
decrease in government and consumer spending, a decrease in HCM and payroll
solutions spending by SMBs, or a decrease in growth in the overall market, among
other factors.
Key Factors Affecting Our Performance
Our historical financial performance has been, and we expect our financial performance in the future to be, driven by our ability to:
Expand Our Sales Footprint to Add New Customers
Our current customer base represents a small portion of the U.S. market for HCM and payroll solutions. We believe there is substantial opportunity to continue to broaden our customer base, particularly in the 15 most populous metropolitan statistical areas inthe United States (i.e. Tier 1 markets), by expanding our sales footprint. Our ability to do so will depend on several factors, including the effectiveness of our products, the relative pricing of our products, our competitors' offerings, and the effectiveness of our marketing efforts. As ofSeptember 30, 2022 and 2021, we had approximately 29,900 and 28,700 customers, respectively, representing a period-over-period increase of 4.2%. We define a customer as a parent company grouping, which may include multiple subsidiary client accounts with separate taxpayer identification numbers. We also track client accounts as it provides an alternative measure of the scale of our business and customers. In addition, we are also focused on expanding our broker referral relationships to drive the acquisition of new customers. Insurance and benefits brokers are trusted advisors to SMBs and are influential in the HCM selection process.
Increase Product Penetration with Existing and New Customers
In recent years we have increasingly focused our product pricing strategy away from sales of individual products and solutions towards a simplified bundled pricing approach whereby we market multi-product offerings to our customers. We believe that this strategy addresses a key need for SMB customers, while also allowing us to better serve the needs of leaders through a more comprehensive product suite. This strategy has enabled us to effectively drive increased product penetration and PEPM growth at the initial point of sale, as well as stronger retention. We define "effective PEPM," as recurring and other revenue for the period divided by the average number of customer employees, which we calculate as the sum of the number of customer employees at the end of each month over the period divided by the total number of months in the period. We intend to advance this strategy by progressively expanding the breadth of features included in our product bundles. In addition to sales to new customers, there is a substantial opportunity within our existing customer base to cross-sell additional products from our portfolio, including Workforce Management,Benefits Administration and Talent Management. Our ability to successfully increase revenue per customer is dependent upon several factors, including the number of employees working for our customers, the number of products purchased by each of our customers, our customers' satisfaction with our solutions and support, and our ability to add new products to our suite. 22 -------------------------------------------------------------------------------- We believe our ability to retain and expand our existing customers' spending on our solutions is evidenced by our net revenue retention. We define net revenue retention as the current quarterly period recurring revenue for the cohort of customers at the beginning of the prior year quarterly period, divided by the recurring revenue in the prior year reporting period for that same cohort. In calculating the net revenue retention for a period longer than a quarter, such as a fiscal year, we use the weighted average of the retention rates (calculated in accordance with the preceding sentence) for each applicable quarter included in such period. Our net revenue retention has continued to trend favorably and is in line with historical pre-COVID-19 pandemic levels. Our net revenue retention had been negatively impacted during the COVID-19 pandemic by stay-at-home, business closure and other restrictive orders, which resulted in reduced employee headcount, temporary and permanent business closures, and delayed sales and starts with many of our customers.
Ongoing Product Innovation and Optimization
We believe that our product features and functionality are key differentiators
of our offerings. We intend to continue to invest in research and development,
particularly regarding the functionality of our platform, to sustain and advance
our product leadership. For instance, in 2019 we released our Paycor Analytics
and Scheduling products. In 2020 we built and released our compensation
management product. In 2021 we launched our OnDemand Pay solution and a full
suite of talent management tools, including performance reviews, one-on-one
coaching, objectives and key results ("OKRs") and structured goal setting.
Additionally, in 2021, we released a facial recognition time clock promoting a
touchless employee experience, introduced a new payroll-based journal reporting
platform to simplify complex staffing reporting requirements for nursing
facilities and released a predictive resignation feature providing leaders with
actionable insights to identify the top drivers of employee resignation. In
2022, we released a Developer Portal to enhance Paycor's industry-leading
interoperability, making it even easier for clients and partners to seamlessly
integrate and sync data between HR and third-party systems. Additionally, in
2022, we launched an Expense Management solution, empowering leaders to easily
reimburse employee expenses utilizing the same unified Paycor platform used to
pay, hire, onboard, manage, grow, and recognize talent. As a result of these and
other product launches, the total list PEPM and customer-perceived value for our
full suite of products continues to increase. Our ability to innovate and
introduce competitive new products is dependent on our ability to recruit and
retain top technical talent and invest in research and development initiatives.
Components of Results of Operations
Factors Affecting the Comparability of our Results of Operations
IPO-Related Expenses
In connection with our IPO, we incurred certain transaction-related expenses.
These expenses include transaction bonuses, share-based compensation expense
associated with two Long Term Incentive Plans ("LTIPs") and outstanding
performance awards under the Pride Aggregator, L.P. Management Equity Plan
("MEP"), and expenses related to the redemption of our Series A Redeemable
Preferred Stock. The specifics of the LTIPs, MEP and Series A Redeemable
Preferred Stock are presented below.
We granted Long Term Incentive Plan units ("LTIP Units") under the Pride
Aggregator, L.P. Top Talent Incentive Plan and Sales Equity Incentive Plan. In
connection with our IPO, the LTIP Units converted into the entitlement to
receive a fixed number of shares of our common stock, based on the IPO price. We
settled such entitlements by issuing restricted stock units, which vest on the
applicable payment dates and we will recognize compensation expense over the
requisite service period relating to the LTIP Units.
Under the terms of the MEP, one-half of the MEP incentive units vest based on an
associate's service time. Vesting for the second half of the MEP incentive units
is established based on our performance relative to the amount originally
invested by Pride Aggregator L.P. ("Pride Aggregator"), the investment vehicle
controlled by certain funds advised by Apax Partners (the "Apax Funds") through
which the Apax Funds acquired their interest in us, with the performance
calculations defined in the plan, which were triggered by our IPO (an implied
performance condition).
As a result of our IPO, and due to an election by Pride Aggregator, the MEP performance-based incentive units converted to time-based incentive units ("Modified MEP Incentive Units"), with 25% vesting upon successive six month anniversary dates for the 24 months beginning on the date of the IPO. The conversion was treated as a modification for accounting purposes, and accordingly, we estimated fair value as of the modification date.
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The Modified MEP Incentive Units are accounted for as equity awards and the
compensation expense calculated based upon the fair value of the Modified MEP
Incentive Units at the modification date is recognized as the Modified MEP
Incentive Units vest. We estimate the fair value of the Modified MEP Incentive
Units based upon the IPO price adjusted for a floor amount established at the
grant date and other liquidation preferences in accordance with the terms of the
MEP.
We redeemed the Series A Redeemable Preferred Stock in connection with, and
using proceeds from, our IPO. The redemption price per share was equal to 101%
of the liquidation preference, plus accrued and unpaid dividends to the
redemption date, or approximately
Basis of Presentation Revenues Recurring and Other Revenue We derive our revenue from contractual agreements, which contain recurring and non-recurring service fees. The majority of our contracts are cancellable by the customer on 30 days' notice. We recognize revenue when control of the promised goods or services is transferred to customers in an amount that reflects the consideration that we are entitled to for those goods or services. Recurring revenue consists primarily of revenues derived from the provision of our payroll, workforce management, and HR-related cloud-based computing services. The performance obligations related to recurring services are generally satisfied monthly as services are provided, with fees charged and collected based on a PEPM or per-employee-per-payroll basis. Recurring revenue is generally recognized as the services are provided during each client's payroll period. Other revenue and non-recurring services fees consist mainly of nonrefundable implementation fees, which involve onboarding and configuring the customer within our cloud-based platform. These nonrefundable implementation fees provide certain clients with a material right to renew the contract, with revenue deferred and recognized over the period to which the material right exists. This is generally a period of 24 months from finalization of onboarding, which typically concludes within three to six months of the original booking. Deferred revenue also includes an immaterial portion related to recurring subscription services where revenue is recognized over the subscription period. Deferred revenue for these nonrefundable upfront fees and recurring subscription services was$16.5 million as ofSeptember 30, 2022 , with$4.7 million of revenue recognized for the three months endedSeptember 30, 2022 . Deferred revenue for these nonrefundable upfront fees and recurring subscription services was$14.8 million as ofSeptember 30, 2021 , with$4.8 million of revenue recognized for the three months endedSeptember 30, 2021 . We defer certain commission costs that meet the capitalization criteria. We also capitalize certain costs to fulfill a contract related to our proprietary products if they are identifiable, generate or enhance resources used to satisfy future performance obligations and are expected to be recovered. We utilize the portfolio approach to account for both the cost of obtaining a contract and the cost of fulfilling a contract. Capitalized costs to fulfill a contract and cost to obtain a contract are amortized over the expected period of benefit, which is generally six years based on our average client life and other qualitative factors, including rate of technological changes. We do not incur any additional costs to obtain or fulfill contracts upon renewal. We recognize additional selling and commission costs and fulfillment costs when an existing client purchases additional services. The additional costs only relate to the additional services purchased and do not relate to the renewal of previous services. We continue to expense certain costs to obtain a contract and cost to fulfill a contract if those costs do not meet the capitalization criteria.
We expect recurring and other revenue to increase as we continue to add new customers and sell additional products to our existing customers.
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--------------------------------------------------------------------------------Interest Income on Funds Held for Clients
We earn interest income on funds held for clients. We generally collect substantially all funds for employee payroll payments and related taxes in advance of remittance to employees and taxing authorities. Prior to remittance to employees and taxing authorities, we earn interest on these funds through demand deposit accounts with financial institutions with which we have automated clearing house arrangements. We also earn interest by investing a portion of funds held for clients in highly liquid, investment-grade marketable securities. We expect funds held for our clients to generally grow as the employees per customer increase and as we add customers. Interest income on funds held for clients will fluctuate based on market rates of demand deposit accounts, as well as the highly liquid, investment-grade marketable securities in which we invest the client funds. Cost of Revenues Cost of revenues includes costs relating to the provision of ongoing customer support and implementation activities, payroll tax filing, distribution of printed checks and other materials providing our payroll and other HCM solutions. These costs primarily consist of employee-related expenses for associates who service customers, as well as third-party processing fees, delivery costs, hosting costs, and bank fees associated with client fund transfers. Costs for recurring support are generally expensed as incurred, while such costs for onboarding and configuring our products for our customers are capitalized and amortized over a period of six years. We amortized$5.6 million and$3.6 million of capitalized contract fulfillment costs during the three months endedSeptember 30, 2022 and 2021, respectively. We expect to realize increased amortization in future periods as the total capitalized contract fulfillment costs on our balance sheet increases. We also capitalize a portion of our internal-use software costs including external direct costs of materials and services associated with developing or obtaining internal-use software and certain payroll and payroll-related costs for associates who are directly associated with internal-use software projects, which are then generally amortized over a period of three years into cost of revenues. We amortized$7.6 million and$16.6 million of capitalized internal-use and acquired software costs during the three months endedSeptember 30, 2022 and 2021, respectively.
Our cost of revenues is expected to increase in absolute dollars as we expand our customer base. However, in the long-term we expect cost of revenues to reduce as a percentage of total revenues as our business scales.
Operating Expenses
Sales and Marketing
Sales and marketing expenses consist primarily of employee-related expenses for our direct sales and marketing staff, marketing, advertising and promotion expenses, including amortization expense associated with the naming rights agreement, and other related costs. We capitalize certain commission costs related to new contracts or purchases of additional services by our existing customers and amortize such items over a period of six years. We amortized$4.4 million and$3.0 million of capitalized contract acquisition costs during the three months endedSeptember 30, 2022 and 2021, respectively. We expect to realize increased amortization in future periods as the total capitalized contract acquisition costs on our balance sheet increases. We seek to grow our number of new customers and upsell existing customers, and therefore our sales and marketing expense is expected to continue to increase in absolute dollars as we grow our sales organization and expand our marketing activities.
General and Administrative
General and administrative expenses consist primarily of employee-related costs
for our administrative, finance, accounting, legal, enterprise technology and
human resources departments. Additional expenses include consulting and
professional fees, occupancy costs, insurance, and other corporate expenses.
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We amortized $21.3 million and $20.3 million of intangible assets, excluding
acquired software amortized through cost of revenues, during the three months
ended September 30, 2022 and 2021, respectively. The increase in amortization
expense in the three months ended September 30, 2022 is attributable to our
asset acquisition in February 2021 .
We expect our general and administrative expenses to increase in absolute dollars as we grow and scale our business.
Research and Development
Research and development expenses consist primarily of employee-related expenses
for our software development and product management staff. Additional expenses
include costs related to the development, maintenance, quality assurance and
testing of new technologies, and ongoing refinement of our existing solutions.
Research and development expenses, other than internal-use software costs
qualifying for capitalization, including costs associated with preliminary
project stage activities, training, maintenance, and all other
post-implementation stage activities are expensed as incurred.
We capitalize a portion of our development costs related to internal-use
software, which are amortized over a period of three years into cost of
revenues. The timing of our capitalized development projects may affect the
amount of development costs expensed in any given period. The table below sets
forth the amounts of capitalized and expensed research and development costs for
the following periods:
Three Months Ended
September 30,
(in thousands) 2022 2021
Capitalized software $ 8,603 $ 7,241
Research and development expenses $ 12,402 $ 10,191
We expect to increase our research and development expenses in absolute dollars as we continue to broaden our product offerings and extend our technological leadership by investing in the development of new technologies and introducing them to new and existing customers.
Interest Expense
Interest expense consists primarily of interest payments and accruals relating to outstanding borrowings as well as accretion expense associated with the naming rights liability. We expect interest expense to vary each reporting period depending on the amount of outstanding borrowings and prevailing interest rates. Other Income (Expense)
Other income (expense) generally consists of other income and expense items outside of our normal operations, such as realized gains or losses on the sale of certain positions of funds held for clients, gains or losses on the extinguishment of debt and expenses relating to our financing arrangements.
Results of Operations
The following table sets forth our unaudited condensed consolidated statements of operations for the periods indicated.
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Three Months Ended
September 30, September 30,
(in thousands) 2022 2021
Consolidated Statement of Operations Data:
Revenues:
Recurring and other revenue $ 114,169 $ 92,416
Interest income on funds held for clients 4,134 316
Total revenues 118,303 92,732
Cost of revenues 43,185 45,611
Gross profit 75,118 47,121
Operating expenses:
Sales and marketing 48,195 45,788
General and administrative 47,911 43,411
Research and development 12,402 10,191
Total operating expenses 108,508 99,390
Loss from operations (33,390) (52,269)
Interest expense (1,087) (235)
Other income 445 1,224
Loss before benefit for income taxes (34,032) (51,280)
Income tax benefit (4,980) (9,244)
Net loss $ (29,052) $ (42,036)
Comparison of the Three Months Ended September 30, 2022 and September 30, 2021
Revenues
Three Months Ended
September 30, September 30,
(in thousands) 2022 2021 $ Change % Change
Revenues:
Recurring and other revenue $ 114,169 $ 92,416 $ 21,753 24 %
Interest income on funds held for
clients 4,134 316 3,818 1,208
Total revenues $ 118,303 $ 92,732 $ 25,571 28 %
Total revenue for the three months ended September 30, 2022 and 2021 was $118.3
million and $92.7 million , respectively. In the three months ended September 30,
2022 and 2021, recurring and other revenue accounted for $114.2 million and
$92.4 million , respectively. Additionally, interest income on funds held for
clients accounted for $4.1 million and $0.3 million , respectively, for the three
months ended September 30, 2022 and 2021. Total revenues increased primarily as
a result of a 4.2% increase in customers to approximately 29,900 at
September 30, 2022 from approximately 28,700 at September 30, 2021 , an increase
in the average number of employees per customer, an increase in effective PEPM
and an increase in interest income on funds held for clients discussed below.
Interest income on funds held for clients increased primarily as a result of
higher average daily balances for funds held due to the addition of new
customers and higher average interest rates across our portfolio of
debt-security investments. Average client funds balance for the three months
ended September 30, 2022 and 2021 were $920.2 million and $759.9 million ,
respectively.
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Cost of Revenues
Three Months Ended
(in thousands) September 30, 2022 September 30, 2021 $ Change % Change
Cost of revenues $ 43,185 $ 45,611 $ (2,426) (5) %
Percentage of total revenues 37 % 49 %
Gross profit $ 75,118 $ 47,121 $ 27,997 59 %
Percentage of total revenues 63 % 51 %
Total cost of revenues for the three months ended September 30, 2022 and 2021
were $43.2 million and $45.6 million , respectively. Our total cost of revenues
decreased primarily as a result of a $10.6 million decrease in amortization
expense relating to software acquired in November 2018 which had fully amortized
during the three months ended December 31, 2021 and a $0.4 million decrease in
professional services, partially offset by a $5.3 million increase in
employee-related costs to support new customers, including $0.6 million of
share-based compensation expense, a $2.0 million increase in amortization of
deferred contract costs and a $1.6 million increase in amortization expense
relating to capitalized software.
Operating Expenses
Sales and Marketing
Three Months Ended
(in thousands) September 30, 2022 September 30, 2021 $ Change % Change
Sales and marketing $ 48,195 $ 45,788 $ 2,407 5 %Percentage of total revenues 41 % 49 % Sales and marketing expenses for the three months endedSeptember 30, 2022 and 2021 were$48.2 million and$45.8 million , respectively. The increase in sales and marketing expense was primarily the result of a$1.8 million increase in amortization expense associated with the naming rights agreement and advertising expenses, a$1.4 million increase in amortization expense associated with costs to obtain a contract, a$1.2 million increase in travel and event related expenses and a$0.4 million increase in professional services, partially offset by a$2.5 million decrease in employee-related costs, which includes a$6.2 million decrease in share-based compensation expense. General and Administrative Three Months Ended (in thousands) September 30, 2022 September 30, 2021 $ Change % Change General and administrative $ 47,911 $ 43,411$ 4,500 10 % Percentage of total revenues 40 % 47 % General and administrative expenses for the three months endedSeptember 30, 2022 and 2021 were$47.9 million and$43.4 million , respectively. The increase in general and administrative expenses was primarily driven by a$2.3 million increase in professional services, consulting fees and other costs, a$1.0 million increase in intangible amortization expense primarily associated with an asset acquisition completed inFebruary 2021 , including the capitalization of subsequent earn out payments, and a$0.9 million increase in employee-related costs, which includes$0.3 million of share-based compensation expense. 28 --------------------------------------------------------------------------------
Research and Development
Three Months Ended
(in thousands) September 30, 2022 September 30, 2021 $ Change % Change
Research and development $ 12,402 $ 10,191 $ 2,211 22 %Percentage of total revenues 10 % 11 % Research and development expenses for the three months endedSeptember 30, 2022 and 2021 were$12.4 million and$10.2 million , respectively. The increase in research and development expenses was primarily the result of a$1.7 million increase in employee-related costs, including a$0.4 million increase in share-based compensation expense and a$0.4 million increase in licensing fees. Interest Expense Three Months Ended September 30, (in thousands) September 30, 2022 2021 $ Change % Change Interest expense$ 1,087 $ 235$ 852 363 % Percentage of total revenues <1 %
<1 %
Interest expense for the three months endedSeptember 30, 2022 and 2021 was$1.1 million and$0.2 million , respectively. The increase in interest expense was primarily the result of accretion expense associated with the naming rights agreement. Other income Three Months Ended
(in thousands)
$ 1,224 $ (779) (64) %
Other income for the three months ended
Income tax benefit
Income tax benefit for the three months endedSeptember 30, 2022 and 2021 was$5.0 million and$9.2 million , respectively, reflecting effective tax rates for the periods of 14.6% and 18.0%, respectively. The decrease in tax benefit is primarily related to an increase in expense related to executive compensation in which no tax benefit can be recognized in the three months endedSeptember 30, 2022 . Non-GAAP Financial Measures In addition to our results determined in accordance withU.S. GAAP, we believe the following non-GAAP measures are useful in evaluating our operating performance. We believe that non-GAAP financial information, when taken collectively, may be helpful to investors because it provides consistency and comparability with past financial performance and assists in comparisons with other companies, some of which use similar non-GAAP financial information to supplement theirU.S. GAAP results. The non-GAAP financial information is presented for supplemental informational purposes only and should not be considered a substitute for financial information presented in accordance withU.S. GAAP and may be different from similarly titled non-GAAP measures used by other companies. A reconciliation is provided below for each non-GAAP financial measure to the most directly comparable financial measure stated in accordance withU.S. GAAP. Investors are encouraged to review the relatedU.S. GAAP financial measures and the reconciliation of these non-GAAP financial measures to their most directly comparableU.S. GAAP financial measures. 29 --------------------------------------------------------------------------------
Adjusted Gross Profit and Adjusted Gross Profit Margin
We define Adjusted Gross Profit as gross profit before amortization of intangible assets, stock-based award compensation expense, and certain corporate expenses, in each case that are included in costs of recurring revenues. We define Adjusted Gross Profit Margin as Adjusted Gross Profit divided by total revenues. We use Adjusted Gross Profit and Adjusted Gross Profit Margin to understand and evaluate our core operating performance and trends. We believe these metrics are useful measures to us and to our investors to assist in evaluating our core operating performance because it provides consistency and direct comparability with our past financial performance and between fiscal periods, as the metrics eliminate the effects of variability of items such as stock-based award compensation expense and amortization of intangible assets, which are non-cash expenses that may fluctuate for reasons unrelated to overall operating performance. Adjusted Gross Profit and Adjusted Gross Profit Margin have limitations as analytical tools, and you should not consider them in isolation, or as a substitute for analysis of our results as reported underU.S. GAAP and should not be considered as replacements for gross profit and gross profit margin, as determined byU.S. GAAP, or as measures of our profitability. We compensate for these limitations by relying primarily on ourU.S. GAAP results and using non-GAAP measures only for supplemental purposes. Adjusted Gross Profit was$78.5 million and$60.5 million , or 66.3% and 65.2% of total revenue, for the three months endedSeptember 30, 2022 and 2021, respectively. Adjusted Gross Profit increased for the three months endedSeptember 30, 2022 , primarily driven by the increase in total revenue from customer growth, partially offset by additional employee-related costs to support new customers, amortization of costs to fulfill contracts within cost of revenues and amortization of capitalized software. Three Months Ended (in thousands) September 30, 2022 September 30, 2021 Gross Profit* $ 75,118 $ 47,121 Gross Profit Margin 63.5 % 50.8 % Amortization of intangible assets 1,128 11,722 Stock-based compensation expense 2,210 1,657 Adjusted Gross Profit* $ 78,456 $ 60,500 Adjusted Gross Profit Margin 66.3 % 65.2 % * Gross Profit and Adjusted Gross Profit are burdened by depreciation expense of$0.4 million and$0.7 million for the three months endedSeptember 30, 2022 and 2021, respectively. Gross Profit and Adjusted Gross Profit are burdened by amortization of capitalized software of$6.4 million and$4.8 million for the three months endedSeptember 30, 2022 and 2021, respectively. Gross Profit and Adjusted Gross Profit are burdened by amortization of deferred contract costs of$5.6 million and$3.6 million for the three months endedSeptember 30, 2022 and 2021, respectively. Adjusted Operating Income We define Adjusted Operating Income as loss from operations before amortization of acquired intangible assets and naming rights, stock-based award compensation expense, exit cost due to exiting leases of certain facilities and other certain corporate expenses, such as costs related to acquisitions. We define Adjusted Operating Income Margin as Adjusted Operating Income divided by total revenues. We use Adjusted Operating Income and Adjusted Operating Income Margin to understand and evaluate our core operating performance and trends, to prepare and approve our annual budget, and to develop short-term and long-term operating plans. We believe that Adjusted Operating Income and Adjusted Operating Income Margin facilitate comparison of our operating performance on a consistent basis between periods, and when viewed in combination with our results prepared in accordance withU.S. GAAP, help provide a broader picture of factors and trends affecting our results of operations. While the 30 -------------------------------------------------------------------------------- amortization expense relating to intangible assets is excluded from Adjusted Operating Income, the revenue related to such intangible assets is reflected in Adjusted Operating Income as these assets contribute to our revenue generation. Adjusted Operating Income and Adjusted Operating Income Margin have limitations as analytical tools, and you should not consider them in isolation, or as substitutes for analysis of our results as reported underU.S. GAAP. Because of these limitations, Adjusted Operating Income and Adjusted Operating Income Margin should not be considered as replacements for operating loss and operating loss margin, as determined byU.S. GAAP, or as measures of our profitability. We compensate for these limitations by relying primarily on ourU.S. GAAP results and using non-GAAP measures only for supplemental purposes. Adjusted Operating Income was$10.4 million and$3.4 million for the three months endedSeptember 30, 2022 and 2021, respectively. Adjusted Operating Income increased for the three months endedSeptember 30, 2022 , primarily driven by an increase in total revenue, partially offset by continued investment in employee-related costs to support new customers, expand our sales coverage, and develop our products, as well as increased amortization related to deferred contract costs and capitalized software. Three Months Ended (in thousands) September 30, 2022 September 30, 2021 Loss from Operations $ (33,390) $ (52,269) Operating Margin (28.2) % (56.4) % Amortization of intangible assets 23,270 32,050 Stock-based compensation expense 16,951 21,812 Loss on lease exit* 509 - Corporate adjustments** 3,073 1,799 Adjusted Operating Income $ 10,413 $ 3,392 Adjusted Operating Income Margin 8.8 % 3.7 % * Represents exit cost due to exiting leases of certain facilities. ** Corporate adjustments for the three months endedSeptember 30, 2022 relate to costs associated with a secondary offering completed inSeptember 2022 ("September 2022 Secondary Offering") of$1.5 million , professional, consulting, and other costs of$1.0 million and transaction expenses and other costs of$0.6 million . Corporate adjustments for the three months endedSeptember 30, 2021 relate to certain costs associated with becoming a public company, including the implementation of a new enterprise-resource planning system and professional, consulting, and other costs. Adjusted Operating Expenses We define Adjusted Sales and Marketing expense as sales and marketing expenses before amortization of naming rights, stock-based award compensation expense and other certain corporate expenses. We define Adjusted General and Administrative expense as general and administrative expenses before amortization of acquired intangible assets, stock-based award compensation expense, exit cost due to exiting leases of certain facilities and other certain corporate expenses. We defineAdjusted Research and Development expense as research and development expenses before stock-based award compensation expense and other certain corporate expenses. We use Adjusted Sales and Marketing expense, Adjusted General and Administrative expense andAdjusted Research and Development expense (collectively, "Adjusted Operating Expenses") to understand and evaluate our core operating performance and trends, to prepare and approve our annual budget, and to develop short-term and long-term operating plans. We believe that Adjusted Operating Expenses facilitate comparison of our operating performance on a consistent basis between periods, and when viewed in combination with our results prepared in accordance withU.S. GAAP, help provide a broader picture of factors and trends affecting our results of operations. Adjusted Operating Expenses have limitations as analytical tools, and you should not consider them in isolation, or as substitutes for analysis of our results as reported underU.S. GAAP. Because of these limitations, Adjusted Operating Expenses should not be considered as replacements for operating expenses, as determined byU.S. GAAP. We compensate for these limitations by relying primarily on ourU.S. GAAP results and using non-GAAP measures only for supplemental purposes. 31 -------------------------------------------------------------------------------- Adjusted Sales and Marketing expense was$39.9 million and$32.1 million for the three months endedSeptember 30, 2022 and 2021. Adjusted Sales and Marketing expenses increased for the three months endedSeptember 30, 2022 , primarily driven by expanding our sales coverage, an increase in amortization of costs to obtain contracts, an increase in travel and event related expenses and an increase in advertising expense. Adjusted General and Administrative expense was$17.7 million and$16.3 million for the three months endedSeptember 30, 2022 and 2021. Adjusted General and Administrative expenses increased for the three months endedSeptember 30, 2022 , primarily driven by an increase in professional services and consulting fees and additional employee-related costs.Adjusted Research and Development expense was$10.4 million and$8.7 million for the three months endedSeptember 30, 2022 and 2021, respectively.Adjusted Research and Development expenses increased for the three months endedSeptember 30, 2022 , primarily driven by an increase in employee-related costs and an increase in licensing fees. Three Months Ended September 30, September 30, (in thousands) 2022 2021 Sales and Marketing expense
Amortization of intangible assets (827) - Stock-based compensation expense (7,434) (13,646) Corporate adjustments* - (53) Adjusted Sales and Marketing expense$ 39,934 $ 32,089 General and Administrative expense$ 47,911 $ 43,411 Amortization of intangible assets (21,315) (20,328) Stock-based compensation expense (5,336) (4,988) Loss on lease exit** (509) - Corporate adjustments*** (3,073) (1,746) Adjusted General and Administrative expense$ 17,678 $ 16,349 Research and Development expense
Stock-based compensation expense (1,971) (1,521) Adjusted Research and Development expense$ 10,431 $ 8,670 * Corporate adjustments for the three months endedSeptember 30, 2021 relate to costs associated with becoming a public company. ** Represents exit cost due to exiting leases of certain facilities. *** Corporate adjustments for the three months endedSeptember 30, 2022 relate to costs associated with theSeptember 2022 Secondary Offering of$1.5 million , professional, consulting, and other costs of$1.0 million and transaction expenses and other costs of$0.6 million . Corporate adjustments for the three months endedSeptember 30, 2021 relate to certain costs associated with becoming a public company, including the implementation of a new enterprise-resource planning system and professional, consulting, and other costs.
Adjusted Net Income Attributable to
We define Adjusted Net Income Attributable toPaycor HCM, Inc. as loss before benefit for income tax after adjusting for amortization of acquired intangible assets and naming rights, accretion expense associated with the naming rights, stock-based award compensation expense, gain or loss on the extinguishment of debt, exit cost due to exiting leases of certain facilities and other certain corporate expenses, such as costs related to acquisitions, all of which are tax effected applying an adjusted effective tax rate. We define Adjusted Net Income Attributable toPaycor HCM, Inc. Per Share as Adjusted Net Income Attributable toPaycor HCM, Inc. divided by adjusted shares outstanding. Adjusted shares outstanding includes potentially dilutive securities excluded from theU.S. GAAP dilutive net loss per share calculation. 32 -------------------------------------------------------------------------------- We use Adjusted Net Income Attributable toPaycor HCM, Inc. and Adjusted Net Income Attributable toPaycor HCM, Inc. Per Share to understand and evaluate our core operating performance and trends, to prepare and approve our annual budget, and to develop short-term and long-term operating plans. We believe that Adjusted Net Income Attributable toPaycor HCM, Inc. and Adjusted Net Income Attributable toPaycor HCM, Inc. Per Share facilitate comparison of our operating performance on a consistent basis between periods, and when viewed in combination with our results prepared in accordance withU.S. GAAP, help provide a broader picture of factors and trends affecting our results of operations. While the amortization expense relating to intangible assets is excluded from Adjusted Net Income Attributable toPaycor HCM, Inc. , the revenue related to such intangible assets is reflected in Adjusted Net Income Attributable toPaycor HCM, Inc. as these assets contribute to our revenue generation. Adjusted Net Income Attributable toPaycor HCM, Inc. and Adjusted Net Income Attributable toPaycor HCM, Inc. Per Share have limitations as analytical tools, and you should not consider these in isolation, or as a substitute for analysis of our results as reported underU.S. GAAP. Because of these limitations, Adjusted Net Income Attributable toPaycor HCM, Inc. should not be considered as a replacement for Net Loss Attributable toPaycor HCM, Inc. , and Adjusted Net Income Attributable toPaycor HCM, Inc. Per Share should not be considered as a replacement for diluted net loss attributable toPaycor HCM, Inc. per share, as determined byU.S. GAAP, or as a measure of our profitability. We compensate for these limitations by relying primarily on ourU.S. GAAP results and using non-GAAP measures only for supplemental purposes. Adjusted Net Income Attributable toPaycor HCM, Inc. was$8.2 million and$2.3 million for the three months endedSeptember 30, 2022 and 2021, respectively. Adjusted Net Income Attributable toPaycor HCM, Inc. increased for the three months endedSeptember 30, 2022 , primarily driven by an increase in total revenue, partially offset by continued investment in employee-related costs to support new customers, expand our sales coverage, and develop our products, as well as increased amortization related to deferred contract costs and capitalized software. Three Months Ended September 30, September 30, (in thousands) 2022 2021 Net loss before benefit for income taxes$ (34,032) $ (51,280) Loss on debt amendment - 35 Amortization of intangible assets 23,270 32,050 Naming rights accretion expense 893 - Gain on installment sale - (1,359) Stock-based compensation expense 16,951 21,812 Loss on lease exit* 509 - Corporate adjustments** 3,073 1,799 Non-GAAP adjusted income before applicable income taxes 10,664 3,057 Income tax effect on adjustments*** (2,453) (734) Adjusted Net Income Attributable toPaycor HCM, Inc.
Adjusted Net Income Attributable to Paycor HCM, Inc. Per Share$ 0.05 $ 0.01 Adjusted shares outstanding**** 175,933,418 169,660,544 * Represents exit cost due to exiting leases of certain facilities. ** Corporate adjustments for the three months endedSeptember 30, 2022 relate to costs associated with theSeptember 2022 Secondary Offering of$1.5 million , professional, consulting, and other costs of$1.0 million and transaction expenses and other costs of$0.6 million . Corporate adjustments for the three months endedSeptember 30, 2021 relate to certain costs associated with becoming a public company, including the implementation of a new enterprise-resource planning system and professional, consulting, and other costs. *** Non-GAAP adjusted income before applicable income taxes is tax effected using an adjusted effective tax rate of 23.0% for the three months endedSeptember 30, 2022 and 24% for the three months endedSeptember 30, 2021 . **** The adjusted shares outstanding for the three months endedSeptember 30, 2021 assume the conversion of the Series A Preferred Stock as if it would have occurred onJuly 1, 2021 , based on the if-converted method and include potentially dilutive securities that are excluded fromU.S. GAAP dilutive net income per share calculation because including them would have an anti-dilutive effect.
Liquidity and Capital Resources
33
--------------------------------------------------------------------------------General
As ofSeptember 30, 2022 , our principal sources of liquidity were cash and cash equivalents totaling$98.2 million , which was held for working capital purposes, as well as$200.0 million of borrowing capacity available under our revolving credit facility, described further below. As ofSeptember 30, 2022 , our cash and cash equivalents principally included demand deposit accounts. We expect our operating cash flows to further improve as we increase our operational efficiency and experience economies of scale. We have historically financed our operations primarily through cash received from operations and debt financing and, more recently, with the issuance of equity in our IPO. We believe our existing cash and cash equivalents, borrowings available under our revolving credit facility and cash provided by sales of our solutions and services will be sufficient to meet our working capital and capital expenditure needs for at least the next twelve months. Our future capital requirements will depend on many factors including our growth rate, the timing and extent of spending to support development efforts, the expansion of sales and marketing activities, and the introduction of new and enhanced products and services offerings. In the future, we may enter into arrangements to acquire or invest in complementary businesses, services, and technologies, including intellectual property rights. We may be required to seek additional equity or debt financing. If additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us or at all. If we are unable to raise additional capital or generate cash flows necessary to expand our operations and invest in new technologies, this could reduce our ability to compete successfully and harm our results of operations. The majority of the Company's recurring fees are satisfied over time as the services are provided and invoiced by the customer payroll processing period or by month. The Company recognizes deferred revenue for nonrefundable upfront fees as well as for subscription services related to certain ancillary products invoiced prior to the satisfaction of the performance obligation. As ofSeptember 30, 2022 , we had deferred revenue of$16.5 million , of which$11.3 million was recorded as a current liability and is expected to be recorded as revenue in the next twelve months, provided all other revenue recognition criteria have been met. Revolving Credit FacilityPaycor, Inc. is party to a credit agreement (as amended, the "Credit Agreement") withPNC Bank, National Association ("PNC"), Fifth Third, National Association, and other lenders, providing a$200.0 million senior secured revolving credit facility (the "Revolving Credit Facility"). The Revolving Credit Facility includes an "accordion feature" that allows us, under certain circumstances, to increase the size of the Revolving Credit Facility by an additional principal amount of up to$200.0 million , with a resulting maximum principal amount of$400.0 million , subject to the participating lenders electing to increase their commitments or new lenders being added to the Credit Agreement. The Revolving Credit Facility will mature onJune 11, 2026 . Borrowings under the Revolving Credit Facility, if any, have variable interest rates. The variable interest rates equal, at our option, either, (i) in the case of ABR borrowings, the highest of (a) the PNC prime rate, (b) the Federal Funds Rate plus 0.50%, and (c) the adjusted London interbank offered rate ("LIBOR") with a maturity of one month, plus 1.00% ("ABR") or (ii) in the case of LIBOR borrowings, the LIBOR rate, plus, in each case, an applicable margin of (A) prior to the IPO, (i) in the case of ABR borrowings, 0.95% per annum and (ii) in the case of LIBOR borrowings, 1.95% per annum or (B) following the IPO, (i) in the case of ABR borrowings, 0.375% per annum or (ii) in the case of LIBOR borrowings, 1.375% per annum, in each case, with step downs based on achievement of certain total leverage ratios.
The Credit Agreement contains financial covenants, which are reviewed for
compliance on a quarterly basis, including a total leverage ratio financial
covenant of 3.50 to 1.00 and an interest coverage ratio financial covenant of
3.00 to 1.00. As of
34
--------------------------------------------------------------------------------Cash Flows
The following table presents a summary of our unaudited condensed consolidated
cash flows from operating, investing and financing activities for the three
months ended
Three Months Ended
September 30, September 30,
(in thousands) 2022 2021
Net cash used in operating activities $ (24,101) $ (17,245)
Net cash used in investing activities (118,960) (5,258)
Net cash (used in) provided by financing activities (772,641) 1,052,127
Impact of foreign exchange on cash and cash equivalents (14) (3)
Net change in cash and cash equivalents (915,716) 1,029,621
Cash and cash equivalents at beginning of period 1,682,923 560,000
Cash and cash equivalents at end of period $ 767,207 $ 1,589,621
Operating Activities
Net cash used in operating activities was $24.1 million and $17.2 million for
the three months ended September 30, 2022 and 2021, respectively. The change in
operating activities for the three months ended September 30, 2022 reflects a
decrease in changes in assets and liabilities and a decrease in adjustments to
add back non-cash items, partially offset by a decrease in net loss.
Investing Activities
Net cash used in investing activities was$119.0 million and$5.3 million , for the three months endedSeptember 30, 2022 and 2021, respectively. The change in investing activities for the three months endedSeptember 30, 2022 was primarily attributable to the timing of proceeds and purchases within our client funds portfolio. Financing Activities Net cash used in financing activities was$772.6 million for the three months endedSeptember 30, 2022 and consisted primarily of a decrease in funds held to satisfy client fund obligations. Net cash provided by financing activities was$1,052.1 million for the three months endedSeptember 30, 2021 and consisted primarily of an increase in funds held to satisfy client fund obligations and proceeds from the issuance of common stock sold in our IPO, net of offering costs, partially offset by cash used for the redemption of our Series A Redeemable Preferred Stock and increased net repayments of long-term debt.
Contractual Obligations and Commitments
Our principal commitments primarily consist of leases for office space atSeptember 30, 2022 . Except for the naming rights agreement, which is discussed throughout Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations of this Form 10-Q, 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 onAugust 24, 2022 . For additional information regarding our leases, long-term debt and our commitments and contingencies, see "Note 10. Leases", "Note 9. Debt Agreements and Letters of Credit" and "Note 18. Commitments and Contingencies" in the Form 10-K and "Note 9. Debt Agreements and Letters of Credit" and "Note 15. Commitments and Contingencies" in the notes to our unaudited condensed consolidated financial statements included elsewhere in this Form 10-Q.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have or are reasonably
likely to have a current or future effect on our financial condition, changes in
financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures or capital resources that may be material to investors.
35
--------------------------------------------------------------------------------JOBS Act
We currently qualify as an "emerging growth company" pursuant to the provisions of the JOBS Act. For as long as we are an "emerging growth company," we may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not "emerging growth companies," including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404(b) of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our annual reports and proxy statements, exemptions from the requirements of holding advisory "say-on-pay" votes on executive compensation and stockholder advisory votes on golden parachute compensation. The JOBS Act also permits an emerging growth company like us to take advantage of an extended transition period to comply with new or revised accounting standards applicable to public companies. We have elected to "opt-in" to this extended transition period for complying with new or revised accounting standards and, therefore, we will not be subject to the same new or revised accounting standards as other public companies that comply with such new or revised accounting standards on a non-delayed basis.
Critical Accounting Policies and Significant Judgments and Estimates
The discussion and analysis of our financial condition and results of operations are based upon our unaudited condensed consolidated financial statements, which have been prepared in accordance withU.S. GAAP. The preparation of these unaudited condensed consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenue and expenses and related disclosures of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions, impacting our reported results of operations and financial condition. Certain accounting policies involve significant judgments and assumptions by management, which have a material impact on the carrying value of assets and liabilities and the recognition of income and expenses. Management considers these accounting policies to be critical accounting policies. The estimates and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances. The significant accounting policies which we believe are the most critical to aid in fully understanding and evaluating our reported financial results are described 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 filed onAugust 24, 2022 . There have been no material changes to the critical accounting policies disclosed in the Form 10-K, except as described in Note 2 to our unaudited condensed consolidated financial statements: "Summary of Significant Accounting Policies."
Adoption of Accounting Pronouncements
For a description of recently issued accounting standards not yet adopted, see Note 2 to our unaudited condensed consolidated financial statements: "Summary of Significant Accounting Policies -Pending Accounting Pronouncements" appearing elsewhere in this report.
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