Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Management’s Discussion and Analysis of Financial Condition and Results of Operations is intended to provide a reader of our financial statements with management’s perspective on our financial condition, results of operations, liquidity, and certain other factors that may affect our future results. The following discussion and analysis should be read in conjunction with (i) the accompanying unaudited consolidated financial statements and notes thereto for the three months ended March 31, 2023, (ii) the audited consolidated financial statements and notes thereto for the year ended December 31, 2022 included in our Annual Report on Form 10-K (the “Form 10-K”) filed with the Securities and Exchange Commission (the “SEC”) on February 16, 2023 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, 2022, 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.
Special Note Regarding Forward-Looking Statements
The following discussion contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are any statements that look to future events and include, but are not limited to, statements regarding our business strategy; anticipated future operating results and operating expenses, cash flows, capital resources, dividends and liquidity; trends, opportunities and risks affecting our business, industry and financial results; future expansion or growth plans and potential for future growth; our ability to attract new clients to purchase our solution; our ability to retain clients and induce them to purchase additional applications; our ability to accurately forecast future revenues and appropriately plan our expenses; market acceptance of our solution and applications; our expectations regarding future revenues generated by certain applications; our ability to attract and retain qualified employees and key personnel; future regulatory, judicial and legislative changes; how certain factors affecting our performance correlate to improvement or deterioration in the labor market; our plan to open additional sales offices and our ability to effectively execute such plan; the sufficiency of our existing cash and cash equivalents to meet our working capital and capital expenditure needs over the next 12 months; our plans regarding our capital expenditures and investment activity as our business grows, including with respect to research and development and the expansion of our corporate headquarters and other facilities; our plans to pay cash dividends; and our plans to repurchase shares of our common stock through a stock repurchase plan. In addition, forward-looking statements also consist of statements involving trend analyses and statements including such words as “anticipate,” “believe,” “could,” “estimate,” “expect,” “will,” “intend,” “may,” “might,” “plan,” “potential,” “should,” “would,” and similar expressions or the negative of such terms or other comparable terminology.
Forward-looking statements are neither historical facts nor assurances of future performance, and are based only on our current beliefs, expectations and assumptions regarding the future of our business, future plans and strategies, projections, anticipated events and trends, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and many of which are outside of our control. Therefore, you should not rely on any of these forward-looking statements. Important factors that could cause our actual results and financial condition to differ materially from those indicated in the forward-looking statements include, among others, the following:
•the possibility of security vulnerabilities, cyberattacks and network disruptions, including breaches of data security and privacy leaks, data loss, and business interruptions;
•changes in laws, government regulations and policies and interpretations thereof;
•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;
•our ability to manage our rapid growth and organizational change effectively;
•fluctuations in our financial results due to factors beyond our control;
•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;
21
•the impact of adverse economic and market conditions, including those related to the COVID-19 pandemic and geopolitical conflicts;
•our failure to develop and maintain our brand cost-effectively;
•seasonality of certain operating results and financial metrics;
•our failure to adequately protect our intellectual property rights;
•our reliance on relationships with third parties;
•the possibility that the Affordable Care Act may be modified, repealed or declared unconstitutional; and
•the other factors set forth in Part I, Item 1A, “Risk Factors” of the Form 10-K 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 March 31, 2023. Our revenues are primarily generated through our sales force that solicits new clients and our client relations representatives ("CRRs") who sell new applications to existing clients.
Our continued growth depends on attracting new clients through further penetration of our existing markets and geographic expansion into new markets, targeting a high degree of client employee usage across our solution, and introducing new applications to our existing client base. We believe our ability to continue to develop new applications and to improve existing applications will enable us to increase revenues in the future, and the number of our new applications adopted by our clients has been a significant factor in our revenue growth. We plan to open additional sales offices in the future to further expand our market presence.
Our principal marketing efforts include national and local advertising campaigns, email campaigns, social and digital media campaigns, search engine marketing methods, sponsorships, tradeshows, print advertising and outbound marketing including personalized direct mail campaigns. In addition, we generate leads and build recognition of our brand and thought leadership with relevant and informative content, such as white papers, blogs, podcast episodes and webinars.
Throughout our history, we have built strong relationships with our clients. As the HCM needs of our clients evolve, we believe that we are well-positioned to expand the HCM spending of our clients and we believe this opportunity is significant. To be successful, we must continue to demonstrate the operational and economic benefits of our solution, as well as effectively hire, train, motivate and retain qualified personnel.
22
Growth Outlook, Opportunities and Challenges
As a result of our significant revenue growth and geographic expansion, we are presented with a variety of opportunities and challenges. Our payroll application is the foundation of our solution and all of our clients are required to utilize this application in order to access our other applications. Consequently, we have historically generated the majority of our revenues from our payroll applications, although our revenue mix has evolved and will continue to evolve as we develop and add new non-payroll applications to our solution. We believe our strategy of focusing on increased employee usage is key to long-term client satisfaction and client retention. Client adoption of new applications and client employee usage of both new and existing applications have been significant factors in our revenue growth, and we expect the continuation of this trajectory will depend, in part, on the introduction of applications to our existing client base that encourage and promote more employee usage. For example, in 2021, we launched our industry-first Beti technology, which further automates and streamlines the payroll process by empowering employees to do their own payroll. Moreover, in order to increase revenues and continue to improve our operating results, we must also attract new clients. We intend to obtain new clients by (i) continuing to leverage our sales force productivity within markets where we currently have existing sales offices, (ii) expanding our presence in metropolitan areas where we currently have an existing sales office through adding sales teams or offices, thereby increasing the number of sales professionals within such markets, and (iii) opening sales offices in new metropolitan areas.
Our target client size range is 50 to 10,000 employees. While we continue to serve a diversified client base ranging in size from one employee to many thousands of employees, the average size of our clients has grown significantly as we have organically grown our operations, increased the number of applications we offer and gained traction with larger companies. We believe larger employers represent a substantial opportunity to increase 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. Generally, we expect that changes in certain factors affecting our performance will correlate with improvement or deterioration in the labor market.
We collect funds from clients in advance of either the applicable due date for payroll tax submissions or the applicable disbursement date for employee payment services. Those collections from clients are typically disbursed from one to 30 days after receipt, with some funds being held for up to 120 days. We typically invest funds held for clients in money market funds, demand deposit accounts, U.S. treasury securities, commercial paper and certificates of deposit until they are paid to the applicable tax or regulatory agencies or to client employees. As we introduce new applications, expand our client base and renew and expand relationships with existing clients, we expect our average funds held for clients balance and, accordingly, interest earned on funds held for clients, will increase; however, the amount of interest we earn can be positively or negatively impacted by changes in interest rates.
Growing our business has resulted in, and will continue to result in, substantial investments in sales professionals, operating expenses, system development and programming costs and general and administrative expenses, which have increased and will continue to increase our expenses. Specifically, our revenue growth and geographic expansion drive increases in our employee headcount, which in turn precipitates increases in (i) salaries and benefits, (ii) stock-based compensation expense and (iii) facility costs related to the expansion of our corporate headquarters and operations facilities and additional sales office leases.
We believe the challenges of managing the ever-changing complexity of payroll and human resources will continue to drive companies to turn to outsourced providers for help with their HCM needs. The HCM industry historically has been driven, in part, by legislation and regulatory action, including COBRA, changes to the minimum wage laws or overtime rules, and legislation from federal, state or municipal taxation authorities.
Our revenues are seasonal in nature and generally we expect our first and fourth quarter recurring revenues to be higher than other quarters during the year. Recurring revenues include revenues relating to the annual processing of payroll tax filing forms and ACA form filing requirements, such as Form W-2, Form 1099, and Form 1095 and revenues from processing unscheduled payroll runs (such as bonuses) for our clients. As payroll tax forms are typically processed in the first quarter of the year, first quarter recurring revenues and margins are positively impacted. In addition, unscheduled payroll runs at the end of the year often result in increased recurring revenues in the fourth quarter. These seasonal fluctuations in revenues can also have an impact on gross profits. Historical results impacted by these seasonal trends should not be considered a reliable indicator of our future results of operations.
For the three months ended March 31, 2023 and 2022, our total gross margins were approximately 86%. Although our gross margins may fluctuate from quarter to quarter due to seasonality and hiring trends, we expect that our gross margins will remain relatively consistent in future periods.
23
Results of Operations
The following table sets forth certain consolidated statements of income data and such data as a percentage of total revenues for the periods presented:
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|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
|
|
|
2023 |
|
|
2022 |
|
|
% Change |
Revenues |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Recurring |
|
$ |
444,421 |
|
|
|
98.4 |
% |
|
$ |
348,164 |
|
|
|
98.5 |
% |
|
27.6% |
Implementation and other |
|
|
7,216 |
|
|
|
1.6 |
% |
|
|
5,355 |
|
|
|
1.5 |
% |
|
34.8% |
Total revenues |
|
|
451,637 |
|
|
|
100.0 |
% |
|
|
353,519 |
|
|
|
100.0 |
% |
|
27.8% |
Cost of revenues |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses |
|
|
53,085 |
|
|
|
11.8 |
% |
|
|
38,492 |
|
|
|
10.9 |
% |
|
37.9% |
Depreciation and amortization |
|
|
12,147 |
|
|
|
2.6 |
% |
|
|
9,992 |
|
|
|
2.8 |
% |
|
21.6% |
Total cost of revenues |
|
|
65,232 |
|
|
|
14.4 |
% |
|
|
48,484 |
|
|
|
13.7 |
% |
|
34.5% |
Administrative expenses |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales and marketing |
|
|
103,574 |
|
|
|
22.9 |
% |
|
|
74,996 |
|
|
|
21.2 |
% |
|
38.1% |
Research and development |
|
|
42,669 |
|
|
|
9.4 |
% |
|
|
31,605 |
|
|
|
8.9 |
% |
|
35.0% |
General and administrative |
|
|
65,605 |
|
|
|
14.5 |
% |
|
|
60,504 |
|
|
|
17.1 |
% |
|
8.4% |
Depreciation and amortization |
|
|
14,125 |
|
|
|
3.2 |
% |
|
|
11,663 |
|
|
|
3.3 |
% |
|
21.1% |
Total administrative expenses |
|
|
225,973 |
|
|
|
50.0 |
% |
|
|
178,768 |
|
|
|
50.5 |
% |
|
26.4% |
Total operating expenses |
|
|
291,205 |
|
|
|
64.4 |
% |
|
|
227,252 |
|
|
|
64.2 |
% |
|
28.1% |
Operating income |
|
|
160,432 |
|
|
|
35.6 |
% |
|
|
126,267 |
|
|
|
35.8 |
% |
|
27.1% |
Interest expense |
|
|
(837 |
) |
|
|
-0.2 |
% |
|
|
(215 |
) |
|
|
-0.1 |
% |
|
289.3% |
Other income (expense), net |
|
|
6,004 |
|
|
|
1.3 |
% |
|
|
1,412 |
|
|
|
0.4 |
% |
|
325.2% |
Income before income taxes |
|
|
165,599 |
|
|
|
36.7 |
% |
|
|
127,464 |
|
|
|
36.1 |
% |
|
29.9% |
Provision for income taxes |
|
|
46,303 |
|
|
|
10.3 |
% |
|
|
35,534 |
|
|
|
10.1 |
% |
|
30.3% |
Net income |
|
$ |
119,296 |
|
|
|
26.4 |
% |
|
$ |
91,930 |
|
|
|
26.0 |
% |
|
29.8% |
Revenues
The increase in total revenues for the three months ended March 31, 2023 compared to the same period in 2022 was primarily the result of the addition of new clients and productivity and efficiency gains in mature sales offices, which are offices that have been open for at least 24 months, and the sale of additional applications to our existing clients. In addition, the performance of our tax forms filing business contributed to the increase in total revenues for the three months ended March 31, 2023 as compared to the same period in 2022. Because we charge our clients on a per-employee basis for certain services we provide, the drivers of revenue for the three months ended March 31, 2023 described above were impacted by the headcount fluctuations within our client base. Additionally, rising interest rates and a higher average funds held for clients balance during the three months ended March 31, 2023 as compared to the same period in 2022, resulted in increased interest earned on funds held for clients, which had a positive impact on recurring revenue.
The increase in implementation and other revenues for the three months ended March 31, 2023 from the same period in 2022 was primarily the result of the increased non-refundable upfront conversion fees collected from the addition of new clients. These fees are deferred and recognized ratably over the ten-year estimated life of our clients.
Expenses
Cost of Revenues
During the three months ended March 31, 2023, operating expenses increased from the comparable prior year period by $14.6 million primarily due to a $12.5 million increase in employee-related expenses primarily attributable to growth in the number of operating personnel and a $1.6 million increase in shipping and supplies fees. Depreciation and amortization expense increased $2.2 million from the comparable prior year period, primarily due to the development of additional technology and purchases of other fixed assets.
24
Administrative Expenses
Sales and Marketing
During the three months ended March 31, 2023, sales and marketing expenses increased from the comparable prior year period by $28.6 million due to a $21.4 million increase in employee-related expenses, including commissions and bonuses, and a $7.2 million increase in marketing and advertising expense attributable to increased spending across most components of our marketing program.
Research and Development
During the three months ended March 31, 2023, research and development expenses increased from the comparable prior year period due to an increase in employee-related expenses of $11.1 million.
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 March 31, 2023 and 2022:
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|
|
Three Months Ended March 31, |
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|
|
|
|
2023 |
|
|
2022 |
|
|
% Change |
Capitalized portion of research and development |
|
$ |
21,353 |
|
|
$ |
15,400 |
|
|
39% |
Expensed portion of research and development |
|
|
42,669 |
|
|
|
31,605 |
|
|
35% |
Total research and development costs |
|
$ |
64,022 |
|
|
$ |
47,005 |
|
|
36% |
General and Administrative
During the three months ended March 31, 2023, general and administrative expenses increased $5.1 million from the comparable prior year period due to a $3.9 million increase in employee-related expenses and a $1.2 million increase in accounting and legal expenses.
Non-Cash Stock-Based Compensation Expense
The following table presents the non-cash stock-based compensation expense that is included within the specified line items in our consolidated statements of comprehensive income:
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|
Three Months Ended March 31, |
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|
|
2023 |
|
|
2022 |
|
|
% Change |
Non-cash stock-based compensation expense |
|
|
|
|
|
|
|
|
Operating expenses |
|
$ |
2,385 |
|
|
$ |
982 |
|
|
143% |
Sales and marketing |
|
|
5,476 |
|
|
|
2,877 |
|
|
90% |
Research and development |
|
|
5,258 |
|
|
|
2,219 |
|
|
137% |
General and administrative |
|
|
14,700 |
|
|
|
15,977 |
|
|
-8% |
Total non-cash stock-based compensation expense |
|
$ |
27,819 |
|
|
$ |
22,055 |
|
|
26% |
Depreciation and Amortization
During the three months ended March 31, 2023, depreciation and amortization expense increased from the comparable prior year period primarily due to the development of additional technology and purchases of other related fixed assets.
Interest Expense
The increase in interest expense for the three months ended March 31, 2023, as compared to the comparable prior year period, is due to the timing of our entrance into the July 2022 Credit Agreement on July 29, 2022.
25
Other Income (Expense), net
The $4.6 million increase in other income (expense), net for the three months ended March 31, 2023 was primarily due to $5.2 million of income earned on our corporate funds during the period, compared to $0.1 million in the comparable prior year period.
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 28.0% for the three months ended March 31, 2023, which is consistent with the effective income tax rate of 27.9% for the three months ended March 31, 2022.
Liquidity and Capital Resources
Our principal sources of capital and liquidity are our operating cash flow and cash and cash equivalents. Our cash and cash equivalents consist primarily of demand deposit accounts, money market funds and certificates of deposit. Additionally, we maintain a $650.0 million senior secured revolving credit facility (the “July 2022 Revolving Credit Facility”), and a $750.0 million senior secured delayed draw term loan facility (the “July 2022 Term Loan Facility”), which can be accessed as needed to supplement our operating cash flow and cash balances. As of March 31, 2023, we have $29.0 million of outstanding borrowings under the July 2022 Revolving Credit Facility and no outstanding borrowings under the July 2022 Term Loan Facility.
We have historically funded our operations from cash flows generated from operations, cash from the sale of equity securities and debt financing. Although we have funded most of the costs for construction projects at our corporate headquarters and other facilities from available cash, we have incurred indebtedness for a portion of these costs. We are funding the current building expansion at our Oklahoma City headquarters from available cash. Further, all purchases under our stock repurchase plans were paid for from available cash. We believe our existing cash and cash equivalents, cash generated from operations and available sources of liquidity will be sufficient to maintain operations, make necessary capital expenditures, pay dividends and opportunistically repurchase shares for at least the next 12 months. In addition, based on our strong profitability and continued growth, we expect to meet our longer-term liquidity needs with cash flows from operations and, as needed, financing arrangements.
July 2022 Credit Agreement. On July 29, 2022 (the “July 2022 Facility Closing Date”), we entered into a new credit agreement (the “July 2022 Credit Agreement”) with JPMorgan Chase Bank, N.A., as a lender, swingline lender and issuing bank, the lenders from time to time party thereto (collectively with JPMorgan Chase Bank, N.A., the “July 2022 Lenders”), and JPMorgan Chase Bank, N.A., as the administrative agent. The July 2022 Credit Agreement provides for the July 2022 Revolving Credit Facility in the aggregate principal amount of up to $650.0 million, and the ability to request an incremental facility of up to an additional $500.0 million, subject to obtaining additional lender commitments and certain approvals and satisfying certain other conditions. The July 2022 Credit Agreement includes a $25.0 million sublimit for swingline loans and a $6.5 million sublimit for letters of credit. The July 2022 Credit Agreement also provides for the July 2022 Term Loan Facility in the aggregate amount of up to $750.0 million. All loans under the July 2022 Credit Agreement will mature on July 29, 2027 (the “Scheduled Maturity Date”).
The borrowings under the July 2022 Credit Agreement bear interest at a rate per annum equal to (i) the Alternate Base Rate (“ABR”) plus an applicable margin (“ABR Loans”) or (ii) (x) the term Secured Overnight Financing Rate (“SOFR”) plus 0.10% (the “Adjusted Term SOFR Rate”) or (y) the daily SOFR plus 0.10%, in each case plus an applicable margin (“SOFR Rate Loans”). ABR is calculated as the highest of (i) the rate of interest last quoted by The Wall Street Journal in the United States as the prime rate in effect, (ii) the federal funds rate plus 0.5% and (iii) the Adjusted Term SOFR Rate for a one-month interest period plus 1.00%; provided that, if the ABR as determined pursuant to the foregoing would be less than 1.00%, such rate shall be deemed to be 1.00%. The applicable margin for ABR Loans is (i) 0.25% if the Company’s consolidated leverage ratio is less than 1.0 to 1.0; (ii) 0.50% if the Company’s consolidated leverage ratio is greater than or equal to 1.0 to 1.0 but less than 2.0 to 1.0; (iii) 0.75% if the Company’s consolidated leverage ratio is greater than or equal to 2.0 to 1.0 but less than 3.0 to 1.0; or (iv) 1.00% if the Company’s consolidated leverage ratio is greater than or equal to 3.0 to 1.0. The applicable margin for SOFR Rate Loans is (i) 1.25% if the Company’s consolidated leverage ratio is less than 1.0 to 1.0; (ii) 1.5% if the Company’s consolidated leverage ratio is greater than or equal to 1.0 to 1.0 but less than 2.0 to 1.0; (iii) 1.75% if the Company’s consolidated leverage ratio is greater than or equal to 2.0 to 1.0 but less than 3.0 to 1.0; or (iv) 2.00% if the Company’s consolidated leverage ratio is greater than or equal to 3.0 to 1.0. We are required to pay a quarterly commitment fee on the daily amount of the undrawn portion of the revolving commitments under the July 2022 Revolving Credit Facility and a quarterly ticking fee on the daily amount of the undrawn portion of the July 2022 Term Loan Facility, in each case at a rate per annum of (i) 0.20% if the Company’s consolidated leverage ratio is less than 1.0 to 1.0; (ii) 0.225% if the Company’s consolidated leverage ratio is greater than or equal to 1.0 to 1.0 but less than 2.0 to 1.0; (iii) 0.25% if the Company’s consolidated leverage ratio is greater than or equal to 2.0 to 1.0 but less than 3.0 to 1.0; or (iv) 0.275% if the Company’s consolidated leverage ratio is greater than or equal to 3.0 to 1.0. We are also required to pay customary letter of credit fees upon drawing any letter of credit.
26
Under the July 2022 Credit Agreement, we are required to maintain as of the end of each fiscal quarter a consolidated interest ratio of not less than 3.0 to 1.0 and a consolidated leverage ratio of not greater than 3.75 to 1.0, stepping down to 3.0 to 1.0 at intervals thereafter.
We may make up to ten draws under the July 2022 Term Loan Facility at any time during the period from and after the July 2022 Facility Closing Date through twelve months after the July 2022 Facility Closing Date. Loans under the July 2022 Term Loan Facility will amortize in equal quarterly installments commencing with the first full fiscal quarter after the earlier of (x) the date on which the July 2022 Term Loan Facility has been fully drawn and (y) the expiration of the draw period, in an aggregate annual amount equal to 7.5% in year one (if applicable) and year two, and 10% thereafter.
On the July 2022 Facility Closing Date, we borrowed $29.0 million under the July 2022 Revolving Credit Facility to repay the outstanding indebtedness under our prior credit facility, along with accrued interest, expenses and fees. The loan bears interest at the Adjusted Term SOFR Rate for the interest period in effect plus 1.25%.
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 August 2022, our Board of Directors authorized the repurchase of up to $1.1 billion of our common stock. As of March 31, 2023, there was $1.1 billion available for repurchases under our stock repurchase plan. Our stock repurchase plan may be suspended or discontinued at any time. The actual timing, number and value of shares repurchased depends on a number of factors, including the market price of our common stock, general market and economic conditions, shares withheld for taxes associated with the vesting of restricted stock and other corporate considerations. The current stock repurchase plan will expire on August 15, 2024.
During the three months ended March 31, 2023, we repurchased an aggregate of 1,923 shares of our common stock at an average cost of $325.37 per share, all of which were shares withheld to satisfy tax withholding obligations for certain employees upon the vesting of restricted stock. Our payment of the taxes on behalf of those employees resulted in an aggregate cash expenditure of $0.6 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.
Dividend Policy. On May 2, 2023, we announced that our Board of Directors has adopted a dividend policy under which we intend to pay quarterly cash dividends on our common stock, beginning in the second quarter of 2023, at an initial rate of $0.375 per share per quarter. The aggregate amount of cash payable pursuant to this policy is expected to be approximately $91 million annually.
The declaration, timing and amount of each quarterly cash dividend will be subject to the approval of the Board of Directors, including a determination that the dividend policy and the declaration of dividends thereunder are in the best interests of our stockholders and are in compliance with applicable law. The Board of Directors retains the power to modify, suspend, or cancel the dividend policy in any manner and at any time that it may deem necessary or appropriate.
Cash Flow Analysis
Our cash flows from operating activities have historically been significantly impacted by profitability, implementation revenues received but deferred, our investment in sales and marketing to drive growth, and research and development. Our ability to meet future liquidity needs will be driven by our operating performance and the extent of continued investment in our operations. Failure to generate sufficient revenues and related cash flows could have a material adverse effect on our ability to meet our liquidity needs and achieve our business objectives.
As our business grows, we expect our capital expenditures and our investment activity to continue to increase. We are currently focused on the expansion of our corporate headquarters. Capital expenditures related to this expansion began in the fourth quarter of 2021. We estimate that the cost of construction will be between $70 million and $75 million and we expect construction to be completed in the first half of 2024. In addition, we purchased the naming rights to the downtown Oklahoma City arena that is home to the Oklahoma City Thunder National Basketball Association franchise. Under the terms of the naming rights agreement, we committed to make payments escalating annually from $4.0 million in 2021 to $6.1 million in 2035. The payments are due in the fourth quarter of each year. Upon the conclusion of the initial term, the agreement may be extended upon the mutual agreement of both parties for an additional five-year period. Depending on certain growth opportunities, we may choose to accelerate investments in sales and marketing, acquisitions, technology and services. Actual future capital requirements will depend on many factors, including our future revenues, cash from operating activities and the level of expenditures in all areas of our business.
As part of our payroll and payroll tax filing services, we collect funds from our clients for federal, state and local employment taxes, which we remit to the appropriate tax agencies. We invest these funds in money market funds, demand deposit accounts,
27
commercial paper, U.S. treasury securities and certificates of deposit from which we earn interest income during the period between their receipt and disbursement.
Our cash flows from investing and financing activities are influenced by the amount of funds held for clients, which can vary significantly from quarter to quarter. The balance of the funds we hold depends on our clients’ payroll calendars, and therefore such balance changes from period to period in accordance with the timing of each payroll cycle.
Our cash flows from financing activities are also affected by the extent to which we use available cash to purchase shares of common stock under our stock repurchase plan as well as restricted stock vesting events that result in net share settlements and the Company paying withholding taxes on behalf of certain employees.
The following table summarizes the consolidated statements of cash flows for the three months ended March 31, 2023 and 2022:
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
|
|
2023 |
|
|
2022 |
|
|
% Change |
Net cash provided by (used in): |
|
|
|
|
|
|
|
|
Operating activities |
|
$ |
146,103 |
|
|
$ |
117,231 |
|
|
25% |
Investing activities |
|
|
(40,618 |
) |
|
|
(67,626 |
) |
|
-40% |
Financing activities |
|
|
183,003 |
|
|
|
2,098,868 |
|
|
-91% |
Change in cash, cash equivalents, restricted cash and restricted cash equivalents |
|
$ |
288,488 |
|
|
$ |
2,148,473 |
|
|
-87% |
Operating Activities
Cash provided by operating activities for the three months ended March 31, 2023 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 three months ended March 31, 2022, our operating cash flows for the three months ended March 31, 2023 were positively impacted by the growth of our business.
Investing Activities
Cash flows used in investing activities for the three months ended March 31, 2023 decreased from the comparable prior year period due to a $144.2 million decrease in purchases of investments from funds held for clients, which were partially offset by a $111.0 decrease in proceeds from investments from funds held for clients and a $6.1 million increase in purchases of property and equipment,.
Financing Activities
Cash provided by financing activities for the three months ended March 31, 2023 decreased from the comparable prior year period primarily due to the impact of a $1,915.9 million change related to the client funds obligation, which is due to the timing of receipts from our clients and payments made to our clients’ employees and applicable taxing authorities on their behalf and $0.4 million increase in withholding taxes paid related to net share settlements. The decrease in cash flows provided by financing activities was partially offset by a $0.4 decrease in payments of long-term debt.
Contractual Obligations
Our principal commitments primarily consist of long-term debt, leases for office space and the naming rights agreement. There have been no material changes to our contractual obligations disclosed in the contractual obligations section of Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Form 10-K that was filed with the SEC on February 16, 2023. For additional information regarding our naming rights agreement, leases, long-term debt and our commitments and contingencies, see “Note 4. Goodwill and Intangible Assets, Net”, “Note 5. Leases”, “Note 6. Long-Term Debt, Net” and “Note 13. Commitments and Contingencies” in the Form 10-K and “Note 5. Goodwill and Intangible Assets, Net”, “Note 6. Long-Term Debt”, and “Note 13. Commitments and Contingencies” in the notes to our unaudited consolidated financial statements included elsewhere in this Form 10-Q.
28
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 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 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 comprehensive 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.
29
The following tables reconcile net income to adjusted EBITDA, net income to non-GAAP net income and earnings per share to non-GAAP net income per share on a basic and diluted basis:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
|
2023 |
|
|
2022 |
|
Net income to adjusted EBITDA: |
|
|
|
|
|
|
Net income |
|
$ |
119,296 |
|
|
$ |
91,930 |
|
Interest expense |
|
|
837 |
|
|
|
215 |
|
Provision for income taxes |
|
|
46,303 |
|
|
|
35,534 |
|
Depreciation and amortization |
|
|
26,272 |
|
|
|
21,655 |
|
EBITDA |
|
|
192,708 |
|
|
|
149,334 |
|
Non-cash stock-based compensation expense |
|
|
27,819 |
|
|
|
22,055 |
|
Change in fair value of interest rate swap |
|
|
— |
|
|
|
(1,263 |
) |
Adjusted EBITDA |
|
$ |
220,527 |
|
|
$ |
170,126 |
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
|
2023 |
|
|
2022 |
|
Net income to non-GAAP net income: |
|
|
|
|
|
|
Net income |
|
$ |
119,296 |
|
|
$ |
91,930 |
|
Non-cash stock-based compensation expense |
|
|
27,819 |
|
|
|
22,055 |
|
Change in fair value of interest rate swap |
|
|
— |
|
|
|
(1,263 |
) |
Income tax effect on non-GAAP adjustments |
|
|
(4,464 |
) |
|
|
(2,074 |
) |
Non-GAAP net income |
|
$ |
142,651 |
|
|
$ |
110,648 |
|
|
|
|
|
|
|
|
Weighted average shares outstanding: |
|
|
|
|
|
|
Basic |
|
|
57,867 |
|
|
|
58,014 |
|
Diluted |
|
|
57,991 |
|
|
|
58,219 |
|
|
|
|
|
|
|
|
Earnings per share, basic |
|
$ |
2.06 |
|
|
$ |
1.58 |
|
Earnings per share, diluted |
|
$ |
2.06 |
|
|
$ |
1.58 |
|
Non-GAAP net income per share, basic |
|
$ |
2.47 |
|
|
$ |
1.91 |
|
Non-GAAP net income per share, diluted |
|
$ |
2.46 |
|
|
$ |
1.90 |
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
|
2023 |
|
|
2022 |
|
Earnings per share to non-GAAP net income per share, basic: |
|
|
|
|
|
|
Earnings per share, basic |
|
$ |
2.06 |
|
|
$ |
1.58 |
|
Non-cash stock-based compensation expense |
|
|
0.48 |
|
|
|
0.38 |
|
Change in fair value of interest rate swap |
|
|
— |
|
|
|
(0.02 |
) |
Income tax effect on non-GAAP adjustments |
|
|
(0.07 |
) |
|
|
(0.03 |
) |
Non-GAAP net income per share, basic |
|
$ |
2.47 |
|
|
$ |
1.91 |
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
|
2023 |
|
|
2022 |
|
Earnings per share to non-GAAP net income per share, diluted: |
|
|
|
|
|
|
Earnings per share, diluted |
|
$ |
2.06 |
|
|
$ |
1.58 |
|
Non-cash stock-based compensation expense |
|
|
0.48 |
|
|
|
0.38 |
|
Change in fair value of interest rate swap |
|
|
— |
|
|
|
(0.02 |
) |
Income tax effect on non-GAAP adjustments |
|
|
(0.08 |
) |
|
|
(0.04 |
) |
Non-GAAP net income per share, diluted |
|
$ |
2.46 |
|
|
$ |
1.90 |
|
30