Item 7. 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 of our financial condition and results of operations should be read in conjunction with the audited consolidated financial statements (prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) and related notes included elsewhere in this Annual Report on Form 10-K (this “Form 10-K”). The following discussion contains forward-looking statements that are subject to risks and uncertainties. See “Cautionary Statements” for a discussion of the uncertainties, risks, and assumptions associated with those statements. Actual results could differ materially from those discussed in or implied by forward-looking statements as a result of various factors, including those discussed below and elsewhere in this Form 10-K, particularly in the section entitled “Risk Factors.” 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.
Overview
We are a leading provider of a comprehensive, cloud-based human capital management 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 year ended December 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.
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 an important differentiator for attracting new clients and is also key to long-term client satisfaction and client retention. 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. Client adoption of new applications and, historically, client employee usage of both new and existing applications have been significant factors in our revenue growth. Nonetheless, because Beti is designed to eliminate payroll errors that lead to billable corrections and
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unscheduled payroll runs, we have experienced and expect to continue to experience a reduction in these activities that would otherwise generate additional revenue for us.
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 markets 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 markets.
The market for HCM software is highly competitive, rapidly evolving and fragmented, and we expect competition to continue to intensify as new market entrants and disruptive technologies emerge and increasingly aggressive pricing and client retention strategies persist.
Historically, our target client range has been organizations with 50 to 10,000 employees. In 2023, we expanded our target client size range to include organizations with more than 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 and increased the number of applications we offer. Furthermore, with the launch of our Global HCM solution and expansion of payroll services into certain international markets, such as Canada and Mexico, we expect that our ability to serve organizations with international employees makes our solution more attractive to larger companies, many of which have a global presence. 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. A multitude of macroeconomic pressures, such as inflation and rising interest rates, impact our clients’ hiring practices to varying degrees and, in turn, impact our revenues. Generally, we expect that changes in certain factors affecting our performance will correlate with improvement or deterioration in the labor market. For example, the performance of our pre-employment services offerings is sensitive to changes in hiring trends and we believe it will reflect the current slowdown in hiring among U.S. employers.
Based on our total revenues, we have grown at a 23% compound annual growth rate from January 1, 2020 through December 31, 2023. 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. The implementation of the Affordable Care Act (the “ACA”) is an example of legislation that has created demand in the HCM industry. We generate ACA-related revenues (i) on an annual basis in connection with processing and filing Forms 1094 and 1095 on behalf of clients and (ii) from clients who have purchased our Enhanced ACA application as part of the fixed, bundled price charged per billing period. While we generally do not track our revenues on an application-by-application basis (because applications are often sold in various groupings and configurations for a single price), we estimate that, if the ACA is not modified or repealed, revenues from our Enhanced ACA application and ACA forms filings business will represent approximately 2% of total projected revenues for the year ending December 31, 2024.
For each of the years ended December 31, 2023, 2022 and 2021, our gross margins were approximately 84%, 85% and 85%, respectively. Although our gross margin may fluctuate from quarter to quarter due to seasonality and hiring trends, we expect that our gross margin will remain relatively consistent in future periods.
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Key Metrics
In addition to the U.S. GAAP and non-GAAP metrics discussed elsewhere in this Form 10-K, we also monitor the following metrics to evaluate our business, measure our performance and identify trends affecting our business:
Year Ended December 31,
Key performance indicators:
Annual revenue retention rate(1) 90 % 91 % 94 %
(1)
As described below, during 2023, we modified the method by which we calculate annual revenue retention rate. Amounts for 2022 and 2021 have been recast to reflect the new methodology.
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Clients. When we calculate the number of clients at period end, we treat client accounts with separate taxpayer identification numbers (or, in certain circumstances, separate client codes) as separate clients, which often separates client accounts that are affiliated with the same parent organization. We track the number of our clients to provide an accurate gauge of the size of our business. Unless we state otherwise or the context otherwise requires, references to clients throughout this Form 10-K refer to this metric.
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Clients (based on parent company grouping). When we calculate the number of clients based on parent company grouping at period end, we combine client accounts that have identified the same person(s) as their decision-maker regardless of whether the client accounts have separate taxpayer identification numbers (or, in certain circumstances, separate client codes), which often combines client accounts that are affiliated with the same parent organization. We track the number of our clients based on parent company grouping to provide an alternate measure of the size of our business and clients.
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Sales Teams. We monitor our sales professionals by the number of sales teams at period end. CRRs and emerging markets representatives are counted as one sales team. Each outside sales team typically consists of a sales manager and approximately eight sales professionals. Certain larger metropolitan areas can support more than one sales team. We believe the number of sales teams is an indicator of potential revenues for future periods.
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Annual Revenue Retention Rate. Our annual revenue retention rate tracks the percentage of revenues that we retain from our existing clients. We monitor this metric because it is an indicator of client satisfaction and revenues for future periods.
During the year ended December 31, 2023, we modified the method by which we calculate annual revenue retention rate. Prior period amounts have been recast to reflect the new methodology. We now calculate annual revenue retention rate for any 12-month period (a “Measurement Period”) as follows:
Total Revenues – Interest Earned on Funds Held for Clients
The trailing 12-month value of revenue from clients lost during the Measurement Period (“TTM Revenue Attrition”) is equal to the actual recurring fees paid by such lost clients during the 12 months preceding the respective dates on which they last processed payroll with us.
The point at which a client is deemed “lost” is determined based on the terms of our standard services agreement with clients. Beginning in July 2023, commensurate with operational changes related to how we mobilize our services department to manage relationships with clients that have missed a payroll, we amended our standard services agreement and, as a result, the point at which a client was deemed “lost” accelerated. Due to this change in methodology, the TTM Revenue Attrition for the year ended December 31, 2023 (i) includes revenue from certain former clients deemed lost in December 2023 that, under the historical methodology, may have been deemed lost in early 2024, and (ii) excludes revenue from certain former clients that, under the historical methodology, may have been deemed lost in early 2023 but was instead included in the TTM Revenue Attrition for the year ended December 31, 2022. In addition, due to rising interest rates and higher average balances of funds held for clients, we determined that interest earned on funds held for clients should be excluded from the annual revenue retention rate calculation beginning in 2023. In prior years, we did not believe that the interest earned on funds held for clients was material for purposes of this calculation.
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Components of Results of Operations
Sources of Revenues
Revenues consist of recurring revenues, and implementation and other revenues. We expect our revenues to increase as we introduce new applications, expand our client base and renew and expand relationships with existing clients. As a percentage of total revenues, we expect our mix of recurring revenues, and implementation and other revenues to remain relatively constant.
Recurring Revenues
Recurring revenues are derived primarily from our talent acquisition, time and labor management, payroll, talent management and HR management applications as well as fees charged for form filings and delivery of client payroll checks and reports. 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. Because recurring revenues are based, in part, on fees for use of our applications and the delivery of checks and reports that are levied on a per-employee basis, our recurring revenues increase as our clients hire more employees. Recurring revenues are recognized in the period services are rendered.
Recurring revenues include revenues relating to the annual processing of payroll tax filing forms and ACA form filing requirements and revenues from processing unscheduled payroll runs (such as bonuses) for our clients. These payroll forms are typically processed in the first quarter of the year and many of our clients are subject to ACA form filing requirements in the first quarter, which positively impacts first quarter revenues and margins. We anticipate our revenues will continue to exhibit this seasonal pattern related to ACA form filings for so long as the ACA (or replacement legislation) includes employer reporting requirements. In addition, our recurring revenues during the fourth quarter are positively impacted by unscheduled payroll runs for our clients that occur before the end of the year. Nonetheless, we expect the magnitude of these seasonal fluctuations in our revenues to decrease to the extent clients utilize more of our non-payroll applications.
Recurring revenues also include interest earned on funds held for clients. 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. These 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, certificates of deposit and commercial paper 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.
Implementation and Other Revenues
Implementation and other revenues consist of implementation fees for the deployment of our solution and other revenues from sales of time clocks as part of our time and attendance services. Non-refundable implementation fees are charged to new clients at inception and upon the addition of certain incremental applications for existing clients. These fees generally range from 10% to 30% of the annualized value of the transaction. Implementation revenues are recognized as deferred revenue and amortized into income over the life of the client, which is estimated to be ten years, and other revenues are recognized upon shipment of time clocks. Implementation and other revenues comprised approximately 1.7% of our total revenues for each of the years ended December 31, 2023 and 2022.
Cost of Revenues
Cost of revenues consists of expenses related to hosting and supporting our applications, hardware costs, systems support and technology and depreciation and amortization. These costs include employee-related expenses (including non-cash stock-based compensation expenses) and other expenses related to client support, bank charges for processing ACH transactions, certain implementation expenses, delivery charges and paper costs. They also include our cost for time clocks sold and ongoing technology and support costs related to our systems. The amount of depreciation and amortization of property and equipment allocated to cost of revenues is determined based upon an estimate of assets used to support our operations.
Administrative Expenses
Administrative expenses consist of sales and marketing expenses, research and development expenses, general and administrative expenses and depreciation and amortization expenses. Sales and marketing expenses consist primarily of employee-related expenses for our direct sales and marketing staff (such as the amortization of commissions and bonuses and non-cash stock-based compensation expenses), marketing expenses and other related costs. Based on positive results from our advertising campaigns, we plan to continue to invest in our marketing program and may adjust spending levels in future periods as we see opportunities for favorable returns on our investments. Research and development expenses consist primarily of employee-related expenses (including
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non-cash stock-based compensation expenses) for our development staff, net of capitalized software costs for internally developed software. We expect to grow our research and development efforts as we continue to broaden our payroll and HR solution offerings and extend our technological solutions by investing in the development of new applications and enhancements for existing applications. General and administrative expenses consist of employee-related expenses for finance and accounting, legal, human resources and management information systems personnel (including non-cash stock-based compensation expenses), legal costs, professional fees and other corporate expenses. Depreciation and amortization expenses consist of (i) the amount of depreciation and amortization of property and equipment allocated to administrative expenses (based upon an estimate of assets used to support our selling, general and administrative functions) and (ii) amortization of intangible assets.
Interest Expense
Interest expense includes interest on our long-term debt and settlements related to an interest rate swap prior to the termination of the interest rate swap agreement on August 24, 2022. Prior to the repayment of our long-term debt in November 2023, we capitalized interest costs incurred for indebtedness related to construction in progress. See “Note 6. Long-Term Debt” for discussion of the repayment of our debt.
Other Income (Expense), net
Other income (expense), net includes interest earned on our own funds, any gain or loss on the sale or disposal of fixed assets, costs associated with the early repayment of debt, loss on the extinguishment of debt, and the realized gain that resulted from the settlement of our interest rate swap agreement.
Provision for Income Taxes
Our consolidated financial statements include a provision for income taxes incurred for the anticipated tax consequences of the reported results of operations using the asset and liability method. Under this method, we recognize deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial reporting and tax basis of assets and liabilities, as well as for any operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using the tax rates expected to apply to taxable income for the years in which those tax assets and liabilities are expected to be realized or settled. We recognize a valuation allowance to reduce deferred tax assets to the net amount we believe is more likely than not to be realized.
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Results of Operations
The following table sets forth selected consolidated statements of income data and such data as a percentage of total revenues for each of the periods indicated, as well as year-over-year changes with respect to each line item. Refer to “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Annual Report on Form 10-K for the year ended December 31, 2022, filed with the SEC on February 16, 2023, for a discussion of results for the year ended December 31, 2021, including a discussion of the changes in our results of operations for the year ended December 31, 2022 compared to the year ended December 31, 2021.
Year Ended December 31,
Revenues
Cost of revenues
Administrative expenses
Revenues
The increase in total revenues for the year ended December 31, 2023 from the year ended December 31, 2022 was primarily the result of the addition of new clients in our target market range and productivity and efficiency gains across our sales offices, which were partially offset by a decrease in revenue generated by the sale of additional applications to our existing clients. We believe that the Beti-driven reduction in billable corrections and unscheduled payroll runs, as well as lower retention among smaller clients, also adversely impacted the magnitude of the year-over-year increase in revenues. The performance of our tax forms filing business in the first quarter of 2023 contributed to the increase in total revenues for the year ended December 31, 2023, as compared to the year ended December 31, 2022. Because we charge our clients on a per-employee basis for certain services we provide, the drivers of revenue for the year ended December 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 year ended December 31, 2023 as compared to the year ended December 31, 2022, resulted in increased interest earned on funds held for clients, which had a positive impact on recurring revenue. The average daily balance of funds held for clients was $2.2 million and $2.0 million the years ended December 31, 2023 and 2022, respectively.
The increase in implementation and other revenues for the year ended December 31, 2023 from the year ended December 31, 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 year ended December 31, 2023, operating expenses increased from the prior year by $53.9 million primarily due to a $44.2 million increase in employee-related expenses attributable to growth in the number of operating personnel, a $5.0 million increase in shipping and supplies fees, and a $2.5 million increase in automated clearing house fees in connection with the increase in revenues. Depreciation and amortization expense increased $9.7 million, or 22%, primarily due to the development of additional technology and purchases of other related fixed assets.
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Administrative Expenses
Sales and marketing
During the year ended December 31, 2023, sales and marketing expenses increased from the prior year by $71.1 million due to a $51.7 million increase in employee-related expenses, including commissions and bonuses, and a $19.4 million increase in marketing and advertising expense attributable to increased spending across many components of our marketing program.
Research and development
During the year ended December 31, 2023, research and development expenses increased $50.6 million from the prior year primarily due to an increase in employee-related expenses.
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, such as our international expansion, 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 years ended December 31, 2023 and 2022:
Year Ended December 31,
Capitalized portion of research and development $ 96,744 $ 66,407 46%
General and administrative
During the year ended December 31, 2023, general and administrative expenses increased by $49.0 million from the prior year due to a $44.0 million increase in employee-related expenses and a $5.0 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:
Year Ended December 31,
Total non-cash stock-based compensation expense $ 129,806 $ 94,898 37%
Depreciation and Amortization
During the year ended December 31, 2023, depreciation and amortization expense increased from the prior year primarily due to the development of additional technology and purchases of other related fixed assets.
Interest Expense
The decrease in interest expense for the year ended December 31, 2023 was due to the timing and progress of construction of the expansion of our corporate headquarters, which resulted in a higher capitalization rate of interest in 2023. The increase in capitalized interest during 2023 was partially offset by increased costs due to the timing of our entrance into the Credit Agreement (as defined below) on July 29, 2022. Prior to the repayment of our long-term debt in November 2023, we capitalized interest costs incurred for indebtedness related to construction in progress. See “Note 6. Long-Term Debt” for discussion of the repayment of our debt.
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Other Income (Expense), net
The increase in other income (expense), net for the year ended December 31, 2023 was primarily due to income earned on our corporate funds of $23.5 million. Additionally, as a result of the termination of the Term Loan Facility (as defined below), we incurred a loss on the extinguishment of debt of $1.2 million in the year ended December 31, 2023, which consisted of the write-off of unamortized debt issuance costs. See “Note 6. Long-Term Debt” for additional information.
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% for the years ended December 31, 2023 and 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 $1.0 billion senior secured revolving credit facility (the “Revolving Credit Facility”), which can be accessed as needed to supplement our operating cash flow and cash balances. As of December 31, 2023, we did not have any outstanding borrowings under the Revolving Credit Facility.
We have historically funded our operations from cash flows generated from operations, cash from the sale of equity securities and debt financing. We are funding our current building expansion projects from available cash. Further, to date, all cash dividends and purchases under our stock repurchase plan have been funded 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.
Credit Agreement. On July 29, 2022 , we entered into a new credit agreement (the “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 “Lenders”), and JPMorgan Chase Bank, N.A., as the administrative agent. The Credit Agreement initially provided for the 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 Credit Agreement includes a $25.0 million sublimit for swingline loans and a $6.5 million sublimit for letters of credit. The Credit Agreement also initially provided for a $750.0 million senior secured delayed draw term loan facility (the “Term Loan Facility”). As discussed below, the Term Loan Facility was terminated on July 28, 2023. All loans under the Credit Agreement will mature on July 29, 2027 (the “Scheduled Maturity Date”).
The borrowings under the 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 Revolving Credit Facility and, prior to its termination, a quarterly ticking fee on the daily amount of the undrawn portion of the Term Loan Facility, in each case at a rate per annum of (i) 0.20% if the Company’s consolidated leverage ratio is less than 1.0 to 1.0; (ii) 0.225% if the Company’s consolidated leverage ratio is greater than or equal to 1.0 to 1.0 but less than 2.0 to 1.0; (iii) 0.25% if the Company’s consolidated leverage ratio is greater than or equal to 2.0 to 1.0 but less than 3.0 to 1.0; or (iv) 0.275% if the Company’s consolidated leverage ratio is greater than or equal to 3.0 to 1.0. We are also required to pay customary letter of credit fees upon drawing any letter of credit.
Under the Credit Agreement, we are required to maintain as of the end of each fiscal quarter a consolidated interest coverage ratio of not less than 3.0 to 1.0 and a consolidated leverage ratio of not greater than 3.5 to 1.0, stepping down to 3.25 to 1.0 as of December 31, 2024 and 3.0 to 1.0 as of December 31, 2025 and thereafter.
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On July 29, 2022, we borrowed $29.0 million under the Revolving Credit Facility to repay the outstanding indebtedness under our prior credit facility, along with accrued interest, expenses and fees. The loan bore interest at the Adjusted Term SOFR Rate for the interest period in effect plus 1.25%.
On July 28, 2023, we entered into an amendment to the Credit Agreement (the “Credit Agreement Amendment”), pursuant to which the aggregate revolving commitments thereunder were increased from $650.0 million to $1.0 billion, the Term Loan Facility was terminated and the Credit Agreement was amended in contemplation of the formation and future operating activities of Paycom Client Trust (the “Client Trust”) and Paycom National Trust Bank, NA (the “Trust Bank”). We intend to form the Client Trust to hold client payroll and related funds and the Trust Bank to serve as trustee of the Client Trust. We did not make any draws under the Term Loan Facility prior to its termination.
On November 21, 2023, we fully repaid the outstanding indebtedness under the Revolving Credit Facility.
Stock Repurchase Plan and Withholding Shares to Cover Taxes. In May 2016, our Board of Directors authorized a stock repurchase plan allowing for the repurchase of shares of our common stock in open market transactions at prevailing market prices, in privately negotiated transactions or by other means in accordance with federal securities laws, including Rule 10b5-1 programs. Since the initial authorization of the stock repurchase plan, our Board of Directors has amended and extended and authorized new stock repurchase plans from time to time. Most recently, in August 2022, our Board of Directors authorized the repurchase of up to $1.1 billion of our common stock. As of December 31, 2023, there was $799.1 million available for repurchases under our stock repurchase plan. Our stock repurchase plan may be suspended or discontinued at any time. The actual timing, number and value of shares repurchased depends on a number of factors, including the market price of our common stock, general market and economic conditions, shares withheld for taxes associated with the vesting of equity incentive awards and other corporate considerations. The current stock repurchase plan will expire on August 15, 2024.
During the year ended December 31, 2023, we repurchased an aggregate of 1,495,752 shares of our common stock at an average cost of $200.93 per share, including 51,119 shares withheld to satisfy tax withholding obligations for certain employees upon the vesting of equity incentive awards. Our payment of the taxes on behalf of those employees resulted in an aggregate cash expenditure of $13.9 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.
Dividends on Common Stock. For a discussion of our dividends, see “Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.”
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. For example, we estimate that the total cost of the current expansion project at our corporate headquarters will be between $87 million and $90 million. Capital expenditures related to this expansion began in the fourth quarter of 2021 and we expect construction to be completed in the first quarter 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 employment taxes, which we remit to the appropriate tax agencies. We typically invest these funds in money market funds, demand deposit accounts, certificates of deposit, commercial paper and U.S. treasury securities from which we earn interest income during the period between receipt and disbursement of such funds.
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 equity incentive award vesting events that result in net share settlements and
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the Company paying withholding taxes on behalf of certain employees. Additionally, we intend to continue to pay a quarterly cash dividend, subject to the discretion of the Board of Directors.
The following table summarizes the consolidated statements of cash flows for the years ended December 31, 2023 and 2022:
Year Ended December 31,
Net cash provided by (used in):
Operating Activities
Cash provided by operating activities for the year ended December 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 year ended December 31, 2022, our operating cash flows for the year ended December 31, 2023 were positively impacted by the growth of our business.
Investing Activities
Cash used in investing activities for the year ended December 31, 2023 increased from the prior year due to a $357.2 million decrease in proceeds from investments from funds held for clients, a $59.9 million increase in purchases of property and equipment, and a $0.1 million increase in purchases of intangible assets, which were partially offset by a $243.7 million decrease in purchases of investments from funds held for clients and a $0.1 million increase in proceeds from the sale of property and equipment.
Financing Activities
Cash used in financing activities for the year ended December 31, 2023 increased from the prior year primarily due to the impact of a $240.8 million change related to the client funds obligation, which is due to the timing of receipts from our clients and payments made to our clients’ employees and applicable taxing authorities on their behalf, a $192.0 million increase in common stock repurchases, the payment of $64.8 million in cash dividends, a $29.0 million decrease in proceeds from the issuance of debt, and a $8.8 million increase in withholding taxes paid related to net share settlements. The increase in cash used in financing activities was partially offset by a $0.3 million decrease in payments on long-term debt and a $5.8 million decrease in payment of debt issuance costs.
Contractual Obligations
Our principal commitments primarily consist of leases for office space and the naming rights agreement. For additional information regarding our naming rights agreement, leases, and our commitments and contingencies, see “Note 4. Goodwill and Intangible Assets, Net”, “Note 5. Leases” and “Note 13. Commitments and Contingencies”.
We plan to continue to lease additional office space to support our growth. In addition, many of our existing lease agreements provide us with the option to renew. When applicable, our future operating lease obligations include payments due during any renewal period provided for in the lease where the lease imposes a penalty for failure to renew. Additional details on our leases, including the related future cash outflows, are included within “Note 5. Leases” in the notes to our consolidated financial statements included elsewhere within this Form 10-K.
Critical Accounting Policies and Estimates
Our consolidated financial statements and accompanying notes have been prepared in accordance with 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. Estimates made in accordance with U.S. GAAP that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on our financial condition are described below. 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 described below. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our consolidated financial condition and results of operations.
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Revenue Recognition
Revenues are recognized when control of the promised goods or services is transferred to our clients in an amount that reflects the consideration we expect to be entitled to for those goods or services. Substantially all of our revenues are revenues from contracts with clients. Sales and other applicable taxes are excluded from revenues.
Recurring revenues are derived primarily from our talent acquisition, time and labor management, payroll, talent management and HR management applications as well as fees charged for form filings and delivery of client payroll checks and reports. Talent acquisition includes our Applicant Tracking, Candidate Tracker, Enhanced Background Checks, Onboarding, E-Verify and Tax Credits applications. Time and labor management includes Time and Attendance, Scheduling, Time-Off Requests with GONE, Labor Allocation, Labor Management Reports/Push Reporting, Geofencing/Geotracking and Microfence tools and applications. Payroll includes Beti, Payroll and Tax Management, Vault, Everyday, Paycom Pay, Client Action Center, Expense Management, Mileage Tracker/FAVR, Garnishment Administration and GL Concierge applications. Talent management includes our Employee Self-Service, Compensation Budgeting, Performance Management, Position Management, My Analytics and Paycom Learning applications. HR management includes our Manager on-the-Go, Direct Data Exchange, Ask Here, Documents and Checklists, Government and Compliance, Benefits Administration/Benefits to Carrier, Benefit Enrollment Service, COBRA Administration, Personnel Action Forms and Performance Discussion Forms, Surveys, Enhanced ACA and Clue applications. With Global HCM, a number of our HCM applications and tools are available in 15 languages and dialects and are accessible to users in more than 180 countries.
The performance obligations related to recurring revenues are generally satisfied during each client’s payroll period, with the agreed-upon fee being charged and collected as part of our processing of the client’s payroll. Recurring revenues are recognized at the conclusion of processing of each client’s payroll period, when each respective payroll client is billed. Collectability is reasonably assured as the fees are generally collected through an automated clearing house as part of the client’s payroll cycle or through direct wire transfer, which minimizes the default risk.
The contract period for substantially all contracts associated with these revenues is one month due to the fact that both we and the client have the unilateral right to terminate a wholly unperformed contract without compensating the other party by providing 30 days’ notice of termination. 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. For clients who purchase multiple applications, due to the short-term nature of our contracts, we do not believe it is meaningful to separately assess and identify whether or not each application potentially represents its own, individual, performance obligation as the revenue generated from each application is recognized within the same month as the revenue from the core payroll application. Similarly, we do not believe it is meaningful to individually determine the standalone selling price for each application. We consider the total price charged to a client in a given period to be indicative of the standalone selling price, as the total amount charged is within a reasonable range of prices typically charged for our goods and services for comparable classes of client groups, which we periodically assess for price adjustments.
Interest income on funds held for clients is earned on funds that are collected from clients in advance of either the applicable due date for payroll tax submissions or the applicable disbursement date for employee payment services. The interest earned on these funds is included in recurring revenues in the consolidated statements of comprehensive income, as the collection, holding, and remittance of these funds are essential components of providing these services.
Implementation and other revenues consist of nonrefundable upfront conversion fees which are charged to new clients to offset the expense of new client set-up as well as revenues from the sale of time clocks as part of our time and attendance application. Although these revenues are related to our recurring revenues, they represent distinct performance obligations.
Implementation activities primarily represent administrative activities that allow us to fulfill future performance obligations for our clients and do not represent services transferred to the client. However, the nonrefundable upfront fee charged to our clients results in an implied performance obligation in the form of a material right to the client related to the client’s option to renew at the end of each 30-day contract period. Further, given that all other services within the contract are sold at a total price indicative of the standalone selling price, coupled with the fact that the upfront fees are consistent with upfront fees charged in similar contracts that we have with clients, the standalone selling price of the client’s option to renew the contract approximates the dollar amount of the nonrefundable upfront fee. The nonrefundable upfront fee is typically included on the client’s first invoice, and is deferred and recognized ratably over the estimated renewal period (i.e. ten-year estimated client life).
Revenues from the sale of time clocks are recognized when control is transferred to the client upon delivery of the product. We estimate the standalone selling price for the time clocks by maximizing the use of observable inputs such as our specific pricing practices for time clocks.
Goodwill and Other Intangible Assets
Goodwill is not amortized, but we are required to test the carrying value of goodwill for impairment at least annually, or earlier if, at the reporting unit level, an indicator of impairment arises. Our business is largely homogeneous and, as a result, goodwill is
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associated with one reporting unit. We have selected June 30 as our annual goodwill impairment testing date. A review of goodwill may be initiated before or after conducting the annual analysis if events or changes in circumstances indicate the carrying value of goodwill may no longer be recoverable. The Company performed a qualitative assessment to determine if it is more-likely-than-not that the fair value of the reporting units had declined below its carrying value. In the qualitative assessment, we consider the macroeconomic conditions, including any deterioration of general economic conditions, industry and market conditions, including any deterioration in the environment where the reporting unit operates, changes in the products/services and regulator and political developments; cost of doing business; overall financial performance; other relevant reporting unit specific facts, such as changes in management or key personnel or pending litigation. Based on our assessment, there was no impairment recorded as of June 30, 2023. For the years ended December 31, 2023, 2022 and 2021, there were no indicators of impairment. Intangible assets with definite lives are amortized on a straight-line basis over their estimated useful lives.
Impairment of Long-Lived Assets
Long-lived assets, including intangible assets with finite lives, are reviewed for impairment when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized for the amount by which the carrying amount of the asset exceeds the estimated fair value of the asset. We have determined that there was no impairment of long-lived assets for the years ended December 31, 2023, 2022 and 2021.
Market-Based Restricted Stock Awards and Performance-Based Restricted Stock Units
We measure non-cash stock-based compensation expense based on the fair value of the award on the date of grant. We determine the fair value of stock and unit awards issued by using a Monte Carlo simulation model. This model considers various subjective assumptions as inputs, and represent our best estimates, which involve inherent uncertainties and the application of our judgment as it relates to market volatilities, the historical volatility of our stock price, risk-free rates and expected life. The valuation model also incorporates exercise and forfeiture assumptions based on an analysis of historical data. Determining these assumptions is subjective and complex, and therefore, a change in the assumptions utilized could impact the calculation of the fair value of our market-based stock awards and performance-based restricted stock units and the associated compensation expense. Refer to Note 12 in the notes to our consolidated financial statements for further information regarding our stock-based compensation awards.
Recent Accounting Pronouncements
Refer to Note 2 in the notes to the consolidated financial statements for a full description of recent accounting pronouncements.
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), the change in fair value of our interest rate swap (if any) and any loss on the extinguishment of debt 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), the change in fair value of our interest rate swap (if any) and any loss on the extinguishment of debt, 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, paying dividends, repurchasing common stock and other purposes. Management believes that the non-GAAP measures presented in this Form 10-K, 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.
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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. Refer to “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Annual Report on Form 10-K for the year ended December 31, 2022, filed with the SEC on February 16, 2023, for a presentation of the amounts for the year ended December 31, 2021.
Year Ended December 31,
Net income to adjusted EBITDA:
Non-cash stock-based compensation expense 129,806 94,898
Loss on extinguishment of debt 1,222 —
Year Ended December 31,
Net income to non-GAAP net income:
Non-cash stock-based compensation expense 129,806 94,898
Loss on extinguishment of debt 1,222 —
Income tax effect on non-GAAP adjustments (22,331 ) (19,053 )
Weighted average shares outstanding:
Earnings per share, basic $ 5.91 $ 4.86
Earnings per share, diluted $ 5.88 $ 4.84
Non-GAAP net income per share, basic $ 7.79 $ 6.17
Non-GAAP net income per share, diluted $ 7.75 $ 6.14
Year Ended December 31,
Earnings per share to non-GAAP net income per share, basic:
Earnings per share, basic $ 5.91 $ 4.86
Non-cash stock-based compensation expense 2.25 1.64
Loss on extinguishment of debt 0.02 —
Income tax effect on non-GAAP adjustments (0.39 ) (0.33 )
Non-GAAP net income per share, basic $ 7.79 $ 6.17
Year Ended December 31,
Earnings per share to non-GAAP net income per share, diluted:
Earnings per share, diluted $ 5.88 $ 4.84
Non-cash stock-based compensation expense 2.24 1.63
Loss on extinguishment of debt 0.02 —
Income tax effect on non-GAAP adjustments (0.39 ) (0.33 )
Non-GAAP net income per share, diluted $ 7.75 $ 6.14
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Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Interest rate sensitivity
As of December 31, 2023, we had corporate cash and cash equivalents totaling $294.0 million and funds held for clients cash and cash equivalents totaling $2.3 billion. These amounts are invested primarily in demand deposit accounts and money market funds. We consider all highly liquid debt instruments with an original maturity of three months or less and SEC-registered money market mutual funds to be cash equivalents. Additionally, we had available-for-sale securities totaling $198.6 million included within funds held for clients on the consolidated balance sheets as of December 31, 2023. Our available-for-sale securities consisted of U.S. treasury securities with an original maturity greater than one year and certificates of deposit. The primary objectives of our investing activities are capital preservation, meeting our liquidity needs and, with respect to investing client funds, generating interest income while maintaining the safety of principal. We do not enter into investments for trading or speculative purposes.
Our investments are subject to market risk due to changes in interest rates. The market value of fixed rate securities may be adversely affected due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates, or we may suffer losses in principal if we are forced to sell securities that decline in market value due to changes in interest rates. We classify all debt securities as available-for-sale and, as a result, no gains or losses are recognized due to changes in interest rates until such securities are sold or decreases in fair value are determined to be nonrecoverable. To date, we have not recorded any credit impairment losses on our portfolio.
As of December 31, 2023, a hypothetical increase or decrease in interest rates of 100 basis points would result in an approximately $19.2 million increase or decrease, respectively, in interest earned on funds held for clients over the ensuing 12-month period. Interest earned on funds held for clients is included in recurring revenues in the consolidated statements of comprehensive income. There are no incremental costs of revenue associated with changes in interest earned on funds held for clients.
An immediate increase in interest rates of 100 basis points would have resulted in a $0.5 million reduction in the aggregate market value of our fixed rate securities as of December 31, 2023. An immediate decrease in interest rates of 100 basis points would have resulted in a $0.5 million increase in the aggregate market value of our fixed rate securities as of December 31, 2023. These estimates are based on a sensitivity model that measures market value changes when changes in interest rates occur.
As of December 31, 2023, we did not have any indebtedness outstanding under the Revolving Credit Facility. As of December 31, 2023, a hypothetical 100 basis point change in the applicable reference rates would not result in a change our interest expense over the ensuing 12-month period. Please refer to “Note 6. Long-Term Debt” for additional information.
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Item 8. Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Paycom Software, Inc.
Consolidated Annual Financial Statements
Report of Independent Registered Public Accounting Firm (PCAOB ID Number 248) 56
Consolidated Balance Sheets as of December 31, 2023 and 2022 58
Notes to the Consolidated Financial Statements 63
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Paycom Software, Inc.
Opinion on the financial statements
We have audited the accompanying consolidated balance sheets of Paycom Software, Inc. (a Delaware corporation) and subsidiaries (the “Company”) as of December 31, 2023 and 2022, the related consolidated statements of comprehensive income, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2023, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2023 and 2022, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2023, in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company’s internal control over financial reporting as of December 31, 2023, based on criteria established in the 2013 Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”), and our report dated February 15, 2024 expressed an unqualified opinion.
Basis for opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical audit matter
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Deferred implementation revenue and contract costs amortization period
As described further in Note 2 to the financial statements, the Company capitalizes costs associated with obtaining and fulfilling revenue contracts when it expects the amortization period to be longer than one year. The resulting assets are amortized over the expected period of benefit of ten years, which the Company has determined to be the estimated life of a client relationship. The Company also uses the estimated client relationship period in recognizing deferred implementation revenue. We identified the amortization period of both the deferred contract costs as well as the deferred implementation revenue as a critical audit matter.
The principal considerations for our determination that the amortization period of both the deferred contract costs as well as the deferred implementation revenue is a critical audit matter are as follows. Given the materiality of the balances of deferred contract costs and deferred implementation revenue, this assumption is considered sensitive as a change could yield a material impact on the financial statements. Auditing the estimated life of the Company’s client relationships required significant auditor judgment in planning and executing the appropriate audit procedures.
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Our audit procedures related to the estimated life of the Company’s client relationships included the following, among others. We tested the design and operating effectiveness of controls relating to management’s annual review of the reasonableness of the estimated life of a client relationship, including controls over the completeness of key inputs in the calculation and the review of the methodology applied by the Company’s third-party specialist. With the assistance of a valuation specialist, we tested the methodologies used in determining the appropriateness of the estimated life by evaluating the relationship between the average life of a client and the associated attrition rate for reasonableness. This included reperforming the calculation and verifying that all provided historical data was utilized in the analysis. We also performed procedures over the data utilized in the analysis, including comparing a sample of historical data to previously audited information.
/s/ GRANT THORNTON LLP
We have served as the Company’s auditor since 2009.
Oklahoma City, Oklahoma
February 15, 2024
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Paycom Software, Inc.
Consolidated Balance Sheets
(in thousands, except per share amounts)
Assets
Current assets:
Liabilities and Stockholders’ Equity
Current liabilities:
Accrued expenses and other current liabilities 83,302 59,990
Current liabilities before client funds obligation 206,567 169,331
Commitments and contingencies
Stockholders’ equity:
Accumulated other comprehensive earnings (loss) (1,039 ) (3,703 )
See accompanying notes to the consolidated financial statements.
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Paycom Software, Inc.
Consolidated Statements of Comprehensive Income
(in thousands, except per share amounts)
Year Ended December 31,
Revenues
Cost of revenues
Administrative expenses
Earnings per share, basic $ 5.91 $ 4.86 $ 3.39
Earnings per share, diluted $ 5.88 $ 4.84 $ 3.37
Weighted average shares outstanding:
Comprehensive earnings (loss):
Unrealized net gains (losses) on available-for-sale securities 3,501 (4,757 ) —
Other comprehensive income (loss), net of tax 2,664 (3,703 ) —
See accompanying notes to the consolidated financial statements.
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Paycom Software, Inc.
Consolidated Statements of Stockholders’ Equity
(in thousands)
Common Stock Additional Retained Accumulated Other Treasury Stock Total
Vesting of restricted stock 437 5 (5 ) — — — — —
Other comprehensive earnings (loss), net of tax — — — — — — — —
Vesting of restricted stock 220 2 (2 ) — — — — —
Other comprehensive earnings (loss), net of tax — — — — (3,703 ) — — (3,703 )
Vesting of restricted stock 157 2 (1 ) — — — — 1
Other comprehensive earnings (loss), net of tax — — — — 2,664 — — 2,664
See accompanying notes to the consolidated financial statements.
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Paycom Software, Inc.
Consolidated Statements of Cash Flows
(in thousands)
Year Ended December 31,
Cash flows from operating activities
Accretion of discount on available-for-sale securities (520 ) (1,020 ) (452 )
Loss (Gain) on disposition of property and equipment 23 (150 ) 146
Amortization of debt issuance costs 1,225 847 36
Loss on extinguishment of debt 1,222 — —
Cash paid for derivative settlement — 205 (741 )
Gain on derivative — (1,559 ) (662 )
Changes in operating assets and liabilities:
Cash flows from investing activities
Proceeds from sale of property and equipment 119 — —
Cash flows from financing activities
Proceeds from the issuance of debt — 29,000 —
Dividends paid (64,838 ) — —
Payment of debt issuance costs (647 ) (6,436 ) —
Cash, cash equivalents, restricted cash and restricted cash equivalents
See accompanying notes to the consolidated financial statements.
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Paycom Software, Inc.
Consolidated Statements of Cash Flows, continued
(in thousands)
Year Ended December 31,
Supplemental disclosures of cash flow information:
Cash paid for interest, net of amounts capitalized $ 985 $ 507 $ 2
Non-cash investing and financing activities:
Stock-based compensation for capitalized software $ 14,657 $ 8,965 $ 7,141
See accompanying notes to the consolidated financial statements.
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Paycom Software, Inc.
Notes to the Consolidated Financial Statements
(tabular dollars and shares in thousands, except per share and per unit amounts)
1.
ORGANIZATION AND DESCRIPTION OF BUSINESS
Description of Business
Paycom Software, Inc. (“Software”), together with its wholly owned subsidiaries (collectively, the “Company”), is a leading provider of a comprehensive, cloud-based human capital management solution delivered as Software-as-a-Service. Unless we state otherwise or the context otherwise requires, the terms “we,” “our,” “us” and the “Company” refer to Software and its consolidated subsidiaries.
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.
2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
Our consolidated financial statements include the financial results of Software and its wholly owned subsidiaries and have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and applicable rules and regulations of the Securities and Exchange Commission (“SEC”). Intercompany balances and transactions have been eliminated in consolidation. In the opinion of management, the accompanying consolidated financial statements include all adjustments necessary for the fair presentation for the periods presented.
Recently Adopted Accounting Pronouncements
In March 2020, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2020-04, “Reference Rate Reform (Topic 848) Facilitation of the Effects of Reference Rate Reform on Financial Reporting” (“ASU 2020-04”). ASU 2020-04 provides temporary optional expedients and exceptions for applying U.S. GAAP to contracts, hedging relationships and other transactions affected by reference rate reform. Prior to August 24, 2022, our floating-to-fixed interest rate swap was outstanding to offset the rate variability associated with our outstanding indebtedness. As discussed in Note 7, the interest rate swap was terminated on August 24, 2022. As a result, the adoption of ASU 2020-04 had no material impact on our consolidated financial statements.
In January 2021, the FASB issued ASU No. 2021-01, “Reference Rate Reform (Topic 848) Scope” (“ASU 2021-01”), which clarifies that certain optional expedients and exceptions in Topic 848 for contract modifications and hedge accounting apply to derivative instruments that are affected by the discounting transition. ASU 2021-01 amends the expedients and exceptions in Topic 848 to capture the incremental consequences of the scope clarification and to tailor the existing guidance to derivative instruments affected by the discounting transition. As discussed in Note 7, the interest rate swap was terminated on August 24, 2022. As a result, the adoption of ASU 2021-01 had no material impact on our consolidated financial statements.
Use of Estimates
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Significant estimates include income taxes, loss contingencies, the useful life of property and equipment and intangible assets, the life of our client relationships, the fair value of our stock-based awards and the fair value of our financial instruments, intangible assets and goodwill. These estimates are based on historical experience, where applicable, and other assumptions that management believes are reasonable under the circumstances. Actual results could materially differ from these estimates.
Segment Information
We operate in a single operating segment and a single reporting segment. Operating segments are defined as components of an enterprise about which separate financial information is evaluated regularly by the chief operating decision maker function (which is fulfilled by the Co-Chief Executive Officers) in deciding how to allocate resources and assessing performance. Our Co-Chief Executive Officers allocate resources and assess performance based upon financial information at the consolidated level. As we operate in one operating segment, all required financial segment information is presented in the consolidated financial statements.
Cash Equivalents
We consider all highly liquid instruments with an original maturity of three months or less and SEC-registered money market mutual funds to be cash equivalents. We maintain cash and cash equivalents in demand deposit accounts, money market funds, and certificates of deposit, which may not be federally insured. The fair value of our cash and cash equivalents approximates carrying
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Paycom Software, Inc.
Notes to the Consolidated Financial Statements
(tabular dollars and shares in thousands, except per share and per unit amounts)
value. We have not experienced any losses in such accounts and do not believe there is exposure to any significant credit risk on such accounts.
Accounts Receivable
We generally collect revenues from our clients through an automatic deduction from the clients’ bank accounts at the time payroll processing occurs. Accounts receivable on our consolidated balance sheets generally consists of revenue-related receivables, including processing fees, interest income receivable, and revenue fees related to the last business day of the year, which are collected on the following business day. As accounts receivable are collected via automatic deduction on the following business day, the Company has not recognized an allowance for doubtful accounts.
Property and Equipment
Property and equipment is stated at cost, net of accumulated depreciation and amortization. Depreciation is computed using the straight line method over the estimated useful lives of the assets as follows:
Furniture, fixtures and equipment 5 years
Computer equipment 3 years
Software and capitalized software 3 years
Buildings 30 years
Leasehold improvements 5 years
Rental clocks 5 years
Land improvements 15 years
Vehicles 3 years
Costs incurred during construction of long-lived assets are recorded as construction in progress and are not depreciated until the asset is placed in service.
Prior to the repayment of our debt on November 21, 2023, we capitalized interest costs incurred for indebtedness related to construction in progress. For the years ended December 31, 2023, 2022 and 2021, we incurred interest costs of $5.3 million, $3.4 million and $1.4 million, respectively. For the years ended December 31, 2023, 2022 and 2021, interest costs of $3.4 million, $0.9 million and $1.4 million, respectively, were capitalized. See Note 6 for discussion of repayment of our indebtedness.
Leases
Our leases primarily consist of noncancellable operating leases for office space. We recognize a right-of-use asset and operating lease liability on the lease commencement date based on the present value of the lease payments over the lease term. Operating lease liabilities are measured by discounting future lease payments at an estimated incremental borrowing rate. Right-of-use assets are amortized over the lease term and include adjustments related to prepaid rent.
Internal Use Software
Capitalized costs include costs for services associated with developing or obtaining internal use computer software andcertain payroll and payroll-related costs for employees who are directly associated with internal use computer software projects. The amount of payroll costs that are capitalized with respect to these employees is limited to the time directly spent on such projects. Expenditures for software purchases and software developed or obtained for internal use are capitalized and amortized over a three-year period on a straight-line basis. Costs associated with preliminary project stage activities, training, maintenance and all other post-implementation stage activities are expensed as incurred. We also expense internal costs related to minor upgrades and enhancements, as it is impractical to separate these costs from normal maintenance activities.
The total capitalized payroll costs related to internal use computer software projects were $96.7 million and $66.4 million during the years ended December 31, 2023 and 2022, respectively, and are included in property and equipment. Amortization expense of capitalized software costs was $61.9 million, $47.3 million and $36.5 million for the years ended December 31, 2023, 2022 and 2021, respectively.
Derivatives
In December 2017, we entered into a floating-to-fixed interest rate swap agreement to limit the exposure to floating interest rate risk related to the 2017 Term Loans (as defined in Note 6). We do not hold derivative instruments for trading or speculative purposes. The interest rate swap agreement effectively converted a portion of the variable interest rate payments to fixed interest rate payments. We account for our derivatives under ASC Topic 815, “Derivatives and Hedging,” and recognize all derivative instruments in the consolidated balance sheets at fair value as either short-term or long-term assets or liabilities based on their anticipated settlement
64
Paycom Software, Inc.
Notes to the Consolidated Financial Statements
(tabular dollars and shares in thousands, except per share and per unit amounts)
date. See Note 9, “Fair Value of Financial Instruments”. We elected not to designate our interest rate swap as a hedge; therefore, changes in the fair value of the derivative instrument were recognized in our consolidated statements of comprehensive income within Other income (expense), net. As further discussed in Note 7, on August 24, 2022, we terminated the interest rate swap by settling the contract.
Goodwill and Other Intangible Assets
Goodwill is not amortized, but we are required to test the carrying value of goodwill for impairment at least annually, or earlier if, at the reporting unit level, an indicator of impairment arises. Our business is largely homogeneous and, as a result, goodwill is associated with one reporting unit. We have selected June 30 as our annual goodwill impairment testing date. A review of goodwill may be initiated before or after conducting the annual analysis if events or changes in circumstances indicate the carrying value of goodwill may no longer be recoverable. The Company performed a qualitative assessment to determine if it is more-likely-than-not that the fair value of the reporting unit had declined below its carrying value. In the qualitative assessment, we consider macroeconomic conditions, including any deterioration of general economic conditions; industry and market conditions, including any deterioration in the environment where the reporting unit operates; changes in the products/services; regulatory and political developments; cost of doing business; overall financial performance; and other relevant reporting unit specific facts, such as changes in management or key personnel or pending litigation. Based on our assessment, there was no impairment recorded as of June 30, 2023. For the years ended December 31, 2023, 2022 and 2021, there were no indicators of impairment. Intangible assets with definite lives are amortized on a straight-line basis over their estimated useful lives.
Impairment of Long-Lived Assets
Long-lived assets, including intangible assets with definite lives, are reviewed for impairment when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized for the amount by which the carrying amount of the asset exceeds the estimated fair value of the asset. We have determined that there was no impairment of long-lived assets including intangible assets with definite lives, for the years ended December 31, 2023, 2022 and 2021.
Funds Held for Clients and Client Funds Obligation
As part of our payroll and tax filing services, we (i) collect client funds to satisfy their respective employment tax obligations, (ii) remit such funds to the appropriate taxing authorities and accounts designated by our clients, and (iii) manage client tax filings and any related correspondence with taxing authorities. Amounts collected by us from clients for their employment taxes are invested by us, and we earn interest on these funds during the interval between receipt and disbursement.
These investments are shown in our consolidated balance sheets as funds held for clients, and the associated liability for the tax filings is shown as client funds obligation. The liability is recorded in the accompanying consolidated balance sheets at the time we obtain the funds from clients. The client funds obligation represents liabilities that will be repaid within one year of the consolidated balance sheet date. As of December 31, 2023 and December 31, 2022, the funds held for clients were invested in money market funds, demand deposit accounts and certificates of deposit. Additionally, the funds held for clients were invested in U.S. treasury securities with an original maturity of greater than one year. Historically, we have also invested funds held for clients in commercial paper. Short-term investments in instruments with an original maturity greater than three months, including certificates of deposit, commercial paper and U.S. treasury securities, are classified as available for-sale securities, and are also included within the funds held for clients line item in the consolidated balance sheets. These available-for-sale securities are recorded in the consolidated balance sheets at fair value, with the difference between the amortized cost and fair value of these available-for-sale securities recorded as unrealized net gains (losses) on available-for-sale securities, and are included within comprehensive earnings (loss) in the consolidated statements of comprehensive income. Funds held for clients are classified as a current asset in the consolidated balance sheets because the funds are held solely to satisfy the client funds obligation. Additionally, the funds held for clients is classified as restricted cash and restricted cash equivalents and presented within the reconciliation of cash, cash equivalents, restricted cash and restricted cash equivalents on the consolidated statements of cash flows.
Stock Repurchase Plan
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 December 31, 2023, there was $799.1 million available for repurchases under our stock repurchase plan. Our stock repurchase plan may be suspended or discontinued at any
65
Paycom Software, Inc.
Notes to the Consolidated Financial Statements
(tabular dollars and shares in thousands, except per share and per unit amounts)
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 equity incentive awards and other corporate considerations. The current stock repurchase plan will expire on August 15, 2024.
During the year ended December 31, 2023, we repurchased an aggregate of 1,495,752 shares of our common stock at an average cost of $200.93 per share, including 51,119 shares withheld to satisfy tax withholding obligations for certain employees upon the vesting of equity incentive awards. During the year ended December 31, 2022, we repurchased an aggregate of 364,667 shares of our common stock at an average cost of $273.74 per share, including 17,355 shares withheld to satisfy tax withholding obligations for certain employees upon the vesting of the restricted stock.
Revenue Recognition
Revenues are recognized when control of the promised goods or services is transferred to our clients in an amount that reflects the consideration we expect to be entitled to for those goods or services. Substantially all of our revenues are revenues from contracts with clients. Sales taxes and other applicable taxes are excluded from revenues.
Recurring Revenues
Recurring revenues are derived primarily from our talent acquisition, time and labor management, payroll, talent management and HR management applications as well as fees charged for form filings and delivery of client payroll checks and reports. Talent acquisition includes our Applicant Tracking, Candidate Tracker, Enhanced Background Checks, Onboarding, E-Verify and Tax Credits applications. Time and labor management includes Time and Attendance, Scheduling, Time-Off Requests with GONE, Labor Allocation, Labor Management Reports/Push Reporting, Geofencing/Geotracking and Microfence tools and applications. Payroll includes Beti, Payroll and Tax Management, Vault, Everyday, Paycom Pay, Client Action Center, Expense Management, Mileage Tracker/FAVR, Garnishment Administration and GL Concierge applications. Talent management includes our Employee Self-Service, Compensation Budgeting, Performance Management, Position Management, My Analytics and Paycom Learning applications. HR management includes our Manager on-the-Go, Direct Data Exchange, Ask Here, Documents and Checklists, Government and Compliance, Benefits Administration/Benefits to Carrier, Benefit Enrollment Service, COBRA Administration, Personnel Action Forms and Performance Discussion Forms, Surveys, Enhanced ACA and Clue applications. With Global HCM, a number of our HCM applications and tools are available in 15 languages and dialects and are accessible to users in more than 180 countries.
The performance obligations related to recurring revenues are generally satisfied during each client’s payroll period, with the agreed-upon fee being charged and collected as part of our processing of the client’s payroll. Recurring revenues are recognized at the conclusion of processing of each client’s payroll period, when each respective payroll client is billed. Collectability is reasonably assured as the fees are generally collected through an automated clearing house as part of the client’s payroll cycle or through direct wire transfer, which minimizes the default risk.
The contract period for substantially all contracts associated with these revenues is one month due to the fact that both we and the client have the unilateral right to terminate a wholly unperformed contract without compensating the other party by providing 30 days’ notice of termination. 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. For clients who purchase multiple applications, due to the short-term nature of our contracts, we do not believe it is meaningful to separately assess and identify whether or not each application potentially represents its own, individual, performance obligation as the revenue generated from each application is recognized within the same month as the revenue from the core payroll application. Similarly, we do not believe it is meaningful to individually determine the standalone selling price for each application. We consider the total price charged to a client in a given period to be indicative of the standalone selling price, as the total amount charged is within a reasonable range of prices typically charged for our goods and services for comparable classes of client groups, which we periodically assess for price adjustments.
Interest income on funds held for clients is earned on funds that are collected from clients in advance of either the applicable due date for payroll tax submissions or the applicable disbursement date for employee payment services. The interest earned on these funds is included in recurring revenues in the consolidated statements of comprehensive income as the collection, holding, and remittance of these funds are essential components of providing these services.
Implementation and Other Revenues
Implementation and other revenues consist of nonrefundable upfront conversion fees which are charged to new clients to offset the expense of new client set-up as well as revenues from the sale of time clocks as part of our time and attendance application. Although these revenues are related to our recurring revenues, they represent distinct performance obligations.
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Paycom Software, Inc.
Notes to the Consolidated Financial Statements
(tabular dollars and shares in thousands, except per share and per unit amounts)
Implementation activities primarily represent administrative activities that allow us to fulfill future performance obligations for our clients and do not represent services transferred to the client. However, the nonrefundable upfront fee charged to our clients results in an implied performance obligation in the form of a material right to the client related to the client’s option to renew at the end of each 30-day contract period. Further, given that all other services within the contract are sold at a total price indicative of the standalone selling price, coupled with the fact that the upfront fees are consistent with upfront fees charged in similar contracts that we have with clients, the standalone selling price of the client’s option to renew the contract approximates the dollar amount of the nonrefundable upfront fee. The nonrefundable upfront fee is typically included on the client’s first invoice, and is deferred and recognized ratably over the estimated renewal period (i.e., ten-year estimated client life).
Revenues from the sale of time clocks are recognized when control is transferred to the client upon delivery of the product. We estimate the standalone selling price for the time clocks by maximizing the use of observable inputs such as our specific pricing practices for time clocks.
Contract Balances
The timing of revenue recognition for recurring services is consistent with the invoicing of clients as they both occur during the respective client payroll period for which the services are provided. Therefore, we do not recognize a contract asset or liability resulting from the timing of revenue recognition and invoicing.
Changes in deferred revenue related to material rights for the years ended December 31, 2023 and 2022 were as follows:
Year Ended December 31,
Contract balance, net of revenue recognized during the period 32,142 31,939
We expect to recognize $22.8 million of deferred revenue related to material rights in 2024, $21.9 million in 2025, and $85.8 million of such deferred revenue thereafter.
Assets Recognized from the Costs to Obtain and Costs to Fulfill Revenue Contracts
We recognize an asset for the incremental costs of obtaining a contract with a client if we expect the amortization period to be longer than one year. We also recognize an asset for the costs to fulfill a contract with a client if such costs are specifically identifiable, generate or enhance resources used to satisfy future performance obligations, and are expected to be recovered. We have determined that substantially all costs related to implementation activities are administrative in nature and also meet the capitalization criteria under ASC 340-40. These capitalized costs to fulfill principally relate to upfront direct costs that are expected to be recovered through margin and that enhance our ability to satisfy future performance obligations.
The assets related to both costs to obtain, and costs to fulfill, contracts with clients are accounted for utilizing a portfolio approach, and are capitalized and amortized ratably over the expected period of benefit, which we have determined to be the estimated life of the client relationship of ten years. The expected period of benefit has been determined to be the estimated life of the client relationship primarily because we incur no new costs to obtain, or costs to fulfill, a contract upon renewal of such contract. Additional commission costs may be incurred when an existing client purchases additional applications; however, these commission costs relate solely to the additional applications purchased and are not related to contract renewal. Furthermore, additional fulfillment costs associated with existing clients purchasing additional applications are minimized by our seamless single-database platform. These assets are presented as deferred contract costs in the accompanying consolidated balance sheets. Amortization expense related to costs to obtain and costs to fulfill a contract are included in the “sales and marketing” and “general and administrative” line items in the accompanying consolidated statements of comprehensive income.
67
Paycom Software, Inc.
Notes to the Consolidated Financial Statements
(tabular dollars and shares in thousands, except per share and per unit amounts)
The following tables present the asset balances and related amortization expense for these contract costs:
As of and for the Year Ended December 31, 2023
Beginning Balance Capitalization of Costs Amortization Ending Balance
As of and for the Year Ended December 31, 2022
Beginning Balance Capitalization of Costs Amortization Ending Balance
Cost of Revenues
Our costs and expenses applicable to total revenues represent operating expenses and systems support and technology costs, including labor and related expenses, bank fees, shipping fees and costs of paper stock, envelopes, etc. In addition, costs included to derive gross margins are comprised of support labor and related expenses, related hardware costs and applicable depreciation and amortization costs.
Advertising Costs
Advertising costs are expensed the first time that advertising takes place. Advertising costs for the years ended December 31, 2023, 2022 and 2021 were $106.8 million, $90.6 million and $71.6 million, respectively.
Sales Taxes
We collect and remit sales tax on sales of time and attendance clocks and on payroll services in certain states. These taxes are recognized on a net basis, and therefore, excluded from revenues. For the years ended December 31, 2023, 2022 and 2021, sales taxes collected were $17.6 million, $15.5 million and $11.9 million, respectively.
Employee Stock-Based Compensation
Time-based stock compensation awards to employees are recognized on a straight-line basis over the applicable service period as compensation costs in the consolidated statements of comprehensive income based on their fair values measured as of the date of grant. Market-based stock compensation awards to employees are recognized on a straight-line basis over the applicable estimated service period as compensation costs in the consolidated statements of comprehensive income based on their fair value as of the date of the grant unless vesting occurs sooner at which time the remaining respective unrecognized compensation cost is recognized. Performance-based stock compensation awards are recognized on a straight-line basis over the applicable service period as compensation costs in the consolidated statements of comprehensive income based on their fair values measured as of the date of grant. Forfeitures related to our stock-based compensation awards are recognized as they occur.
Employee Stock Purchase Plan
An award issued under the Paycom Software, Inc. Employee Stock Purchase Plan (the “ESPP”) is classified as a share-based liability and recognized at the fair value of the award. Expense is recognized, net of estimated forfeitures, on a straight-line basis over the requisite service period.
Income Taxes
Our consolidated financial statements include a provision for income taxes incurred for the anticipated tax consequences of the reported results of operations using the asset and liability method. Under this method, we recognize deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial reporting and tax basis of assets and liabilities, as well as for operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using the tax rates that are expected to apply to taxable income for the years in which those tax assets and liabilities are expected to be realized or settled. We recognize a valuation allowance to reduce our deferred tax assets to the net amount that we believe is more likely than not to be realized.
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Paycom Software, Inc.
Notes to the Consolidated Financial Statements
(tabular dollars and shares in thousands, except per share and per unit amounts)
We file income tax returns with the United States federal government and various state jurisdictions. We evaluate tax positions taken or expected to be taken in the course of preparing our tax returns and disallow the recognition of tax positions not deemed to meet a “more-likely-than-not” threshold of being sustained by the applicable tax authority. We believe there is one tax position taken within the consolidated financial statements that does not meet this threshold. Our policy is to recognize interest and penalties, if any, related to uncertain tax positions as a component of general and administrative expenses. With few exceptions, we are no longer subject to U.S. federal, state and local income tax examinations by tax authorities for years prior to 2020.
Seasonality
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 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.
Recently Issued Accounting Pronouncements
Accounting pronouncements issued, but not effective until after December 31, 2023, are not expected to have a significant impact on our consolidated financial position or results of operations.
3.
PROPERTY AND EQUIPMENT
Property and equipment and accumulated depreciation and amortization were as follows:
Property and equipment
Software and capitalized software development costs $ 371,665 $ 270,645
Less: accumulated depreciation and amortization (437,291 ) (331,340 )
We capitalize computer software development costs related to software developed for internal use in accordance with ASC 350-40. For the years ended December 31, 2023 and 2022, we capitalized $96.7 million and $66.4 million, respectively, of computer software development costs related to software developed for internal use.
Rental clocks included in property and equipment, net represent time clocks issued to clients under month-to-month operating leases. As such, these items are transferred from inventory to property and equipment and depreciated over their estimated useful lives.
Prior to the repayment of our debt on November 21, 2023, we capitalized interest costs incurred for indebtedness related to construction in progress. For the years ended December 31, 2023, 2022 and 2021, we incurred interest costs of $5.3 million, $3.4 million and $1.4 million, respectively. For the years ended December 31, 2023, 2022 and 2021, interest costs of $3.4 million, $0.9 million and $1.4 million, respectively, were capitalized. Included in the construction in progress balance at December 31, 2023 and 2022 was $4.2 million and $2.0 million in retainage, respectively. See Note 6 for discussion of repayment of our indebtedness.
Depreciation and amortization expense for property and equipment, net was $110.0 million, $88.7 million and $64.7 million for the years ended December 31, 2023, 2022 and 2021, respectively.
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Paycom Software, Inc.
Notes to the Consolidated Financial Statements
(tabular dollars and shares in thousands, except per share and per unit amounts)
4.
GOODWILL AND INTANGIBLE ASSETS, NET
As of both December 31, 2023 and 2022, goodwill totaled $51.9 million. We have selected June 30 as our annual goodwill impairment testing date. We performed a qualitative impairment test of our goodwill and concluded that, as of June 30, 2023, it was more likely than not that the fair value exceeded the carrying value and therefore goodwill was not impaired. As of December 31, 2023 and 2022, there were no indicators of impairment.
In connection with our marketing initiatives, 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. We also made a $1.5 million one-time payment in July 2021 to cover sponsorship rights leading up to the 2021-2022 season. 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. The cost of the naming rights has been recorded as an intangible asset with an offsetting liability as of the date of the contract. The intangible asset is being amortized over the life of the agreement on a straight line basis that commenced in June 2021. The difference between the present value of the offsetting liability and actual cash payments is being relieved through sales and marketing expense using the effective interest method over the life of the agreement.
All of our intangible assets other than goodwill are considered to have definite lives and, as such, are subject to amortization. The following tables present the components of intangible assets within our consolidated balance sheets:
Weighted Average Remaining Accumulated
Useful Life Gross Amortization Net
(Years)
Intangibles:
Weighted Average Remaining Accumulated
Useful Life Gross Amortization Net
(Years)
Intangibles:
Amortization of intangible assets for the years ended December 31, 2023, 2022 and 2021 was $3.9 million, $4.0 million and $2.5 million, respectively. We estimate the aggregate amortization expense will be $3.9 million in 2024, and $3.9 million for each of 2025, 2026, 2027 and 2028, respectively.
5.
LEASES
The Company’s leases primarily consist of noncancellable operating leases for office space with contractual terms expiring from 2024 to 2030. All of our leases are operating leases and, as a lessee, we have not entered into any sublease agreements. The lease term is defined as the fixed noncancellable term of the lease plus all periods, if any, for which failure to renew the lease imposes a penalty on us in an amount that appears, at the inception of the lease, to be reasonably assured. While some of our leases include an option to extend the lease up to five years, it is not reasonably certain that any such options will be exercised due, in part, to the dynamic nature of our sales force and rate of growth. Some of our leases contain a termination option that is not reasonably certain to be exercised. If a termination option is exercised, we remeasure the lease asset in the consolidated balance sheets using the updated lease period. None of our leases contain residual value guarantees, substantial restrictions or covenants.
The table below presents the lease assets and liabilities as of December 31, 2023 and December 31, 2022.
Lease liabilities:
Accrued expenses and other current liabilities $ 19,236 $ 14,986
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Paycom Software, Inc.
Notes to the Consolidated Financial Statements
(tabular dollars and shares in thousands, except per share and per unit amounts)
Rent expense under operating leases for the years ended December 31, 2023, 2022 and 2021 was $18.1 million, $12.3 million and $11.9 million, respectively. Cash paid for amounts relating to our operating leases was $20.5 million for the year ended December 31, 2023.
Because no implicit discount rates for our leases could be readily determined, we elected to use an estimated incremental borrowing rate to determine the present value of our leases. The weighted average discount rate related to our portfolio of leases at December 31, 2023 was 4.6%. The average remaining lease term for our leases was 4.7 years as of December 31, 2023.
The undiscounted cash flows for the future annual maturities of our operating lease liabilities and the reconciliation of those total undiscounted cash flows to our lease liabilities as of December 31, 2023 were as follows:
Total undiscounted cash flows $ 84,789
Present value discount (8,840 )
Lease liabilities $ 75,949
The table above does not include any legally binding minimum lease payments for leases signed but not yet commenced. As of December 31, 2023, the present value of the operating lease liabilities that had not yet commenced was $11.6 million.
6.
LONG-TERM DEBT
Long-term debt consisted of the following:
Total long-term debt $ — $ 29,000
On December 7, 2017, we entered into a senior secured term credit agreement (as amended from time to time, the “2017 Term Credit Agreement”), pursuant to which JPMorgan Chase Bank, N.A., Bank of America, N.A. and Kirkpatrick Bank made certain term loans to us (the “2017 Term Loans”). Our obligations under the 2017 Term Loans were secured by a mortgage and first priority security interest in our corporate headquarters property. The 2017 Term Loans were due to mature on September 7, 2025 and bore interest, at our option, at either (a) a prime rate plus 1.0% or (b) an adjusted LIBOR rate for the interest period in effect for such 2017 Term Loan plus 1.5%.
As discussed below, the 2017 Term Loans were repaid in full on May 4, 2022 and the 2017 Term Credit Agreement was terminated. At the time of payoff, unamortized debt issuance costs totaling $0.1 million were written off. On May 4, 2022 (the “May 2022 Facility Closing Date”), Paycom Payroll, LLC (the “Borrower”), Software, and certain other subsidiaries of Software (collectively, the “Guarantors,” and collectively with the Borrower, the “Loan Parties”), entered into a credit agreement (as amended from time to time, the “May 2022 Revolving Credit Agreement”) with Bank of America, N.A., as a lender, swingline lender and letters of credit issuer, the lenders from time to time party thereto and Bank of America, N.A., as the administrative agent.
The May 2022 Revolving Credit Agreement provided for a senior secured revolving credit facility (the “May 2022 Facility”) in the initial aggregate principal amount of up to $250.0 million, and the ability to request an incremental facility of up to an additional $100.0 million, subject to obtaining additional lender commitments and certain approvals and satisfying certain other conditions. The May 2022 Facility included a $25.0 million sublimit for swingline loans and a $2.5 million sublimit for letters of credit. On June 7, 2022, the aggregate commitments under the May 2022 Revolving Credit Agreement were increased from $250.0 million to $350.0 million. Our obligations under the May 2022 Facility were secured by a senior security interest in all personal property of the Loan Parties. The May 2022 Facility was scheduled to mature on May 4, 2027.
On the May 2022 Facility Closing Date, we borrowed $29.0 million under the May 2022 Facility to repay the 2017 Term Loans, along with accrued interest, expenses and fees. The loan on the May 2022 Facility Closing Date bore interest at the BSBY rate plus 1.125%. In connection with the repayment of the 2017 Term Loans, the 2017 Term Credit Agreement was terminated on May 4, 2022.
As discussed below, the May 2022 Facility was repaid in full on July 29, 2022 and the May 2022 Revolving Credit Agreement was terminated.
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Paycom Software, Inc.
Notes to the Consolidated Financial Statements
(tabular dollars and shares in thousands, except per share and per unit amounts)
On July 29, 2022 (the “July 2022 Facility Closing Date”), the Borrower, Software, and certain other subsidiaries of Software 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 initially provided for a senior secured revolving credit facility (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 initially provided for a senior secured delayed draw term loan (the “July 2022 Term Loan Facility”) in the aggregate amount of up to $750.0 million. As discussed below, the July 2022 Term Loan Facility was terminated on July 28, 2023. All loans under the July 2022 Credit Agreement will mature on July 29, 2027 (the “Scheduled Maturity Date”). Unamortized debt issuance costs of $4.0 million as of December 31, 2023, are included in “Other assets” on our consolidated balance sheets.
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, prior to its termination, 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.
The July 2022 Revolving Credit Facility provides for no scheduled principal amortization prior to the Scheduled Maturity Date. Subject to certain conditions set forth in the July 2022 Credit Agreement, we may borrow, prepay and reborrow under the July 2022 Revolving Credit Facility and terminate or reduce the July 2022 Lenders’ commitments at any time prior to the Scheduled Maturity Date.
The proceeds of the loans and letters of credit under the July 2022 Credit Agreement are to be used for ongoing working capital and general corporate purposes, permitted acquisitions, share repurchases and refinancing the May 2022 Facility. 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 the May 2022 Facility, along with accrued interest, expenses and fees. The loan bore interest at the Adjusted Term SOFR Rate for the interest period in effect plus 1.25%. In connection with the repayment of the May 2022 Facility, the May 2022 Revolving Credit Agreement was terminated on July 29, 2022.
Under the July 2022 Credit Agreement, we are required to maintain as of the end of each fiscal quarter a consolidated interest coverage ratio of not less than 3.0 to 1.0 and a consolidated leverage ratio of not greater than 3.5 to 1.0, stepping down to 3.25 to 1.0 as of December 31, 2024 and 3.0 to 1.0 as of December 31, 2025, and thereafter. Additionally, the July 2022 Credit Agreement contains customary affirmative and negative covenants, including covenants limiting our ability to, among other things, grant liens, incur debt, effect certain mergers, make investments, dispose of assets, enter into certain transactions, including swap agreements and sale and leaseback transactions, pay dividends or distributions on our capital stock, and enter into transactions with affiliates, in each case subject to customary exceptions. As of December 31, 2023, we were in compliance with these covenants. Our obligations under the July 2022 Credit Agreement are secured by a senior security interest in all personal property of the Loan Parties.
The events of default under the July 2022 Credit Agreement include, among others, payment defaults, breaches of covenants, defaults under the related loan documents, material misrepresentations, cross defaults with certain other material indebtedness,
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Paycom Software, Inc.
Notes to the Consolidated Financial Statements
(tabular dollars and shares in thousands, except per share and per unit amounts)
bankruptcy and insolvency events, judgment defaults, certain events related to plans subject to the Employee Retirement Income Security Act of 1974, as amended, invalidity of the July 2022 Credit Agreement or the related loan documents and change in control events. The occurrence of an event of default could result in the acceleration of our obligations under the July 2022 Credit Agreement, the requirement to post cash collateral with respect to letters of credit, the termination of the July 2022 Lenders’ commitments and a 2.0% increase in the rate of interest.
On July 28, 2023, the Borrower, Software, and certain other subsidiaries of Software entered into Amendment No. 2 to Credit Agreement (“Amendment No. 2”) with the July 2022 Lenders, pursuant to which, among other things, (i) the aggregate revolving commitments under the July 2022 Revolving Credit Facility were increased from $650.0 million to $1.0 billion, (ii) the July 2022 Term Loan Facility was terminated and (iii) the July 2022 Credit Agreement was amended in contemplation of the formation and future operating activities of the Paycom Client Trust (the “Client Trust”) and Paycom National Trust Bank, NA (the “Trust Bank”). The Company intends to form the Client Trust to hold client payroll and related funds and the Trust Bank to serve as trustee of the Client Trust. We did not make any draws under the July 2022 Term Loan Facility prior to its termination on July 28, 2023. At the time of termination, unamortized debt issuance costs totaling $1.2 million were written off and recognized as a loss on extinguishment of debt, which is included in Other income, net in the consolidated statements of comprehensive income.
On November 21, 2023, we fully repaid the outstanding indebtedness under the Revolving Credit Facility.
As of December 31, 2023 and 2022, the carrying value of our total long-term debt approximated its fair value as of such date. The fair value of our long-term debt is estimated based on the borrowing rates currently available to us for bank loans with similar terms and maturities.
7.
DERIVATIVE INSTRUMENTS
In December 2017, we entered into a floating-to-fixed interest rate swap agreement to limit the exposure to floating interest rate risk related to the 2017 Term Loans. We do not hold derivative instruments for trading or speculative purposes. The interest rate swap agreement effectively converted a portion of the variable interest rate payments to fixed interest rate payments. We account for our derivatives under ASC Topic 815, “Derivatives and Hedging,” and recognize all derivative instruments in the consolidated balance sheets at fair value as either short-term or long-term assets or liabilities based on their anticipated settlement date. See Note 9, “Fair Value of Financial Instruments”. We have elected not to designate our interest rate swap as a hedge; therefore, changes in the fair value of the derivative instrument were recognized in our consolidated statements of comprehensive income within Other income (expense), net.
The objective of the interest rate swap was to reduce the variability in the forecasted interest payments of the 2017 Term Loans, which was based on a one-month USD LIBOR rate versus a fixed interest rate of 2.54% on a notional value of $35.5 million. Under the terms of the interest rate swap agreement, we received quarterly variable interest payments based on the LIBOR rate and paid interest at a fixed rate. As further discussed in Note 6, on May 4, 2022, we repaid the 2017 Term Loans and terminated the 2017 Term Credit Agreement. The interest rate swap agreement had a maturity date of September 7, 2025. On August 24, 2022, we terminated the interest rate swap by settling the contract, which resulted in a cash receipt of $0.5 million. The realized gain from the settlement of the interest rate swap contract is included in Other income (expense), net in the consolidated statements of comprehensive income.
73
Paycom Software, Inc.
Notes to the Consolidated Financial Statements
(tabular dollars and shares in thousands, except per share and per unit amounts)
8.
CORPORATE INVESTMENTS AND FUNDS HELD FOR CLIENTS
The tables below present our cash and cash equivalents, the funds held for clients cash and cash equivalents as well as the investments that were included within funds held for clients on the consolidated balance sheets:
Funds held for clients cash and cash equivalents 2,128,735 — — 2,128,735
Available-for-sale securities(1):
Funds held for clients cash and cash equivalents 2,008,365 — — 2,008,365
Available-for-sale securities(1):
(1)
All available-for-sale securities were included within the funds held for clients.
The unrealized losses and fair values of available-for-sale securities that have been in an unrealized loss position for a period of less than and greater than 12 months as of December 31, 2023, are as follows:
The unrealized losses and fair values of available-for-sale securities that have been in an unrealized loss position for a period of less than and greater than 12 months as of December 31, 2022, are as follows:
We did not make any reclassification adjustments out of accumulated other comprehensive income for realized gains or losses on the sale or maturity of available-for-sale securities for the years ended December 31, 2023 or 2022. There were no realized gains or losses on the sale of available-for-sale securities for the years ended December 31, 2023 or 2022.
We regularly review the composition of our investment portfolio and did not recognize any credit impairment losses during the years ended December, 2023 or 2022. As of December 31, 2023, all of our U.S. treasury securities held a rating of AA+.
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Paycom Software, Inc.
Notes to the Consolidated Financial Statements
(tabular dollars and shares in thousands, except per share and per unit amounts)
Expected maturities of available-for-sale securities at December 31, 2023 are as follows:
Expected maturity Amortized cost Fair value
One year to five years $ — $ —
9.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Our financial instruments consist primarily of cash and cash equivalents, accounts receivable, accounts payable, funds held for clients, client funds obligation and long-term debt. The carrying amount of cash and cash equivalents, accounts receivable, accounts payable, funds held for clients and client funds obligation approximates fair value due to the short-term nature of the instruments. See Note 6 for discussion of the fair value of our debt.
Our corporate investments consist primarily of money market funds and demand deposit accounts and are classified as cash and cash equivalents on the consolidated balance sheets.
As discussed in Note 2, we typically invest the funds held for clients in money market funds, demand deposit accounts, certificates of deposit and commercial paper with an original maturity of less than three months and classify these items as cash and cash equivalents within the funds held for clients line item in the consolidated balance sheets. Short-term investments in certificates of deposit and commercial paper with an original maturity greater than three months are classified as available-for-sale securities and are also included within the funds held for clients line item. These available-for-sale securities are recognized in the consolidated balance sheets at fair value, with the difference between the amortized cost and fair value of these available-for-sale securities recorded as unrealized net gains (losses) within comprehensive earnings (loss) in our consolidated statements of comprehensive income. See Note 8 for additional information.
We also invest funds held for clients in U.S. treasury securities with initial maturity durations greater than one year. These U.S. treasury securities are classified as available-for-sale securities and included within the funds held for clients line item. The unrealized gains and losses associated with these available-for-sale securities are included within comprehensive earnings (loss) in our consolidated statements of comprehensive income. See Note 8 for additional information.
As discussed in Note 7, during the year ended December 31, 2017, we entered into an interest rate swap. While outstanding, the interest rate swap was measured on a recurring basis based on quoted prices for similar financial instruments and other observable inputs recognized at fair value. We terminated the interest rate swap on August 24, 2022.
The accounting standard for fair value measurements establishes a three-level fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:
•
Level 1 – Observable inputs such as quoted prices in active markets
•
Level 2 – Inputs other than quoted prices in active markets for identical assets or liabilities that are observable either directly or indirectly or quoted prices that are not active
•
Level 3 – Unobservable inputs in which there is little or no market data
Included in the following tables are the Company’s major categories of assets and liabilities measured at fair value on a recurring basis as of December 31, 2023 and 2022:
Level 1 Level 2 Level 3 Total
Assets:
Level 1 Level 2 Level 3 Total
Assets:
75
Paycom Software, Inc.
Notes to the Consolidated Financial Statements
(tabular dollars and shares in thousands, except per share and per unit amounts)
10.
EMPLOYEE SAVINGS PLAN AND EMPLOYEE STOCK PURCHASE PLAN
Employees over the age of 18 who have completed ninety days of service are eligible to participate in our 401(k) plan. We have made a Qualified Automatic Contribution Arrangement (“QACA”) election, whereby the Company matches the contribution of our employees equal to 100% of the first 1% of salary deferrals and 50% of salary deferrals between 2% and 6%, up to a maximum matching contribution of 3.5% of an employee’s salary each plan year. We are allowed to make additional discretionary matching contributions and discretionary profit sharing contributions. Employees are 100% vested in amounts attributable to salary deferrals and rollover contributions. The QACA matching contributions as well as the discretionary matching and profit sharing contributions vest 100% after two years of employment from the date of hire. Matching contributions were $15.9 million, $12.7 million and $11.6 million for the years ended December 31, 2023, 2022 and 2021, respectively.
The ESPP has overlapping offering periods, with each offering period lasting approximately 24 months. At the beginning of each offering period, eligible employees may elect to contribute, through payroll deductions, up to 10% of their compensation, subject to an annual per employee maximum of $25,000. Eligible employees purchase shares of the Company’s common stock at a price equal to 85% of the fair market value of the shares on the exercise date. The maximum number of shares that may be purchased by a participant during each offering period is 2,000 shares, subject to limits specified by the Internal Revenue Service. The shares reserved for purposes of the ESPP are shares we purchase in the open market. The maximum aggregate number of shares of the Company’s common stock that may be purchased by all participants under the ESPP is 2.0 million shares. During the years ended December 31, 2023, 2022 and 2021, eligible employees purchased 72,942, 54,059 and 40,699 shares, respectively, of the Company’s common stock under the ESPP. Compensation expense related to the ESPP is recognized on a straight-line basis over the requisite service period. Our compensation expense related to the ESPP was $3.5 million, $2.8 million and $2.7 million for the years ended December 31, 2023, 2022 and 2021, respectively.
11.
EARNINGS PER SHARE
Basic earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding for the period. Diluted earnings per share is computed in a similar manner to basic earnings per share after assuming the issuance of shares of common stock for all potentially dilutive equity incentive awards.
The following is a reconciliation of net income and the shares of common stock used in the computation of basic and diluted earnings per share:
Year Ended December 31,
Numerator:
Denominator:
Earnings per share:
12.
STOCK-BASED COMPENSATION
Restricted Stock Awards
In May 2023, the stockholders of the Company approved the Paycom Software, Inc. 2023 Long-Term Incentive Plan (the “2023 LTIP”), which provides for the granting of equity-based awards to the Company’s employees, contractors and outside directors. Subject to certain adjustments, the maximum number of shares of common stock that may be delivered pursuant to awards under the 2023 LTIP is 3,600,000, subject to increase by any awards under the Paycom Software, Inc. 2014 Long-Term Incentive Plan (as amended, the “2014 LTIP”) (i) that are outstanding on or after May 1, 2023, and that, on or after such date, are forfeited, expire or are canceled (but excluding the 1,610,000 shares of restricted stock granted to Mr. Richison on November 23, 2020 (the “2020 CEO Performance Award”)); and (ii) any shares subject to awards relating to common stock under the 2014 LTIP that are settled in cash on or after May 1, 2023.
We have historically issued shares of restricted stock that are subject to either market-based vesting conditions (“Market-Based Shares”) or time-based or no vesting conditions (“Time-Based Shares”). The market-based vesting conditions are based on the Company’s total enterprise value (“TEV”) or volume weighted average stock price over a specific period exceeding certain specified
76
Paycom Software, Inc.
Notes to the Consolidated Financial Statements
(tabular dollars and shares in thousands, except per share and per unit amounts)
thresholds. Compensation expense related to the issuance of Market-Based Shares is measured based upon the fair value of the award on the grant date and recognized on a straight-line basis over the service period based upon the probability that the vesting conditions will be met. Compensation expense related to the issuance of Time-Based Shares is measured based on the fair value of the award on the grant date and recognized over the requisite service period on a straight-line basis.
During the year ended December 31, 2023, we issued an aggregate of 754,815 restricted shares of common stock under the 2014 LTIP and the 2023 LTIP, consisting of 87,618 Market-Based Shares and 667,197 Time-Based Shares. Market-Based Shares will vest 50% on the first date, if any, that the arithmetic average of the Company’s volume weighted average price on each of the twenty consecutive trading days immediately preceding such date (the “VWAP Value”) equals or exceeds $404 per share and 50% on the first date, if any, that the Company’s VWAP Value equals or exceeds $466 per share, in each case provided that (i) such date occurs on or before the eighth anniversary of the grant date and (ii) the recipient is employed by, or providing services to, the Company on the applicable vesting date, and subject to the terms and conditions of the 2014 LTIP or the 2023 LTIP, as applicable, and the applicable restricted stock award agreement. The Time-Based Shares granted to non-executive employees will vest over periods ranging from three to four years, provided that the recipient is employed by, or providing services to, the Company on the applicable vesting date, and subject to the terms and conditions of the 2014 LTIP or the 2023 LTIP, as applicable, and the applicable restricted stock award agreement.
The Time-Based Shares mentioned above include an aggregate of 5,523 Time-Based Shares issued to the non-employee members of our Board of Directors in May 2023 under the 2023 LTIP. Such shares of restricted stock will cliff-vest on the seventh day following the first anniversary date of the grant, provided that such director is providing services to the Company through the applicable vesting date, and subject to the terms and conditions of the 2023 LTIP and the applicable restricted stock award agreement.
The following table presents a summary of the grant date fair values of restricted stock granted during the years ended December 31, 2023, 2022 and 2021 and the related assumptions:
Year Ended December 31,
Expected life (in years) 2.3 2.5 2.3
The following table summarizes restricted stock awards activity for the year ended December 31, 2023:
Time-Based Market-Based
Restricted Stock Awards Restricted Stock Awards
The following table presents the aggregate fair value of awards that vested during the indicated period.
Year Ended December 31,
Market-Based Restricted Stock Awards $ — $ — $ 76,153
77
Paycom Software, Inc.
Notes to the Consolidated Financial Statements
(tabular dollars and shares in thousands, except per share and per unit amounts)
Restricted Stock Units
In February 2023, we issued, in the aggregate, 5,232 shares of common stock upon the vesting of performance-based restricted stock units (“PSUs”) awarded to certain executive officers in February 2021. The number of shares delivered upon vesting of the PSUs was determined based on the Company’s achievement of a Relative Total Stockholder Return (“Relative TSR”) performance goal, which compared the Company’s Total Stockholder Return (“TSR”) to the TSR of a peer group for the two-year performance period that commenced on January 1, 2021 and ended on December 31, 2022.
For purposes of the PSU awards granted in 2021 (the “2021 PSUs”), TSR was determined by dividing (i) the sum of (A) the average VWAP of a share of the Company’s common stock or the common stock of a peer company, as applicable, during the final 60 trading day period of the applicable performance period, less (ii) the average VWAP of a share of the Company’s common stock or the common stock of a peer company, as applicable, during the 60 trading day period ending on December 31, 2020, plus (iii) the sum of all dividends which are paid by the Company (or the member of the peer group) to its stockholders, assuming such dividends are reinvested in the applicable company through the applicable performance period, by (ii) the average VWAP of a share of the Company’s common stock or the common stock of a peer company, as applicable, during the 60 trading day period ending on December 31, 2020. For purposes of the 2021 PSUs, the Company’s peer group includes 34 publicly traded companies, which were reflective of the S&P 500 Software & Services index on the grant date.
On April 3, 2023, the Company announced the resignation of Justin Long from the position of Vice President of Operations of the Company, effective March 28, 2023. In connection with Mr. Long’s resignation, the Company, Paycom Payroll, LLC and Mr. Long entered into a Severance and Release Agreement (the “Severance Agreement”), which became effective on April 8, 2023, pursuant to which 1,505 Time-Based Shares previously granted to Mr. Long accelerated in vesting.
On May 2, 2023, the Company issued the following awards to executive officers under the 2023 LTIP: (i) an aggregate of 39,131 PSUs; (ii) an aggregate of 8,695 time-based restricted stock units (“RSUs”); and (iii) an aggregate of 142,000 Time-Based Shares. The number of shares deliverable upon vesting of such PSUs will be determined based on achievement of pre-established performance goals. The performance goals vary for each executive officer but are based on the Company’s revenue, adjusted EBITDA, the daily volume weighted average price of the Company’s common stock and annual revenue retention rate, in each case for the one-year performance period from January 1, 2023 to December 31, 2023. The PSUs were eligible to vest following the performance period, but no later than February 29, 2024, provided that the recipient was employed by, or providing services to, the Company on the applicable vesting date, and subject to the terms and conditions of the 2023 LTIP and the applicable restricted stock unit award agreement. For a discussion of the PSU vesting and related forfeitures that occurred on February 5, 2024, see “Note 15. Subsequent Events”. The RSUs vest in three equal annual tranches over a period of approximately two and a half years, provided that the recipient is employed by, or providing services to, the Company on the applicable vesting date, and subject to the terms and conditions of the 2023 LTIP and the applicable restricted stock unit award agreement. The Time-Based Shares vest in four tranches over a period of approximately three and a half years, provided that the recipient is employed by, or providing services to, the Company on the applicable vesting date, and subject to the terms and conditions of the 2023 LTIP and the applicable restricted stock award agreement.
The following table presents a summary of the grant date fair values of restricted stock units granted during the years ended December 31, 2023, 2022 and 2021 and the related assumptions:
Year Ended December 31,
Expected life (in years) 1.0 2.7 2.6
78
Paycom Software, Inc.
Notes to the Consolidated Financial Statements
(tabular dollars and shares in thousands, except per share and per unit amounts)
The following table summarizes restricted stock unit activity for the year ended December 31, 2023:
Time RSUs PSUs
(1)
A maximum of 81,843 shares could be delivered upon settlement of PSUs based upon the Company’s achievement of the applicable performance goals over the applicable performance periods.
The following table presents the unrecognized compensation cost and the related weighted average recognition period associated with unvested restricted stock awards and unvested restricted stock unit awards as of December 31, 2023:
Restricted Stock Restricted Stock
Awards Units
Weighted average period for recognition (years) 2.3 0.7