Paycom Software, Inc. - Quarter Report: 2020 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2020

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______ to ______

Commission File Number: 001-36393

Paycom Software, Inc.

(Exact name of registrant as specified in its charter)

Delaware

80-0957485

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification Number)

7501 W. Memorial Road

Oklahoma City, Oklahoma 73142

(Address of principal executive offices, including zip code)

(405) 722-6900

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

Trading

Symbol(s)

Name of each exchange on which registered

Common Stock, $0.01 par value

PAYC

New York Stock Exchange

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ☒	Accelerated filer	☐

Non-accelerated filer ☐	Smaller reporting company	☐

Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

As of October 27, 2020, there were 58,512,531 shares of common stock, par value of $0.01 per share, outstanding, including 881,490 shares of restricted stock.

Paycom Software, Inc.

	PART I – FINANCIAL INFORMATION
Item 1.	Financial Statements	3
	Unaudited Consolidated Balance Sheets	3
	Unaudited Consolidated Statements of Income	4
	Unaudited Consolidated Statements of Stockholders’ Equity	5
	Unaudited Consolidated Statements of Cash Flows	6
	Notes to the Unaudited Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	18
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	30
Item 4.	Controls and Procedures	30
	PART II – OTHER INFORMATION
Item 1.	Legal Proceedings	31
Item 1A.	Risk Factors	31
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	33
Item 6.	Exhibits	34
Signatures		35

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Paycom Software, Inc.

Unaudited Consolidated Balance Sheets

(in thousands, except per share amounts)

	September 30, 2020			December 31, 2019
Assets
Current assets:
Cash and cash equivalents	$	156,398		$	133,667
Accounts receivable		12,355			9,298
Prepaid expenses		20,757			13,561
Inventory		924			1,158
Income tax receivable		9,280			4,020
Deferred contract costs		56,245			46,618
Current assets before funds held for clients		255,959			208,322
Funds held for clients		1,522,357			1,662,778
Total current assets		1,778,316			1,871,100
Property and equipment, net		275,624			238,458
Goodwill		51,889			51,889
Long-term deferred contract costs		342,436			292,134
Other assets		36,934			33,336
Total assets	$	2,485,199		$	2,486,917
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable	$	9,237		$	5,051
Accrued commissions and bonuses		7,940			12,343
Accrued payroll and vacation		27,722			14,870
Deferred revenue		13,887			11,105
Current portion of long-term debt		1,775			1,775
Accrued expenses and other current liabilities		44,883			45,600
Current liabilities before client funds obligation		105,444			90,744
Client funds obligation		1,522,357			1,662,778
Total current liabilities		1,627,801			1,753,522
Deferred income tax liabilities, net		102,421			91,217
Long-term deferred revenue		71,500			65,139
Net long-term debt, less current portion		29,554			30,858
Other long-term liabilities		21,524			19,553
Total long-term liabilities		224,999			206,767
Total liabilities		1,852,800			1,960,289
Commitments and contingencies
Stockholders' equity:
Common stock, $0.01 par value (100,000 shares authorized, 61,639 and 61,350 shares issued at September 30, 2020 and December 31, 2019, respectively; 57,605 and 57,660 shares outstanding at September 30, 2020 and December 31, 2019, respectively)		616			613
Additional paid-in capital		322,321			257,501
Retained earnings		695,252			576,166
Treasury stock, at cost (4,034 and 3,689 shares at September 30, 2020 and December 31, 2019, respectively)		(385,790	)		(307,652	)
Total stockholders' equity		632,399			526,628
Total liabilities and stockholders' equity	$	2,485,199		$	2,486,917

See accompanying notes to the unaudited consolidated financial statements.

Paycom Software, Inc.

Unaudited Consolidated Statements of Income

(in thousands, except per share amounts)

	Three Months Ended September 30,					Nine Months Ended September 30,
	2020		2019				2020			2019
Revenues
Recurring	$	192,664	$	171,405		$	609,109		$	534,267
Implementation and other		3,868		3,601			11,378			9,995
Total revenues		196,532		175,006			620,487			544,262
Cost of revenues
Operating expenses		24,278		21,088			71,651			66,153
Depreciation and amortization		6,634		5,304			18,865			14,796
Total cost of revenues		30,912		26,392			90,516			80,949
Administrative expenses
Sales and marketing		62,146		47,060			173,228			128,280
Research and development		21,772		19,605			65,171			54,869
General and administrative		40,516		25,728			121,487			98,386
Depreciation and amortization		7,150		5,665			20,209			15,848
Total administrative expenses		131,584		98,058			380,095			297,383
Total operating expenses		162,496		124,450			470,611			378,332
Operating income		34,036		50,556			149,876			165,930
Interest expense		—		(260	)		(19	)		(794	)
Other income (expense), net		246		195			(522	)		(168	)
Income before income taxes		34,282		50,491			149,335			164,968
Provision for income taxes		6,800		11,339			30,249			29,772
Net income	$	27,482	$	39,152		$	119,086		$	135,196
Earnings per share, basic	$	0.48	$	0.68		$	2.07		$	2.35
Earnings per share, diluted	$	0.47	$	0.67		$	2.04		$	2.31
Weighted average shares outstanding:
Basic		57,603		57,654			57,609			57,528
Diluted		58,171		58,383			58,312			58,403

See accompanying notes to the unaudited consolidated financial statements.

Paycom Software, Inc.

Unaudited Consolidated Statements of Stockholders’ Equity

(in thousands)

	Common Stock				Additional			Retained		Treasury Stock					Total
	Shares		Amount		Paid-in Capital			Earnings		Shares		Amount			Stockholders' Equity


Balances at December 31, 2018		60,747	$	607	$	203,680		$	395,590		3,470	$	(265,124	)	$	334,753
Vesting of restricted stock		280		2		(2	)		—		—		—			—
Stock-based compensation		—		—		36,187			—		—		—			36,187
Repurchases of common stock		—		—		—			—		110		(19,669	)		(19,669	)
Net income		—		—		—			47,282		—		—			47,282
Balances at March 31, 2019		61,027	$	609	$	239,865		$	442,872		3,580	$	(284,793	)	$	398,553
Vesting of restricted stock		275		3		(3	)		—		—		—			—
Stock-based compensation		—		—		6,207			—		—		—			6,207
Repurchases of common stock		—		—		—			—		92		(18,760	)		(18,760	)
Net income		—		—		—			48,762		—		—			48,762
Balances at June 30, 2019		61,302	$	612	$	246,069		$	491,634		3,672	$	(303,553	)	$	434,762
Vesting of restricted stock		44		—		—			—		—		—			—
Stock-based compensation		—		—		4,784			—		—		—			4,784
Repurchases of common stock		—		—		—			—		16		(3,800	)		(3,800	)
Net income		—		—		—			39,152		—		—			39,152
Balances at September 30, 2019		61,346	$	612	$	250,853		$	530,786		3,688	$	(307,353	)	$	474,898

	Common Stock				Additional			Retained		Treasury Stock					Total
	Shares		Amount		Paid-in Capital			Earnings		Shares		Amount			Stockholders' Equity

Balances at December 31, 2019		61,350	$	613	$	257,501		$	576,166		3,689	$	(307,652	)	$	526,628
Vesting of restricted stock		2		1		(1	)		—		—		—			—
Stock-based compensation		—		—		18,313			—		—		—			18,313
Repurchases of common stock		—		—		—			—		41		(8,168	)		(8,168	)
Net income		—		—		—			63,015		—		—			63,015
Balances at March 31, 2020		61,352	$	614	$	275,813		$	639,181		3,730	$	(315,820	)	$	599,788
Vesting of restricted stock		261		2		(2	)		—		—		—			—
Stock-based compensation		—		—		24,597			—		—		—			24,597
Repurchases of common stock		—		—		—			—		295		(67,121	)		(67,121	)
Net income		—		—		—			28,589		—		—			28,589
Balances at June 30, 2020		61,613	$	616	$	300,408		$	667,770		4,025	$	(382,941	)	$	585,853
Vesting of restricted stock		26		—		—			—		—		—			—
Stock-based compensation		—		—		21,913			—		—		—			21,913
Repurchases of common stock		—		—		—			—		9		(2,849	)		(2,849	)
Net income		—		—		—			27,482		—		—			27,482
Balances at September 30, 2020		61,639	$	616	$	322,321		$	695,252		4,034	$	(385,790	)	$	632,399

See accompanying notes to the unaudited consolidated financial statements.

Paycom Software, Inc.

Unaudited Consolidated Statements of Cash Flows

(in thousands)

	Nine Months Ended September 30,
	2020			2019
Cash flows from operating activities
Net income	$	119,086		$	135,196
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		39,073			30,644
Accretion of discount on available-for-sale securities		(1,374	)		(646	)
Amortization of debt issuance costs		27			26
Stock-based compensation expense		56,531			41,122
Cash paid for derivative settlement		(424	)		(26	)
Loss on derivative		2,042			1,789
Deferred income taxes, net		11,204			15,715
Changes in operating assets and liabilities:
Accounts receivable		(3,057	)		805
Prepaid expenses		(7,196	)		(5,066	)
Inventory		32			(181	)
Other assets		(3,757	)		(2,367	)
Deferred contract costs		(56,922	)		(53,654	)
Accounts payable		4,491			(970	)
Income taxes, net		(5,260	)		(5,550	)
Accrued commissions and bonuses		(4,403	)		(2,239	)
Accrued payroll and vacation		12,853			6,931
Deferred revenue		9,143			8,714
Accrued expenses and other current liabilities		2,239			6,176
Net cash provided by operating activities		174,328			176,419
Cash flows from investing activities
Purchase of short-term investments from funds held for clients		(217,858	)		(61,268	)
Proceeds from maturities of short-term investments from funds held for clients		93,593			54,200
Purchases of property and equipment		(73,502	)		(71,080	)
Net cash used in investing activities		(197,767	)		(78,148	)
Cash flows from financing activities
Repurchases of common stock		(52,040	)		—
Withholding taxes paid related to net share settlements		(26,099	)		(42,229	)
Payments on long-term debt		(1,331	)		(1,331	)
Net change in client funds obligation		(140,421	)		(131,869	)
Payment of debt issuance costs		—			(16	)
Net cash used in financing activities		(219,891	)		(175,445	)
Decrease in cash, cash equivalents, restricted cash and restricted cash equivalents		(243,330	)		(77,174	)
Cash, cash equivalents, restricted cash and restricted cash equivalents
Cash, cash equivalents, restricted cash and restricted cash equivalents, beginning of period		1,641,854			986,464
Cash, cash equivalents, restricted cash and restricted cash equivalents, end of period	$	1,398,524		$	909,290

	Nine Months Ended September 30,
	2020			2019
Reconciliation of cash, cash equivalents, restricted cash and restricted cash equivalents
Cash and cash equivalents	$	156,398		$	108,127
Restricted cash included in funds held for clients		1,242,126			801,163
Total cash, cash equivalents, restricted cash and restricted cash equivalents, end of period	$	1,398,524		$	909,290


Supplemental disclosures of cash flow information:
Non-cash investing and financing activities:
Purchases of property and equipment, accrued but not paid	$	2,707		$	2,190
Stock-based compensation for capitalized software	$	5,284		$	4,287
Right of use assets obtained in exchange for operating lease liabilities	$	9,323		$	9,924

See accompanying notes to the unaudited consolidated financial statements.

Paycom Software, Inc.

Notes to the Unaudited Consolidated Financial Statements

(tabular dollars and shares in thousands, except per share amounts)

1.	ORGANIZATION AND DESCRIPTION OF BUSINESS

Paycom Software, Inc. (“Software”) and its wholly-owned subsidiaries (collectively, the “Company”) is a leading provider of comprehensive, cloud-based human capital management (“HCM”) software 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 (“HR”) management applications.

2.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Our significant accounting policies are discussed in “Note 2. Summary of Significant Accounting Policies” in the notes to our audited consolidated financial statements included in the Annual Report on Form 10-K for the year ended December 31, 2019 (the “Form 10-K”) filed with the Securities and Exchange Commission (“SEC”) on February 13, 2020.

Basis of Presentation

The accompanying unaudited interim consolidated financial statements and notes have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) and applicable rules and regulations of the SEC regarding interim financial statements that permit reduced disclosure for interim periods. In the opinion of management, the unaudited consolidated financial statements reflect all adjustments of a normal recurring nature that are necessary for a fair presentation of the results for the interim periods presented. These unaudited consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and related notes presented in the Form 10-K. The results of operations for the three and nine months ended September 30, 2020 are not necessarily indicative of the results expected for the full year.

Recently Adopted Accounting Pronouncements

In January 2020, we adopted Accounting Standards Update (“ASU”) No. 2018-15, “Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (a consensus of the FASB Emerging Issues Task Force)” (“ASU 2018-15”). ASU 2018-15 aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). The adoption of this guidance did not have a material impact on our unaudited interim consolidated financial statements.

In January 2020, we adopted ASU No. 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement” (“ASU 2018-13”). ASU No. 2018-13 modifies the disclosure requirements in Topic 820, “Fair Value Measurement,” based on the FASB Concepts Statement, “Conceptual Framework for Financial Reporting – Chapter 8: Notes to Financial Statements,” including consideration of costs and benefits. The adoption of this guidance did not have a material impact on our unaudited interim 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.

Paycom Software, Inc.

Notes to the Unaudited Consolidated Financial Statements

(tabular dollars and shares in thousands, except per share amounts)

Seasonality

Our revenues are seasonal in nature. Recurring revenues include revenues relating to the annual processing of payroll forms, such as Form W-2, Form 1099, and Form 1095 and revenues from processing unscheduled payroll runs (such as bonuses) for our clients. As payroll forms are typically processed in the first quarter of the year, first quarter revenues and margins are generally higher than in subsequent quarters. These seasonal fluctuations in revenues can also have an impact on gross profits. Historical results impacted by these seasonal trends should not be considered a reliable indicator of our future results of operations.

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.

Funds Held for Clients and Client Funds Obligation

As part of our payroll and tax filing application, we (i) collect client funds to satisfy their respective federal, state and local 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 federal, state and local 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 offsetting 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 September 30, 2020 and December 31, 2019, the funds held for clients were invested in money market funds, demand deposit accounts, commercial paper with a maturity duration less than three months and certificates of deposit. Short-term investments in commercial paper and certificates of deposit with an original maturity duration greater than three months 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, which approximates the amortized cost of the securities. 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.

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 March 2020, our Board of Directors authorized the repurchase of up to $250.0 million of our common stock. As of September 30, 2020, there was $172.0 million available for repurchases under our stock repurchase plan. Our stock repurchase plan may be suspended or discontinued at any time. The actual timing, number and value of shares repurchased depends on a number of factors, including the market price of our common stock, general market and economic conditions, shares withheld for taxes associated with the vesting of restricted stock and other corporate considerations. The current stock repurchase plan will expire on March 12, 2022.

Recently Issued Accounting Pronouncements

In March 2020, the Financial Accounting Standard Board 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. Our interest-bearing notes bear interest at our option, at either (a) a prime rate plus 1.0% or (b) fluctuating interest rates based on LIBOR. If LIBOR ceases to exist, we may need to renegotiate our loan documents and we cannot predict what alternative index would be negotiated with our lenders. ASU 2020-04 is currently effective and upon adoption may be applied prospectively to contract modifications made on or before December 31, 2022. We are currently assessing the impact that this guidance will have on our financial position and results of operations, if any.

Paycom Software, Inc.

Notes to the Unaudited Consolidated Financial Statements

(tabular dollars and shares in thousands, except per share amounts)

In December 2019, the Financial Accounting Standards Board issued ASU No. 2019-12, “Income Taxes (Topic 740) Simplifying the Accounting for Income Taxes” (“ASU 2019-12”). The amendments in ASU 2019-12 eliminate certain exceptions related to the approach for intraperiod tax allocation, the methodology for calculating income tax in an interim period and the recognition of deferred tax liabilities for outside basis differences. ASU 2019-12 also clarifies and simplifies other aspects of the accounting for income taxes. This guidance is effective for fiscal years beginning after December 15, 2020, and for interim periods within those fiscal years, with early adoption permitted. We are currently evaluating the impact that this guidance will have on our financial position and results of operations, if any.

REVENUE

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 comprised of revenue 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, background check, on-boarding, e-verify and tax credit services applications. Time and labor management includes time and attendance, scheduling/schedule exchange, time-off requests, labor allocation, labor management reports/push reporting and geofencing/geotracking. Payroll includes our payroll and tax management, Paycom Pay, expense management, garnishment management and GL Concierge applications. Talent management includes our employee self-service, compensation budgeting, performance management, executive dashboard and Paycom learning and course content applications. HR management includes our document and task management, government and compliance, beneﬁts administration, COBRA administration, personnel action forms, surveys and enhanced Affordable Care Act applications.

The performance obligations related to recurring revenues are 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 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.

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 employee time and attendance services. Although these revenues are related to our recurring revenues, they represent distinct performance obligations.

Paycom Software, Inc.

Notes to the Unaudited Consolidated Financial Statements

(tabular dollars and shares in thousands, except per share 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 right performance obligations as of September 30, 2020 and 2019 were as follows:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2020			2019			2020			2019
Balance, beginning of period	$	80,887		$	70,004		$	76,244		$	64,651
Deferral of revenue		7,838			6,631			20,324			17,651
Recognition of unearned revenue		(3,338	)		(3,270	)		(11,181	)		(8,937	)
Balance, end of period	$	85,387		$	73,365		$	85,387		$	73,365

We expect to recognize $4.4 million of deferred revenue related to material right performance obligations in the remainder of 2020, $12.6 million of such deferred revenue in 2021, and $68.4 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 over the expected period of benefit, which we have determined to be the estimated 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 income.

Paycom Software, Inc.

Notes to the Unaudited Consolidated Financial Statements

(tabular dollars and shares in thousands, except per share amounts)

The following tables present the asset balances and related amortization expense for these contract costs:

	As of and for the Three Months Ended September 30, 2020
	Beginning		Capitalization					Ending
	Balance		of Costs		Amortization			Balance
Costs to obtain a contract	$	209,462	$	12,174	$	(7,716	)	$	213,920
Costs to fulfill a contract	$	171,941	$	18,709	$	(5,889	)	$	184,761

	As of and for the Three Months Ended September 30, 2019
	Beginning		Capitalization					Ending
	Balance		of Costs		Amortization			Balance
Costs to obtain a contract	$	178,445	$	11,315	$	(6,321	)	$	183,439
Costs to fulfill a contract	$	121,664	$	15,323	$	(4,258	)	$	132,729

	As of and for the Nine Months Ended September 30, 2020
	Beginning		Capitalization					Ending
	Balance		of Costs		Amortization			Balance
Costs to obtain a contract	$	194,964	$	41,340	$	(22,384	)	$	213,920
Costs to fulfill a contract	$	143,788	$	57,289	$	(16,316	)	$	184,761

	As of and for the Nine Months Ended September 30, 2019
	Beginning		Capitalization					Ending
	Balance		of Costs		Amortization			Balance
Costs to obtain a contract	$	158,989	$	42,513	$	(18,063	)	$	183,439
Costs to fulfill a contract	$	101,756	$	42,614	$	(11,641	)	$	132,729

4.	PROPERTY AND EQUIPMENT

Property and equipment and accumulated depreciation and amortization were as follows:

	September 30, 2020			December 31, 2019
Property and equipment
Software and capitalized software costs	$	132,356		$	99,125
Buildings		115,754			101,707
Computer equipment		65,686			56,879
Rental clocks		24,278			20,836
Furniture, fixtures and equipment		19,152			18,311
Other		7,001			6,242
		364,227			303,100
Less: accumulated depreciation and amortization		(163,865	)		(124,950	)
		200,362			178,150
Construction in progress		46,228			31,274
Land		29,034			29,034
Property and equipment, net	$	275,624		$	238,458

We capitalize computer software development costs related to software developed for internal use in accordance with ASC 350-40. For the three and nine months ended September 30, 2020, we capitalized $11.7 million and $32.4 million, respectively, of computer software development costs related to software developed for internal use. For the three and nine months ended September 30, 2019, we capitalized $7.1 million and $22.7 million, respectively, of computer software development costs related to software developed for internal use.

Paycom Software, Inc.

Notes to the Unaudited Consolidated Financial Statements

(tabular dollars and shares in thousands, except per share amounts)

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.

We capitalize interest incurred for indebtedness related to construction in progress. For the three and nine months ended September 30, 2020, we incurred interest costs of $0.4 million and $1.1 million, respectively, of which we capitalized $0.4 million and $1.1 million, respectively. For the three and nine months ended September 30, 2019, we incurred interest costs of $0.3 million and $1.1 million, respectively, of which we capitalized $0.2 million and $0.4 million, respectively. Included in the construction in progress balance at September 30, 2020 and December 31, 2019 is $2.9 million and $2.2 million in retainage, respectively.

Depreciation and amortization expense for property and equipment was $13.8 million and $39.1 million, respectively, for the three and nine months ended September 30, 2020. Depreciation and amortization expense for property and equipment was $10.9 million and $30.5 million, respectively, for the three and nine months ended September 30, 2019.

5.	GOODWILL AND INTANGIBLE ASSETS, NET

As of both September 30, 2020 and December 31, 2019, goodwill was $51.9 million. We have selected June 30 as our annual goodwill impairment testing date. We have elected to perform a qualitative analysis of the fair value of our goodwill and determined there was no impairment as of June 30, 2020. As of September 30, 2020 and December 31, 2019, there were no indicators of impairment.

All of our intangible assets other than goodwill are considered to have definite lives and, as such, are subject to amortization. The following tables provide the components of intangible assets, which are included in Other assets in our consolidated balance sheets:

	September 30, 2020
	Weighted Average Remaining				Accumulated
	Useful Life		Gross		Amortization			Net
	(Years)
Intangibles:
Trade name		1.8	$	3,194	$	(2,821	)	$	373
Total			$	3,194	$	(2,821	)	$	373

	December 31, 2019
	Weighted Average Remaining			Accumulated
	Useful Life	Gross		Amortization			Net
	(Years)
Intangibles:
Trade name	2.5	$	3,194	$	(2,662	)	$	532
Total		$	3,194	$	(2,662	)	$	532

The weighted average remaining useful life of our intangible assets was 1.8 years as of September 30, 2020. Amortization of intangible assets for the three and nine months ended September 30, 2020 was less than $0.1 million and $0.2 million, respectively. Amortization of intangible assets for the three and nine months ended September 30, 2019 was $0.1 million and $0.2 million, respectively.

6.	LONG-TERM DEBT, NET

Long-term debt consisted of the following:

	September 30, 2020			December 31, 2019
Net term note to bank due September 7, 2025	$	31,329		$	32,633
Total long-term debt, net (including current portion)		31,329			32,633
Less: Current portion		(1,775	)		(1,775	)
Total long-term debt, net	$	29,554		$	30,858

Paycom Software, Inc.

Notes to the Unaudited Consolidated Financial Statements

(tabular dollars and shares in thousands, except per share amounts)

On December 7, 2017, we entered into a senior secured term credit agreement (as amended from time to time, the “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 “Term Loans”). Our obligations under the Term Loans are secured by a mortgage and first priority security interest in our corporate headquarters property. The Term Loans mature on September 7, 2025 and bear interest, at our option, at either (a) a prime rate plus 1.0% or (b) an adjusted LIBOR rate for the interest period in effect for such Term Loan plus 1.5%. As of September 30, 2020, our indebtedness of $29.6 million consisted solely of Term Loans made under the Term Credit Agreement. Unamortized debt issuance costs of $0.2 million as of both September 30, 2020 and December 31, 2019 are presented as a direct deduction from the carrying amount of the debt liability.

Under the Term Credit Agreement, we are subject to two material financial covenants, which require us to maintain a fixed charge coverage ratio of not less than 1.25 to 1.0 and a funded indebtedness to EBITDA ratio of not greater than 2.0 to 1.0. As of September 30, 2020, we were in compliance with these covenants.

On February 12, 2018, we entered into a senior secured revolving credit agreement (the “Revolving Credit Agreement”) with JPMorgan Chase Bank, N.A. and Bank of America, N.A. that provided for a senior secured revolving credit facility (the “Facility”) in the aggregate principal amount of $50.0 million (the “Revolving Commitment”), which could be increased to up to $100.0 million, subject to obtaining additional lender commitments and certain approvals and satisfying certain other conditions. The Facility includes a $5.0 million sublimit for swingline loans and a $2.5 million sublimit for letters of credit. The Facility was scheduled to mature on February 12, 2020. On April 15, 2019, we entered into the First Amendment to Revolving Credit Agreement (the “First Amendment”). Pursuant to the First Amendment, Wells Fargo Bank, N.A., was added as a lender and the Revolving Commitment was increased to $75.0 million, which may be further increased to $125.0 million subject to obtaining additional lender commitments and certain approvals and satisfying other conditions. The scheduled maturity date of the Facility was extended to April 15, 2022.

Borrowings under the Facility will generally bear interest at a prime rate plus 1.0% or, at our option, an adjusted LIBOR rate for the interest period in effect for such borrowing plus 1.5%. The proceeds of the loans and letters of credit under the Facility are to be used only for our general business purposes and working capital. Letters of credit are to be issued only to support our business operations. As of September 30, 2020, we did not have any borrowings outstanding under the Facility.

Under the Revolving Credit Agreement, we are required to maintain a fixed charge coverage ratio of not less than 1.25 to 1.0 and a funded indebtedness to EBITDA ratio of not greater than 2.0 to 1.0. Additionally, the Revolving 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 certain investments, dispose of assets, enter into certain transactions, including swap agreements and sale and leaseback transactions, pay dividends or distributions on our capital stock, and enter into transactions with affiliates, in each case subject to customary exceptions for a facility of the size and type of the Facility. As of September 30, 2020, we were in compliance with all covenants related to the Revolving Credit Agreement.

As of September 30, 2020 and December 31, 2019, 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 Term Loans. We do not hold derivative instruments for trading or speculative purposes. The interest rate swap agreement effectively converts 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 8, “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 are recognized in our consolidated statements of income within Other income (expense), net.

The objective of the interest rate swap is to reduce the variability in the forecasted interest payments of the Term Loans, which is based on a one-month 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 will receive quarterly variable interest payments based on the LIBOR rate and will pay interest at a fixed rate. The interest rate swap agreement has a maturity date of September 7, 2025. For the three months ended September 30, 2020, we recorded a gain of $0.1 million and for the nine months ended September 30, 2020, we recorded a loss of $1.6 million, for the change in fair value of the interest rate swap, which is included in Other income (expense), net in the consolidated statements of income. For the three and nine months ended September 30, 2019, we recorded losses of $0.4 million and $1.8 million, respectively, for the change in fair value of the interest rate swap, which is included in Other income (expense), net in the consolidated statements of income.

Paycom Software, Inc.

Notes to the Unaudited Consolidated Financial Statements

(tabular dollars and shares in thousands, except per share amounts)

8.	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.

As discussed in Note 2, we invest the funds held for clients in money market funds, demand deposit accounts, commercial paper with a maturity duration less than three months and certificates of deposit, 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 commercial paper and certificates of deposit with an original maturity duration 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, which approximates the amortized cost of the securities. As of September 30, 2020 and December 31, 2019, all available-for-sale securities and certificates of deposit were due in thirteen months or less.

As discussed in Note 7, during the year ended December 31, 2017, we entered into an interest rate swap. The interest rate swap is measured on a recurring basis based on quoted prices for similar financial instruments and other observable inputs recognized at fair value.

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 September 30, 2020 and December 31, 2019:

	September 30, 2020
	Level 1		Level 2		Level 3		Total
Assets:
Commercial paper	$	—	$	89,843	$	—	$	89,843
Certificates of deposit	$	—	$	190,388	$	—	$	190,388
Liabilities:
Interest rate swap	$	—	$	2,976	$	—	$	2,976

	December 31, 2019
	Level 1		Level 2		Level 3		Total
Assets:
Commercial paper	$	—	$	79,591	$	—	$	79,591
Certificates of deposit	$	—	$	75,000	$	—	$	75,000
Liabilities:
Interest rate swap	$	—	$	1,358	$	—	$	1,358

9.	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 $1.9 million and $6.3 million for the

Paycom Software, Inc.

Notes to the Unaudited Consolidated Financial Statements

(tabular dollars and shares in thousands, except per share amounts)

three and nine months ended September 30, 2020, respectively. Matching contributions were $1.5 million and $4.8 million for the three and nine months ended September 30, 2019, 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. Eligible employees purchased 42,966 and 39,137 shares of the Company’s common stock under the ESPP during the nine months ended September 30, 2020 and 2019, respectively. 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 $0.7 million and $1.5 million for the three and nine months ended September 30, 2020, respectively. Our compensation expense related to the ESPP was $0.4 million and $1.3 million for the three and nine months ended September 30, 2019, respectively.

10.	EARNINGS PER SHARE

Basic earnings per share is based on 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 shares of restricted stock whether or not they are vested.

In accordance with ASC Topic 260, “Earnings Per Share,” the two-class method determines earnings for each class of common stock and participating securities according to an earnings allocation formula that adjusts the income available to common stockholders for dividends or dividend equivalents and participation rights in undistributed earnings. Certain unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents are participating securities and, therefore, are included in computing earnings per share pursuant to the two-class method. The unvested shares of restricted stock granted in 2015 are considered participating securities, while all other unvested shares of restricted stock are not considered participating securities.

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:

	Three Months Ended September 30,					Nine Months Ended September 30,
	2020		2019			2020		2019
Numerator:
Net income	$	27,482	$	39,152		$	119,086	$	135,196
Less: income allocable to participating securities		—		(18	)		—		(62	)
Income allocable to common shares	$	27,482	$	39,134		$	119,086	$	135,134
Add back: undistributed earnings allocable to participating securities	$	—	$	18		$	—	$	62
Less: undistributed earnings reallocated to participating securities		—		(18	)		—		(61	)
Numerator for diluted earnings per share	$	27,482	$	39,134		$	119,086	$	135,135
Denominator:
Basic weighted average shares outstanding		57,603		57,654			57,609		57,528
Dilutive effect of unvested restricted stock		568		729			703		875
Diluted weighted average shares outstanding		58,171		58,383			58,312		58,403
Earnings per share:
Basic	$	0.48	$	0.68		$	2.07	$	2.35
Diluted	$	0.47	$	0.67		$	2.04	$	2.31

Paycom Software, Inc.

Notes to the Unaudited Consolidated Financial Statements

(tabular dollars and shares in thousands, except per share amounts)

11.	STOCK-BASED COMPENSATION

The following table summarizes restricted stock awards activity for the nine months ended September 30, 2020:

	Time-Based					Market-Based
	Restricted Stock Awards					Restricted Stock Awards
	Shares			Weighted Average Grant Date Fair Value		Shares			Weighted Average Grant Date Fair Value
Unvested shares of restricted stock outstanding at December 31, 2019		742.6		$	107.93		—		$	—
Granted		152.9		$	281.02		360.9		$	216.69
Vested		(288.6	)	$	98.78		—		$	251.33
Forfeited		(41.0	)	$	171.11		(3.4	)	$	251.33
Unvested shares of restricted stock outstanding at September 30, 2020		565.9		$	154.78		357.5		$	216.35

During the nine months ended September 30, 2020, we issued an aggregate of 507,860 restricted shares of common stock to our executive officers and certain non-executive employees under the Paycom Software, Inc. 2014 Long-Term Incentive Plan (the “LTIP”), consisting of 360,948 shares subject to market-based vesting conditions (“Market-Based Shares”) and 146,912 shares subject to time-based vesting conditions (“Time-Based Shares”). Market-Based Shares for executive officers will vest 50% on the first date, if any, that the Company’s total enterprise value (calculated as defined in the applicable restricted stock award agreement) (“TEV”) equals or exceeds $23.75 billion and 50% on the first date, if any, that the Company’s TEV equals or exceeds $27.7 billion, in each case provided that (i) such date occurs on or before the sixth anniversary of the grant date and (ii) the recipient is employed by, or providing services to, the Company on the applicable vesting date. Market-Based Shares for non-executive employees will vest 50% on the first date, if any, that the Company’s TEV equals or exceeds $19.8 billion and 50% on the first date, if any, that the Company’s TEV equals or exceeds $22.15 billion, in each case provided that (i) such date occurs on or before the sixth anniversary of the grant date and (ii) the recipient is employed by, or providing services to, the Company on the applicable vesting date. 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. On April 27, 2020, we issued an aggregate of 5,970 restricted shares of common stock under the LTIP to the non-employee members of our Board of Directors. Such shares of restricted stock will cliff-vest on the seventh day following the first anniversary of the date of grant, provided that such director is providing services to the Company through the applicable vesting date.

For the three and nine months ended September 30, 2020, our total compensation expense related to restricted stock was $19.5 million and $56.5 million, respectively. For the three and nine months ended September 30, 2019, our total compensation expense related to restricted stock was $4.5 million and $41.1 million, respectively. There was $106.3 million of unrecognized compensation cost, net of estimated forfeitures, related to unvested shares of restricted stock outstanding as of September 30, 2020. The unrecognized compensation cost for the unvested shares is expected to be recognized over a weighted average period of 1.6 years as of September 30, 2020.

We capitalized stock-based compensation costs related to software developed for internal use of $1.6 million and $5.3 million for the three and nine months ended September 30, 2020, respectively. We capitalized stock-based compensation costs related to software developed for internal use of $0.3 million and $4.3 million for the three and nine months ended September 30, 2019, respectively.

Paycom Software, Inc.

Notes to the Unaudited Consolidated Financial Statements

(tabular dollars and shares in thousands, except per share amounts)

12.	COMMITMENTS AND CONTINGENCIES

As previously disclosed, since February 2019, we have received subpoenas and requests from the SEC focused on whether certain of our clients were charged, and paid, an additional amount for one or more applications for which the clients were already being charged. In connection with this matter, we identified less than 250 affected clients, representing approximately 0.5% of our client base as of December 31, 2019. Since December 2019, we have been in the process of notifying clients affected by such charges between approximately 2011 and September 2020 and have refunded approximately $2.5 million, in the aggregate, to such clients. This issue did not have a material impact on our financial results for any prior period. The SEC staff has informed our legal counsel that its inquiry concerns our books and records and internal controls. We cannot predict the timing, scope or outcome of this matter.

We are involved in various legal proceedings in the ordinary course of business. Although we cannot predict the outcome of these proceedings, legal matters are subject to inherent uncertainties and there exists the possibility that the ultimate resolution of these matters could have a material adverse effect on our business, financial condition, results of operations and cash flows.

13.	INCOME TAXES

The Company’s effective income tax rate was 20.3% and 18.0% for the nine months ended September 30, 2020 and 2019, respectively. The higher effective tax rate for the nine months ended September 30, 2020 is primarily related to a decrease in excess tax benefits from stock-based compensation related to vesting events as compared to the nine months ended September 30, 2019.

14.	SUBSEQUENT EVENTS

On October 22, 2020, the Company’s TEV exceeded $19.8 billion, which resulted in the vesting of 40,146 Market-Based Shares issued on January 30, 2020. For additional information on our stock-based compensation, see “Note 11. Stock-Based Compensation” in this Form 10-Q.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Management’s Discussion and Analysis of Financial Condition and Results of Operations is intended to provide a reader of our financial statements with a narrative from the perspective of our management on our financial condition, results of operations, liquidity, and certain other factors that may affect our future results. The following discussion and analysis should be read in conjunction with (i) the accompanying unaudited consolidated financial statements and notes thereto for the three and nine months ended September 30, 2020, (ii) the audited consolidated financial statements and notes thereto for the year ended December 31, 2019 included in our Annual Report on Form 10-K (the “Form 10-K”) filed with the Securities and Exchange Commission (the “SEC”) on February 13, 2020 and (iii) the discussion under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Form 10-K. Except for certain information as of December 31, 2019, all amounts herein are unaudited. Unless we state otherwise or the context otherwise requires, the terms “we,” “us,” “our” and the “Company” refer to Paycom Software, Inc. and its consolidated subsidiaries. All amounts presented in tables, other than per share amounts, are in thousands unless otherwise noted.

Forward-Looking Statements

The following discussion contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are any statements that look to future events and include, but are not limited to, statements regarding our business strategy; anticipated future operating results and operating expenses, cash flows, capital resources, dividends and liquidity; trends, opportunities and risks affecting our business, industry and financial results; future expansion or growth plans and potential for future growth; our ability to attract new clients to purchase our solution; our ability to retain clients and induce them to purchase additional applications; our ability to accurately forecast future revenues and appropriately plan our expenses; market acceptance of our solution and applications; our expectations regarding future revenues generated by certain applications; our ability to attract and retain qualified employees and key personnel; future regulatory, judicial and legislative changes; how certain factors affecting our performance correlate to improvement or deterioration in the labor market; our plan to open additional sales offices and our ability to effectively execute such plan; the sufficiency of our existing cash and cash equivalents to meet our working capital and capital expenditure needs over the next 12 months; our plans regarding our capital expenditures and investment activity as our business grows, including with respect to our new Texas operations facility and research and development; our plans to repurchase shares of our common stock through a stock repurchase plan; and the impact of the novel coronavirus (COVID-19) pandemic on our business, results of operations, cash flows, financial condition and liquidity. In addition, forward-looking statements also consist of statements involving trend analyses and statements including such words as “anticipate,” “believe,” “could,” “expect,” “intend,” “may,” “might,” “plan,” “potential,” “should,” “will,” “would,” and similar expressions or the negative of such terms or other comparable terminology.

Forward-looking statements are neither historical facts nor assurances of future performance, and are based only on our current beliefs, expectations and assumptions regarding the future of our business, future plans and strategies, projections, anticipated events and trends, the economy and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and many of which are outside of our control. Therefore, you should not rely on any of these forward-looking statements. Important factors that could cause our actual results and financial condition to differ materially from those indicated in the forward-looking statements include, among others, the following:

•

the impact of the COVID-19 pandemic on the U.S. economy, including reductions in employment levels, business disruptions resulting from government-mandated mitigation measures and an increase in business failures;

•

changes in laws, government regulations and policies and interpretations thereof;

•

the possibility of security vulnerabilities, cyberattacks and network disruptions, including breaches of data security and privacy leaks, data loss, and business interruptions;

•

our compliance with data privacy laws and regulations;

•

the possibility that the Affordable Care Act may be modified, repealed or declared unconstitutional;

•

our ability to develop enhancements and new applications, keep pace with technological developments and respond to future disruptive technologies;

•

our ability to compete effectively;

•

fluctuations in our financial results due to factors beyond our control;

•

our ability to manage our rapid growth and organizational change effectively;

•

the possibility that clients may not be satisfied with our deployment or technical support services, or that our solution fails to perform properly;

•

our dependence on our key executives;

•

our ability to attract and retain qualified personnel, including software developers and skilled IT, sales, marketing and operational personnel;

•

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

•

seasonality of certain operating results and financial metrics;

•

our failure to adequately protect our intellectual property rights;

•

our reliance on relationships with third parties; and

•

the other factors set forth in Part I, Item 1A, “Risk Factors” of the Form 10-K, Part II, Item 1A, “Risk Factors” of this Form 10-Q and our other reports filed with the SEC.

Forward-looking statements are based only on information currently available to us and speak only as of the date of this Form 10-Q. We do not undertake any obligation to update or revise the forward-looking statements to reflect events that occur or circumstances that exist after the date on which such statements were made, except to the extent required by law.

Overview

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

We generate revenues from (i) fixed amounts charged per billing period plus a fee per employee or transaction processed and (ii) fixed amounts charged per billing period. We do not require clients to enter into long-term contractual commitments with us. Our billing period varies by client based on when each client pays its employees, which may be weekly, bi-weekly, semi-monthly or monthly. We serve a diverse client base in terms of size and industry. None of our clients constituted more than one-half of one percent of our revenues for the nine months ended September 30, 2020. Our revenues are primarily generated through our sales force that solicits new clients and our client relations representatives who sell new applications to existing clients.

Our continued growth depends on attracting new clients through further penetration of our existing markets and geographic expansion into new markets, targeting a high degree of client employee usage across our solution, and introducing new applications to our existing client base. We believe our ability to continue to develop new applications and to improve existing applications will enable us to increase revenues in the future, and the number of our new applications adopted by our clients has been a significant factor in our revenue growth. We also plan to open additional sales offices in the future to further expand our presence in the U.S. market.

Our principal marketing efforts include email campaigns, social and digital media, search engine marketing methods, tradeshows and outbound marketing including television and print advertising. In addition, we generate leads and build recognition of our brand and thought leadership with relevant and informative content, such as white papers, blogs, podcast episodes and webinars.

Throughout our history, we have built strong relationships with our clients. As the HCM needs of our clients evolve, we believe that we are well-positioned to expand the HCM spending of our clients and we believe this opportunity is significant. To be successful, we must continue to demonstrate the operational and economic benefits of our solution, as well as effectively hire, train, motivate and retain qualified personnel.

Growth Outlook, Opportunities and Challenges

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

Our target client size range is 50 to 5,000 employees. While we continue to serve a diversified client base ranging in size from one employee to many thousands of employees, the average size of our clients has grown significantly as we have organically grown our operations, increased the number of applications we offer and gained traction with larger companies. We believe larger employers represent a substantial opportunity to increase the number of potential clients and to increase our revenues per client, with limited incremental cost to us. Because we charge our clients on a per-employee basis for certain services we provide, any increase or

decrease in the number of employees of our clients will have a positive or negative impact, respectively, on our results of operations. As discussed in more detail below, client headcount fluctuations are particularly relevant in light of the ongoing COVID-19 pandemic. Generally, we expect that changes in certain factors affecting our performance will correlate with improvement or deterioration in the labor market.

We collect funds from clients in advance of either the applicable due date for payroll tax submissions or the applicable disbursement date for employee payment services. Those collections from clients are typically disbursed from one to 30 days after receipt, with some funds being held for up to 120 days. We typically invest funds held for clients in money market funds, demand deposit accounts, commercial paper and certificates of deposit until they are paid to the applicable tax or regulatory agencies or to client employees. As we introduce new applications, expand our client base and renew and expand relationships with existing clients, we expect our average funds held for clients balance and, accordingly, interest earned on funds held for clients, will increase; however, the amount of interest we earn can be positively or negatively impacted by changes in interest rates. Even if our average funds held for clients balance increases, the impact of significantly lower average interest rates could partially offset the impact of such increased balance and, as a result, have a negative impact on recurring revenue growth.

Growing our business has resulted in, and will continue to result in, substantial investments in sales professionals, operating expenses, system development and programming costs and general and administrative expenses, which have increased and will continue to increase our expenses. Specifically, our revenue growth and geographic expansion drive increases in our employee headcount, which in turn precipitates increases in (i) salaries and benefits, (ii) stock-based compensation expense and (iii) facility costs related to the expansion of our corporate headquarters and operations facilities and additional sales office leases.

We believe the challenges of managing the ever-changing complexity of payroll and human resources will continue to drive companies to turn to outsourced providers for help with their HCM needs. The HCM industry historically has been driven, in part, by legislation and regulatory action, including COBRA, changes to the minimum wage laws or overtime rules, and legislation from federal, state or municipal taxation authorities.

Our revenues are seasonal in nature. Recurring revenues include revenues relating to the annual processing of payroll forms, such as Form W-2, Form 1099, and Form 1095, and revenues from processing unscheduled payroll runs (such as bonuses) for our clients. Because payroll forms are typically processed in the first quarter of the year, first quarter revenues and margins are generally higher than in subsequent quarters. These seasonal fluctuations in revenues can also have an impact on gross profits. Historical results impacted by these seasonal trends should not be considered a reliable indicator of our future results of operations. For the three months ended September 30, 2020 and 2019, our total gross margins were approximately 84% and 85%, respectively. For the nine months ended September 30, 2020 and 2019, our total gross margins were approximately 85% and 85%, respectively. Although our gross margins may fluctuate from quarter to quarter due to seasonality and hiring trends, we expect that our gross margins will remain relatively consistent in future periods.

Impact of the COVID-19 Pandemic

On March 11, 2020, the World Health Organization declared the COVID-19 outbreak to be a global pandemic. In response, federal, state and local governments imposed various restrictions on social and commercial activity to promote social distancing in an effort to slow the spread of the disease, and many such restrictions remain in place. Beginning in February 2020, we took various actions in order to minimize the risk of COVID-19 to our employees, our clients, and the communities in which we operate, and in March 2020, we prohibited all business-related travel until further notice and began transitioning our employees to work-from-home arrangements. Our sales employees have been conducting all meetings with current and prospective clients virtually since March 2020, and we expect this practice to continue for the foreseeable future. As of September 30, 2020, 95% of our employees were working remotely. We will continue to actively monitor the situation and may take further actions that alter our business operations as may be required by federal, state or local authorities or that we determine are in the best interests of our employees and clients.

The COVID-19 pandemic has disrupted the operations of our clients and client prospects and may continue to do so for an indefinite period of time. Across many industries, temporary and permanent business closures as well as business occupancy limitations have resulted in significant layoffs and employee furloughs since late March 2020. Because we charge our clients on a per-employee basis for certain services we provide, decreases in headcount at our clients as of the onset of the pandemic negatively impacted our recurring revenue in the third quarter of 2020, and we expect that our recurring revenue in future periods will continue to be negatively impacted by such headcount reductions until employment levels among such client base return to pre-pandemic levels. Further, at the onset of the COVID-19 pandemic, a limited number of new clients temporarily delayed service implementation. As the COVID-19 pandemic continues to create uncertainty and the potential for ongoing business disruptions, we may experience similar client-driven delays in service implementation in the future.

In addition, during 2019, interest earned on funds held for clients contributed to growth in recurring revenue, due to both higher average interest rates and an increased average funds held for clients balance. Since August 2019, the Federal Open Market Committee has reduced the target range for short-term interest rates several times, with the most significant rate cut occurring in March 2020 to support the economy and potentially reduce the impacts of the COVID-19 pandemic. Further, a provision in the

Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) allows employers to delay the payment of the employer’s share of Social Security taxes to a future date. To the extent our clients make such election, we are collecting less money from them to hold and then remit to the appropriate taxing authorities, which adversely affects our average funds held for clients balance and, consequently, interest earned on funds held for clients. In the third quarter of 2020, despite the growth in the number of clients in our base, employee headcount reductions at our clients as well as clients electing to defer payment of their share of Social Security taxes under the CARES Act resulted in nominal growth in our average funds held for clients balance, relative to the third quarter of 2019. Due to significantly lower average interest rates in 2020 and, to a lesser extent, the lack of growth of our average funds held for clients balance, interest earned on funds held for clients for the three and nine months ended September 30, 2020 decreased from the comparable prior year periods, which had a negative effect on recurring revenue growth.

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

Despite the economic challenges brought on by the COVID-19 pandemic, we remain confident in the overall health of our business, the strength of our product offerings, and our ability to continue to execute on our strategy. Internally, all applications within the Paycom solution, and more specifically Employee Self-Service, Manager on-the-Go, Documents and Checklists, Ask Here and our enhanced Learning Management System, have been instrumental in our ability to seamlessly manage and communicate with our remote workforce. As many clients have also transitioned their workforces to work-from-home arrangements, we believe they too are recognizing the benefits of these applications and our focus on employee usage, as well as the strengths and advantages of our single database solution. In contrast, we believe the remote work environment is exposing the weaknesses and disadvantages arising from the combination of disparate systems offered by some of our competitors.

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

Although we currently have some insight with respect to the shorter-term effects of the COVID-19 pandemic on our business and results of operations, we are unable to estimate the full impact that the COVID-19 pandemic could have on our business and results of operations in the future due to numerous uncertainties, including the severity of the disease, the duration of the outbreak, actions that may be taken by governmental authorities, the impact to the business of our clients and other factors identified in Part II, Item 1A “Risk Factors” in this Form 10-Q. Further, while our revenue and earnings are relatively predictable, the effect of the ongoing COVID-19 pandemic may not be fully reflected in our results of operations and overall financial performance until future periods.

Results of Operations

The following table sets forth consolidated statements of income data and such data as a percentage of total revenues for the periods presented:

	Three Months Ended September 30,										Nine Months Ended September 30,
	2020				2019					% Change	2020					2019					% Change
Revenues
Recurring	$	192,664	98.0	%	$	171,405		97.9	%	12%	$	609,109		98.2	%	$	534,267		98.2	%	14%
Implementation and other		3,868	2.0	%		3,601		2.1	%	7%		11,378		1.8	%		9,995		1.8	%	14%
Total revenues		196,532	100.0	%		175,006		100.0	%	12%		620,487		100.0	%		544,262		100.0	%	14%
Cost of revenues
Operating expenses		24,278	12.3	%		21,088		12.1	%	15%		71,651		11.5	%		66,153		12.2	%	8%
Depreciation and amortization		6,634	3.4	%		5,304		3.0	%	25%		18,865		3.0	%		14,796		2.7	%	28%
Total cost of revenues		30,912	15.7	%		26,392		15.1	%	17%		90,516		14.5	%		80,949		14.9	%	12%
Administrative expenses
Sales and marketing		62,146	31.6	%		47,060		26.9	%	32%		173,228		27.9	%		128,280		23.6	%	35%
Research and development		21,772	11.1	%		19,605		11.2	%	11%		65,171		10.5	%		54,869		10.1	%	19%
General and administrative		40,516	20.6	%		25,728		14.7	%	57%		121,487		19.6	%		98,386		18.0	%	23%
Depreciation and amortization		7,150	3.6	%		5,665		3.2	%	26%		20,209		3.3	%		15,848		2.9	%	28%
Total administrative expenses		131,584	66.9	%		98,058		56.0	%	34%		380,095		61.3	%		297,383		54.6	%	28%
Total operating expenses		162,496	82.6	%		124,450		71.1	%	31%		470,611		75.8	%		378,332		69.5	%	24%
Operating income		34,036	17.4	%		50,556		28.9	%	-33%		149,876		24.2	%		165,930		30.5	%	-10%
Interest expense		—	0.0	%		(260	)	-0.1	%	-100%		(19	)	0.0	%		(794	)	-0.1	%	-98%
Other income (expense), net		246	0.1	%		195		0.1	%	26%		(522	)	-0.1	%		(168	)	-0.1	%	211%
Income before income taxes		34,282	17.5	%		50,491		28.9	%	-32%		149,335		24.1	%		164,968		30.3	%	-9%
Provision for income taxes		6,800	3.5	%		11,339		6.5	%	-40%		30,249		4.9	%		29,772		5.5	%	2%
Net income	$	27,482	14.0	%	$	39,152		22.4	%	-30%	$	119,086		19.2	%	$	135,196		24.8	%	-12%

Revenues

The increase in total revenues for the three and nine months ended September 30, 2020 compared to the same periods in 2019 was primarily the result of (i) the addition of new clients and productivity and efficiency gains in mature sales offices, which are offices that have been open for at least 24 months, (ii) contributions from new sales offices opened in 2018 and 2019 that are progressing to maturity and (iii) the sale of additional applications to our existing clients. In addition, the strong performance of our tax forms filing business in the first quarter contributed to the increase in total revenues for the nine months ended September 30, 2020 as compared to the same period in 2019. The COVID-19 pandemic has resulted in, and may continue to result in, headcount reductions across our client base. Because we charge our clients on a per-employee basis for certain services we provide, the drivers of revenue for the three and nine months ended September 30, 2020 described above were partially offset by the negative impact of headcount reductions within our client base as of the onset of the pandemic. Additionally, lower employee headcount at our clients as well as clients electing the Social Security tax deferral under the CARES Act negatively impacted our average funds held for clients balance for the three and nine months ended September 30, 2020. Significantly lower average interest rates in the first nine months of 2020 as compared to the same period in 2019, as well as minimal growth in the average funds held for clients balance, resulted in a decrease in interest earned on funds held for clients and, consequently, had a negative effect on recurring revenue growth for the three and nine months ended September 30, 2020. We expect that the foregoing adverse macroeconomic factors will continue to have a negative effect on recurring revenues in future periods for so long as such conditions persist.

The increase in implementation and other revenues for the three and nine months ended September 30, 2020 from the same periods in 2019 was primarily the result of the increased recognition of non-refundable upfront conversion fees that are charged to new clients to offset the expense of new client set up. These fees are deferred and recognized ratably over the ten-year estimated life of our clients.

Expenses

Cost of Revenues

During the three months ended September 30, 2020, cost of revenues increased from the comparable prior year period by $4.5 million. Depreciation and amortization expense increased $1.3 million from the comparable prior year period, primarily due to the development of additional technology and purchases of other fixed assets. Additionally, for the three months ended September 30, 2020, as compared to the same period in 2019, employee-related expenses increased $1.7 million due to growth in the number of operating personnel, shipping and supplies fees increased $0.6 million, non-cash stock-based compensation increased $0.5 million, and automated clearing house fees increased $0.5 million in connection with the increase in revenues.

During the nine months ended September 30, 2020, cost of revenues increased from the comparable prior year period by $9.6 million. Depreciation and amortization expense increased $4.1 million from the comparable prior year period, primarily due to the development of additional technology and purchases of other fixed assets. Additionally, for the nine months ended September 30, 2020, as compared to the same period in 2019, employee-related expenses increased $4.3 million due to growth in the number of operating personnel, and non-cash stock-based compensation increased $0.2 million. Automated clearing house fees also increased $0.9 million in connection with the increase in revenues.

Administrative Expenses

Sales and Marketing

During the three months ended September 30, 2020, sales and marketing expenses increased from the comparable prior year period by $15.1 million due to a $10.4 million increase in marketing and advertising expense attributable to increased spending across most components of our marketing program, a $3.5 million increase in non-cash stock-based compensation, and a $1.2 million increase in employee-related expenses, including commissions and bonuses.

During the nine months ended September 30, 2020, sales and marketing expenses increased from the comparable prior year period by $44.9 million due to a $31.5 million increase in marketing and advertising expense attributable to increased spending across most components of our marketing program, a $8.1 million increase in employee-related expenses, including commissions and bonuses, and a $5.3 million increase in non-cash stock-based compensation. Based on positive results from recent advertising campaigns, we plan to continue to make significant investments in our marketing program and may increase spending in future periods as we see opportunities for returns on our investments.

Research and Development

During the three months ended September 30, 2020, research and development expenses increased from the comparable prior year period due to a $2.2 million increase in employee-related expenses, including a $0.5 million increase in non-cash stock-based compensation expense. During the nine months ended September 30, 2020, research and development expenses increased from the comparable prior year period due to a $10.3 million increase in employee-related expenses, including a $2.1 million increase in non-cash stock-based compensation expense.

As we continue the ongoing development of our platform and product offerings, we generally expect research and development expenses (exclusive of stock-based compensation) to continue to increase, particularly as we hire more personnel to support our growth. While we expect this trend to continue on an absolute dollar basis and as a percentage of total revenues, we also anticipate the rate of increase to decline over time as we leverage our growth and realize additional economies of scale. As is customary for our business, we also expect fluctuations in research and development expense as a percentage of revenue on a quarter-to-quarter basis due to seasonal revenue trends, the introduction of new products, the amount and timing of research and development costs that may be capitalized and the timing of onboarding new hires and restricted stock vesting events.

Expenditures for software developed or obtained for internal use are capitalized and amortized over a three-year period on a straight-line basis. The nature of the development projects underway during a particular period directly impacts the timing and extent of these capitalized expenditures and can affect the amount of research and development expenses in such period. The table below sets forth the amounts of capitalized and expensed research and development costs for the three and nine months ended September 30, 2020 and 2019:

	Three Months Ended September 30,					Nine Months Ended September 30,
	2020		2019		% Change	2020		2019		% Change
Capitalized portion of research and development	$	11,727	$	7,089	65%	$	32,448	$	22,726	43%
Expensed portion of research and development		21,772		19,605	11%		65,171		54,869	19%
Total research and development costs	$	33,499	$	26,694	25%	$	97,619	$	77,595	26%

General and Administrative

During the three months ended September 30, 2020, general and administrative expenses increased $14.8 million from the comparable prior year period primarily due to a $10.6 million increase in non-cash stock-based compensation and a $4.4 million increase in employee-related expenses. These increases in general and administrative expenses were partially offset by a $0.2 million decrease in accounting and legal expenses.

During the nine months ended September 30, 2020, general and administrative expenses increased $23.1 million from the comparable prior year period primarily due to a $13.4 million increase in employee-related expenses, a $7.7 million increase in stock-based compensation, and a $2.0 million increase in accounting and legal expenses related to regulatory and compliance matters.

Non-Cash Stock-Based Compensation Expense

The following table presents the non-cash stock-based compensation expense that is included within the specified line items in our consolidated statements of income:

	Three Months Ended September 30,					Nine Months Ended September 30,
	2020		2019		% Change	2020		2019		% Change
Non-cash stock-based compensation expense
Operating expenses	$	1,227	$	750	64%	$	4,158	$	3,955	5%
Sales and marketing		3,829		344	1013%		10,795		5,453	98%
Research and development		2,115		1,586	33%		7,270		5,137	42%
General and administrative		12,331		1,774	595%		34,308		26,577	29%
Total non-cash stock-based compensation expense	$	19,502	$	4,454	338%	$	56,531	$	41,122	37%

During the three months ended September 30, 2020, our non-cash stock-based compensation expense increased $15.0 million from the comparable prior year period primarily due to the timing of vesting events for restricted stock subject to market-based vesting conditions during the first quarter of 2019. During the nine months ended September 30, 2020, our non-cash stock-based compensation expense increased $15.4 million from the comparable prior year period due to an increase in both the number of employees who received awards and the grant date fair value associated with the issuances in 2020.

Depreciation and Amortization

During the three and nine months ended September 30, 2020, depreciation and amortization expense increased from the respective comparable prior year periods primarily due to the development of additional technology and purchases of other related fixed assets.

Interest Expense

The decreases in interest expense for the three and nine months ended September 30, 2020, as compared to the comparable prior year periods were due to the timing of construction of our expanded operations facility in Grapevine, Texas, which resulted in more capitalized interest in 2020.

Other Income (Expense), net

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

Provision for Income Taxes

The provision for income taxes is based on a current estimate of the annual effective income tax rate adjusted to reflect the impact of discrete items. Our effective income tax rate was 20.3% and 18.0% for the nine months ended September 30, 2020 and 2019, respectively. The higher effective income tax rate for the nine months ended September 30, 2020 primarily resulted from a decrease in excess tax benefits from stock-based compensation related to vesting events as compared to the nine months ended September 30, 2019.

Liquidity and Capital Resources

Our principal sources of capital and liquidity are our operating cash flow and cash and cash equivalents. Our cash and cash equivalents consist primarily of demand deposit accounts, money market funds and certificates of deposit. Additionally, we maintain a

senior secured revolving credit facility (the “Facility”), which can be accessed as needed to supplement our operating cash flow and cash balances. The Facility provides us the ability to borrow funds in the aggregate principal amount of $75.0 million, which may be increased to $125.0 million, subject to obtaining additional lender commitments and certain approvals and satisfying certain other conditions. We believe our existing cash and cash equivalents and cash generated from operations will be sufficient to meet our working capital and capital expenditure needs over at least the next 12 months. Given the rapidly changing market and economic conditions related to the COVID-19 outbreak, we will continue to evaluate the nature and extent of the impact to our business, financial position and liquidity.

We have historically funded our operations from cash flows generated from operations, cash from the sale of equity securities and debt financing. Although we have funded most of the costs for ongoing construction projects at our corporate headquarters from available cash, we have incurred indebtedness for a portion of these costs. Further, all purchases under our stock repurchase plans were paid for from available cash.

Term Credit Agreement. As of September 30, 2020, our indebtedness consisted solely of term loans (the “Term Loans”) made under a senior secured term credit agreement (as amended from time to time, the “Term Credit Agreement”) among the Company, certain of our subsidiaries, JPMorgan Chase Bank, N.A., Bank of America, N.A. and Kirkpatrick Bank. All Term Loans were used to finance construction projects at our corporate headquarters. Our obligations under the Term Loans are secured by a mortgage and first priority security interest in our corporate headquarters property. The Term Loans mature on September 7, 2025 and bear interest, at our option, at either (a) a prime rate plus 1.0% or (b) an adjusted LIBOR rate for the interest period in effect for such Term Loan plus 1.5%.

Under the Term Credit Agreement, we are required to comply with certain financial and non-financial covenants, including maintaining a fixed charge coverage ratio of not less than 1.25 to 1.0 and a funded indebtedness to EBITDA ratio of not greater than 2.0 to 1.0. Additionally, the Term Credit Agreement contains customary affirmative and negative covenants, including covenants limiting our ability to, among other things, grant liens, incur debt, effect certain mergers, make investments, dispose of assets, enter into certain transactions including swap agreements and sale and leaseback transactions, pay dividends or distributions on our capital stock, and enter into transactions with affiliates, in each case subject to customary exceptions for a credit agreement of this size and type. As of September 30, 2020, we were in compliance with all covenants set forth in the Term Credit Agreement.

Interest Rate Swap Agreement. In connection with entering into the Term Credit Agreement, we also entered into a floating-to-fixed interest rate swap agreement to limit the exposure to interest rate risk related to the Term Loans (the “Interest Rate Swap Agreement”). The Interest Rate Swap Agreement, which has a maturity date of September 7, 2025, provides that we will receive quarterly variable interest payments based on the LIBOR rate and will pay interest at a fixed rate. We have elected not to designate this interest rate swap as a hedge and, as such, changes in the fair value of the derivative instrument are recognized in our consolidated statements of income. For the three months ended September 30, 2020, we recognized a gain of $0.1 million and for the nine months ended September 30, 2020, we recognized a loss of $1.6 million, for the change in fair value of the interest rate swap, which is included in Other income (expense), net in the consolidated statements of income. For the three and nine months ended September 30, 2019, we recognized a loss of $0.4 million and $1.8 million, respectively, for the change in fair value of the interest rate swap, which is included in Other income, net in the consolidated statements of income.

Revolving Credit Agreement. On February 12, 2018, we entered into a senior secured revolving credit agreement (the “Revolving Credit Agreement”) with JPMorgan Chase Bank, N.A. and Bank of America, N.A. that provided for the Facility in the aggregate principal amount of $50.0 million (the “Revolving Commitment”), which could be increased to up to $100.0 million, subject to obtaining additional lender commitments and certain approvals and satisfying certain other conditions. The Facility includes a $5.0 million sublimit for swingline loans and a $2.5 million sublimit for letters of credit. The Facility was scheduled to mature on February 12, 2020. On April 15, 2019, we entered into the First Amendment to Revolving Credit Agreement (the “First Amendment”). Pursuant to the First Amendment, Wells Fargo Bank, N.A. was added as a lender and the Revolving Commitment was increased to $75.0 million, which may be further increased to $125.0 million subject to obtaining additional lender commitments and certain approvals and satisfying other conditions, and the scheduled maturity date of the Facility was extended to April 15, 2022.

Borrowings under the Facility will generally bear interest at a prime rate plus 1.0% or, at our option, an adjusted LIBOR rate for the interest period in effect for such borrowing plus 1.5%, in each case subject to certain conditions set forth in the Revolving Credit Agreement. As of September 30, 2020, we did not have any borrowings outstanding under the Facility.

Stock Repurchase Plan and Withholding Shares to Cover Taxes. In May 2016, our Board of Directors authorized a stock repurchase plan allowing for the repurchase of shares of our common stock in open market transactions at prevailing market prices, in privately negotiated transactions or by other means in accordance with federal securities laws, including Rule 10b5-1 programs. Since the initial authorization of the stock repurchase plan, our Board of Directors has amended and extended and authorized new stock repurchase plans from time to time. Most recently, in March 2020, our Board of Directors authorized the repurchase of up to $250.0 million of our common stock. As of September 30, 2020, there was $172.0 million available for repurchases under our stock repurchase plan. Our stock repurchase plan may be suspended or discontinued at any time. The actual timing, number and value of shares repurchased depends on a number of factors, including the market price of our common stock, general market and economic

conditions, shares withheld for taxes associated with the vesting of restricted stock and other corporate considerations. The current stock repurchase plan will expire on March 12, 2022.

During the nine months ended September 30, 2020, we repurchased an aggregate of 344,216 shares of our common stock at an average cost of $227.00 per share, including 99,785 shares withheld to satisfy tax withholding obligations for certain employees upon the vesting of restricted stock. Our payment of the taxes on behalf of those employees resulted in an aggregate cash expenditure of $26.1 million and, as such, we generally subtract the amounts attributable to such withheld shares from the aggregate amount available for future purchases under our stock repurchase plan.

Cash Flow Analysis

Our cash flows from operating activities have historically been significantly impacted by profitability, implementation revenues received but deferred, our investment in sales and marketing to drive growth, and research and development. Our ability to meet future liquidity needs will be driven by our operating performance and the extent of continued investment in our operations. Failure to generate sufficient revenues and related cash flows could have a material adverse effect on our ability to meet our liquidity needs and achieve our business objectives.

As our business grows, we expect our capital expenditures and our investment activity to continue to increase. We are currently focused on the ongoing construction of our new Texas operations facility in Grapevine, Texas. Capital expenditures related to the construction of the facility began in the second quarter of 2019. Depending on certain growth opportunities, we may choose to accelerate investments in sales and marketing, acquisitions, technology and services. Actual future capital requirements will depend on many factors, including our future revenues, cash from operating activities and the level of expenditures in all areas of our business, as well as the duration and extent of remote work arrangements due to the COVID-19 pandemic.

As part of our payroll and payroll tax filing services, we collect funds from our clients for federal, state and local employment taxes, which we remit to the appropriate tax agencies. We invest these funds in money market funds, demand deposit accounts, commercial paper and certificates of deposit from which we earn interest income during the period between their receipt and disbursement.

Our cash flows from investing and financing activities are influenced by the amount of funds held for clients, which can vary significantly from quarter to quarter. The balance of the funds we hold depends on our clients’ payroll calendars, and therefore such balance changes from period to period in accordance with the timing of each payroll cycle.

Our cash flows from financing activities are also affected by the extent to which we use available cash to purchase shares of common stock under our stock repurchase plan as well as restricted stock vesting events that result in net share settlements and the Company paying withholding taxes on behalf of certain employees.

The following table summarizes the consolidated statements of cash flows for the nine months ended September 30, 2020 and 2019:

	Nine Months Ended September 30,
	2020			2019			% Change
Net cash provided by (used in):
Operating activities	$	174,328		$	176,419		-1%
Investing activities		(197,767	)		(78,148	)	153%
Financing activities		(219,891	)		(175,445	)	25%
Change in cash, cash equivalents, restricted cash and restricted cash equivalents	$	(243,330	)	$	(77,174	)	215%

Operating Activities

Cash provided by operating activities for the nine months ended September 30, 2020 primarily consisted of payments received from our clients and interest earned on funds held for clients. Cash used in operating activities primarily consisted of personnel-related expenditures to support the growth and infrastructure of our business. These payments included costs of operations, advertising and other sales and marketing efforts, IT infrastructure development, product research and development and security and administrative costs. Compared to the nine months ended September 30, 2019, our operating cash flows for the nine months ended September 30, 2020 decreased primarily due to our increased spending across most components of our marketing program and the impact of COVID-19 conditions on our revenues.

Investing Activities

Cash flows used in investing activities for the nine months ended September 30, 2020 increased from the comparable prior year period due to a $156.6 million increase in purchases of short-term investments from funds held for clients and a $2.4 million increase

in cash used for purchases of property and equipment. The increase in cash used in investing activities was partially offset by a $39.4 million increase in proceeds from maturities of short-term investments from funds held for clients.

Financing Activities

Cash flows used in financing activities for the nine months ended September 30, 2020 increased from the comparable prior year period primarily due to $52.0 million in repurchases of common stock. Additionally, cash flows used in financing activities increased by the impact of an $8.6 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. These cash flows used in financing activities were partially offset by a $16.1 million decrease in withholding taxes paid related to net share settlements.

Contractual Obligations

Our principal commitments primarily consist of long-term debt and leases for office space. There have been no material changes to our contractual obligations disclosed in the contractual obligations section of Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Form 10-K. For additional information regarding our leases, long-term debt and our commitments and contingencies, see “Note 5. Leases”, “Note 6. Long-Term Debt” and “Note 12. Commitments and Contingencies” in the Form 10-K and “Note 6. Long-Term Debt, Net” and “Note 12. Commitments and Contingencies” in the notes to our unaudited consolidated financial statements included elsewhere in this Form 10-Q.

Off-Balance Sheet Arrangements

As of September 30, 2020, we did not have any off-balance sheet arrangements that had or were reasonably likely to have an effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources that may be material to investors.

Critical Accounting Policies and Estimates

Our consolidated financial statements and accompanying notes have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”). The preparation of these consolidated financial statements requires us to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses, and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions to ensure that management believes them to be reasonable under the then-current facts and circumstances. Actual amounts and results may materially differ from these estimates made by management under different assumptions and conditions.

Certain accounting policies that require significant management estimates, and are deemed critical to our results of operations or financial position, are discussed in the critical accounting policies and estimates section of Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Form 10-K. There have been no material changes to the critical accounting policies disclosed in the Form 10-K.

Adoption of Accounting Pronouncements

Discussion of our adoption of ASU 2018-13 and ASU 2018-15 can be found in Note 2 in this Form 10-Q.

Non-GAAP Financial Measures

Management uses adjusted EBITDA and non-GAAP net income as supplemental measures to review and assess the performance of our core business operations and for planning purposes. We define (i) adjusted EBITDA as net income plus interest expense, taxes, depreciation and amortization, non-cash stock-based compensation expense, certain transaction expenses that are not core to our operations (if any) and the change in fair value of our interest rate swap and (ii) non-GAAP net income as net income plus non-cash stock-based compensation expense, certain transaction expenses that are not core to our operations (if any) and the change in fair value of our interest rate swap, all of which are adjusted for the effect of income taxes. Adjusted EBITDA and non-GAAP net income are metrics that provide investors with greater transparency to the information used by management in its financial and operational decision-making. We believe these metrics are useful to investors because they facilitate comparisons of our core business operations across periods on a consistent basis, as well as comparisons with the results of peer companies, many of which use similar non-GAAP financial measures to supplement results under U.S. GAAP. In addition, adjusted EBITDA is a measure that provides useful information to management about the amount of cash available for reinvestment in our business, repurchasing common stock and other purposes. Management believes that the non-GAAP measures presented in this Form 10-Q, when viewed in combination with our results prepared in accordance with U.S. GAAP, provide a more complete understanding of the factors and trends affecting our business and performance.

Adjusted EBITDA and non-GAAP net income are not measures of financial performance under U.S. GAAP, and should not be considered a substitute for net income, which we consider to be the most directly comparable U.S. GAAP measure. Adjusted EBITDA and non-GAAP net income have limitations as analytical tools, and when assessing our operating performance, you should not consider adjusted EBITDA or non-GAAP net income in isolation, or as a substitute for net income or other consolidated statements of

income data prepared in accordance with U.S. GAAP. Adjusted EBITDA and non-GAAP net income may not be comparable to similarly titled measures of other companies and other companies may not calculate such measures in the same manner as we do.

The following tables reconcile net income to adjusted EBITDA, net income to non-GAAP net income and earnings per share to non-GAAP net income per share on a basic and diluted basis:

	Three Months Ended September 30,					Nine Months Ended September 30,
	2020			2019		2020		2019
Net income to adjusted EBITDA:
Net income	$	27,482		$	39,152	$	119,086	$	135,196
Interest expense		—			260		19		794
Provision for income taxes		6,800			11,339		30,249		29,772
Depreciation and amortization		13,784			10,969		39,074		30,644
EBITDA		48,066			61,720		188,428		196,406
Non-cash stock-based compensation expense		19,502			4,454		56,531		41,122
Change in fair value of interest rate swap		(88	)		391		1,618		1,763
Adjusted EBITDA	$	67,480		$	66,565	$	246,577	$	239,291

	Three Months Ended September 30,						Nine Months Ended September 30,
	2020			2019			2020			2019
Net income to non-GAAP net income:
Net income	$	27,482		$	39,152		$	119,086		$	135,196
Non-cash stock-based compensation expense		19,502			4,454			56,531			41,122
Change in fair value of interest rate swap		(88	)		391			1,618			1,763
Income tax effect on non-GAAP adjustments		(6,332	)		(2,875	)		(22,802	)		(23,974	)
Non-GAAP net income	$	40,564		$	41,122		$	154,433		$	154,107

Weighted average shares outstanding:
Basic		57,603			57,654			57,609			57,528
Diluted		58,171			58,383			58,312			58,403

Earnings per share, basic	$	0.48		$	0.68		$	2.07		$	2.35
Earnings per share, diluted	$	0.47		$	0.67		$	2.04		$	2.31
Non-GAAP net income per share, basic	$	0.70		$	0.71		$	2.68		$	2.68
Non-GAAP net income per share, diluted	$	0.70		$	0.70		$	2.65		$	2.64

	Three Months Ended September 30,						Nine Months Ended September 30,
	2020			2019			2020			2019
Earnings per share to non-GAAP net income per share, basic:
Earnings per share, basic	$	0.48		$	0.68		$	2.07		$	2.35
Non-cash stock-based compensation expense		0.34			0.08			0.98			0.71
Change in fair value of interest rate swap		—			0.01			0.03			0.03
Income tax effect on non-GAAP adjustments		(0.12	)		(0.06	)		(0.40	)		(0.41	)
Non-GAAP net income per share, basic	$	0.70		$	0.71		$	2.68		$	2.68

	Three Months Ended September 30,						Nine Months Ended September 30,
	2020			2019			2020			2019
Earnings per share to non-GAAP net income per share, diluted:
Earnings per share, diluted	$	0.47		$	0.67		$	2.04		$	2.31
Non-cash stock-based compensation expense		0.34			0.08			0.97			0.70
Change in fair value of interest rate swap		—			0.01			0.03			0.03
Income tax effect on non-GAAP adjustments		(0.11	)		(0.06	)		(0.39	)		(0.40	)
Non-GAAP net income per share, diluted	$	0.70		$	0.70		$	2.65		$	2.64

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Sensitivity

We had cash and cash equivalents totaling $156.4 million as of September 30, 2020. These amounts are invested primarily in demand deposit accounts and money market funds. We consider all highly liquid debt instruments purchased with a maturity of three months or less and SEC-registered money market mutual funds to be cash equivalents. 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 cash equivalents 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.

As described elsewhere in this Form 10-Q, the Term Loans made under the Term Credit Agreement bear interest, at our option, at either (a) a prime rate plus 1.0% or (b) an adjusted LIBOR rate for the interest period in effect for such Term Loan plus 1.5%. As a result, we are exposed to increased interest rate risk. To mitigate the increased interest rate risk, we entered into the Interest Rate Swap Agreement. The Interest Rate Swap Agreement has effectively fixed our interest rate at 4.0%, eliminating a portion of the variable rate and coinciding interest rate risk associated with the Term Loans. As of September 30, 2020, an increase or decrease in interest rates of 100-basis points would not have had a material effect on our operating results or financial condition.

As described elsewhere in this Form 10-Q, the Revolving Credit Agreement, as amended, provides for a Facility in the aggregate amount of $75.0 million, which may be increased to up to $125.0 million. Borrowings under the Facility will generally bear interest at a prime rate plus 1.0% or, at our option, an adjusted LIBOR rate for the interest period in effect for such borrowing plus 1.5%. As of September 30, 2020, we have not made any draws under the Facility. To the extent we make draws under the Facility in the future, we may be exposed to increased interest rate risk.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

As required by Rule 13a-15(b) and Rule 15d-15(b) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), our management, including our chief executive officer and chief financial officer, evaluated, as of September 30, 2020, the effectiveness of our disclosure controls and procedures as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Exchange Act. Based on that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective as of September 30, 2020 to ensure that information required to be disclosed by us in this Form 10-Q is recorded, processed, summarized and reported within the time periods specified by the rules and forms of the Exchange Act and is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosures.

We believe, however, that a controls system, no matter how well designed and operated, can only provide reasonable assurance that the objectives of the controls systems are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud or error, if any, within a company have been detected.

Changes in Internal Control over Financial Reporting

There have been no material changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. In light of our remote work arrangements necessitated by the ongoing COVID-19 pandemic, we are continually monitoring and assessing the impact of such remote work arrangements on the design and effectiveness of our internal controls.

PART II

OTHER INFORMATION

Item 1. Legal Proceedings

From time to time, we are involved in various disputes, claims, suits, investigations and legal proceedings arising in the ordinary course of business. We believe that the resolution of current pending legal matters will not have a material adverse effect on our business, financial condition, results of operations or cash flows. Nonetheless, we cannot predict the outcome of these proceedings, as legal matters are subject to inherent uncertainties, and there exists the possibility that the ultimate resolution of these matters could have a material adverse effect on our business, financial condition, results of operations or cash flows.

Item 1A. Risk Factors

Except as set forth below, there have been no material changes from the information set forth in “Item 1A. Risk Factors” in the Form 10-K.

The novel coronavirus (COVID-19) pandemic could adversely impact our business, results of operations, cash flows, financial condition and liquidity.

The global spread of the novel coronavirus (COVID-19) has created significant volatility, uncertainty and economic disruption. Individually and collectively, the consequences of the COVID-19 pandemic could adversely impact our business, results of operations, cash flows, financial condition and liquidity. The extent to which the COVID-19 pandemic ultimately impacts our business, results of operations, cash flows, financial condition and liquidity will depend on future developments, which are highly uncertain and cannot be predicted, including, but not limited to:

•

the duration and scope of the pandemic;

•

governmental, business and individual actions taken in response to the pandemic and the impact of those actions on global economic activity;

•

the impact of business disruptions and reductions in headcount on our clients and the resulting impact on their demand for our services and solution;

•

the increase in business failures among businesses that we serve;

•

our clients’ ability to pay for our services and solutions; and

•

our ability to provide our services and solutions, including as a result of our employees or our clients’ employees working remotely and/or closures of offices and facilities.

Across many industries, temporary and permanent business closures as well as business occupancy limitations have resulted in significant layoffs and employee furloughs since late March 2020. Because we charge our clients on a per-employee basis for certain services we provide, decreases in headcount at our clients negatively impact our results of operations. Further, at the onset of the COVID-19 pandemic, a limited number of new clients temporarily delayed service implementation. As the COVID-19 pandemic continues to create uncertainty and the potential for ongoing business disruptions, we may experience similar client-driven delays in service implementation in the future.

In order to spur economic activity to counteract the adverse effects of the COVID-19 pandemic, the Federal Open Market Committee lowered its target for the federal funds rate in March 2020. In addition, a provision in the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) allows employers to delay the payment of the employer’s share of Social Security taxes to a future date. To the extent our clients make such election, we are collecting less money from them to hold and then remit to the appropriate taxing authorities, which adversely affects our average funds held for clients balance and, consequently, interest earned on funds held for clients. Significantly lower average interest rates in 2020, combined with the lack of growth of the average funds held for clients balance due to lower employee headcount at our clients as well as clients electing the Social Security tax deferral under the CARES Act, had a negative effect on interest earned on funds held for clients and, consequently, recurring revenue growth for the three and nine months ended September 30, 2020. We expect that the foregoing adverse economic factors will continue to have a negative impact on recurring revenues in future periods for so long as such conditions persist. Further, the impact of the pandemic on our recurring revenues combined with our deliberate, increased level of investment to drive the growth of our business may negatively affect net income.

Beginning in February 2020, we took various actions in order to minimize the risk of COVID-19 to our employees, our clients, and the communities in which we operate. Our remote work arrangements may create operational challenges and may result in increased costs related to investments in technology. As of September 30, 2020, 95% of our employees were working remotely.

Furthermore, we have prohibited all business-related travel until further notice and our salesforce is conducting all sales meetings virtually. If clients and client prospects are not as willing or available to engage via video conference and teleconference, the shift from in-person to virtual sales meetings could negatively affect our sales efforts, impede client acquisition and lengthen our sales cycles, which would negatively impact our business and results of operations and could impact our financial condition in the future.

Even after the COVID-19 outbreak has subsided, depending upon its duration and frequency of recurrence, and the governmental policies in response thereto, we may continue to experience materially adverse impacts to our business as a result of its global economic impact, including any recession that may occur or be continuing as a result. We continue to monitor and evaluate the extent to which COVID-19 has impacted us and our employees and clients, and the extent to which it and other emerging developments are expected to impact us in the future.

Our financial results may fluctuate due to many factors, some of which may be beyond our control.

Our results of operations, including our revenues, costs of revenues, administrative expenses, operating income, cash flow and deferred revenue, may vary significantly in the future, and the results of any one period should not be relied upon as an indication of future performance. Fluctuations in our financial results may negatively impact the value of our common stock. Our financial results may fluctuate as a result of a variety of factors, many of which are outside of our control, and as a result, may not fully reflect the underlying performance of our business. Factors that may cause our financial results to fluctuate from period to period include, without limitation:

•

our ability to attract new clients or sell additional applications to our existing clients;

•

the number of new clients and their employees, as compared to the number of existing clients and their employees in a particular period;

•

the mix of clients between small, mid-sized and large organizations;

•

the extent to which we retain existing clients and the expansion or contraction of our relationships with them;

•

the mix of applications sold during a period;

•

changes in our pricing policies or those of our competitors;

•

seasonal factors affecting payroll processing, demand for our applications or potential clients’ purchasing decisions;

•

the amount and timing of operating expenses, including those related to the maintenance and expansion of our business, operations and infrastructure;

•

the timing and success of new applications introduced by us and the timing of expenses related to the development of new applications and technologies;

•

the timing and success of current and new competitive products and services offered by our competitors;

•

economic conditions affecting our clients, including their ability to outsource HCM solutions and hire employees;

•

business disruptions caused by pandemics such as the COVID-19 outbreak;

•

changes in laws, regulations or policies affecting our clients’ legal obligations and, as a result, demand for certain applications;

•

changes in the competitive dynamics of our industry, including consolidation among competitors or clients;

•

our ability to manage our existing business and future growth, including expenses related to our data centers and the expansion of such data centers and the addition of new offices;

•

the effects and expenses of acquisition of third-party technologies or businesses and any potential future charges for impairment of goodwill resulting from those acquisitions;

•

inclement weather or natural disasters, including but not limited to tornadoes, hurricanes, fires, earthquakes and floods;

•

network outages or security breaches; and

•

general economic, industry and market conditions.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

	Total Number of Shares Purchased		Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs ⁽¹⁾		Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs ⁽¹⁾
July 1 - 31, 2020⁽²⁾		8,894	$	318.28		8,894	$	174,800,000
August 1 - 31, 2020⁽²⁾		63	$	295.84		63	$	172,000,000
September 1 - 30, 2020		—	$	—		—	$	172,000,000
Total		8,957				8,957

(1)

Pursuant to a stock repurchase plan announced on November 20, 2018, we were authorized to purchase (in the aggregate) up to $150.0 million of our common stock in open market purchases, privately negotiated transactions or by other means. On March 12, 2020, we announced that our Board of Directors increased the availability under the existing stock repurchase plan to $250.0 million and extended the expiration date to March 12, 2022.

(2)

Consists of shares withheld to satisfy tax withholding for certain employees upon the vesting of restricted stock.

Item 6. Exhibits

The following exhibits are incorporated herein by reference or are filed with this Quarterly Report on Form 10-Q, in each case as indicated therein (numbered in accordance with Item 601 of Regulation S-K):

Exhibit No.		Description

3.1		Amended and Restated Certificate of Incorporation of Paycom Software, Inc. (incorporated by reference to Exhibit 3.1 to the Company’s Amendment No. 1 to the Registration Statement on Form S-1/A dated March 31, 2014, filed with the SEC on March 31, 2014).

3.2		Amended and Restated Bylaws of Paycom Software, Inc. (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K dated June 5, 2020, filed with the SEC on June 8, 2020).

4.1		Form of Common Stock Certificate (incorporated by reference to Exhibit 4.1 to the Company’s Amendment No. 1 to the Registration Statement on Form S-1/A dated March 31, 2014, filed with the SEC on March 31, 2014).

31.1*		Certification of the Chief Executive Officer of the Company, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2*		Certification of the Chief Financial Officer of the Company, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1**		Certification of the Chief Executive Officer and Chief Financial Officer of the Company, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


101.INS		Inline XBRL Instance Document – the XBRL Instance Document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.

101.SCH*		Inline XBRL Taxonomy Extension Schema Document.

101.CAL*		Inline XBRL Taxonomy Extension Calculation Linkbase Document.

101.DEF*		Inline XBRL Taxonomy Extension Definition Linkbase Document.

101.LAB*		Inline XBRL Taxonomy Extension Label Linkbase Document.

101.PRE*		Inline XBRL Taxonomy Extension Presentation Linkbase Document.
104		Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101).

*	Filed herewith.

The certifications attached as Exhibit 32.1 are not deemed “filed” with the SEC and are not to be incorporated by reference into any filing of Paycom Software, Inc. under the Securities Act whether made before or after the date of this Quarterly Report on Form 10-Q, irrespective of any general incorporation language contained in such filing.

SIGNATURES

Pursuant to the requirements of the Securities Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


		PAYCOM SOFTWARE, INC.

Date: November 5, 2020	By:	/s/ Chad Richison
		Chad Richison
		President and Chief Executive Officer
		(Principal Executive Officer)

Date: November 5, 2020	By:	/s/ Craig E. Boelte
		Craig E. Boelte
		Chief Financial Officer
		(Principal Accounting Officer and Principal Financial Officer)