Online payroll and human resource software provider Paycom (NYSE:PAYC) reported results in line with analysts' expectations in Q2 FY2023, with revenue up 26.6% year on year to $401.1 million. The company also expects next quarter's revenue to be around $411 million, roughly in line with analysts' estimates. Paycom Software made a GAAP profit of $64.5 million, improving from its profit of $57.4 million in the same quarter last year.
Paycom Software (PAYC) Q2 FY2023 Highlights:
- Revenue: $401.1 million vs analyst estimates of $398.3 million (small beat)
- EPS (non-GAAP): $1.62 vs analyst estimates of $1.60 (1.34% beat)
- Revenue Guidance for Q3 2023 is $411 million at the midpoint, roughly in line with what analysts were expecting
- The company reconfirmed revenue guidance for the full year of $1.72 billion at the midpoint
- Free Cash Flow of $63.1 million, down 40.2% from the previous quarter
- Gross Margin (GAAP): 83.2%, down from 87.5% in the same quarter last year
Founded in 1998 as one of the first online payroll companies. Today, Paycom (NYSE:PAYC) provides software for small and medium-sized businesses (SMBs) to manage their payroll and HR needs in one place.
Human Capital Management (HCM) software is meant to streamline mundane, but vital, business functions like keeping attendance, running payroll, and keeping compliant with shifting Federal and local government taxes and labor laws. For many small and medium sized businesses, these are often handled by their accountant which is an unnecessarily expensive use of resources, or QuickBooks style spreadsheets which don’t have sufficient functionality.
Using a single database or system of records, Paycom is a cost effective solution that allows SMBs to simplify the management of all their HR operations throughout an employee’s lifecycle, from when they first apply for a job, to onboarding and managing performance reviews, all the way through collecting retirement benefits.
Paycom has useful functionality that differentiates it from rivals, in part because the company regularly iterates its platform based on customer feedback. One example is that HR managers can automatically share open positions to career sites, which funnels qualified applicants back to the company to easily schedule interviews and conduct background checks. Another is the ability for businesses to conduct self evaluations based on analytics that pull together performance reviews and other HR data from across the company.
HR software benefits from dual trends around costs savings and ease of use. First is the SaaS-ification of businesses, large and small, who much prefer the flexibility of cloud-based, web-browser delivered software paid for on a subscription basis than the hassle and expense of purchasing and managing on-premise enterprise software. Second is the consumerization of business software, whereby multiple standalone processes like payroll processing and compliance are aggregated into a single, easy to use platforms.
Other providers of HR solutions for small and medium-sized businesses include Paychex (NASDAQ:PAYX), ADP (NASDAQ:ADP), Asure, (NYSE:ASUR) and Paylocity (NASDAQ:PCTY).
As you can see below, Paycom Software's revenue growth has been over the last two years, growing from $242.1 million in Q2 FY2021 to $401.1 million this quarter.
This quarter, Paycom Software's quarterly revenue was once again up a very solid 26.6% year on year. However, the company's revenue actually decreased by $50.5 million in Q2 compared to the $81 million increase in Q1 2023. Regardless, we aren't too concerned because Paycom Software's sales seem to follow a seasonal pattern and management is guiding for revenue to rebound in the coming quarter.
Next quarter's guidance suggests that Paycom Software is expecting revenue to grow 23% year on year to $411 million, slowing down from the 30.4% year-on-year increase it recorded in the same quarter last year. Ahead of the earnings results announcement, the analysts covering the company were expecting sales to grow 21.5% over the next 12 months.
What makes the software as a service business so attractive is that once the software is developed, it typically shouldn't cost much to provide it as an ongoing service to customers. Paycom Software's gross profit margin, an important metric measuring how much money there's left after paying for servers, licenses, technical support, and other necessary running expenses, was 83.2% in Q2.
That means that for every $1 in revenue the company had $0.83 left to spend on developing new products, sales and marketing, and general administrative overhead. Despite its decline over the last year, Paycom Software's excellent gross margin allows it to fund large investments in product and sales during periods of rapid growth and achieve profitability when reaching maturity.
Cash Is King
If you've followed StockStory for a while, you know that we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can't use accounting profits to pay the bills. Paycom Software's free cash flow came in at $63.1 million in Q2, up 241% year on year.
Paycom Software has generated $299.8 million in free cash flow over the last 12 months, an impressive 18.9% of revenue. This high FCF margin stems from its asset-lite business model and strong competitive positioning, giving it the option to return capital to shareholders or reinvest in its business while maintaining a cash cushion.
Key Takeaways from Paycom Software's Q2 Results
Sporting a market capitalization of $21.3 billion, more than $536.5 million in cash on hand, and positive free cash flow over the last 12 months, we believe that Paycom Software is attractively positioned to invest in growth.
There were not many surprised in Paycom's results, revenue came in line with what analysts were expecting and free cash flow was decent. On the other hand, its deteriorating gross margin was a negative. Overall, this was an ok quarter for Paycom Software. But the market was likely expecting more and the company is down 5.6% on the results and currently trades at $350 per share.
Is Now The Time?
Paycom Software may have had a bad quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity. There are several reasons why we think Paycom Software is a great business. While we'd expect growth rates to moderate from here, its revenue growth has been strong over the last two years. On top of that, its impressive gross margins are indicative of excellent business economics, and its very efficient customer acquisition hints at the potential for strong profitability.
There's no doubt that the market is optimistic about Paycom Software's growth prospects, as its price to sales ratio based on the next 12 months of 11.4x would suggest. And looking at the tech landscape today, Paycom Software's qualities as one of the best businesses really stand out and we think that the multiple is justified. We like the stock at this price.Wall Street analysts covering the company had a one year price target of $385.8 per share right before these results, implying that they saw upside in buying Paycom Software even in the short term.
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