What changed in this filing

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Item 2. Management’s Discussion and Analysis

2021-05-06 compared with 2020-11-05 · 90 added, 138 removed, 253 unchanged (47% of the section changed)

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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.

The following discussion and analysis should be read in conjunction with (i) the accompanying unaudited consolidated financial statements and notes thereto for the three months ended March 31, 2021, (ii) the audited consolidated financial statements and notes thereto for the year ended December 31, 2020 included in our Annual Report on Form 10-K (the “Form 10-K”) filed with the Securities and Exchange Commission (the “SEC”) on February 18, 2021 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, 2020, all amounts herein are unaudited.

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the sufficiency of our existing cash and cash equivalents to meet our working capital and capital expenditure needs over the next 12 months;

our ability to relocate our Texas operations facility within an expected timeframe;

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;

the expected impact on our consolidated financial statements of new accounting pronouncements;

our plans to repurchase shares of our common stock through a stock repurchase plan;

our expected income tax rate for future periods;

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.

In addition, forward-looking statements also consist of statements involving trend analyses and statements including such words as “anticipate,” “believe,” “could,” “expect,” “will,” “intend,” “may,” “might,” “plan,” “potential,” “should,” “would,” and similar expressions or the negative of such terms or other comparable terminology.

Forward-looking statements are neither historical facts nor assurances of future performance, and are based only on our current beliefs, expectations and assumptions regarding the future of our business, future plans and strategies, projections, anticipated events and trends, the economy and other future conditions.

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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;

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;

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;

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

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

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

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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.

Forward-looking statements are based only on information currently available to us and speak only as of the date of this Form 10-Q and are subject to business and economic risks.

We do not undertake any obligation to update or revise the forward-looking statements to reflect events that occur or circumstances that exist after the date on which such statements were made, except to the extent required by law.

We are a leading provider of comprehensive, cloud-based human capital management (“HCM”) software delivered as Software-as-a-Service.

We are a leading provider of a comprehensive, cloud-based human capital management (“HCM”) solution delivered as Software-as-a-Service.

We provide functionality and data analytics that businesses need to manage the complete employment lifecycle, from recruitment to retirement.

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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.

None of our clients constituted more than one-half of one percent of our revenues for the three months ended March 31, 2021.

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.

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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.

Our principal marketing efforts include email campaigns, social and digital media, search engine marketing methods, tradeshows and outbound marketing including television and print advertising.

We also plan to open additional sales offices in the future and leverage virtual sales meetings to further expand our presence in the U.S.

Our principal marketing efforts include national and local advertising campaigns, email campaigns, social and digital media campaigns, search engine marketing methods, tradeshows, print advertising and outbound marketing including personalized direct mail campaigns.

In addition, we generate leads and build recognition of our brand and thought leadership with relevant and informative content, such as white papers, blogs, podcast episodes and webinars.

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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.

As a result of our significant revenue growth and geographic expansion, we are presented with a variety of opportunities and challenges.

Our payroll application is the foundation of our solution and all of our clients are required to utilize this application in order to access our other applications.

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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.

We intend to obtain new clients by (i) continuing to leverage our sales force productivity within markets where we currently have existing sales offices, (ii) expanding our presence in metropolitan areas where we currently have an existing sales office through adding sales teams or offices, thereby increasing the number of sales professionals within such markets, and (iii) opening sales offices in new metropolitan areas.

Our target client size range is 50 to 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.

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, w e expect that changes in certain factors affecting our performance will correlate with improvement or deterioration in the labor market.

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.

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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.

For the three months ended March 31, 2021 and 2020, our total gross margins were approximately 87% and 88%, 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.

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.

In March 2020, we prohibited all business-related travel until further notice and began transitioning our employees to work-from-home arrangements.

As of March 31, 2021, 95% of our employees were working remotely.

Our sales employees have been conducting all meetings with current and prospective clients virtually since March 2020.

Although we have developed a plan for certain employees to safely begin returning to our offices, 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.

Business continuity and safety will continue to guide our return-to-office plans.

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.

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 beginning in the second 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 ear ned 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 A ct 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.

Between August 2019 and March 2020, the Federal Open Market Committee 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.

Due to significantly lower average interest rates in the first quarter of 2021, as compared to the majority of the first quarter of 2020, interest earned on funds held for clients for the three months ended March 31, 2021 decreased from the comparable prior year period, which had a negative effect on recurring revenue growth.

D emand for our solution remains high and d espite 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.

Prior to the COVID-19 pandemic, our sales force historically traveled frequently to sell our solution.

The current remote work environment presents a unique opportunity for our sales force, 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.

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.

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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.

We will continue to aggressively invest in sales and marketing and in research and development to drive future growth and expand our market share.

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 I, Item 1A “Risk Factors” in our Form 10-K that was filed with the SEC on February 18, 2021.

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.

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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,

Three Months Ended March 31,

Implementation and other

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Provision for income taxes

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 increase in total revenues for the three months ended March 31, 2021 compared to the same period in 2020 was primarily the result of the addition of new clients and productivity and efficiency gains in mature sales offices, which are offices that have been open for at least 24 months, and the sale of additional applications to our existing clients.

In addition, our tax forms filing business contributed to the increase in total revenues for the three months ended March 31, 2021 as compared to the same period in 2020.

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.

Because we charge our clients on a per-employee basis for certain services we provide, the drivers of revenue for the three months ended March 31, 2021 described above were partially offset by the negative impact of headcount reductions within our client base as of the onset of the pandemic.

Significantly lower average interest rates during the three months ended March 31, 2021 as compared to the three months

ended March 31, 20 20 , had a negative effect on recurring revenue growth for the three months ended March 3 1 , 202 1 .

We expect that the foregoing adverse macroeconomic factors may 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 months ended March 31, 2021 from the same period in 2020 was primarily the result of increased non-refundable upfront conversion fees collected from the addition of new clients.

These fees are deferred and recognized ratably over the ten-year estimated life of our clients.

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.

During the three months ended March 31, 2021, operating expenses increased from the comparable prior year period by $5.0 million due to a $3.4 million increase attributable to growth in the number of operating personnel, a $1.0 million increase in shipping and supplies fees, and a $0.6 million increase in automated clearing house fees in connection with the increase in revenues.

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 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.

During the three months ended March 31, 2021, sales and marketing expenses increased from the comparable prior year period by $7.7 million due to a $5.1 million increase in marketing and advertising expense attributable to increased spending across most components of our marketing program, and a $2.6 million increase in employee-related expenses, including commissions and bonuses.

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.

During the three months ended March 31, 2021, research and development expenses increased from the comparable prior year period due to an increase in employee-related expenses.

As we continue the ongoing development of our platform and product offerings, we generally expect research and development expenses (exclusive of stock-based compensation) to continue to increase, particularly as we hire more personnel to support our growth.

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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,

The table below sets forth the amounts of capitalized and expensed research and development costs for the three months ended March 31, 2021 and 2020:

Three Months Ended March 31,

Capitalized portion of research and development

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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.

During the three months ended March 31, 2021, general and administrative expenses increased $6.1 million from the comparable prior year period primarily due to an $8.2 million increase in non-cash stock-based compensation and a $2.9 million increase in employee-related expenses, which were partially offset by a $5.1 million decrease in accounting and legal expenses.

Non-Cash Stock-Based Compensation Expense

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

Three Months Ended September 30,

Nine Months Ended September 30,

Three Months Ended March 31,

Non-cash stock-based compensation expense

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Total non-cash stock-based compensation expense

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.

During the three months ended March 31, 2021, our non-cash stock-based compensation expense increased $7.8 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 2021.

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.

During the three months ended March 31, 2021, depreciation and amortization expense increased from the comparable prior year period primarily due to the development of additional technology and purchases of other related fixed assets.

Interest Expense

The 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.

The decrease in interest expense for the three months ended March 31, 2021, as compared to the three months ended March 31, 2020, was due to the timing of construction of our expanded operations facility in Grapevine, Texas, which resulted in a higher capitalization rate of interest in 2021.

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.

The change in other income (expense), net for the three months ended March 31, 2021 was primarily due to the increase in the fair value of our interest rate swap as compared to the three months ended March 31, 2020.

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.

Our effective income tax rate was 32.1% and 28.7 % for the three months ended March 31, 2021 and 2020, respectively.

The higher effective income tax rate for the three months ended March 31, 2021 primarily resulted from an increase in nondeductible expenses as compared to the three months ended March 31, 2020.

Liquidity and Capital Resources

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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 operatin g 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 satisf ying certain other conditions.

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.

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.

Although we have funded most of the costs for ongoing construction projects at our corporate headquarters and other facilities 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.

As of March 31, 2021, 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.

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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.

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 ag reement of this size and type.

As of March 31 , 20 2 1 , 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.

The Interest Rate Swap Agreement, which has a maturity date of September 7, 2025, provides that we receive quarterly variable interest payments based on the LIBOR rate and 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.

For the three months ended March 31, 2021, we recorded a gain of $0.7 million for the change in fair value of the interest rate swap and for the three months ended March 31, 2020, we recorded a loss of $1.6 million, for the change in fair value of the interest rate swap.

The change in fair value of the interest rate swap is included in Other income (expense), net in the consolidated statements of income .

Revolving Credit Agreement.

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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.

The scheduled maturity date of the Facility was also 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.

As of March 31, 2021, we did not have any borrowings outstanding under the Facility.

Stock Repurchase Plan and Withholding Shares to Cover Taxes.

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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.

As of March 31, 2021, there was $134.9 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 o ther corporate considerations.

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.

During the three months ended March 31, 2021, we repurchased an aggregate of 919 shares of our common stock at an average cost of $410.07 per share, all of which were shares withheld to satisfy tax withholding obligations for certain employees upon the vesting of restricted stock.

Our payment of the taxes on behalf of those employees resulted in an aggregate cash expenditure of $0.4 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.

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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.

Actual future capital requirements will depend on many factors, including our future revenues, cash from operating activities and the level of expenditures in all areas of our business.

As part of our payroll and payroll tax filing services, we collect funds from our clients for federal, state and local employment taxes, which we remit to the appropriate tax agencies.

We invest these funds in money market funds, demand deposit accounts, commercial paper and certificates of deposit from which we earn interest income during the period between their receipt and disbursement.

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.

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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,

The following table summarizes the consolidated statements of cash flows for the three months ended March 31, 2021 and 2020:

Three Months Ended March 31,

Net cash provided by (used in):

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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 provided by operating activities for the three months ended March 31, 2021 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.

Compared to the three months ended March 31, 2020, our operating cash flows for the three months ended March 31, 2021 were positively impacted by the growth of our business.

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 in crease in cash used in investing activities was partially offset by a $ 39 .

4 million in crease in proceeds from maturities of short-term investments from funds held for clients.

Cash flows provided by investing activities for the three months ended March 31, 2021 increased from the comparable prior year period due to a $130.7 million decrease in purchases of short-term investments from funds held for clients and a $60.0 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.

Cash flows provided by financing activities for the three months ended March 31, 2021 increased from the comparable prior year period primarily due to the impact of a $956.6 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.

Also contributing to the increase in cash flows provided by financing activities was a decrease of $8.0 million in repurchases of common stock.

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.

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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.

As of March 31, 2021, we did not have any off-balance sheet arrangements that have or are reasonably likely to have an effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that may be material to investors.

Critical Accounting Policies and Estimates

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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.

Discussion of our recently adopted accounting pronouncements can be found in Note 2 in this Form 10-Q.

Non-GAAP Financial Measures

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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.

Adjusted EBITDA and non-GAAP net income may not be comparable to similar ly titled measures of other companies and other companies may not calculate such measures in the same manner as we do.

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,

Three Months Ended March 31,

Net income to adjusted EBITDA:

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Adjusted EBITDA

Three Months Ended September 30,

Nine Months Ended September 30,

Three Months Ended March 31,

Net income to non-GAAP net income:

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Non-GAAP net income per share, diluted

Three Months Ended September 30,

Nine Months Ended September 30,

Three Months Ended March 31,

Earnings per share to non-GAAP net income per share, basic:

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Non-GAAP net income per share, basic

Three Months Ended September 30,

Nine Months Ended September 30,

Three Months Ended March 31,

Earnings per share to non-GAAP net income per share, diluted:

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Non-GAAP net income per share, diluted

Quantit ative 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.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis