Paycom Software, Inc. 10-Q

Item 1. Financial Statements Paycom Software, Inc. Unaudited Consolidated Balance Sheets (in thousands, except per share amounts) March 31, 2021 December 31, 2020 Assets Current assets: Cash and cash equivalents $ 215,093 $ 151,710 Accounts receivable 19,792 9,130 Prepaid expenses 24,109 17,854 Inventory 1,088 1,151 Income tax receivable — 10,447 Deferred contract costs 64,441 60,819 Current assets before funds held for clients 324,523 251,111 Funds held for clients 2,299,684 1,613,494 Total current assets 2,624,207 1,864,605 Property and equipment, net 301,579 285,218 Goodwill 51,889 51,889 Long-term deferred contract costs 394,867 371,357 Other assets 34,231 34,843 Total assets $ 3,406,773 $ 2,607,912 Liabilities and Stockholders' Equity Current liabilities: Accounts payable $ 12,133 $ 6,787 Income tax payable 12,977 — Accrued commissions and bonuses 6,781 13,703 Accrued payroll and vacation 32,634 24,529 Deferred revenue 14,191 13,567 Current portion of long-term debt 1,775 1,775 Accrued expenses and other current liabilities 45,399 44,175 Current liabilities before client funds obligation 125,890 104,536 Client funds obligation 2,299,684 1,613,494 Total current liabilities 2,425,574 1,718,030 Deferred income tax liabilities, net 115,336 112,598 Long-term deferred revenue 74,802 73,259 Net long-term debt, less current portion 28,684 29,119 Other long-term liabilities 16,901 19,263 Total long-term liabilities 235,723 234,239 Total liabilities 2,661,297 1,952,269 Commitments and contingencies Stockholders' equity: Common stock, $ 0.01 par value ( 100,000 shares authorized, 61,864 and 61,861 shares issued at March 31, 2021 and December 31, 2020, respectively; 57,741 and 57,739 shares outstanding at March 31, 2021 and December 31, 2020, respectively) 618 618 Additional paid-in capital 383,502 357,908 Retained earnings 784,235 719,619 Treasury stock, at cost ( 4,123 and 4,122 shares at March 31, 2021 and December 31, 2020, respectively) ( 422,879 ) ( 422,502 ) Total stockholders' equity 745,476 655,643 Total liabilities and stockholders' equity $ 3,406,773 $ 2,607,912 See accompanying notes to the unaudited consolidated financial statements. 3 Paycom Software, Inc. Unaudited Consolidated Statements of Income (in thousands, except per share amounts) Three Months Ended March 31, 2021 2020 Revenues Recurring $ 267,774 $ 238,495 Implementation and other 4,424 3,873 Total revenues 272,198 242,368 Cost of revenues Operating expenses 29,073 24,116 Depreciation and amortization 7,200 5,930 Total cost of revenues 36,273 30,046 Administrative expenses Sales and marketing 62,761 55,018 Research and development 24,711 21,621 General and administrative 46,191 40,134 Depreciation and amortization 7,716 6,285 Total administrative expenses 141,379 123,058 Total operating expenses 177,652 153,104 Operating income 94,546 89,264 Interest expense — ( 16 ) Other income (expense), net 629 ( 930 ) Income before income taxes 95,175 88,318 Provision for income taxes 30,559 25,303 Net income $ 64,616 $ 63,015 Earnings per share, basic $ 1.12 $ 1.09 Earnings per share, diluted $ 1.11 $ 1.08 Weighted average shares outstanding: Basic 57,740 57,655 Diluted 58,394 58,440 See accompanying notes to the unaudited consolidated financial statements. 4 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, 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 Common Stock Additional Retained Treasury Stock Total Shares Amount Paid-in Capital Earnings Shares Amount Stockholders' Equity Balances at December 31, 2020 61,861 $ 618 $ 357,908 $ 719,619 4,122 $ ( 422,502 ) $ 655,643 Vesting of restricted stock 3 — — — — — — Stock-based compensation — — 25,594 — — — 25,594 Repurchases of common stock — — — — 1 ( 377 ) ( 377 ) Net income — — — 64,616 — — 64,616 Balances at March 31, 2021 61,864 $ 618 $ 383,502 $ 784,235 4,123 $ ( 422,879 ) $ 745,476 See accompanying notes to the unaudited consolidated financial statements. 5 Paycom Software, Inc. Unaudited Consolidated Statements of Cash Flows (in thousands) Three Months Ended March 31, 2021 2020 Cash flows from operating activities Net income $ 64,616 $ 63,015 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 14,916 12,215 Accretion of discount on available-for-sale securities ( 77 ) ( 467 ) Loss on disposition of property and equipment 132 — Amortization of debt issuance costs 9 9 Stock-based compensation expense 23,581 15,811 Cash paid for derivative settlement ( 232 ) ( 69 ) (Gain)/loss on derivative ( 424 ) 1,644 Deferred income taxes, net 2,738 1,392 Changes in operating assets and liabilities: Accounts receivable ( 10,662 ) 1,239 Prepaid expenses ( 6,255 ) ( 4,292 ) Inventory ( 125 ) 254 Other assets 559 ( 1,801 ) Deferred contract costs ( 26,575 ) ( 27,630 ) Accounts payable 803 408 Income taxes, net 23,424 19,973 Accrued commissions and bonuses ( 6,922 ) ( 6,681 ) Accrued payroll and vacation 8,105 6,289 Deferred revenue 2,167 2,211 Accrued expenses and other current liabilities ( 321 ) ( 1,490 ) Net cash provided by operating activities 89,457 82,030 Cash flows from investing activities Purchase of short-term investments from funds held for clients ( 47,215 ) ( 177,903 ) Proceeds from maturities of short-term investments from funds held for clients 80,000 20,000 Purchases of property and equipment ( 25,330 ) ( 25,726 ) Net cash provided by (used in) investing activities 7,455 ( 183,629 ) Cash flows from financing activities Repurchases of common stock — ( 7,998 ) Withholding taxes paid related to net share settlements ( 377 ) ( 170 ) Payments on long-term debt ( 444 ) ( 444 ) Net change in client funds obligation 686,190 ( 270,399 ) Net cash provided by (used in) financing activities 685,369 ( 279,011 ) Increase (decrease) in cash, cash equivalents, restricted cash and restricted cash equivalents 782,281 ( 380,610 ) Cash, cash equivalents, restricted cash and restricted cash equivalents Cash, cash equivalents, restricted cash and restricted cash equivalents, beginning of period 1,585,275 1,641,854 Cash, cash equivalents, restricted cash and restricted cash equivalents, end of period $ 2,367,556 $ 1,261,244 Three Months Ended March 31, 2021 2020 Reconciliation of cash, cash equivalents, restricted cash and restricted cash equivalents Cash and cash equivalents $ 215,093 $ 181,827 Restricted cash included in funds held for clients 2,152,463 1,079,417 Total cash, cash equivalents, restricted cash and restricted cash equivalents, end of period $ 2,367,556 $ 1,261,244 Supplemental disclosures of cash flow information: Non-cash investing and financing activities: Purchases of property and equipment, accrued but not paid $ 6,217 $ 8,251 Stock-based compensation for capitalized software $ 1,456 $ 1,601 Right of use assets obtained in exchange for operating lease liabilities $ 541 $ 3,536 See accompanying notes to the unaudited consolidated financial statements. 6 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 a comprehensive, cloud-based human capital management (“HCM”) solution delivered as Software-as-a-Service. Unless we state otherwise or the context otherwise requires, the terms “we,” “our,” “us” and the “Company” refer to Software and its consolidated subsidiaries. We provide functionality and data analytics that businesses need to manage the complete employment lifecycle, from recruitment to retirement. Our solution requires virtually no customization and is based on a core system of record maintained in a single database for all HCM functions, including talent acquisition, time and labor management, payroll, talent management and human resources (“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, 2020 (the “Form 10-K”) filed with the Securities and Exchange Commission (“SEC”) on February 18, 2021. 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 months ended March 31, 2021 are not necessarily indicative of the results expected for the full year. Recently Adopted Accounting Pronouncements In January 2021, we adopted Accounting Standards Update (“ASU”) No. 2019-12, “Income Taxes (Topic 740) Simplifying the Accounting for Income Taxes” (“ASU 2019-12”) utilizing the prospective transition method. 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. 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. 2018-15, “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”) utilizing the prospective transition method. 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 ASU 2018-13 removed or modified disclosure requirements retrospectively to all periods presented, whereas any new requirements have been applied prospectively from the adoption date. 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, the life of our client relationships, the fair value of our stock-based awards and the fair value of our financial instruments 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. 7 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 March 31, 2021 and December 31, 2020, 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 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 other corporate considerations. The current stock repurchase plan will expire on March 12, 2022 . 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. Recently Issued Accounting Pronouncements In March 2020, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2020-04, “Reference Rate Reform (Topic 848) Facilitation of the Effects of Reference Rate Reform on Financial Reporting” (“ASU 2020-04”). ASU 2020-04 provides temporary optional expedients and exceptions for applying U.S. GAAP to contracts, hedging relationships and other transactions affected by reference rate reform. 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 consolidated financial statements. In January 2021, the FASB issued ASU No. 2021-01, “Reference Rate Reform (Topic 848) Scope” (“ASU 2021-01”), which clarifies that certain optional expedients and exceptions in Topic 848 for contract modifications and hedge accounting apply to 8 Paycom Software, Inc. Notes to the Unaudited Consolidated Financial Statements (tabular dollars and shares in thousands, except per share amounts) derivative instruments that are affected by the discounting transition. ASU 2021-01 amends the expedients and exceptions in Topic 848 to capture the incremental consequences of the scope clarification and to tailor the existing guidance to derivative instruments affected by the discounting transition. ASU 2021-01 is currently effective and upon adoption may be applied to contract modifications that change the interest rate used for margining, discounting, or contract price alignment retrospectively as of any date from the beginning of the interim period that includes March 12, 2020, or prospectively to new modifications from any date within the interim period that includes or is subsequent to January 7, 2021, up to the date that financial statements are available to be issued. We are currently assessing the impact that this guidance will have on our consolidated financial statements . 3. 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, benefit enrollment services, 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. 9 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 servi ces 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 March 31, 2021 and 2020 were as follows: Three Months Ended March 31, 2021 2020 Balance, beginning of period $ 86,826 $ 76,244 Deferral of revenue 6,962 5,885 Recognition of unearned revenue ( 4,795 ) ( 3,674 ) Balance, end of period $ 88,993 $ 78,455 We expect to recognize $ 10.7 million of deferred revenue related to material right performance obligations in the remainder of 2021, $ 13.5 million of such deferred revenue in 2022, and $ 64.8 million of such deferred revenue thereafter . Assets Recognized from the Costs to Obtain and Costs to Fulfill Revenue Contracts We recognize an asset for the incremental costs of obtaining a contract with a client if we expect the amortization period to be longer than one year. We also recognize an asset for the costs to fulfill a contract with a client if such costs are specifically identifiable, generate or enhance resources used to satisfy future performance obligations, and are expected to be recovered. We have determined that substantially all costs related to implementation activities are administrative in nature and also meet the capitalization criteria under ASC 340-40. These capitalized costs to fulfill principally relate to upfront direct costs that are expected to be recovered through margin and that enhance our ability to satisfy future performance obligations. The assets related to both costs to obtain, and costs to fulfill, contracts with clients are accounted for utilizing a portfolio approach, and are capitalized and amortized 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. 10 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 March 31, 2021 Beginning Capitalization Ending Balance of Costs Amortization Balance Costs to obtain a contract $ 232,583 $ 20,541 $ ( 8,785 ) $ 244,339 Costs to fulfill a contract $ 199,593 $ 22,178 $ ( 6,802 ) $ 214,969 As of and for the Three Months Ended March 31, 2020 Beginning Capitalization Ending Balance of Costs Amortization Balance Costs to obtain a contract $ 194,964 $ 21,184 $ ( 7,188 ) $ 208,960 Costs to fulfill a contract $ 143,788 $ 19,509 $ ( 4,976 ) $ 158,321 4. PROPERTY AND EQUIPMENT Property and equipment and accumulated depreciation and amortization were as follows: March 31, 2021 December 31, 2020 Property and equipment Software and capitalized software costs $ 156,664 $ 144,190 Buildings 115,792 115,772 Computer equipment 71,749 68,181 Rental clocks 26,544 25,474 Furniture, fixtures and equipment 19,963 19,829 Other 7,078 7,016 397,790 380,462 Less: accumulated depreciation and amortization ( 192,786 ) ( 178,111 ) 205,004 202,351 Construction in progress 67,541 53,833 Land 29,034 29,034 Property and equipment, net $ 301,579 $ 285,218 We capitalize computer software development costs related to software developed for internal use in accordance with ASC 350-40. For the three months ended March 31, 2021 and 2020, we capitalized $ 12.3 million and $ 9.7 million, respectively, of computer software development costs related to software developed for internal use. Rental clocks included in property and equipment, net represent time clocks issued to clients under month-to-month operating leases. As such, these items are transferred from inventory to property and equipment and depreciated over their estimated useful lives. We capitalize interest incurred for indebtedness related to construction in progress. For both the three months ended March 31, 2021 and 2020, we incurred interest costs of $ 0.4 million, of which we capitalized $ 0.4 million. Included in the construction in progress balance at March 31, 2021 and December 31, 2020 is $ 4.2 million and $ 3.5 million in retainage, respectively. Depreciation and amortization expense for property and equipment was $ 14.9 million and $ 12.2 million for the three months ended March 31, 2021 and 2020, respectively. 5. GOODWILL As of both March 31, 2021 and December 31, 2020, 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 March 31, 2021 and December 31, 2020, there were no indicators of impairment. 11 Paycom Software, Inc. Notes to the Unaudited Consolidated Financial Statements (tabular dollars and shares in thousands, except per share amounts) 6 . LONG-TERM DEBT, NET Long-term debt consisted of the following: March 31, 2021 December 31, 2020 Net term note to bank due September 7, 2025 $ 30,459 $ 30,894 Total long-term debt, net (including current portion) 30,459 30,894 Less: Current portion ( 1,775 ) ( 1,775 ) Total long-term debt, net $ 28,684 $ 29,119 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 March 31, 2021, our indebtedness of $ 28.7 million consisted solely of Term Loans made under the Term Credit Agreement. Unamortized debt issuance costs of $ 0.2 million as of both March 31, 2021 and December 31, 2020 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 March 31, 2021, 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 March 31, 2021, we did no t 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 March 31, 2021, we were in compliance with all covenants related to the Revolving Credit Agreement. As of March 31, 2021 and December 31, 2020, 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. 12 Paycom Software, Inc. Notes to the Unaudited Consolidated Financial Statements (tabular dollars and shares in thousands, except per share amounts) 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 receive quarterly variable interest payments based on the LIBOR rate and pay interest at a fixed rate. The interest rate swap agreement has a maturity date of September 7, 2025 . 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 the fair value of the interest rate swap is included in Other income (expense), net in the consolidated statements of income. 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 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 13 Paycom Software, Inc. Notes to the Unaudited Consolidated Financial Statements (tabular dollars and shares in thousands, except per share amounts) 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 March 31, 2021 and December 31, 2020: March 31, 2021 Level 1 Level 2 Level 3 Total Assets: Commercial paper $ — $ 102,222 $ — $ 102,222 Certificates of deposit $ — $ 45,000 $ — $ 45,000 Liabilities: Interest rate swap $ — $ 2,082 $ — $ 2,082 December 31, 2020 Level 1 Level 2 Level 3 Total Assets: Commercial paper $ — $ 99,929 $ — $ 99,929 Certificates of deposit $ — $ 80,000 $ — $ 80,000 Liabilities: Interest rate swap $ — $ 2,738 $ — $ 2,738 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 $ 3.3 million and $ 2.2 million for the three months ended March 31, 2021 and 2020, 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 15,762 and 25,564 shares of the Company’s common stock under the ESPP during the three months ended March 31, 2021 and 2020, 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 $ 0.4 million for the three months ended March 31, 2021 and 2020, respectively. 1 0 . 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. As of December 31, 2020, all shares of restricted stock granted in 2015 have vested. 14 Paycom Software, Inc. Notes to the Unaudited Consolidated Financial Statements (tabular dollars and shares in thousands, except per share amounts) 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 March 31, 2021 2020 Numerator: Net income $ 64,616 $ 63,015 Less: income allocable to participating securities — ( 27 ) Income allocable to common shares $ 64,616 $ 62,988 Add back: undistributed earnings allocable to participating securities $ — $ 27 Less: undistributed earnings reallocated to participating securities — ( 27 ) Numerator for diluted earnings per share $ 64,616 $ 62,988 Denominator: Basic weighted average shares outstanding 57,740 57,655 Dilutive effect of unvested restricted stock 654 785 Diluted weighted average shares outstanding 58,394 58,440 Earnings per share: Basic $ 1.12 $ 1.09 Diluted $ 1.11 $ 1.08 11. STOCK-BASED COMPENSATION Restricted Stock Awards During the three months ended March 31, 2021, we issued an aggregate of 145,416 restricted shares of common stock to certain non-executive employees under the Paycom Software, Inc. 2014 Long-Term Incentive Plan (the “LTIP”), consisting of 42,912 shares subject to market-based vesting conditions (“Market-Based Shares”) and 102,504 shares subject to time-based vesting conditions (“Time-Based Shares”). The Market-Based Shares will vest 50 % on the first date, if any, that the Company’s VWAP Value equals or exceeds $ 520 per share and 50 % on the first date, if any, that the Company’s VWAP Value equals or exceeds $ 600 per share, in each case provided that (i) such date occurs on or before the eighth anniversary of the grant date and (ii) the recipient is employed by, or providing services to, the Company on the applicable vesting date, and subject to the terms and conditions of the LTIP and the applicable restricted stock award agreement. The Time-Based Shares will vest 21 % on a specified initial vesting date, 21 % on the first anniversary of such initial vesting date, 25 % on the second anniversary of such initial vesting date, and 33 % on the on the third anniversary of such initial vesting date, provided that the recipient is employed by, or providing services to, the Company on the applicable vesting date, and subject to the terms and conditions of the LTIP and the applicable restricted stock award agreement. The following table summarizes restricted stock awards activity for the three months ended March 31, 2021: 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, 2020 559.8 $ 156.48 1,748.5 $ 115.91 Granted 102.5 $ 433.44 42.9 $ 331.35 Vested ( 2.9 ) $ 142.07 — $ — Forfeited ( 6.4 ) $ 258.90 ( 0.7 ) $ 331.35 Unvested shares of restricted stock outstanding at March 31, 2021 653.0 $ 199.03 1,790.7 $ 120.98 15 Paycom Software, Inc. Notes to the Unaudited Consolidated Financial Statements (tabular dollars and shares in thousands, except per share amounts) Performance-Based Restricted Stock Units In February 2021, the Compensation Committee of the Board of Directors authorized the granting of performance-based restricted stock units (“PSUs”) to certain executive officers pursuant to the LTIP (the “PSU Awards”). Each PSU granted under the LTIP represents a notional share of the Company’s common stock. The PSU Awards represented an aggregate of 52,470 target units that may increase to an aggregate of 131,176 awarded units based upon the Company’s performance over two separate performance periods: (i) a two-year performance period commencing on January 1, 2021 and ending on December 31, 2022 (the “Two-Year Performance Period”); and (ii) a three-year performance period commencing on January 1, 2021 and ending on December 31, 2023 (the “Three-Year Performance Period”). Up to 25 % of the PSUs will be eligible to vest no later than March 1, 2023 , for the Two-Year Performance Period, and up to 75 % of the PSUs will be eligible to vest no later than February 29, 2024 , for the Three-Year Performance Period, provided that the grantee remains employed by or providing services to the Company on the applicable vesting date, and subject to the terms and conditions of the LTIP and the Restricted Stock Unit Award Agreement – Performance Based Vesting (the “PSU Award Agreement”). The number of PSUs that will vest and be converted into shares of common stock will depend on the Company’s “Relative Total Stockholder Return” (“Relative TSR”), expressed as a percentile ranking of the Company’s “Total Stockholder Return” (“TSR”) as compared to the Company’s peer group set forth in the PSU Award Agreement. For purposes of the PSU Awards, TSR is determined by dividing (i) the sum of (A) the average daily volume weighted average price (or “VWAP” as defined in the PSU Award Agreement) of a share of the Company’s common stock or the common stock of a peer company, as applicable, during the final 60 trading day period of the applicable performance period, less (B) the average VWAP of a share of the Company’s common stock or the common stock of a peer company, as applicable, during the 60 trading day period ending on December 31, 2020, plus (C) the sum of all dividends which are paid by the Company (or the member of the peer group) to its stockholders, assuming such dividends are reinvested in the applicable company through the applicable performance period, by (ii) the average VWAP of a share of the Company’s common stock or the common stock of a peer company, as applicable, during the 60 trading day period ending on December 31, 2020. The Company’s peer group includes 34 publicly traded companies, which are reflective of the S&P 500 Software & Services index and were selected by the Compensation Committee. The following table summarizes PSU activity for the three months ended March 31, 2021: PSUs Units Weighted Average Grant Date Fair Value Unvested PSUs outstanding at December 31, 2020 — $ — Granted 52.5 $ 579.30 Vested — $ — Forfeited — $ — Unvested PSUs outstanding at March 31, 2021 (1) 52.5 $ 579.30 (1) A maximum of 131,176 units could be awarded based upon Paycom’s Relative TSR over the applicable performance periods. For the three months ended March 31, 2021 and 2020, our total compensation expense related to restricted stock awards and PSU awards, in the aggregate, was $ 23.6 million and $ 15.8 million, respectively. The following table presents the unrecognized compensation cost and the related weighted average recognition period associated with unvested restricted stock awards and unvested PSU awards as of March 31, 2021. Restricted Stock Awards PSUs Unrecognized compensation cost $ 279,947 $ 28,804 Weighted average period for recognition (years) 3.8 2.5 We capitalized stock-based compensation costs related to software developed for internal use of $ 1.5 million and $ 1.6 million for the three months ended March 31, 2021 and 2020, respectively. 16 Paycom Software, Inc. Notes to the Unaudited Consolidated Financial Statements (tabular dollars and shares in thousands, except per share amounts) 1 2 . 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, 2020. We have made diligent efforts to notify clients, and reached substantially all, that were affected by such charges between approximately 2011 and September 2020 and have refunded approximately $ 3.0 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. 1 3 . INCOME TAXES The Company’s effective income tax rate was 32.1 % and 28.7 % for the three months ended March 31, 2021 and 2020, respectively. The higher effective tax rate for the three months ended March 31, 2021 is primarily related to an increase in nondeductible expenses. 14. SUBSEQUENT EVENTS On April 2, 2021, Jeffrey D. York resigned from his position as Chief Sales Officer of the Company and accepted a new role as Leadership Strategist of the Company. In connection with the change in Mr. York’s role, the Company and Mr. York entered into a letter agreement that, among other things, (i) amends that certain Amended and Restated Executive Employment Agreement, dated March 9, 2020, by and between the Company and Mr. York, to, among other things, reflect the change in Mr. York’s role, eliminate certain executive-level benefits and remove the termination and severance provisions, and (ii) forfeits and releases the performance-based restricted stock unit award granted to Mr. York on February 10, 2021. On April 2, 2021, the Board of Directors appointed Holly Faurot to succeed Mr. York as Chief Sales Officer of the Company. In connection with her appointment, Mrs. Faurot was granted an award of PSUs pursuant to the LTIP. Consistent with the PSU awards granted to certain other executive officers of the Company on February 10, 2021, Mrs. Faurot received 5,445 target PSUs that will vest based on the Company’s total stockholder return relative to a peer group of 34 publicly traded companies, subject to the terms and conditions of the LTIP and the PSU Award Agreement. On April 27, 2021, we issued an aggregate of 26,755 restricted shares of common stock to certain non-executive employees under the LTIP consisting of Time-Based Shares that will vest in three equal tranches annually, beginning on the first anniversary of the grant date, provided that the recipient is employed by, or providing services to, the Company on the applicable vesting date, and subject to the terms and conditions of the LTIP and the applicable restricted stock award agreement. On May 3, 2021, we issued an aggregate of 3,558 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, and subject to the terms and conditions of the LTIP and the applicable restricted stock award agreement . 17