Paychex Q2 Earnings Beat Estimates, Reaffirms FY15 Outlook - Analyst Blog

Paychex Inc. (PAYX) reported better-than-expected second-quarter fiscal 2015 results wherein the top and bottom-line figures surpassed the Zacks Consensus Estimate while improving year over year. The company's quarterly earnings of 47 cents per share beat the Zacks Consensus Estimate by a penny and increased 9.3% from the year-ago quarter mainly driven by improved top-line performance.

Quarter Details

Paychex reported total revenue (including Interest on funds held for clients) of $676.3 million increased 10% from the year-ago period and beat the Zacks Consensus Estimate of $674 million. Excluding interest on funds held for clients, total services revenue (Payroll service and Human Resource Services) also grew 10% from the year-ago quarter to $665.9 million.

Payroll Service segment revenues went up 4% from the year-ago period to $411.2 million, primarily driven by higher revenue per check and client base.

Human Resource Services segment revenues increased 21% year over year to $254.7 million mainly driven a new product offering within the company's professional employer organization. Apart from this, a strong growth in client base and worksite employees, increased revenues from retirement and online HR administration services aided to the segment's revenue growth.

Interest on funds held for clients was up 4% on a year-over-year basis to $10.4 million primarily benefited from a rise of 4% in average investment balances owing to increase in client base and wage inflation.

Paychex's total expenses increased 10% from the year-ago quarter to $406.1 million of which 6% is attributable to rise in compensation-related expenses and 4% due to costs associated with the company's new minimum premium plan health insurance offering within its professional employer organization. Total expenses, as a percentage of total revenue, increased 30 basis points (bps) on a year-over-year basis to 60%.

Paychex reported operating income of $270.2 million, up 9% from the year-ago period, attributable to a higher revenue base. Operating margin decreased to 40% from 40.3% in the year-ago quarter, primarily due to higher operating expenses.

Excluding interest on funds held for clients, Paychex's operating income came in at $259.8 million or 38.4% of total services revenue compared with $238.6 million or 38.7% of total services revenue in the year-ago period.

Net income came in at $173 million or 47 cents, which improved from $158.7 million or 43 cents reported in the year-ago quarter.

Balance Sheet & Cash Flow

Paychex exited the quarter with cash and cash equivalents of $140.4 million compared with $152.5 million at the end of fiscal 2014. Corporate investments were $388.6 million versus $398.7 million at the end of fiscal 2014. The company has no long-term debt. The company generated operating cash flow of $404.7 million in the first half of fiscal 2015.

During the first six months of fiscal 2015, Paychex repurchased 1.3 million shares for approximately $52.5 million and paid a dividend of $276.2 million.

Guidance

The company maintained its fiscal 2015 guidance provided in Jun 2014. Management expects 3–5% increase in Payroll Service revenues from the year-ago period. Human Resource Services revenues are expected to increase in the range of 16–19%.

Total service revenue is expected to increase in the range of 8–10%. Interest on funds held for clients and investment income for fiscal 2015 are expected to remain flat, primarily affected by low interest rate. Net income for fiscal 2015 is expected in the range of 6–8%.

Net operating income as a percentage of service revenues is expected in the range of 37% to 38% for fiscal 2015. The effective income tax rate for fiscal 2015 is expected to be same as the fiscal 2014 guidance (36–37%).

Our Take

Paychex reported better-than-expected first-quarter results. Moreover, both revenues and earnings increased on a year-over-year basis, primarily boosted by growth across all its segments. The company reiterated its fiscal 2015 outlook, which signifies that it is relatively well-placed amid the current macroeconomic sluggishness.

Moreover, we remain encouraged by the company's investments in product development and focus on building its sales force to support revenue growth. We also believe that the company's expansionary initiatives such as joint ventures and acquisitions support its long-term growth strategy.

Product launches are expected to provide additional support. Moreover, Paychex's focus on small and mid-sized businesses looking for HR solutions could provide the company with opportunities.

However, unfavorable interest rates and competition from Automatic Data Processing (ADP) and Insperity (NSP) remain the headwinds for the company.

Currently, Paychex has a Zacks Rank #3 (Buy). A better-ranked stock in the outsourcing industry which investors may consider is Sykes Enterprises Inc. (SYKE), sporting a Zacks Rank #1 (Strong Buy).

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