Paychex, Inc. — Fiscal 2012 Second-Quarter Form 10-Q Summary
Business context and reporting period
Paychex provides payroll, human-resource, benefits, retirement, insurance, and related outsourcing services primarily to small and medium-sized U.S. businesses. The company reports one operating segment, with Germany contributing less than 1% of revenue. This filing covers the three and six months ended November 30, 2011, representing the second quarter and first six months of fiscal 2012.
Financial performance and position
| Metric | Three months ended Nov. 30, 2011 | Year-over-year change | Six months ended Nov. 30, 2011 | Year-over-year change |
|---|---|---|---|---|
| Total service revenue | $535.0 million | 7% | $1,087.0 million | 8% |
| Total revenue | $545.7 million | 7% | $1,108.8 million | 8% |
| Operating income | $217.9 million | 7% | $447.6 million | 11% |
| Net income | $140.4 million | 5% | $289.3 million | 9% |
| Diluted EPS | $0.39 | 5% | $0.80 | 10% |
| Operating margin on total revenue | 40% | Stable | 40% | Up from 39% |
| Net margin on total revenue | 26% | Stable | 26% | Stable |
- Payroll service revenue increased 5% to $371.7 million in the quarter and to $754.0 million for the six months.
- Human Resource Services revenue increased 12% to $163.3 million in the quarter and 15% to $333.0 million for the six months.
- Interest on funds held for clients declined 10% to $10.7 million in the quarter and 9% to $21.8 million for the six months because of lower yields.
- Operating income, excluding interest on funds held for clients, increased 8% to $207.2 million in the quarter and 12% to $425.8 million for the six months. This non-GAAP measure represented 38.7% of service revenue in the quarter and 39.2% for the six months.
- Effective tax rates increased to 36.0% for the quarter and 35.8% for the six months, compared with 34.8% in each prior-year period.
- Cash flow from operating activities was $297.2 million for the six months, compared with $319.2 million in the prior-year period. Capital expenditures were $44.1 million.
- Cash and cash equivalents were $96.1 million at November 30, 2011, compared with $119.0 million at May 31, 2011. Cash and total corporate investments totaled $676.3 million, and the company reported no debt.
- Funds held for clients were $3.03 billion and client fund obligations were $2.99 billion at November 30, 2011. Total corporate investments, including long-term investments, were $580.2 million.
- Stockholders’ equity increased to $1.56 billion from $1.50 billion at May 31, 2011. The quarterly dividend was increased 3% to $0.32 per share.
Material changes versus the prior comparable period
- Revenue growth was supported by higher checks per client, price increases, lower discounting, and growth in ancillary services. Checks per client increased 1.5% in the quarter and 1.8% for the six months, but management expected this growth to moderate.
- SurePayroll and ePlan, acquired in the second half of fiscal 2011, contributed approximately 2 percentage points to quarterly total revenue growth. Excluding these acquisitions, service revenue growth was 5% for the quarter and 6% for the six months.
- Human Resource Services growth reflected increased clients and employees served, new HR Essentials activity, higher health and benefits applicants, retirement-services growth, and the ePlan acquisition.
- Combined operating and selling, general and administrative expenses increased 6% in both periods. The increase reflected acquired operations, product development, supporting technology investments, and higher depreciation and amortization.
- Average combined investment balances increased 6% in the quarter and 7% for the six months, but the average return declined to 1.3% from 1.5%.
- Net operating cash flow declined despite higher net income, primarily because of unfavorable changes in receivables and other operating assets and liabilities.
Guidance, outlook, risks, and unusual items
Management reaffirmed fiscal 2012 guidance, assuming current market, economic, and interest-rate conditions continue.
| Fiscal 2012 measure | Guidance |
|---|---|
| Payroll service revenue growth | 5% to 7% |
| Human Resource Services revenue growth | 12% to 15% |
| Total service revenue growth | 7% to 9% |
| Interest on funds held for clients | Down 12% to 14% |
| Investment income growth | 0% to 2% |
| Net income growth | 5% to 7% |
| Operating income excluding client-fund interest as a percentage of service revenue | 36% to 37% |
| Capital expenditures | $90 million to $95 million |
| Depreciation expense | $75 million to $80 million |
| Intangible amortization | $20 million to $25 million |
- Management expected the combined investment portfolio to earn approximately 1.2% in fiscal 2012. Approximately 20% of the long-term portfolio was expected to mature over the following twelve months and be reinvested at an estimated average rate of approximately 1.0%.
- A 25-basis-point change in short-term interest rates was estimated to affect annual after-tax earnings by approximately $3.5 million to $4.0 million.
- The investment portfolio was concentrated in high-quality municipal and short-term securities; more than 95% was rated AA or better. Management reported no high-risk or illiquid investments and no other-than-temporary impairment.
- The company had $900 million of unused capacity under four uncommitted secured lines of credit, all expiring in February 2012. No amounts were outstanding.
- Standby letters of credit totaled $47.4 million, with no amounts outstanding. Capital-asset purchase commitments totaled approximately $8.5 million.
- PEO workers’ compensation reserves are subject to actuarial and legal uncertainty; adverse claims trends or reserve adjustments could materially affect results. The maximum individual claims liability was $1.0 million under the applicable policies.
- Other risks include weak employment and business formation trends, interest-rate and investment-credit risk, competition, regulatory changes, technology or system failures, cybersecurity breaches, third-party service-provider failures, internal-control issues, and legal matters.
- Management stated that pending legal matters were not expected to have a material adverse effect, while acknowledging that outcomes remain uncertain.
Important facts for investors to verify
- Whether checks-per-client growth continues to moderate and affects payroll and Human Resource Services revenue comparisons.
- The extent to which future growth depends on SurePayroll, ePlan, pricing, and acquisitions versus organic expansion.
- The effect of continued low interest rates and reinvestment yields on client-fund interest income, investment income, and earnings.
- Whether the 36% to 37% fiscal 2012 non-GAAP operating margin guidance remains achievable while technology and product investments continue.
- Changes in PEO workers’ compensation claims, reserves, and related insurance exposure.
- Renewal or replacement of the four short-term credit facilities expiring in February 2012.
- Future cash flows after dividends, capital expenditures, acquisitions, and movements in client funds and client fund obligations.
- The filing’s non-GAAP operating-income measure should be reconciled to GAAP operating income and should not be used in isolation.