Paychex, Inc. Form 10-Q Summary
Business context and reporting period
Paychex provides payroll, human resources, benefits outsourcing, retirement, insurance, and SaaS solutions primarily to small and medium-sized U.S. businesses. The filing covers the three and nine months ended February 28, 2013, compared with the periods ended February 29, 2012. Paychex reports one operating segment; Germany generated less than 1% of revenue.
Financial performance and position
| Metric | Three months ended Feb. 28, 2013 | Year-over-year change | Nine months ended Feb. 28, 2013 | Year-over-year change |
|---|---|---|---|---|
| Total revenue | $593.3 million | 4% | $1,740.9 million | 4% |
| Service revenue | $582.4 million | 4% | $1,709.9 million | 4% |
| Operating income | $225.0 million | 7% | $693.0 million | 5% |
| Net income | $144.5 million | 7% | $445.5 million | 5% |
| Diluted EPS | $0.40 | 8% | $1.22 | 4% |
| Operating margin | 37.9% | Improved from 36.9% | 39.8% | Improved from 39.2% |
| Net margin | 24.3% | Improved from 23.8% | 25.6% | Improved from 25.3% |
- Payroll service revenue was $393.7 million in the quarter, up 2%, and $1,156.6 million for nine months, up 1%.
- Human Resource Services revenue was $188.7 million in the quarter and $553.3 million for nine months, both up 10%.
- Interest on funds held for clients was $10.9 million in the quarter, flat year over year, and $31.0 million for nine months, down 6%.
- Operating and SG&A expenses increased 3% in both periods, primarily reflecting investment in product development and supporting technology.
- Net cash provided by operating activities was $606.4 million for the first nine months, compared with $562.6 million in the prior-year period.
- Capital expenditures were $74.2 million and acquisitions consumed $21.3 million during the first nine months.
- Cash and cash equivalents were $100.4 million, while total corporate investments were $697.2 million. Management reported no debt.
- Funds held for clients increased to $5,556.2 million from $4,544.2 million at May 31, 2012, with corresponding client fund obligations of $5,510.2 million.
- Stockholders’ equity was $1,605.9 million at February 28, 2013.
Material changes versus the prior comparable period
- Quarterly total revenue increased 4%, while operating income and net income each increased 7%.
- HRS growth materially outpaced payroll growth, supported by retirement services, HR Solutions, insurance, and e-Services.
- Average combined funds held for clients and corporate investments increased 5% for the quarter and nine months, but average yields declined to 1.0% for the quarter and 1.1% for nine months.
- The investment portfolio shifted toward tax-exempt securities and variable rate demand notes. Available-for-sale securities increased to $4,873.7 million from $3,059.0 million at May 31, 2012.
- Dividends paid increased to $476.7 million from $344.3 million. Paychex accelerated a $0.66-per-share dividend payment in December 2012 that would otherwise have been paid in February and May 2013; the quarterly dividend was also increased 3% to $0.33 per share.
- Two immaterial SaaS-related business acquisitions were completed during the first nine months, compared with one immaterial acquisition in the prior-year period.
- Checks per payroll increased 2.3% in the quarter and 1.9% for nine months. Hurricane Sandy reduced estimated second-quarter payroll service revenue growth by approximately 0.5%.
Guidance, outlook, risks, and unusual items
- Fiscal 2013 guidance calls for payroll service revenue growth of 2% to 3%, HRS revenue growth of 9% to 11%, total service revenue growth of 5% to 6%, net income growth of 5% to 7%, and investment income growth of approximately 0% to 5%.
- Interest on funds held for clients is expected to decline 6% to 8%. Management expects the combined portfolio’s average rate of return to be approximately 1.0% for fiscal 2013.
- Operating income, net of certain items, is expected to equal approximately 37% to 38% of total service revenue. This is a non-GAAP measure that excludes interest on funds held for clients.
- Fiscal 2013 capital expenditures are expected to be $95 million to $100 million; depreciation is expected to be $80 million to $85 million; and intangible amortization is expected to be slightly below $20 million.
- Management expects cash, corporate investments, and projected operating cash flows to fund normal operations, capital purchases, and dividends for the foreseeable future.
- Interest-rate risk remains significant. A 25-basis-point change in short-term rates is estimated to affect after-tax earnings by approximately $4.0 million to $4.5 million over the next 12 months. Lower rates may reduce reinvestment yields and interest income.
- The company had $900 million of unused capacity under four secured, uncommitted short-term lines of credit and no borrowings outstanding. Standby letters of credit totaled $38.8 million, with no amounts drawn.
- Management stated that investments were not other-than-temporarily impaired. Unrealized losses totaled $0.6 million, although securities with $122.6 million of fair value were below amortized cost.
- Other risks include employment and benefits regulation, competition, cybersecurity and data breaches, technology or operational failures, third-party service-provider failures, PEO workers’ compensation claims, and legal matters.
Investor verification points
- Verify whether fiscal 2013 revenue and net-income guidance was achieved and how subsequent interest-rate changes affected client-fund income.
- Assess the sustainability of HRS growth relative to slower payroll service growth and the contribution from acquisitions and SaaS offerings.
- Review the composition, credit quality, duration, liquidity, and unrealized gains or losses of funds held for clients and corporate investments.
- Evaluate dividend sustainability given the accelerated payment, high payout level, and dependence on operating cash flow.
- Monitor PEO workers’ compensation reserves, legal contingencies, cybersecurity exposure, and regulatory changes affecting payroll and benefits services.