Paychex, Inc. Form 10-Q Summary
Business Context and Reporting Period
Paychex provides payroll, human-resource, benefits, retirement, workers’ compensation, and related outsourcing services primarily to small and medium-sized U.S. businesses. The filing covers the three and six months ended November 30, 2009, representing the second quarter and first half of fiscal 2010. Germany contributed less than 1% of revenue.
Financial Performance and Position
| Metric | Three Months Ended Nov. 30, 2009 | Year-over-Year Change | Six Months Ended Nov. 30, 2009 | Year-over-Year Change |
|---|---|---|---|---|
| Total revenue | $496.6 million | (5%) | $996.8 million | (6%) |
| Service revenue | $483.0 million | (4%) | $969.5 million | (4%) |
| Operating income | $193.1 million | (9%) | $382.9 million | (12%) |
| Operating margin | 38.9% | Down from 40.4% | 38.4% | Down from 41.0% |
| Net income | $125.9 million | (10%) | $249.5 million | (14%) |
| Diluted EPS | $0.35 | (10%) | $0.69 | (14%) |
| Operating income excluding client-fund interest | $179.5 million | (7%) | $355.6 million | (9%) |
| Cash flow from operations | Not separately provided | — | $279.2 million | Down from $328.4 million |
Payroll service revenue declined 7% to $350.8 million in the quarter and to $705.2 million for the six-month period. Human Resource Services revenue increased 3% to $132.2 million in the quarter and 2% to $264.3 million for the six months.
Interest on funds held for clients declined 31% in the quarter to $13.6 million and 38% for the six months to $27.3 million. Investment income declined 41% in the quarter and 59% for the six months, reflecting substantially lower interest rates.
At November 30, 2009, cash and cash equivalents were $225.3 million, corporate investments were $62.0 million, and long-term corporate investments were $317.4 million. Management reported $604.7 million of cash and total corporate investments and no debt. Funds held for clients totaled $3.0 billion, with corresponding client fund obligations of $2.9 billion. Stockholders’ equity was $1.39 billion.
The company paid $224.2 million in dividends during the first six months, or $0.62 per share. The quarterly dividend remained $0.31 per share.
Material Changes Versus Prior Comparable Period
- Weak economic conditions reduced client employment, payroll checks per client, new-business starts, client retention, and average funds held for clients.
- Checks per client declined 3.7% in the second quarter and 4.3% for the first six months. The client base declined less than 1% from May 31, 2009.
- New client sales from new business starts declined 8% in the quarter and 10% for the six months, although the rate of decline improved from earlier quarters.
- Human Resource Services growth was supported by health and benefits services, PEO activity, and growth in comprehensive human-resource outsourcing. Retirement-services revenue remained pressured by economic conditions and client asset mix.
- Expenses decreased 3% in the quarter and 2% for the six months, primarily from cost controls, lower headcount, and lower other expenses. Employees decreased to approximately 12,300 from approximately 12,700 a year earlier.
- Average combined investment balances declined 5%; average investment yields declined to 1.7% from 2.4% for the quarter and to 1.7% from 2.7% for the six months.
- The company resumed investing in selected A-1/P-1-rated variable-rate demand notes during November 2009 after avoiding them since September 2008.
- Paychex sold the immaterial Stromberg time-and-attendance business and received $13.1 million of proceeds during the six months.
Guidance, Outlook, Risks, and Unusual Items
Fiscal 2010 guidance was unchanged. Management projected payroll service revenue of down 7% to down 5%, Human Resource Services revenue growth of 3% to 6%, total service revenue down 5% to down 2%, total revenue down 5% to down 2%, investment income down 35% to down 30%, and net income down 12% to down 10%. Operating income excluding interest on funds held for clients was expected to equal 34% to 35% of service revenue, with an effective tax rate of approximately 35%.
Management expected average invested balances to decline approximately 8% for fiscal 2010. Slightly less than 15% of the long-term investment portfolio was expected to mature over the following twelve months and be reinvested at an estimated average rate of approximately 1.1%. Capital expenditures were projected at $60 million to $65 million.
Key risks include continued economic weakness, employment and wage trends, interest-rate volatility, investment credit and valuation risk, competition, regulatory changes affecting payroll and benefits, workers’ compensation claims, technology or systems failures, third-party service-provider disruptions, internal-control failures, and litigation.
The company had $900 million of unused capacity under four uncommitted secured short-term lines of credit, with no borrowings outstanding. Standby letters of credit totaled $65.8 million. Capital-asset purchase commitments were approximately $12.1 million. A litigation reserve of $20.4 million was recorded; management did not expect current matters to have a material adverse effect, while acknowledging that outcomes remain uncertain.
Available-for-sale securities had a net unrealized gain of $78.8 million and gross unrealized losses of only $0.1 million at November 30, 2009. Management concluded that the portfolio was not other-than-temporarily impaired. A hypothetical 25-basis-point increase or decrease in rates was estimated to change the portfolio’s fair value by approximately $12.0 million to $12.5 million in the opposite direction.
Adopted accounting standards had no material effect on results or financial position. The company was evaluating the potential effects of later revenue-recognition and software-related standards, but did not expect the other newly issued standards to be material.
Investor Verification Items
- Verify whether payroll volume, new-client sales, and client retention recover as economic conditions improve.
- Monitor the effect of near-zero short-term rates and portfolio reinvestment yields on client-fund interest income and investment income.
- Reconcile reported GAAP operating income with the non-GAAP measure excluding interest on funds held for clients.
- Review the liquidity and maturity profile of client funds and corporate investments, including variable-rate demand notes and municipal bonds.
- Assess execution against unchanged fiscal 2010 revenue, margin, tax-rate, capital-expenditure, and net-income guidance.
- Track litigation, workers’ compensation claims, investment impairment assessments, and the $12.1 million of capital commitments.
- Confirm the sustainability of dividend payments given lower earnings and operating cash flow.