Paychex (PAYX) Q2 Earnings Match Estimates, Revenues Beat

Paychex Inc. (NASDAQ:PAYX) reported fiscal second-quarter 2018 results wherein the top line beat the Zacks Consensus Estimate but the bottom line came in line with the same. However, the company registered year-over-year improvement on both the counts.

Non-GAAP earnings per share of 59 cents increased 5% from the year-ago quarter.

Notably, the stock has returned 10.6% on a year-to-date basis, outperforming 7% growth recorded by the industry.

Quarter Details

Paychex reported total revenues (including interest on funds held for clients) of $826.5 million, up 7% year over year. Excluding interest on funds held for its clients, total services revenues (Payroll service and Human Resource Services) were up 7% year over year to $812.5 million. The Zacks Consensus Estimate was pegged at $823 million.

Payroll Service segment revenues went up 1% from the year-ago period to $444.8 million, primarily on the back of higher revenues per check, which benefited from price increases and net of discounts. However, revenues were negatively impacted by a change in client base mix.

Human Resource Services segment revenues rose 15% year over year to $367.7 million, chiefly driven by strong growth in client base across the prominent human capital management (HCM) services.

Interest on funds held for clients increased 23% on a year-over-year basis to $14 million, mainly benefiting from higher average interest rates earned.

Paychex’s total expenses rose 7% from the year-ago quarter to $494.3 million due to increased investments in technology and combined PEO business. Acquisition of HROI accounted for 5% of the total increase in expenses. Total expenses, as a percentage of total revenues, increased 20 basis points (bps) to 59.8%.

Operating income grew 7% year over year to $332.2 million. However, Paychex’s operating margin decreased 10 bps to 40.2%.

Adjusted net income surged 8% year over year to $437.2 million.

Balance Sheet & Cash Flow

Paychex exited the fiscal second quarter with cash, cash equivalents and corporate investments of $338.6 million compared with $323.4 million recorded at the end of the previous quarter. The company has no long-term debt. For the first half of fiscal 2018, the company generated operating cash flow of $519.4 million.

During the first two quarters, Paychex repurchased 1.6 million shares for $94.1 million.

Guidance

The guidance for fiscal 2018 provided at the end of the first quarter remains unaltered.

Total revenues are expected to grow around 6%. The Zacks Consensus Estimate is currently pegged at $3.35 billion.

Payroll Services Revenues are anticipated surge between 1% and 2%.

Human Resource Services revenues are projected to grow in the range of 12-14%.

Operating margin is anticipated to be between 39% and 40%. Effective income tax rate, excluding any potential impact from tax reform legislation, is projected to be 35.0% to 35.5%.

Interest on funds held for clients and investment income is expected to grow in the mid-to-upper-teen range.

Net income is still likely to advance 5% year over year on a GAAP basis and 7% on a non-GAAP basis. Non-GAAP earnings per share are estimated to be up in the range of 7-8%, which comes to $2.35-$2.38. The Zacks Consensus Estimate is currently pegged at $2.37.

Our Take

The company’s top-line is benefiting from acquisitions. In the second quarter fiscal 2018, HROI which was acquired in August 2017, added 3% to total service revenue growth.

However, the company is facing issues in retaining its customer base for the last few quarters, which is a major concern. Due to a challenging demand environment and modest decline in retention, the company’s payroll client base remained flat in the previous quarter. Additionally, political uncertainty, which in turn impacted outsourcing decision making in the mid-market, affected the company’s client base.

Furthermore, increasing competition from industry peers like Automatic Data Processing, Insperity, Intuit (NASDAQ:INTU), H&R Block (NYSE:HRB), Broadridge Financial Solutions and DST System is another key concern.

Currently, Paychex has a Zacks Rank #4 (Sell).

A few better-ranked stocks in the broader technology sector are Western Digital Corp. (NASDAQ:WDC) , Axcelis Technologies Inc. (NASDAQ:ACLS) and Applied Materials, Inc. (NASDAQ:AMAT) , all sporting a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

The long-term EPS growth rate for Western Digital, Axcelis and Applied Materials is projected to be 31.12%, 20% and 12.67%, respectively.

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