Paychex (PAYX) Beats Q3 Earnings Estimates, Updates '18 View

Paychex Inc. (NASDAQ:PAYX) reported solid results for third-quarter fiscal 2018, wherein the top and the bottom lines came ahead of the respective Zacks Consensus Estimate. Moreover, the company registered year-over year improvement on both counts.

The company reported non-GAAP earnings per share of 63 cents, which beat the Zacks Consensus Estimate by a penny and grew 15% year over year. The upside mainly stemmed from higher revenues, partially offset by increased expenses.

Quarter Details

Paychex reported total revenues (including interest on funds held for clients) of $866.5 million, up 9% year over year. Excluding interest on funds held for its clients, total services revenues (Payroll service and Human Resource Services) increased 8% year over year to $848.4 million. The Zacks Consensus Estimate was pegged at $588 million.

Payroll Service segment revenues went up 2% from the year-ago period to $455 million, primarily on the back of higher revenues per check.

Human Resource Services segment revenues rose 17% year over year to $393.4 million, chiefly driven by strong growth in client base and worksite employees, elevated revenues from retirement, as well as online HR administration services.

Interest on funds held for clients increased 37% on a year-over-year basis to $18.1 million, mainly benefiting from higher average interest rates earned.

Paychex’s total expenses flared up 17% from the year-ago quarter to $574 million due to increased compensation, one-time bonus to non-management employees and a one-time expense related to termination of certain license agreements. Total expenses, as a percentage of total revenues, increased 470 basis points (bps) to 66.2%.

The company’s operating income declined 5% year over year to $292.5 million. In addition, Paychex’s operating margin contracted 470 bps to 33.8%, chiefly due to higher total expenses as a percentage of revenues.

Net income came in at $260.4 million, up from $202.5 million reported in the prior-year quarter.

Paychex, Inc. Price, Consensus and EPS Surprise

Balance Sheet & Cash Flow

Paychex exited fiscal third quarter with cash, cash equivalents and corporate investments of $421.2 million compared with $338.6 million recorded at the end of the previous quarter. The company has no long-term debt. For the first three quarters of fiscal 2018, the company generated operating cash flow of $989.9 million.

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

Updated Fiscal 2018 Outlook

The company updated guidance for fiscal 2018.

Total revenues are now expected to grow around 7%, up from 6% projected earlier. The Zacks Consensus Estimate is currently pegged at $3.36 billion.

Payroll Services Revenues are anticipated to increase 2%. Previously, growth between 1% and 2% was anticipated.

Human Resource Services revenues are now projected to grow in the range of 13-14% compared with the earlier forecast of 12-14% growth.

Interest on funds held for clients is expected to grow in the range of 20% to 25%, up from the previous projection of mid-to-upper-teen range.

Operating margin is anticipated to be 38%, down from earlier range of 39-40%. Effective income tax rate is projected to be in the band of 28.5% to 29%, down from 35.0% to 35.5% projected earlier.

Net income is likely to advance 13% year over year on a GAAP basis and 15% on a non-GAAP basis. Previously, growth of 5% and 7% on GAAP and non-GAAP basis, respectively, was projected.

GAAP earnings are likely to increase in the range of 13-14%.

Non-GAAP earnings per share are estimated to be up in the range of 15-16%, up from the previous estimate of 7-8%. The Zacks Consensus Estimate is currently pegged at $2.45.

Our Take

Paychex’s investments in product development, technology and focus on building its sales force to support revenue growth boost our optimism. We also believe the company’s expansion initiatives, such as joint ventures and acquisitions, will likely support its long-term growth strategy.

Product launches are likely to be the other growth drivers. Also, Paychex’s focus on small- and mid-sized businesses looking for HR solutions could provide growth opportunities.

However, the company is facing issues in retaining its customer base for the last few quarters, which is a major concern. For the third quarter, the company did not mention anything about client growth for its payroll services.

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

Currently, Paychex has a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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