Paychex Inc. (PAYX) reported fourth-quarter 2010 earnings of 32 cents per share, beating the Zacks Consensus Estimate by a penny.
Revenue
Paychex reported fourth-quarter 2010 revenue of $496.2 million, almost flat with $495.9 million last year. The slight recovery could be due to a 1.1% growth in checks processed per client and a marginal recovery in the retirement services client base compared with the year-ago quarter.
As per the revenue segments, Payroll Service delivered revenue was down 2% from last year to $341.3 million, due to major customer losses in the back half of the year. The result was partially offset by a slight growth in checks per client.
The improvement in checks per client was particularly encouraging, since the last time this metric showed a positive change was way back in the fourth quarter of 2007. Management stated that the growth was primarily driven by an increase in corporate hiring. The contribution from newly formed businesses also increased 12% in the fourth quarter, a reversal of a two-year trend.
Human Resource Services generated $141.2 million, up 6.0% from the prior-year quarter. The improvement was due to growth in the number of employees served. This increase stems from the positive impact of the recently passed Healthcare Reform Act in the U.S. and also to increased hiring.
Operating Results
In the fourth quarter, the company incurred a total expense of $322.6 million, almost flat with the year-ago quarter. Operating income was $173.6 million, almost flat with the year-ago period.
Net income of $115.5 million in the reported quarter increased from $113.8 million last year. Net income per diluted share remained flat year over year at 32 cents.
Balance Sheet
Paychex exited the fourth quarter with cash and cash equivalents of $284.3 million, up from $279.3 million at the end of the prior quarter. Moreover, during the fourth quarter, interest on funds held for clients decreased 9.3% year over year to $13.7 million as a result of lower average interest rates earned, partially offset by a 5% increase in average investment balances.
Fiscal 2010 Highlights
Paychex reported total revenue of $2.0 billion for fiscal year 2010, which was down 4% year over year, mainly due to the cumulative effect of client loss and lower check volume. Earnings dropped 11% as a result of litigation expenses incurred in the third quarter of 2010. Excluding the effect of litigation expense, adjusted earnings declined 8.8% from the year-ago quarter.
Net payroll clients fell 3.2% year over year. New sales units fell roughly 5% in fiscal 2010, driven by a slowdown in new business formations and fewer companies moving to outsourcing. This was, however, slightly offset by a 7% growth in the insurance service client base due to continued investment and expansion in the insurance field.
During the year, Paychex generated significant cash flow of $610.9 million and paid dividends worth $448.6 million.
Guidance
For fiscal year 2011, Paychex expects Payroll service revenue to remain flat year over year and Human Resource Services revenue to increase in the range of 10.0% to 13.0%. Interest on funds held for clients is expected to decrease in the range of 12% to 17%, while net investment income is expected to increase in the range of 24% to 27%. Moreover, net income is expected to improve marginally from the fiscal 2010 level.
Recommendation
We remain concerned about the decreasing customer count and challenging conditions in the U.S. small business segment, stemming from higher employee turnover and constrained credit conditions. Since small businesses contribute largely to total revenue, we remain unclear about when Paychex would be able to return to its normal double-digit revenue growth.
We look forward to a positive contribution from Paychex’s Human Resource Services segment, as there has been a steady increase in clients over the past few quarters.
On the other hand, we are somewhat concerned about escalating competition in the outsourcing space from big players such as Automated Data Processing Inc. (ADP) and Administaff Inc. (ASF), as well as limited margin expansion in the near team due to continuous investment in diverse fields.
We currently have a short-term Hold recommendation on Paychex Inc.
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