Paychex (NASDAQ: PAYX) reported its fourth quarter earnings (fiscal year ends May 31) on July 1, posting 9% year-on-year growth in total revenues to reach $639 million.  This includes the impact of change in Professional Employer Organization (PEO) direct cost adjustment. Growth in client base at Paychex’s Payroll and Human Resource Service divisions contributed to the revenue growth. Growth at these segments also drove an 8% increase in total revenue for the fiscal year 2014, which was partially offset by a decline in interest earned on funds held for clients. Net income and earnings per share grew 18% due to the impact of an increase in provision for tax in the fourth quarter of the previous fiscal year. For the full fiscal year, net income and earnings per share grew 10%.
Paychex has introduced a change in its accounting for direct costs related to its PEO service. Earlier revenues from the PEO service were recorded net of these direct costs. However, from this quarter onwards, these direct costs will now be included in operating expenses. This change in accounting methodology for PEO direct costs does create an artificial increase in the company’s reported revenue but has no impact on its operating income. Excluding the impact of change in accounting for PEO direct costs, the total revenue in the fourth quarter increased 5% year-on-year. Paychex’s operating income, the difference between its revenue and operating expense, grew 8% in the fourth quarter and 9% for fiscal year 2014.
Paychex provided a guidance of 8-10% growth in total service revenues for the fiscal year 2015. This guidance includes the impact of classification of PEO direct costs as operating expenses.
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Payroll services revenue driven by increase in clients
Paychex’s Payroll services revenue grew 3% year-on year in the fourth quarter driven by an increase in its check per client, revenue per check and increased penetration of products.  Check per payroll, which indicates the average number of employees Paychex’s Payroll service caters to for a client, increased 1.1% driven by the healthy employment conditions in the U.S. In March, the unemployment rate was 6.7% and in April and May it was 6.3%.  Revenue per check increased as a result of price increase which was partially offset by discounts.
For the fiscal year 2014, Payroll services revenue grew 4%. Paychex’s Payroll clients increased 2% to reach approximately 580,000. The company expects 3-5% growth in the segment’s revenues for the fiscal year 2015 based on its estimates for growth in revenue per check and client base growth.
HR services posts double-digit growth driven by increase in client base
Paychex’s HR Services revenue grew 22% year-on-year in the fourth quarter as a result of change in classification of PEO direct costs.  Excluding the impact of the PEO adjustment, the segment’s revenue grew 10% during the quarter and 12% during the fiscal year, driven by an increase in its client base for its HR Solutions, retirement services and online HR administration products. Paychex HR Solutions clients grew 13% and client employees grew 14% during the fiscal year. Increase in retirement plans, higher insurance premiums and increase in the number of health and benefits applicants also contributed to the segment’s revenue growth.
Paychex’s growing focus on Software-as-a-Service (SaaS) solutions contributed to strong growth in HR administration products. In October 2013, Paychex announced a new SaaS platform which integrated all of its payroll and HR services and provides a one-stop solution for its clients.  The platform offers payroll, HR benefits, time and attendance, training and performance management services through a single interface backed by a centralized database. Paychex recently acquired nettime solutions in order to add an online based time and attendance solution to its product portfolio. (Read our article here) These products should continue to bolster revenues and help improve margins.
Operating margin declines due to seasonality and technology related investments
Paychex’s operating margin declined 45 basis points year-on-year to reach 35.7% in the fourth quarter driven by various technology investments to expand their Software-as-a-Service portfolio. On a sequential basis, operating margin declined 3.7% on account of seasonal sales related expenses.
For the fiscal year 2014, Paychex’s operating margin increased 10 basis points. We expect to see an increase in margins in the coming years driven by the increased adoption of SaaS based products. However, due to the impact of change in classification of PEO direct costs, the operating margin is expected to remain within the range of 37-38%.