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Paychex Inc. (PAYX - Snapshot Report) reported third-quarter fiscal 2013 earnings of 40 cents per share, beating the Zacks Consensus Estimate by a penny. The quarter’s result was 6.3% above the year-ago level.

Revenues

Paychex reported third-quarter 2013 revenues of $593.3 million, up 4.2% from $569.5 million in the year-ago quarter. The quarter’s revenues were slightly above the Zacks Consensus Estimate of $593.0 million.

Payroll Service segment revenues increased 1.9% year over year to $393.7 million. Checks per payroll grew roughly 2.3% from the year-ago quarter. Revenue per check grew modestly as a result of price increases, partially offset by discounting.

The Human Resource Services segment generated $188.7 million in revenues, up 9.7% from the prior-year quarter. The improvement was mainly attributable to client growth and price increases, partially offset by lower contribution from professional employer organization and unfavorable product mix.

Operating Results

In the third quarter, Paychex incurred total expenses of $368.3 million, up 2.6% from the year-ago quarter. The rise was mainly due to higher selling, general and administrative expenses as well as continuous investments in product development and supporting technology.

Operating income was $225.0 million, up 6.9% from the year-ago period, attributable to modest revenue growth supported by better cost management and capacity utilization. Operating margin was 43.0% versus 42.4% in the year-ago quarter.

Net income of $144.5 million in the reported quarter reflected a 6.7% increase from $135.4 million in the prior-year quarter. Earnings per share were 40 cents compared with 37 cents in the year-ago quarter. There was no one-time item during the quarter.

Balance Sheet & Cash Flow

Paychex exited the third quarter with cash and cash equivalents of $100.4 million, down from $122.6 million at the end of the prior quarter. Corporate investments were $470.2 million compared with $178.6 million in the prior quarter.

Additionally, interest on funds held for clients decreased 0.9% year over year to $10.9 million as a result of lower average interest rates earned, partly offset by an increase in average investment balances. Paychex has no long-term debt.

Guidance

Paychex believes that Payroll Services revenue growth will be supported by modest growth in client base and improved revenue per check. Human Resources organic revenue growth is expected to follow the historical trend. Financial guidelines were maintained for fiscal 2013.

For fiscal 2013, Paychex expects a 2%–3% increase in Payroll Service revenues from the year-ago quarter. Human Resource Services revenues are expected to increase in the range of 9.0% to 11.0%.

Total service revenue will likely grow in the range of 5% to 6%. The company expects an 8%–6% decline in interest on funds held for clients and nil–5% upside in net investment income.

Interest on funds held for clients and investment income for fiscal 2013 are expected to be impacted by the low interest rate environment. However, investment of cash generated from operations is expected to persist, thus increasing investment income.

Net operating income as a percentage of service revenues is expected in the range of 37.0%–38.0% for fiscal 2013. Net income is expected to grow in the range of 5% to 7%.

Our Take

Paychex’ third-quarter results were decent, with both the bottom and top lines surpassing the Zacks Consensus Estimates. Though Paychex mentioned that revenue growth could be stronger during the fourth quarter, the guidance for fiscal 2013 was maintained. We believe that the conservative guidance was mainly due to macro uncertainties.

We are encouraged by management’s commentary regarding continued investments in product development and focus toward building sales force to support revenue growth.

However, lingering unemployment situation, strict interest rates and stiff competition from Automated Data Processing (ADP - Analyst Report) and Insperity (NSP) keep us concerned. However, Paychex’ zero European exposure will be beneficial for the company.

Currently, Paychex has a Zacks Rank # 4 (Sell). Investors should also look into similar stocks that are performing better than Paychex. StarTek Inc. (SRT - Snapshot Report) has a Zacks Rank #1 (Strong Buy) and Broadridge Financial Solutions Inc. (BR - Snapshot Report) has a Zacks Rank #2 (Buy).

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