Paychex, Inc. F4Q10 (Qtr End 05/31/10) Earnings Call Transcript - TheStreet

Paychex, Inc. F4Q10 (Qtr End 05/31/10) Earnings Call Transcript

Paychex, Inc. F4Q10 (Qtr End 05/31/10) Earnings Call Transcript
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Paychex, Inc. (PAYX)

F4Q10 (Qtr End 05/31/10) Earnings Call Transcript

June 24, 2010 10:30 am ET

Executives

John Morphy – SVP, CFO and Secretary

Jon Judge – President and CEO

Analysts

Adam Frisch – Morgan Stanley

Jason Kupferberg – UBS

Gary Bisbee – Barclays Capital

David Grossman – Thomas Weisel

Julio Quinteros – Goldman Sachs

Rod Bourgeois – Bernstein

Tien-Tsin Huang – JPMorgan Chase

Tim McHugh – William Blair & Co.

Chris Mammone – Deutsche Bank

George Nicolaus [ph] – Bank of America-Merrill Lynch

Glenn Greene – Oppenheimer

Tim Willi – Wells Fargo

Giri Krishnan – Credit Suisse

Jim Macdonald – First Analysis

Mark Marcon – R.W. Baird

Joseph Foresi – Janney Montgomery Scott

Thomas Rippl – Schaper, Benz & Wise

Presentation

Operator

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Welcome and thank you for standing by. At this time, all participants are in a listen-only mode. After the presentation, we will conduct a question-and-answer session. (Operator instructions). Today’s conference is being recorded. If you have any objections, you may disconnect at this time.

Now I’ll turn over the meeting to Mr. John Morphy, Senior Vice President and Chief Financial Officer of Paychex. Sir, you may begin.

John Morphy

Thank you for joining us today for our fiscal 2010 year-end earnings release. We’ll begin today with a view of fiscal 2010 financial results, including guidance for fiscal 2011; then Jon Judge, our President and CEO, will provide you an overview and we will end with a Q&A session.

Yesterday afternoon, after the market closed, we released our financial results for the fiscal year-ended May 31, 2010 and filed our Form 8-K, which provides additional discussion and analysis of the results for the year. These are available by accessing our Investor Relations page at www.paychex.com, and we expect to file our Form 10-K by the end of July. In addition, this teleconference is being broadcast over the Internet and will be archived and available on our website for approximately one month.

Early in fiscal 2010, we slightly decreased our service revenue guidance while maintaining our operating income and net income guidance. Our actual fiscal 2010 results were very consistent with that guidance as the year for the most part played out as we foresaw in late last summer.

Our operating income, net of certain items as a percent of service revenue, was 35.4% for fiscal 2010. The poor economic conditions of 2009 and 2010 impeded our revenue growth as they have contributed to declines in new client sales, client retention and checks per client. Despite this we ended the year encouraged by the modest improvement in some of our key indicators, and most importantly, checks per client. We will talk more about that later.

Our served payroll client base declined 3.2% to approximately 536,000 clients. Our client retention was 77% of our beginning of the year client base, slightly better than the prior year. We have begun to see signs of improvement as lost clients decreased 6%, compared to fiscal 2009, when lost clients increased 18% over the prior year. Our range of client retention over the past 10 years has been 76% to 81% of our beginning of the year client base.

The equity markets had a low in March 2009, with interest rates remaining low since then. The Federal funds rate has been at the range of zero to 25 basis points since December 2008. Our combined portfolios have earned an average rate of return of 1.5% for fiscal 2010, compared to 2.1% for fiscal 2009, and 3.7% in fiscal 2008.

We’ll now share our latest results on some of key indicators. Our most positive trend relates to checks per client. Our checks per client have shown modest improvement in each sequential quarter of fiscal 2010. Checks per client declined 2.6% for the year, where the quality breakout is follows.

Declines of 5.0% in the first, 3.7% in the second, and 2.2% in the third, followed by an increase of 1.1% for the fourth quarter of fiscal 2010. The increase in the fourth quarter was the first quarterly increase since the quarter ended February 28, 2007. For the fourth quarter of fiscal 2010 the actual checks per client number was slightly higher than at the end of fiscal 2009.

The calculation of checks per client per quarter is based upon the number of payroll checks issued, divided by the average client base for the quarter. While the new sales units were down approximately 5% for fiscal 2010, this has improved from the 8% decline experienced in fiscal 2009. There was some improvement in new business formation, but the level still remain low.

Clients lost due to companies going out of business or no longer having any employees decreased 11% for fiscal 2010 compared to increasing 17% in fiscal 2009. We continue to invest in our business primarily in our sales force, new and enhanced products and technological infrastructure. Our sales force grew 2% for fiscal 2010 and is expected to grow another 2% for fiscal 2011.

We have invested over $60 million in an enhanced platform for our core payroll processing capability, which allows us to leverage efficiencies in our processes and continue to provide excellent customer service to our clients.

During fiscal 2010, we completed the conversion of almost 500,000 clients to our new platform, which may be one of the biggest conversions probably taken place in America of the system of that nature. This was fully implemented, again, in fiscal 2010.

We continue the expansion of our insurance services nationwide. Our insurance services’ client base, which includes our workers’ compensation insurance clients and our health and benefit services clients, grew 7% to 92,000 clients served as of May 31, 2010.

Health and benefit services revenue grew 49% to $31 million in fiscal 2010 as we continue to take advantage of this growth opportunity. We believe the new health care reform is slightly positive for us.

We see our insurance services as an area that continues to offer significant opportunities for future growth. We strengthened our position as an expert in our industry by serving as a source of education and information to clients and other interested parties.

In fiscal 2010, we launched a new Paychex Insurance Agency website that helps small business owners navigate the area of insurance coverage. We also provide educational materials on our website to help existing and perspective clients understand the impact of regulatory changes. Recent examples include the HIRE Act and the federal health care reform bill.

We are the premier supplier of 401(k) record keeping services as we had total assets in the plans surpassing 11,000,051,000 clients, meaning we are serving one in every 10 401(k) record keeping clients in the U.S.

Our Paychex Premier and PEO are being offered to Paychex HR Solutions. We integrated the sales and service models and expanded these comprehensive human resource outsourcing solutions nationwide. This reduced redundancies and creates more flexible options for potential clients. PEO services will continue to be sold by our registered and licensed Paychex Business Solutions subsidiary.

We continue to generate significant cash flow to support our business and paid almost $450 million in dividends to our shareholders. This represents 94% of net income. Our cash flows historically slightly exceed net income, which allows us to be comfortable with and committed to maintain our current dividend level even though the payout is increasing as a percent of net income.

I will now move on to discussion of our results as presented in the consolidated income statement. First some highlights on fiscal 2010, followed by further color on certain areas.

Payroll service revenue decreased 5% for fiscal 2010 to $1.4 billion. This is the result of the economic impacts of our client base, check volume, which was discussed in our opening comments.

Human Resource Services revenue increased 3% for fiscal 2010 to $541 million. I will give you a better look at HRS service revenues growth in a few moments. Combined interest on funds held the clients in investment income decreased 28% for the year; yields available on high quality securities continued to remain low.

Operating income decreased 10% to $725 million for fiscal 2010. In the third quarter, we recognized an expense charge of $18.7 million to increase our litigation reserve related to the Rapid Payroll litigation, which has now been fully settled.

Operating income net of certain items excluding interest on funds held for clients and the expense charge to increase the litigation reserve decreased 6% to $689 million for the year. Operating income, net of certain items as a percentage of total service revenue, was 35.4% compared to 36.4% for fiscal 2009.

Net income and diluted earnings per share increased 11% to $477 million and $1.32 per share. The expense charge related to litigation reduced our diluted earnings per share by $0.03. The decrease in combined interest on funds held for clients and investment income reduced our diluted earnings per share by $0.04.

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