Payroll and human resources software provider, Paychex (NASDAQ:PAYX) fell short of analysts' expectations in Q2 FY2024, with revenue up 5.7% year on year to $1.26 billion. It made a non-GAAP profit of $1.08 per share, improving from its profit of $0.99 per share in the same quarter last year.
Key Takeaways from Paychex's Q2 Results
This was a weaker quarter for Paychex, as revenue and operating profit both missed. The stock is flat after reporting and currently trades at $126.97 per share.
Paychex (PAYX) Q2 FY2024 Highlights:
- Market Capitalization: $46.19 billion
- Revenue: $1.26 billion vs analyst estimates of $1.27 billion (0.7% miss)
- EPS (non-GAAP): $1.08 vs analyst estimates of $1.07 (small beat)
- Free Cash Flow of $307.8 million, down 50.1% from the previous quarter
- Gross Margin (GAAP): 71.1%, up from 69.8% in the same quarter last year
One of the oldest service providers in the industry, Paychex (NASDAQ:PAYX) offers its customers payroll and HR software solutions.
Managing basic HR functions like payroll and benefits are requirements for all companies, but are particularly time consuming and expensive for small and medium sized businesses, who have historically used a series of patchwork measures involving spreadsheets, accountants and single purpose software from multiple vendors.
Paychex offers a full range of human capital management (HCM) products including payroll processing and HR services to manage employees, from onboarding, managing schedules and benefits, and offering retirement accounts like 401Ks. Paychex also has a large internal staff of professionals who can provide full offers of outsourced HR and compliance functions, while also providing a range of insurance options (e.g. health, cybersecurity, and property) to businesses and their employees.
While considered more of a legacy payroll provider, Paychex’s value proposition is a breadth of offering that many of the newer cloud-native HCM rivals can’t match, such as retirement accounts and serving as an insurance brokerage. It also offers broad flexibility in how customers can choose to purchase any of Paychex’s services as standalone modules or in bundles, delivered either on-premise or through a cloud-based version. In recent years, it has introduced Paychex Flex, a cloud-based integrated HCM platform that addresses the growing demands of SMBs for lower cost, consumer-like user interfaces.
Modern HR software has two powerful benefits: cost savings and ease of use. For cost savings, businesses large and small much prefer the flexibility of cloud-based, web-browser-delivered software paid for on a subscription basis rather than the hassle and complexity of purchasing and managing on-premise enterprise software. On the usability side, the consumerization of business software creates seamless experiences whereby multiple standalone processes like payroll processing and compliance are aggregated into a single, easy-to-use platform.
ADP (NASDAQ:ADP) is Paychex’s primary competitor, but increasingly has come into competition with cloud-native HCM software providers like Asure (NYSE: ASUR), Ceridian (NYSE:CDAY), (Paycom (NYSE:PAYC), Paycor (NASDAQ:PYCR), Paylocity (NASDAQ:PCTY), and Workday (NASDAQ:WDAY).
As you can see below, Paychex's revenue growth has been unremarkable over the last two years, growing from $1.11 billion in Q2 FY2022 to $1.26 billion this quarter.
Paychex's quarterly revenue was only up 5.7% year on year, which might disappoint some shareholders. On top of that, the company's revenue actually decreased by $28.1 million in Q2 compared to the $56.4 million increase in Q1 2024. Taking a closer look we can a similar revenue decline in the same quarter last year, which could suggest that the business has seasonal elements. Regardless, this situation is worth monitoring as management is guiding for a further revenue drop in the next quarter.
Looking ahead, analysts covering the company were expecting sales to grow 6.7% over the next 12 months before the earnings results announcement.
What makes the software as a service business so attractive is that once the software is developed, it typically shouldn't cost much to provide it as an ongoing service to customers. Paychex's gross profit margin, an important metric measuring how much money there's left after paying for servers, licenses, technical support, and other necessary running expenses, was 71.1% in Q2.
That means that for every $1 in revenue the company had $0.71 left to spend on developing new products, sales and marketing, and general administrative overhead. Paychex's gross margin is lower than that of a typical SaaS businesses and its decline over the last year is putting it in an even deeper hole. Gross margin has a major impact on a company’s ability to develop new products and invest in marketing, which may ultimately determine the winner in a competitive market. This makes it a critical metric to track for the long-term investor.
Cash Is King
If you've followed StockStory for a while, you know that we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can't use accounting profits to pay the bills. Paychex's free cash flow came in at $307.8 million in Q2, up 7.5% year on year.
Paychex has generated $1.86 billion in free cash flow over the last 12 months, an eye-popping 35.9% of revenue. This robust FCF margin stems from its asset-lite business model, scale advantages, and strong competitive positioning, giving it the option to return capital to shareholders or reinvest in its business while maintaining a healthy cash balance.
Balance Sheet Health
Debt is a tool that can boost company returns but presents risks if used irresponsibly. As long-term investors, the risk we care most about is the permanent loss of capital (not short-term stock price volatility), which can happen when a company goes bankrupt or raises capital from a disadvantaged position.
Paychex is a well-capitalized company with a net cash position, meaning it could pay back all its debt tomorrow and still have $1.45 billion of cash on its balance sheet. This net cash position also represents 3.1% of its market capitalization, so investors can sleep easy knowing the company won't file Chapter 11 anytime soon.
Is Now The Time?
When considering an investment in Paychex, investors should take into account its valuation and business qualities as well as what's happened in the latest quarter.
We cheer for everyone who's making the lives of others easier through technology, but in case of Paychex, we'll be cheering from the sidelines. Its revenue growth has been very weak over the last two years, and analysts expect growth to deteriorate from here. And while its bountiful generation of free cash flow empowers it to invest in growth initiatives, unfortunately, its gross margins aren't as good as other tech businesses we look at.
Given its price-to-sales ratio based on the next 12 months is 8.4x, Paychex is priced with expectations of a long-term growth, and there's no doubt it's a bit of a market darling, at least for some. While we have no doubt one can find things to like about the company, and the price is not completely unreasonable, we think that at the moment there might be better opportunities in the market.
To get the best start with StockStory check out our most recent Stock picks, and then sign up to our earnings alerts by adding companies to your watchlist here. We typically have the quarterly earnings results analyzed within seconds of the data being released, and especially for the companies reporting pre-market, this often gives investors the chance to react to the results before the market has fully absorbed the information.