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Paychex (NASDAQ:PAYX) Surprises With Q1 Sales, Gross Margin Improves


Full Report / September 28, 2022
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Payroll and human resources software provider, Paychex (NASDAQ:PAYX) reported Q1 FY2023 results topping analyst expectations, with revenue up 11.3% year on year to $1.2 billion. Paychex made a GAAP profit of $379.2 million, improving on its profit of $333.6 million, in the same quarter last year.

Paychex (PAYX) Q1 FY2023 Highlights:

  • Revenue: $1.2 billion vs analyst estimates of $1.16 billion (3.5% beat)
  • EPS (non-GAAP): $1.03 vs analyst estimates of $0.97 (6.11% beat)
  • Free cash flow of $333.7 million, roughly flat from previous quarter
  • Gross Margin (GAAP): 70.9%, in line with same quarter last year

One of the oldest payroll service providers, Paychex provides payroll and human resource (HR) 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.

HR software benefits from dual trends around costs savings and ease of use. First is the SaaS-ification of businesses, large and small, who much prefer the flexibility of cloud-based, web-browser delivered software paid for on a subscription basis than the hassle and expense of purchasing and managing on-premise enterprise software. Second is the consumerization of business software, whereby multiple standalone processes like payroll processing and compliance are aggregated into a single, easy to use platforms.

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).

Sales Growth

As you can see below, Paychex's revenue growth has been unremarkable over the last two years, growing from quarterly revenue of $932.2 million, to $1.2 billion.

Paychex Total Revenue

This quarter, Paychex's quarterly revenue was once again up 11.3% year on year. On top of that, revenue increased $61.9 million quarter on quarter, a strong improvement on the $131.7 million decrease in Q4 2022, and a sign of acceleration of growth, which is very nice to see indeed.

Ahead of the earnings results the analysts covering the company were estimating sales to grow 6.69% over the next twelve months.

Profitability

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 is left after paying for servers, licenses, technical support and other necessary running expenses was at 70.9% in Q1.

Paychex Gross Margin (GAAP)

That means that for every $1 in revenue the company had $0.70 left to spend on developing new products, marketing & sales and the general administrative overhead. Significantly up from the last quarter, this is around the lower average of what we typically see in SaaS businesses. Gross margin has a major impact on a company’s ability to invest in developing new products and sales & marketing, which may ultimately determine the winner in a competitive market so it is important to track.

Cash Is King

If you follow StockStory for a while, you know that we put an emphasis on cash flow. Why, you ask? We believe that in the end cash is king, as you can't use accounting profits to pay the bills. Paychex's free cash flow came in at $333.7 million in Q1, down 6.05% year on year.

Paychex Free Cash Flow

Paychex has generated $1.35 billion in free cash flow over the last twelve months, an impressive 28.5% of revenues. This robust FCF margin is a result of Paychex asset lite business model, scale advantages, and strong competitive positioning, and provides it the option to return capital to shareholders while still having plenty of cash to invest in the business.

Key Takeaways from Paychex's Q1 Results

With a market capitalization of $40.8 billion, more than $1.23 billion in cash and with free cash flow over the last twelve months being positive, the company is in a very strong position to invest in growth.

We enjoyed seeing Paychex’s improve their gross margin materially this quarter. And we were also excited to see that it outperformed analysts' revenue expectations. Overall, this quarter's results seemed pretty positive and shareholders can feel optimistic. The company is up 3.3% on the results and currently trades at $117 per share.

Is Now The Time?

When considering Paychex, investors should take into account its valuation and business qualities, as well as what happened in the latest quarter. We cheer for everyone who is making the lives of others easier through technology, but in case of Paychex we will be cheering from the sidelines. Its revenue growth has been very weak, and analysts expect growth rates to deteriorate from there. And while its bountiful generation of free cash flow empowers it to invest in growth initiatives, unfortunately gross margins aren't as good as other tech businesses we look at.

Paychex's price to sales ratio based on the next twelve months is 8.1x, suggesting that the market has long term growth expectations from the business. 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.

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