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What to Expect When Paychex Reports Earnings

Asit Sharma, The Motley Fool

Payroll, human resources, and employee services provider Paychex (NASDAQ: PAYX) reports on the final quarter of its fiscal 2019 year on June 26 before the markets open for trading. Will the company be able to maintain its phenomenal stock ascent of 37% year to date? Below, let's review significant items that will influence investors' reactions when Paychex issues its financial statements next Wednesday.  

Meeting the fiscal 2019 outlook

Paychex completed its $1.2 billion acquisition of Oasis Outsourcing, the nation's largest PEO (professional employer organization), in late December 2018. To make its earnings projections a little easier on investors, Paychex's fiscal 2019 outlook excludes the impacts of Oasis on revenue and earnings.

The company's guidance calls for year-over-year revenue growth of 4% in the management solutions segment, growth of 18% to 20% in the PEO and insurances services segment, and growth of interest on funds held for clients of 20% to 25%. 

This equates to an overall year-over-year revenue improvement of 6% to 7%. Barring an unexpected fourth-quarter stumble, Paychex shouldn't have a problem meeting this target, as it recorded top-line expansion of 10% through the first three quarters of fiscal 2019. Moreover, in the company's third-quarter earnings conference call, management provided a ballpark fourth-quarter revenue growth estimate of 9%, so executives' confidence on the revenue front remains high.

As for earnings, the company projects full-year improvement of roughly 4% in net income and diluted earnings per share (EPS) over fiscal 2018 benchmarks of $933.7 million and $2.58, respectively. Again, these targets are well within reach, since through the first nine months of the year, Paychex has recorded $804 million in net income and $2.22 in diluted EPS.

A human resources employee assists another employee in her office.

Image source: Getty Images.

Expectations for operating leverage

One of the factors driving Paychex's shares higher is the company's improving operating leverage. As Paychex has bulked up its top line through both organic growth and acquisitions, it's maintained rich profit margins: Through three quarters of the current fiscal year, the company achieved an operating margin of nearly 37%. This high level of operating profitability resulted in a net profit margin of 28%, and, as CFO Efrain Rivera pointed out on last quarter's earnings call, it enabled a formidable 42% return on equity over the last 12 months.    

Shareholders can expect that management will discuss strategies for margin improvement in the coming fiscal year on next week's earnings call. Much of this conversation will likely revolve around Paychex's investments in neuro-linguistic programming, or NLP. Paychex has created a platform that combines NLP with artificial intelligence (AI) to automate some of its customer-service function via chatbots.

While the use of chatbots is an exploratory field for many large corporations seeking to improve customer service, it's especially relevant for a company like Paychex, which offers communication-intensive services like payroll processing. Automating the answering of customer questions on payroll and other human capital management (HCM) tasks translates into higher efficiency and tangible margin improvement for Paychex. And as CFO Rivera and CEO Martin Mucci both observed last quarter, the availability of this technology also helps to accelerate sales.

A preliminary look at fiscal 2020

In both Paychex's earnings release and earnings conference call next week, shareholders will hone in on guidance for the coming fiscal year. Management has already provided an informal preliminary framework for 2020.

This includes the expectation that the management solutions segment will again post year-over-year revenue growth of 4%. Including Oasis sales, the PEO and insurances services segment is slated to notch top-line expansion of 30% to 35% through roughly the midpoint of the fiscal year, when the acquisition will reach its first anniversary. Finally, operating margin is once again expected to land in the 37% to 38% range. Investors will receive tightened estimates on both revenue and earnings when Paychex provides a formal fiscal 2020 outlook alongside earnings next week.

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Asit Sharma has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.