Final PAYX Report

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University of Oregon Investment Group

February 13, 2015 Technology

Covering Analyst: Charles Pontrelli Email: [email protected]

Investment Thesis

� Decreasing US unemployment rates and increasing US corporate profits

will drive Paychex revenue growth.

� Increasing growth rates of small- and medium-sized businesses (Paychex’s

main clients) will increase revenue growth.

� Increasing development of Paychex’s human resource products, such as

Paychex Flex, will capitalize on the strong demand for human resource

outsourcing services in the industry.

� Superior product offerings, coupled with competitors facing product

difficulties, will allow Paychex to increase market share in the payroll and

bookkeeping service industry.

Paychex, Inc.

Ticker: PAYX

Current Price: $47.73

Recommendation: Outperform

Price Target: $51.33

Five-Year Stock Chart

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Key Statistics

52 Week Price Range $39.80 - $48.48

50-Day Moving Average $47.02

Estimated Beta 0.79

Dividend Yield 3.20%

Market Capitalization (mm) 17,569

3-Year Revenue CAGR 4.15%

Trading Statistics

Diluted Shares Outstanding (mm) 363

Average Volume (3-Month) (mm) 2.37

Institutional Ownership 68%

Insider Ownership 10.67%

EV/EBITDA (LTM) 14.304

Margins and Ratios

Gross Margin (LTM) 75.09%

EBITDA Margin (LTM) 43.18%

Net Margin (LTM) 24.91%

Debt to Enterprise Value -

UOIG 2


Business Overview

Paychex, Inc. was founded in 1971 by B. Thomas Golisano under the name Paymaster with the purpose to create a streamlined and easy payroll service for small businesses. Paychex was founded and is currently headquartered in Rochester, New York. In 1979 the company had expanded to include 18 franchises and partnerships, which eventually consolidated to form Paychex. The company now provides payroll and human resource outsourcing services to almost 600,000 small and medium businesses. Approximately 50% of new customers come from referrals current clients, such as business proprietors, CPAs, banks, and various other institutions. In 1983, Paychex went public and started trading on the NASDAQ Stock Market under the ticker PAYX, which it continues to trade under today. The company’s offerings include payroll processing, insurance, human resource outsourcing services, and retirement services. Paychex receives revenue from two sources: its services, and interest from funds held for clients. Services Paychex provides a variety of services to its clients. These services include payroll, human resource outsourcing, and accounting and finance. These services are detailed below. Payroll Paychex’s payroll system is a key aspect of their service offerings. With the payroll system, Paychex calculates, prepares, and delivers employee payroll checks. The preparations of these payroll checks also includes the preparation of federal, state, and local payroll tax returns. Clients have can opt for either a full-service customer service model, or they can choose to use Paychex Online, which is a self-service payroll system that is active 24 hours a day, seven days a week. The services included in the Paychex Online service are Paychex Online Payroll, Internet Time Sheet, Paychex Online Reports, and General Ledger Reporting Service. For larger companies, Paychex offers Major Market Services (“MMS”) that are integrated with various Internet-based services to assist clients with payroll and human resource needs. Paychex makes sure that all tax, payroll, and compliance needs are met with their robust services. Human Resource Paychex also provides a variety of human resource services that businesses can utilize. Companies choose to use Paychex’s HR Services in order to outsource both employer and employee administrative needs. As of May 31, 2014, over 28,000 clients with about 766,000 client employees utilized Paychex HR Services. Paychex also provides retirement services administration through its HR Services product line. Some of the options available to clients are 401(k) plans, 401(k) SIMPLE plans, SIMPLE IRAs, 401(k) plans with safe harbor provisions, profit sharing plans, and money purchase plans. Additionally, Paychex provides insurance services through its licensed insurance agency, Paychex Insurance Agency, Inc. (“PIA”). PIA’s insurance offerings include workers’ compensation, business-owner policies, commercial auto, and health and benefits coverage, including life, vision, dental, and health. Insurance is provided through a variety of carriers. With the current healthcare reform

Figure 2: Paychex, Inc. 2014 Revenue Breakdown

Source: Paychex 2014 10-K

Service Revenue Interest from Funds Held For Clients

Figure 1: Paychex, Inc. Headquarters

Source: Google Images

Figure 3: Paychex, Inc. Service Revenue Growth

Source: UOIG Spreads

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mandates, PIA makes sure that all of its clients understand how it will affect them and offers comprehensive solutions to adapt to certain mandates. Accounting and Finance Alongside their payroll and human resource offerings, Paychex provides a variety of accounting and finance services for small- to medium-sized businesses. One of these services is Paychex Accounting Online, which is a cloud-based accounting service. Paychex also offers their Paychex Payment Processing Services, which provide various ways for small businesses to accept payment from customers, including credit and debit processing, mobile and online 7payment, and point-of-sale processing. Paychex also operates the Paychex Small Business Loan Resource Center, which gives businesses access to over 1,200 lenders. While relatively new, the accounting and finance services offer a great deal that can benefit small-business owners. Interest from Funds Held for Clients Paychex not only receives revenue from providing its various services, but also collects interest from funds it holds for clients. When a client needs payroll processed for a certain pay period, Paychex will withdraw the amount from the client’s bank account and then process the amount for the payroll. The time that funds are held by Paychex can range from 1 day to 90 days, depending on the service being provided and how long it takes to process the amount. During this time, Paychex invests the funds primarily in high quality securities with AAA and AA ratings and A-1/P-1 ratings on short-term securities.

Industry

Overview Paychex operates in the Services sector and the Payroll and Bookkeeping Services industry. Businesses in this industry provide outsourced payroll services as well as bookkeeping services. There are approximately 290,344 businesses in this industry, making it quite large. The company with the largest market share is ADP LLC with a market share of 12.1%, followed by Paychex and Intuit Inc., who both hold 2.7% market share of the industry. The majority of the industry operates in the United States because of the knowledge needed of various laws regarding payroll, bookkeeping, and taxes. Competition is high and is expected to increase over the next few years due to the low barriers to entry. In the future, larger companies will be more successful in the industry due to the large benefits of having economies of scale. Because many companies charge a fee per unit supplied (i.e. clients are charged a fee based on the amount of transactions performed), larger companies can reduce these fees and provide savings to their clients. Still, it is relatively easy to enter the industry and be successful since the industry is very fragmented and many companies in the payroll industry focus on small, local markets. This industry has very low capital intensity. It is estimated that for every dollar spent on labor the industry invests about $0.03 in capital. However, this industry requires a high degree of manual labor. Wages take up the largest percentage of costs in this industry because of the amount of skilled labor required for payroll processing and other administrative tasks. Still, firms are expected to increase their capital expenditures due to the trend of many operators giving clients the ability to submit payroll forms and other information online. These capital expenditures are expected to be invested in a greater amount of software and

ADP, LLC 12.70%Paychex, Inc. 2.70%Intuit, Inc. 2.70%Ceridian, Inc. 1.30%Other 80.6%

Figure 5: Payroll and Bookkeeping Industry Market Share

Source: IBIS World

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Tax Preparation Bookkeeping and Compilation Services

General Accounting Services Other Services

Billing Services Tax Planning and Consulting Services

Payroll Services Sold Separately Full-Service Payroll Services

Figure 6: Breakdown of Industry Services

Source: IBIS World

Figure 4: Paychex, Inc. Interest from Funds Held for Clients Growth


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computer systems in order to reduce the amount of manual labor required and provide more services online to clients. Additionally, cloud computing software is becoming the norm, as well as software on smartphones and tablets to provide mobile business solutions. These investments will most likely cause wages to decrease in the industry. As mentioned above, the payroll and bookkeeping industry is going to continue to develop their payroll software offering. Technological advancements that will be most apparent in the industry will be the transition to widespread cloud computing, increased online payroll services, and automatic searching and storage of data from websites and financial documents to increase efficiencies and reduce costs. The development of cyber security and privacy is essential in this industry, due to the large amount of financial data that is being processed online and in the cloud. Recently, companies have experienced data breaches. One significant security breach was in Intuit’s TurboTax system, which had to completely shut down across the United States in order to do damage control.

Macroeconomic factors Declining Unemployment Rates The largest macroeconomic factor that affects the payroll and bookkeeping industry is the national unemployment rate of the United States. Operators in this industry usually charge on a per-employee-processed or per-transaction-processed basis. Because of this, payroll and bookkeeping companies’ revenues are highly reliant on the national unemployment rate. As unemployment rates go down, businesses in the industry receive more requests for payroll and bookkeeping services. Therefore, revenue is inversely correlated with unemployment rate. As of the beginning of 2015, unemployment rate is expected to decrease and continue to decrease into the coming years. It is expected to decrease to about 5.6% by 2019, and slowly return to the 2007 unemployment rate of 4.6% going to the future. This will take time, though, due to the slow recovery from the 2009 recession. Increasing Number of Businesses Another significant macroeconomic factor that drives the industry is the number of businesses in the United States. Revenue in the payroll and bookkeeping industry is directly correlated with the amount of businesses. As the number of businesses in the US increases, there are more clients to attract. Businesses are expected to grow 2% to 7.75 million in 2015, and continue to grow. However, this growth might be slowed because of expected high interest rates and taxes. These rate increases are expected as the Federal Reserve is attempting to end some policies that were used to boost the economy after the recession. Increasing Corporate Profits Corporate profits refers to the total amount of profit earned by all companies in all industries in the United States. Companies with lower profit margins are more likely to keep their payroll and bookkeeping in-house in order to reduce costs. As corporate profits rise, however, companies will want to outsource their payroll and bookkeeping services. This will allow them to focus more on their main operations and reduce administrative costs. While corporate growth rates have slowed a little because of the increases of commodity prices and increasing of interest rates on loans, they are still expected to increase. Corporate profits are expected to grow on average by 2.9% annually for the next 5 years.

Source: IBIS World

Figure 7: US Unemployment Rate

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Competition Competition in the industry is relatively high due to the sheer amount of businesses that operate in the industry. However, as mentioned before, many of these companies focus on small, local markets, so it is relatively easy to find a market to operate in. It is estimated that the four largest companies account for approximately 20% of the revenue in the industry. Paychex is one of these companies. Its largest competitors are ADP LLC, Intuit Inc., and Ceridian Inc. ADP is Paychex’s biggest competitor by far. ADP offers very similar products and has a very similar business model. However, while Paychex services small- to medium-sized businesses, ADP services mainly medium- to large- sized businesses, including multi-national corporations. Both Paychex and ADP have been developing online and cloud-based services. Intuit, another large competitor of Paychex, offers various payroll and tax software to small businesses. However, they do not offer full service payroll and tax options like ADP and Paychex. Additionally, there have been a few instances of fraud and security breaches at Intuit. This caused Intuit to cease to accept any tax returns through their TurboTax system for a period of time. Cyber security is becoming increasingly necessary in the business as more financial information is going online and into the cloud. Going into the future, success in the industry will be determined by the companies that can achieve economies of scale and reduce costs for their clients. Paychex continues to develop and fine-tune their software in order to streamline their services and reduce administrative costs. Also, because of its relative size to the majority of other companies in the industry, Paychex has an advantage, and will be able to reduce the per-transaction-processed fees for their clients through economies of scale.

Strategic Positioning

Sales and Marketing Paychex uses a direct sales force based in the markets they serve, with sales representatives specializing in the various services in Paychex’s product portfolio. Paychex also utilizes marketing, advertising, public relations, trade shows, and telemarketing programs to attract new customers. In geographic areas where there may not be a local presence, a virtual sales force is used. Approximately 50% of all new core payroll service clients come from referrals from current clients. Additionally, Paychex has partnered with the American Institute of Certified Public Accountants (“AICPA”) as the provider for its AICPA Business Solutions Program. More than 50% of the CPA firms in the US are enrolled are participating in the Paychex Partner Program from AICPA Business Solutions. This partnership will last until September 2016. Paychex has also enhanced its relationships with CPAs by partnering with various state CPA society organizations. Paychex also provides education and assistance to clients and possible future clients by providing free webinars, white papers, and other resources through their website. Their website also includes online payroll sales presentations and service and product information that serves as a source of new sales. Additionally, Paychex’s payroll and insurance services websites provide information regarding

Life Cycle Stage MatureRevenue Volatility LowCapital Intensity LowIndustry Assistance Low

Concentration Level LowRegulation Level MediumTechnology Change MediumBarriers to Entry LowIndustry Globalization LowCompetition Level High

Source: IBIS World

Figure 10: Industry Structure

Source: IBIS World

Figure 11: Sector vs. Industry Costs

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Figure 12: Net Income vs. SG&A Expense


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health care reform, in order for clients to be informed and find solutions for their business. Markets and Competition The majority of Paychex’s revenue comes from the United States. However, Paychex also services some businesses in Germany. They currently have a joint-venture arrangement in Brazil to provide payroll and human resource services. While there is a great deal of competitors in the market, Paychex has a much larger client base than the majority of them, with only one primary national competitor (ADP) in the market. Competition in the industry is primarily based on service responsiveness, product quality and reputation, breadth of product and service offerings, and price. Paychex is widely known for its fantastic customer service and product offerings, as well as its affordability.

Paychex is known for providing excellent service to its clients. At the end of the 2014 fiscal year, Paychex had an 82% client retention rate. The company continues to strive for greater customer satisfaction by increasing the ease of use of their products and services, as well as rolling out new products and services to meet the needs of current and new customers. Some of their new products are their Paychex Accounting Online service, their Biz2Credit online resource, and Paychex Payment Processing Services. Software Development Paychex continually improves current software, as well as develop new software. The company is currently investing in their Paychex Next Generation platform, believing it to be a key building block for future success. On top of this, they are focusing much of their investments into their mobile platforms and cloud-computing applications as the payroll and bookkeeping industry trends towards these systems. The Paychex Next Generation suite includes a software-as-a-service (“SaaS”) platform that streamlines workforce management. This platform, combined with the various mobile apps allow Paychex to provide superior customer service by tailoring to each customers’ specific needs.

Business Growth Strategies

Geographic Growth Paychex operates primarily in the United States, but also has offices in Germany, and is currently part of a joint-venture in Brazil. Paychex recently increased their presence in Germany by acquiring a small payroll provider. It will increase their revenue and client base in Germany. They also are currently in a joint-venture arrangement in Brazil. Brazil is a very large market with a rapidly growing economy. With over five million small businesses, there is significant opportunity for outsourcing payroll and human resource services. Additionally, Paychex continues to increase its customer base domestically through its local sales representatives, as well as its virtual sales force to reach customers where there is no local Paychex branch. As Paychex becomes more established overseas, they will begin expanding to other countries. However, this may take some time. Because of the laws and regulations concerning payroll, bookkeeping, and taxes differs greatly from country to country, it can be difficult to establish operations outside of the United States. However, Paychex is committed expanding into new markets and

Figure 13: Client Base Distribution

Business SizeEstimated Market

DistributionPaychex, Inc. Distribution

of Client Base<10 91% 65%

10-19 4% 17%20-49 3% 12%50+ 2% 6%

Source: Paychex, Inc. 10-K

Figure 14: Capital Expenditures Projections


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geographies, especially emerging markets, in order to further grow the business and capitalize on the demand for outsourcing payroll services. Organic Growth Paychex has had consistent revenue growth the past few years, and is expected to continue having this stead growth in the coming years. They are performing relatively well compared to their peers. Both ADP and Intuit have been performing worse than expected due to product difficulties and lack of client retention. Paychex is known for having great customer service, while ADP, its largest competitor, is known to provide sub-par customer service. Funding for organic growth is planned to increase in the future. Recently, Paychex has been investing a great deal in the development of its software and the expansion and upgrade of various operating facilities. In the fiscal years 2012, 2013, and 2014, Paychex allocated $2.6 million, $6.5 million, and $4.7 million, respectively, of funding to purchase equipment and software from EMC Corporation in order to improve Paychex’s product offerings and efficiency. This equipment and software will also be used to support Paychex’s continued client and ancillary product growth. Also, Paychex has been developing its Paychex Next Generation platform to improve customer experiences. They are doing this by improving the user interface of their platform, having centralized data for all of its functions and applications, and give clients access to mobile technology. Paychex has also focused a great deal on its Human Resource Service products. Demand for human resource outsourcing services has increased the last few years as corporate profits rise. Paychex has a diverse set of products capitalize on this demand, such as their new, minimum-premium health insurance product that was recently introduced. This, combined with their growing retirement-services products, put Paychex in a great position with a diversified portfolio of products. Acquisitions Paychex has engaged in a few acquisitions in recent history. In 2014 Paychex acquired SurePayroll, an online payroll service provider. Paychex identified growth opportunities and the benefits of offering a self-service, online-based payroll processing solution to small businesses. This acquisition allowed Paychex to enter the self-service payroll market with competitors ADP and Intuit. Paychex also acquired ExpenseWire in 2012, which was a leading SaaS based expense management solution. Paychex partakes in acquisitions when they identify a business or product that can either improve and develop its current products, or add new products to its already diversified product portfolio. This way, Paychex can enter more markets in the payroll and bookkeeping industry.

Management and Employee Relations Martin Mucci – President and CEO Martin Mucci joined Paychex in October 2002 when he was hired as the senior vice president of operations. On September 30, 2010 Mr. Mucci assumed the role of president and chief executive officer. Before joining Paychex, he served as the CEO of Frontier Telephone of Rochester, NY. Mr. Mucci holds a bachelor’s degree in accounting from St. John Fisher College, and received his MBA at the University of Rochester.


Figure 16: Paychex Online System

Figure 17: SurePayroll Logo


Figure 18: ExpenseWire Logo


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B. Thomas Golisano – Chairman of the Board of Paychex, Inc. B. Thomas Golisano is the founder of Paychex, Inc., and is currently the Chairman of the Board of Directors. Mr. Golisano founded Paychex in 1971 with $3000. In 2004 he retired from his position as president and CEO. Mr. Golisano has an associate’s degree from Alfred State College. He currently holds approximately 10.4% of ownership in Paychex. Mark Bottini – Senior Vice President of Sales Currently the Senior Vice President of Sales, Mark Bottini joined Paychex in October 2011. Mr. Bottini is responsible for leading all payroll and human resource service sales for the company. Before coming to Paychex, Mr. Bottini was the vice president of sales for Ricoh, North America. He has a bachelor’s degree in marketing from Long Beach State University. Efrain Rivera – Senior Vice President, CFO, and Treasurer Efrain Rivera joined Paychex in June 2011 as senior vice president, chief financial officer, and treasurer. Prior to joining Paychex, Mr. Rivera was the corporate vice president and CFO at Bausch & Lomb. He was also the vice president of finance and administration at Houghton College. Mr. Rivera holds a Doctor of Management degree from Case Western Reserve University, an MBA from the University of Rochester, a JD from New York University, and a bachelor of science from Houghton College.

Management Guidance Management provides guidance on revenues and net income for the fiscal year of 2015 for their operations. The revenue model in the appendices is in line with management guidance. The second fiscal quarter of the 2015 fiscal year exceed management guidance. Management expects that for the fiscal year of 2015 there will be an estimated revenue growth between 8 and 10 percent. Guidance also expects a net income growth of 6 to 8 percent. It should be noted that, historically, management has given relatively accurate guidance. Actual growth percentages usually fall in line with the guidance that management gives at the beginning of the fiscal year.

Portfolio Strategy

Paychex is not currently held in any of the University of Oregon Investment Group’s portfolios. Currently, the Tall Firs portfolio is currently underweight in both large cap and technology. By adding Paychex, the Tall Firs portfolio would be better aligned with the benchmark. With strong management guidance, consistent top-line and bottom-line growth, and competitors underperforming in the industry, Paychex is a great value buy.

Recent News

Paychex Embraces Strong Jobs Data – Investor’s Business Daily – February 4th, 2015 Paychex reported fiscal second-quarter profits up 9% from the year before. Revenue increased 10% from the previous quarter. These growth rates were due to the release of Paychex Flex, as well as new data reflecting decreasing unemployment rates.

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Figure 19: Total Executive Compensation vs. Net Income

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Figure 21: Dividend by Quarter

Source: Paychex, Inc. 10-K

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Paychex Declares Quarterly Dividend– Business Wire – January 16th, 2015 The Paychex Board of Directors declared a quarterly dividend of $.38 per share that would be payable on February 17th, 2015. Paychex has consistently given out dividends to its shareholders since 1988, making it very desirable for shareholders. Paychex Named One of the 2015 Best Companies to Work for in New York State – Business Wire – January 9th, 2015 Paychex, Inc. announced that it had been named one of the Best Companies to Work for in New York State for 2015. It has now made the list two years in a row. The award is a reflection of the company’s strong culture and commitment to employees, as well as the great benefits and employee programs.

Catalysts

Upside

� Diversified product offerings and development of current products will allow Paychex to increase their client base and boost revenues.

� Increasing investments to develop online and cloud-computing software will position Paychex to be a strong competitor in the market.

� Decreasing unemployment rates will cause businesses to demand more payroll and human resource outsourcing services, thereby increasing Paychex’s revenue.

� Increasing US corporate profits will cause firms to switch from in-house payroll to outsourced payroll services in order to focus on core operations.

Downside

� Strong competition and low barriers to entry poise a threat to Paychex. � With growing transitions to online and cloud services, Paychex may be

more susceptible to data breaches. � Both Paychex’s service revenue and revenue from interest on funds held

for clients can be significantly impacted by changes in government regulations and policies.

� Because of its operations in Germany and Brazil, Paychex is susceptible to changes from fluctuating exchange rates.

Comparable Analysis

Comparable companies were screened for historical growth rates of EPS and revenue, beta, D/E, as well as gross profit margins. Other metrics considered were industry, sector, company size, market capitalization, and headquarter location. All comparable companies are based in the United States. Historical revenue growth for the comparable companies is similar to that of PAYX, and is a good indicator of performance. Product offerings and how much of a competitor they are also played a large role in deciding on comparable companies.

ADP, LLC (ADP) – 30% ADP, LLC, provides technology-based outsourcing solutions to employers worldwide. The company operates through Employer Services and Professional

Figure 22: Best Companies to Work for in New York 2014 Logo


Figure 23: ADP, LLC Logo


Figure 24: Intuit, Inc. Logo


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Employer Organization (PEO) Services segments. ADP specializes in payroll services, benefit administration services, human capital management solutions, and human resources outsourcing. – Yahoo Finance ADP was chosen because it is Paychex’s main competitor. Not only this, but it has very similar product offerings. Additionally, both companies have little to no long term debt, similar beta, and have similar capital structures. ADP would have had a higher weighting, but its projected revenue, EBITDA, and EPS growth rates for 2016 are different. Intuit, Inc. (INTU) – 25% Intuit, Inc. provides business and financial management solutions for small businesses, consumers, and accounting professionals in the United States, Canada, the United Kingdom, Australia, India, and Singapore. The company provides QuickBooks payroll services, merchant services, GoPayment mobile solutions, and TurboTax. – Yahoo Finance Intuit was chosen as a comparable companies because it is one of the largest operators in the industry, and is a direct competitor to Paychex. Paychex has begun to compete with them more since it has expanded its online self-service product offerings. It also has very similar margins. Additionally, it has a similar beta and market cap. Insperity, Inc. (NSP) – 15% Insperity, Inc. provides an array of human resources (HR) and business solutions to enhance business performance for small and medium-sized companies in the United States. It provides HR business offerings through its Workforce Optimization solution, and also provides payroll services, performance management, recruiting services, employee benefits, workers’ compensation, and government compliance. – Yahoo Finance This company was weighted as a comparable to Paychex because it in the same industry, it has the same D/E ratio, a very similar beta, and very similar sales. Additionally, its product offerings are similar to Paychex’s, with more of an emphasis on outsourced human resource services. Insperity’s weighting is lower than that of ADP and Intuit because it is much smaller than Paychex. Cognizant Technology Solutions Corp. (CTSH) – 15% Cognizant Technology Solutions Corporation provides information technology (IT), consulting, and business process services worldwide. The company operates in four segments: Financial Services, Healthcare, Manufacturing/Retail/Logistics, and Other. Its products include IT strategy consulting and program management consulting services, enterprise data management services, clinical data management, equity research support, and order management. – Yahoo Finance Cognizant Technology Solutions is included in the comparable companies because it has a similar D/E ratio as Paychex, it operates in the same industry, and it has somewhat similar product offerings. However, it has a different beta and has a much larger market cap than Paychex, so it was weighted lower.

Figure 25: Insperity, Inc. Logo


Figure 26: Cognizant Technology Solutions Corp. Logo


Figure 27: Robert Half International, Inc. Logo


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Robert Half International, Inc. (RHI) – 15% Robert Half International Inc. provides staffing and risk consulting services in North America, South America, Europe, Asia, and Australia. The company operates through three segments: Temporary and Consultant Staffing, Permanent Placement Staffing, and Risk Consulting and Internal Audit Services. It offers temporary staffing in the accounting, tax, and finance areas, as well as IT contract consultants. – Yahoo Finance Robert Half International has an identical D/E ratio, it operates in the same industry and sector as Paychex, and has had very similar EPS growth the past 5 years. However, it has a drastically different beta and is about half the size of Paychex. Therefore, it was weighted lower.

Discounted Cash Flow Analysis

Revenue Model The revenue model was created by breaking out Paychex, Inc. into its service revenue and its interest on funds held for clients. Interest on funds held for clients was projected as a percentage of revenue. Historical data was analyzed to project out interest received. Service revenue for Paychex was forecasted using a Simple Linear Regression model. Historical service revenue from 2002 to 2014 was used, and then regressed against estimated US unemployment rate, estimated non-farm business employees, and estimated corporate profits going into 2024. The estimated US unemployment rate is what is forecasted in the future by the Bureau of Labor Statistics. Estimated non-farm business employees was projected using a Simple Linear Regression model, as was US corporate profits. Service revenue was regressed against these factors because it has been shown by historical data that these factors are highly correlated with revenue. Once the regression was created, it was adjusted to also take into account management guidance going forward.

Beta Beta was calculated using a weighted average of 1and 3 year daily betas. The 1, and 3 year daily betas were calculated by regressing Paychex’s historical stock prices against the historical stock prices of the S&P 500. Each of these betas was then assigned a weighting, with the one year daily receiving a weighting of 50%, and the three year daily receiving a weighting of 50%. They were weighted evenly because they are believed to be the best indicator of future volatility. Both Hamada and Vasicek betas were also calculated, however they were not used. Operating Expenses Operating was projected out by analyzing historical data, and then trending down linearly. The payroll industry requires specialized labor to conduct its operations. Because of this, wages make up the majority of their costs. As Paychex continues to develop their current software and implement new software, the need for skilled labor will gradually decrease. While this decrease will ever be extremely significant, it was taken into account when projecting operating expenses.

Multiple R 0.86R Square 0.74Adjusted R Square 0.72Standard Error 0.03Observations 47

Figure 28: Regression Statistics

Source: Paychex, Inc. Spreads

Figure 29: Beta


Figure 30: Projected Operating Expenses as a Percentage of Revenue


22.50%

23.00%

23.50%

24.00%

24.50%

25.00%

25.50%

26.00%

2015E 2017E 2019E 2021E 2023E

Per

cent

age

of R

even

ue (

%)

Beta SE Weighting

1 Year Daily 0.77 0.06 50.00%

3 Year Daily 0.81 0.03 50.00%

5 Year Daily 0.85 0.02 0.00%

3 Year Weekly 0.94 0.08 0.00%

5 Year Weekly 0.84 0.05 0.00%

3 Year Daily Vasicek - Comps 0.94 0.00%

3 Year Daily Vasicek - ETF 0.88 0.00%

3 Year Daily Hamada - Comps 1.04 0.00%

3 Year Daily Hamada - ETF 0.90 0.00%

Paychex, Inc. Beta 0.79

UOIG 12


Additionally, management has spoken about increasing efficiencies in its operations in the coming years to reduce costs. Selling, General, and Administrative Selling, General, and Administrative costs were projected out by analyzing historical financial data and using percentage of revenue. There is a small decline in SG&A as a percentage of revenue year-over-year as Paychex will try to increase efficiencies and streamline its operations through developments with software and services. Depreciation and Amortization Depreciation and Amortization was projected into the terminal year as a percentage of beginning PP&E. These percentages were calculated by looking at historical financial data, as well as management’s guidance. Net Working Capital Net Working Capital was projected off of historical financial data for Paychex. The projected values were forecasted as a percentage of revenue. Capital Expenditures Capital Expenditures, like Net Working Capital, were also projected using a percentage of revenue method. Percentages increase year-over-year due to management’s plans to increase spending on software development and computing equipment to enhance its product offerings. Tax Rate The tax rate for Paychex was calculated by looking at historical financial data. Additionally, the majority of Paychex’s business is in the United States, therefore causing them to have a higher tax rate. Because of these reasons, a steady tax rate of 35% was used going into the terminal year.

Recommendation Paychex is a very strong player in the industry. Steady revenue growth, commitment to customer service and quality, as well as its expansion into the online service market, positions it to be successful amid large competition. Additionally, decreasing unemployment rates, increasing corporate profit levels, and strong business growth going into the future will drive revenue growth. A weighting of 50% was given to both the discounted cash flow analysis and the comparable analysis, giving a final price target of $51.33, implying an undervaluation of 7.54%. Because of this price target, it is recommended that Paychex will outperform and should be added into the Tall Firs portfolio.

Figure 31: Beta Sensitivity Table


Figure 32: WACC Sensitivity Table


Figure 33: Final Implied Price


Source Implied Price Weighting

Discounted Cash Flow Analysis $50.62 50%

Comparable Analysis 52.04 50%

Weighted Implied Price $51.33

Current Price $47.73

Undervalued 7.54%

Implied Price

Terminal Growth Rate

51 2.0% 2.5% 3.0% 3.5% 4.0%

6.95% 44.40 47.24 50.70 55.00 60.49

7.00% 44.36 47.20 50.66 54.96 60.45

7.06% 44.31 47.16 50.61 54.91 60.40

7.10% 44.28 47.12 50.58 54.88 60.37

7.15% 44.24 47.09 50.54 54.84 60.33

WA

CC

Implied Price

Terminal Growth Rate

51 2.0% 2.5% 3.0% 3.5% 4.0%

0.70 49.68 53.44 58.14 64.17 72.19

0.75 46.60 49.82 53.77 58.76 65.23

0.79 44.32 47.16 50.62 54.92 60.40

0.85 41.45 43.85 46.74 50.28 54.70

0.90 39.27 41.37 43.87 46.89 50.61Ad

just

ed

Be

ta

February 13, 2015 University of Oregon Investment Group

UOIG 13

Appendix 1 – Comparable Analysis

Multiple Implied Price WeightEV/EBIT $51.16 33.33%EV/(EBITDA-Capex) $51.04 33.33%Market Cap/Net Income = P/E $53.92 33.33%Price Target $52.04Current Price 47.73Undervalued 9.03%

Comparables Analysis PAYX ADP INTU NSP CTSH RHI

($ in millions)

Paychex, Inc. ADP, LLC Intuit Inc. Insperity, Inc.

Cognizant Technology Solutions

Corporation

Robert Half International Inc.

Stock Characteristics Max Min Median Weight Avg. 30.00% 25.00% 15.00% 15.00% 15.00%Current Price $87.83 $42.70 $60.81 $72.03 $48.40 $86.44 $87.83 $42.70 $57.44 $60.81Beta 1.35 0.79 0.95 1.03 0.79 0.91 0.98 0.89 1.17 1.35

SizeShort-Term Debt 2,173.00 - 6.50 758.85 - 2,173.00 - - 700.00 13.00 Long-Term Debt 937.50 - 11.50 269.01 - 11.50 499.00 - 937.50 1.20 Cash and Cash Equivalent 4,015.80 282.00 2,203.00 2,407.69 529.00 4,015.80 2,203.00 282.00 3,775.00 291.00 Non-Controlling Interest - - - - - - - - - - Preferred Stock - - - - - - - - - - Diluted Basic Shares 609.00 25.30 285.50 331.52 363.00 482.00 285.50 25.30 609.00 136.00 Market Capitalization 41,664.08 1,080.31 25,075.38 25,417.78 17,569.20 41,664.08 25,075.38 1,080.31 34,980.96 8,270.16 Enterprise Value 39,173.98 798.31 23,627.38 23,902.50 17,040.20 39,173.98 23,627.38 798.31 32,843.46 7,981.32

Growth Expectations % Revenue Growth 2015E 16.06% 4.43% 7.93% 8.00% 8.36% 7.93% 4.67% 4.43% 16.06% 9.20%% Revenue Growth 2016E 19.45% (9.79%) 8.72% 1.81% 5.80% (9.79%) (3.60%) 9.50% 19.45% 8.72%% EBITDA Growth 2015E 14.52% (11.10%) 8.16% 5.25% 9.52% 8.16% 1.55% (11.10%) 12.70% 14.52%% EBITDA Growth 2016E 16.64% (25.20%) 9.95% (2.50%) 5.91% (6.89%) (25.20%) 12.50% 16.64% 9.95%% EPS Growth 2015E 18.72% (20.86%) 9.06% 6.88% 10.87% 8.65% 9.06% (20.86%) 18.72% 15.63%% EPS Growth 2016E 19.09% (28.94%) 12.74% (2.51%) 7.89% (6.69%) (28.94%) 19.09% 13.08% 12.74%

Profitability MarginsGross Margin 85.93% 16.85% 40.96% 49.07% 74.51% 42.96% 85.93% 16.85% 40.16% 40.96%EBIT Margin 39.82% 2.04% 18.22% 18.74% 39.82% 18.22% 34.51% 2.04% 18.37% 10.59%EBITDA Margin 43.65% 3.06% 20.32% 20.79% 43.65% 20.32% 37.77% 3.06% 20.32% 11.63%Net Margin 25.49% 1.15% 12.42% 12.60% 25.49% 12.42% 22.48% 1.15% 14.02% 6.52%

Credit MetricsInterest Expense $31.00 $0.00 $2.00 $9.85 $0.00 $6.00 $31.00 $0.00 $2.00 $0.00Debt/EV 0.06 - 0.02 0.03 - 0.06 0.02 - 0.05 0.00 Leverage Ratio 0.88 - 0.29 0.46 - 0.88 0.29 - 0.79 0.03 Interest Coverage Ratio #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! 413.33 54.90 #DIV/0! 1,042.50 #DIV/0!

Operating ResultsRevenue $12,207.00 $2,356.00 $4,695.00 $7,385.70 $2,729.41 $12,207.00 $4,506.00 $2,356.00 $10,263.00 $4,695.00Gross Profit $5,244.00 $397.00 $3,872.00 $3,507.50 $2,033.70 $5,244.00 $3,872.00 $397.00 $4,122.00 $1,923.00EBIT $2,224.00 $48.00 $1,555.00 $1,420.45 $1,086.90 $2,224.00 $1,555.00 $48.00 $1,885.00 $497.00EBITDA $2,480.00 $72.00 $1,702.00 $1,574.95 $1,191.26 $2,480.00 $1,702.00 $72.00 $2,085.00 $546.00Net Income $1,516.00 $27.00 $1,013.00 $973.85 $695.68 $1,516.00 $1,013.00 $27.00 $1,439.00 $306.00Capital Expenditures $297.00 $16.00 $194.00 $182.90 $104.53 $297.00 $194.00 $16.00 $223.00 $63.00

MultiplesEV/Revenue 6.24x 0.34x 3.20x 3.06x 6.24x 3.21x 5.24x 0.34x 3.20x 1.70xEV/Gross Profit 8.38 2.01 6.10 5.89 8.38 7.47 6.10 2.01 7.97 4.15EV/EBIT 17.61 15.19 16.63 16.60 15.68 17.61 15.19 16.63 17.42 16.06EV/EBITDA 15.80 11.09 14.62 14.43 14.30 15.80 13.88 11.09 15.75 14.62EV/(EBITDA-Capex) 17.95 14.26 16.52 16.56 15.68 17.95 15.67 14.26 17.64 16.52Market Cap/Net Income = P/E 40.01 24.31 27.03 28.14 25.25 27.48 24.75 40.01 24.31 27.03


UOIG 14

Appendix 2 – Discounted Cash Flow Analysis

Appendix 3 – Revenue Model

Revenue Model Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

($ in millions) 2010A 2011A 2012A 2013A 2014A 08/31/2014A 11/30/2014A 02/28/2015E 05/31/2015E 2015E 08/31/2015E 11/30/2015E 02/29/2016E 05/31/2016E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E

Service Revenue 1945.80 2036.20 2186.20 2285.20 2478.20 656.60 665.90 668.63 696.36 2687.49 693.96 705.72 710.22 734.73 2844.63 3006.21 3170.05 3330.13 3474.00 3610.18 3742.31 3866.93 3987.19

% Growth (3.06%) 4.65% 7.37% 4.53% 8.45% 8.87% 9.81% 6.81% 6.51% 8.45% 5.69% 5.98% 6.22% 5.51% 5.85% 5.68% 5.45% 5.05% 4.32% 3.92% 3.66% 3.33% 3.11%

% of Total Revenue 97.25% 97.69% 98.04% 98.24% 98.38% 98.47% 98.46% 98.35% 98.57% 98.46% 98.51% 98.50% 98.40% 98.60% 98.50% 98.54% 98.58% 98.60% 98.62% 98.63% 98.64% 98.65% 98.65%

Interest on Funds Held for Clients 55.00 48.10 43.60 41.00 40.70 10.20 10.40 11.23 10.09 41.92 10.51 10.71 11.56 10.40 43.18 44.47 45.81 47.18 48.60 50.06 51.56 53.10 54.70

% Growth (27.15%) (12.55%) (9.36%) (5.96%) (.73%) 2.00% 4.00% 3.00% 3.00% 3.00% 3.00% 3.00% 3.00% 3.00% 3.00% 3.00% 3.00% 3.00% 3.00% 3.00% 3.00% 3.00% 3.00%

% of Total Revenue 2.75% 2.31% 1.96% 1.76% 1.62% 1.53% 1.54% 1.65% 1.43% 1.54% 1.49% 1.50% 1.60% 1.40% 1.50% 1.46% 1.42% 1.40% 1.38% 1.37% 1.36% 1.35% 1.35%

Total Revenue $2,000.80 $2,084.30 $2,229.80 $2,326.20 $2,518.90 $666.80 $676.30 $679.86 $706.46 $2,729.41 $704.47 $716.43 $721.78 $745.13 $2,887.81 $3,050.68 $3,215.85 $3,377.32 $3,522.59 $3,660.23 $3,793.87 $3,920.03 $4,041.89

% Growth (3.94%) 4.17% 6.98% 4.32% 8.28% 8.76% 9.72% 6.73% 6.46% 8.36% 5.65% 5.93% 6.17% 5.47% 5.80% 5.64% 5.41% 5.02% 4.30% 3.91% 3.65% 3.33% 3.11%

Discounted Cash Flow Analysis Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

($ in millions) 2010A 2011A 2012A 2013A 2014A 08/31/2014A 11/30/2014A 02/28/2015E 05/31/2015E 2015E 08/31/2015E 11/30/2015E 02/29/2016E 05/31/2016E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E

Total Revenue $2,000.80 $2,084.30 $2,229.80 $2,326.20 $2,518.90 $666.80 $676.30 $679.86 $706.46 $2,729.41 $704.47 $716.43 $721.78 $745.13 $2,887.81 $3,050.68 $3,215.85 $3,377.32 $3,522.59 $3,660.23 $3,793.87 $3,920.03 $4,041.89

% YoY Growth (3.94%) 4.17% 6.98% 4.32% 8.28% 8.76% 9.72% 6.73% 6.46% 8.36% 5.65% 5.93% 6.17% 5.47% 5.80% 5.64% 5.41% 5.02% 4.30% 3.91% 3.65% 3.33% 3.11%

Operating Expenses 567.10 564.90 572.30 573.10 627.50 167.80 173.10 174.38 180.43 695.71 177.10 183.26 184.99 190.16 735.52 770.60 805.57 838.93 867.61 893.83 918.49 941.20 957.52

% Revenue 28.34% 27.10% 25.67% 24.64% 24.91% 25.16% 25.60% 25.65% 25.54% 25.49% 25.14% 25.58% 25.63% 25.52% 25.47% 25.26% 25.05% 24.84% 24.63% 24.42% 24.21% 24.01% 23.69%

Gross Profit $1,433.70 $1,519.40 $1,657.50 $1,753.10 $1,891.40 $499.00 $503.20 $505.47 $526.03 $2,033.70 $527.36 $533.17 $536.79 $554.97 $2,152.30 $2,280.08 $2,410.28 $2,538.39 $2,654.98 $2,766.40 $2,875.37 $2,978.83 $3,084.36

Gross Margin 71.66% 72.90% 74.33% 75.36% 75.09% 74.84% 74.40% 74.35% 74.46% 74.51% 74.86% 74.42% 74.37% 74.48% 74.53% 74.74% 74.95% 75.16% 75.37% 75.58% 75.79% 75.99% 76.31%

Selling General and Administrative 622.40 644.30 705.80 750.10 803.70 205.00 207.00 211.44 219.00 842.44 216.41 219.16 224.33 230.77 890.67 939.92 989.84 1,038.52 1,082.491,123.33 1,163.58 1,201.49 1,237.63

% Revenue 31.11% 30.91% 31.65% 32.25% 31.91% 30.74% 30.61% 31.10% 31.00% 30.87% 30.72% 30.59% 31.08% 30.97% 30.84% 30.81% 30.78% 30.75% 30.73% 30.69% 30.67% 30.65% 30.62%

Depreciation and Amortization 86.50 88.70 97.80 98.20 105.00 26.50 26.00 25.83 26.03 104.36 26.36 26.56 26.84 27.11 106.87 111.24 116.27 121.97 128.09 134.30 140.49 146.62 152.36

% of PP&E Beginning 31.51% 32.94% 31.68% 30.28% 30.35% 7.74% 7.50% 7.50% 7.50% 30.50% 7.50% 7.50% 7.50% 7.50% 30.41% 30.40% 30.35% 30.30% 30.25% 30.20% 30.15% 30.10% 30.00%

Earnings Before Interest & Taxes $724.80 $786.40 $853.90 $904.80 $982.70 $267.50 $270.20 $268.21 $280.99 $1,086.90 $284.59 $287.45 $285.62 $297.10 $1,154.76 $1,228.93 $1,304.17 $1,377.90 $1,444.40 $1,508.78 $1,571.30 $1,630.73$1,694.38

% Revenue 36.23% 37.73% 38.29% 38.90% 39.01% 40.12% 39.95% 39.45% 39.77% 39.82% 40.40% 40.12% 39.57% 39.87% 39.99% 40.28% 40.55% 40.80% 41.00% 41.22% 41.42% 41.60% 41.92%

Interest Expense - - - - - - - - - - - - - - - - - - - - - - -

% Revenue - - - - - - - - - - - - - - - - - - - - - - -

Net Interest (Income) (4.50) (5.80) (6.40) (6.60) (5.40) 1.40 1.40 - - 2.80 - - - - - - - - - - - - -

% Revenue (.22%) (.28%) (.29%) (.28%) (.21%) .21% .21% - - .10% - - - - - - - - - - - - -

Earnings Before Taxes 729.30 792.20 860.30 911.40 988.10 266.10 268.80 268.21 280.99 1084.10 284.59 287.45 285.62 297.10 1154.76 1228.93 1304.17 1377.90 1444.40 1508.78 1571.30 1630.73 1694.38

% Revenue 36.45% 38.01% 38.58% 39.18% 39.23% 39.91% 39.75% 39.45% 39.77% 39.72% 40.40% 40.12% 39.57% 39.87% 39.99% 40.28% 40.55% 40.80% 41.00% 41.22% 41.42% 41.60% 41.92%

Less Taxes (Benefits) 252.30 276.90 312.30 342.40 360.60 97.60 98.60 93.87 98.35 388.42 99.61 100.61 99.97 103.98 404.17 430.12 456.46 482.26 505.54 528.07 549.96 570.75 593.03

Tax Rate 34.59% 34.95% 36.30% 37.57% 36.49% 36.68% 36.68% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00%

Net Income $477.00 $515.30 $548.00 $569.00 $627.50 $168.50 $170.20 $174.34 $182.64 $695.68 $184.98 $186.84 $185.65 $193.11 $750.60 $798.80 $847.71 $895.63 $938.86 $980.71 $1,021.35 $1,059.97 $1,101.35

Net Margin 23.84% 24.72% 24.58% 24.46% 24.91% 25.27% 25.17% 25.64% 25.85% 25.49% 26.26% 26.08% 25.72% 25.92% 25.99% 26.18% 26.36% 26.52% 26.65% 26.79% 26.92% 27.04% 27.25%

Add Back: Depreciation and Amortization 86.50 88.70 97.80 98.20 105.00 26.50 26.00 25.83 26.03 104.36 26.36 26.56 26.84 27.11 106.87 111.24 116.27 121.97 128.09 134.30 140.49 146.62 152.36

Add Back: Interest Expense*(1-Tax Rate) - - - - - - - - - - - - - - - - - - - - - - -

Operating Cash Flow $563.50 $604.00 $645.80 $667.20 $732.50 $195.00 $196.20 $200.17 $208.68 $800.04 $211.34 $213.40 $212.49 $220.22 $857.46 $910.04 $963.98 $1,017.60 $1,066.95 $1,115.01 $1,161.84 $1,206.59 $1,253.71

% Revenue 28.16% 28.98% 28.96% 28.68% 29.08% 29.24% 29.01% 29.44% 29.54% 29.31% 30.00% 29.79% 29.44% 29.55% 29.69% 29.83% 29.98% 30.13% 30.29% 30.46% 30.62% 30.78% 31.02%

Current Assets 3,792.30 3,793.90 4,759.60 4,294.40 4,460.20 4,312.70 4,330.90 4,354.76 4,753.74 4,753.74 4,550.64 4,554.08 4,763.19 5,015.01 5,015.01 5,368.59 5,686.60 5,987.98 6,268.45 6,527.29 6,777.36 7,016.07 7,242.66

% Revenue 189.54% 182.02% 213.45% 184.61% 177.07% 646.78% 640.38% 640.54% 672.90% 174.17% 645.97% 635.66% 659.92% 673.04% 173.66% 175.98% 176.83% 177.30% 177.95% 178.33% 178.64% 178.98% 179.19%

Current Liabilities 3,742.00 3,788.30 4,745.70 4,266.20 4,438.90 4,283.80 4,279.30 4,350.48 4,761.66 4,761.66 4,567.34 4,612.04 4,796.39 5,011.89 5,011.89 5,389.94 5,717.15 6,021.08 6,297.69 6,566.09 6,827.06 7,078.01 7,329.96

% Revenue 187.03% 181.75% 212.83% 183.40% 176.22% 642.44% 632.75% 639.91% 674.02% 174.46% 648.34% 643.75% 664.52% 672.62% 173.55% 176.68% 177.78% 178.28% 178.78% 179.39% 179.95% 180.56% 181.35%

Net Working Capital $50.30 $5.60 $13.90 $28.20 $21.30 $28.90 $51.60 $4.28 ($7.91) ($7.91) ($16.70) ($57.96) ($33.20) $3.13 $3.13 ($21.35) ($30.55) ($33.10) ($29.24) ($38.80) ($49.70) ($61.94) ($87.30)

% Revenue 2.51% .27% .62% 1.21% .85% 4.33% 7.63% .63% (1.12%) (.29%) (2.37%) (8.09%) (4.60%) .42% .11% (.70%) (.95%) (.98%) (.83%) (1.06%) (1.31%) (1.58%) (2.16%)

Change in Working Capital ($27.90) ($44.70) $8.30 $14.30 ($6.90) $7.60 $22.70 ($47.32) ($12.20) ($29.21) ($8.78) ($41.26) $24.76 $36.33 $11.04 ($24.48) ($9.20) ($2.55) $3.86 ($9.56) ($10.90) ($12.24) ($25.37)

Capital Expenditures 61.30 100.50 89.60 98.70 84.10 24.90 20.70 28.55 30.38 104.53 29.02 30.31 30.39 31.59 121.31 128.43 135.71 142.86 149.36 155.56 161.62 167.39 172.99

% Revenue 3.06% 4.82% 4.02% 4.24% 3.34% 3.73% 3.06% 4.20% 4.30% 3.83% 4.12% 4.23% 4.21% 4.24% 4.20% 4.21% 4.22% 4.23% 4.24% 4.25% 4.26% 4.27% 4.28%

Acquisitions - 126.40 6.00 21.30 9.30 27.50 - - - 27.50 - - - - - - - - - - - - -

% Revenue 0.00% 6.06% .27% .92% .37% 4.12% - - - 1.01% - - - - - - - - - - - - -

Unlevered Free Cash Flow $530.10 $421.80 $541.90 $532.90 $646.00 $135.00 $152.80 $218.93 $190.50 $697.23 $191.10 $224.36 $157.35 $152.30 $725.11 $806.09 $837.47 $877.29 $913.73 $969.01 $1,011.12 $1,051.44 $1,106.08

Discounted Free Cash Flow $215.23 $184.11 $181.58 $209.58 $144.50 $137.49 $679.77 $659.69 $645.52 $628.02 $622.12 $606.38 $589.01 $578.78


UOIG 15

Appendix 4 – Working Capital Model

Working Capital Model Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

($ in millions) 2010A 2011A 2012A 2013A 2014A 08/31/2014A 11/30/2014A 02/28/2015E 05/31/2015E 2015E 08/31/2015E 11/30/2015E 02/29/2016E 05/31/2016E 2016E 2017E 2018E 2019E 2020E 2021E 2022E2023E 2024E

Total Revenue $2,000.80 $2,084.30 $2,229.80 $2,326.20 $2,518.90 $666.80 $676.30 $679.86 $706.46 $2,729.41 $704.47$716.43 $721.78 $745.13 $2,887.81 $3,050.68 $3,215.85 $3,377.32 $3,522.59 $3,660.23 $3,793.87 $3,920.03 $4,041.89

Current AssetsAccounts Receivable 186.60 161.10 142.40 133.40 149.40 168.90 205.60 157.05 166.72 166.72 166.75 168.08 167.60 173.91 173.91 185.18 197.78 206.35 215.93 225.84 235.22 244.22 252.62Days Sales Outstanding A/R 34.04 28.21 23.37 20.93 21.65 23.30 27.66 20.79 21.71 22.36 21.78 21.35 20.90 21.47 21.98 22.16 22.45 22.30 22.37 22.52 22.63 22.80 22.81

% of Revenue 9.33% 7.73% 6.39% 5.73% 5.93% 25.33% 24.31% 23.10% 23.60% 6.11% 23.67% 23.46% 23.22% 23.34% 6.02% 6.07% 6.15% 6.11% 6.13% 6.17% 6.20% 6.23% 6.25%Prepaid Expenses 25.50 29.40 35.20 36.60 46.70 47.40 48.80 49.02 51.57 51.57 50.72 51.58 51.97 53.65 53.65 56.74 58.85 60.79 62.35 63.69 64.88 65.86 66.69

Days Prepaid Expense Outstanding 4.65 5.15 5.78 5.74 6.77 6.54 6.57 6.49 6.72 6.92 6.62 6.55 6.48 6.62 6.78 6.79 6.68 6.57 6.46 6.35 6.24 6.15 6.02% of Revenue 1.27% 1.41% 1.58% 1.57% 1.85% 7.11% 7.22% 7.21% 7.30% 1.89% 7.20% 7.20% 7.20% 7.20% 1.86% 1.86% 1.83% 1.80% 1.77% 1.74% 1.71% 1.68% 1.65%

Deferred Income Taxes 3.80 5.90 1.60 2.30 12.00 - - - - - - - - - - - - - - - - - - Days Deferred Income Taxes Outstanding 5.50 7.78 1.88 2.45 12.15 - - - - - - - - - - - - - - - - - -

% of Revenue .19% .28% .07% .10% .48% - - - - - - - - - - - - - - - - - - Prepaid Income Taxes 6.70 1.40 5.60 17.20 17.20 - 7.40 - - - - - - - - - - - - - - - -

Days Prepaid Income Taxes Outstanding 9.69 1.85 6.56 18.34 17.41 - 6.83 - - - - - - - - - - - - - - - - % of Revenue .33% .07% .25% .74% .68% - 1.09% - - - - - - - - - - - - - - - -

Interest Receivable 28.70 29.40 30.60 32.40 36.30 29.60 36.40 33.99 35.32 35.32 35.22 35.82 36.09 37.26 37.26 39.35 41.48 43.57 45.44 47.22 48.94 50.57 52.14% of Revenue 1.43% 1.41% 1.37% 1.39% 1.44% 4.44% 5.38% 5.00% 5.00% 1.29% 5.00% 5.00% 5.00% 5.00% 1.29% 1.29% 1.29% 1.29% 1.29% 1.29% 1.29% 1.29% 1.29%

Funds Held for Clients 3541.00 3566.70 4544.20 4072.50 4198.60 4066.80 4032.70 4114.70 4500.13 4500.13 4297.95 4298.60 4507.54 4750.20 4750.20 5087.32 5388.49 5677.27 5944.73 6190.55 6428.33 6655.43 6871.21% of Revenue 176.98% 171.12% 203.79% 175.07% 166.68% 609.90% 596.29% 605.23% 637.00% 164.88% 610.10% 600.00% 624.50% 637.50% 164.49% 166.76% 167.56% 168.10% 168.76% 169.13% 169.44% 169.78% 170.00%

Total Current Assets $3,792.30 $3,793.90 $4,759.60 $4,294.40 $4,460.20 $4,312.70 $4,330.90 $4,354.76 $4,753.74 $4,753.74 $4,550.64 $4,554.08 $4,763.19 $5,015.01 $5,015.01 $5,368.59 $5,686.60 $5,987.98 $6,268.45 $6,527.29 $6,777.36 $7,016.07 $7,242.66% of Revenue 189.54% 182.02% 213.45% 184.61% 177.07% 646.78% 640.38% 640.54% 672.90% 174.17% 645.97% 635.66% 659.92% 673.04% 173.66% 175.98% 176.83% 177.30% 177.95% 178.33% 178.64% 178.98% 179.19%

Long Term AssetsNet PP&E Beginning 274.53 269.30 308.70 324.30 346.00 342.20 346.60 344.40 347.12 342.20 351.47 354.13 357.88 361.42351.47 365.91 383.11 402.54 423.43 444.70 465.96 487.09 507.86

Capital Expenditures 61.30 100.50 89.60 98.70 84.10 24.90 20.70 28.55 30.38 104.53 29.02 30.31 30.39 31.59 121.31 128.43 135.71 142.86 149.36 155.56 161.62 167.39 172.99Acquisitions - 126 6 21 9 28 - - - 28 - - - - - - - - - - - - -

Depreciation and Amortization 86.50 88.70 97.80 98.20 105.00 26.50 26.00 25.83 26.03 104.36 26.36 26.56 26.84 27.11 106.87 111.24 116.27 121.97 128.09 134.30 140.49 146.62 152.36Net PP&E Ending 269.30 308.70 324.30 346.00 342.20 346.60 344.40 347.12 351.47 351.47 354.13 357.88 361.42 365.91 365.91 383.11 402.54 423.43 444.70 465.96 487.09 507.86 528.50

Total Current Assets & Net PP&E $4,061.60 $4,102.60 $5,083.90 $4,640.40 $4,802.40 $4,659.30 $4,675.30 $4,701.88 $5,105.21 $5,105.21 $4,904.77 $4,911.95 $5,124.61 $5,380.92 $5,380.92 $5,751.70 $6,089.14 $6,411.41 $6,713.16 $6,993.25 $7,264.46 $7,523.94 $7,771.15% of Revenue 203.00% 196.83% 228.00% 199.48% 190.65% 698.76% 691.31% 691.60% 722.65% 187.04% 696.24% 685.61% 709.99% 722.15% 186.33% 188.54% 189.35% 189.84% 190.57% 191.06% 191.48% 191.94% 192.27%

Current LiabilitiesAccounts Payable 37.30 45.40 69.70 42.70 48.80 40.10 39.80 40.11 45.57 45.57 43.82 46.21 45.69 48.81 48.81 53.39 57.24 61.13 64.82 68.45 72.08 75.66 79.22

Days Payable Outstanding 24.01 29.33 44.57 27.20 28.39 21.99 20.92 20.70 23.23 23.97 22.76 22.95 22.23 23.61 24.22 25.29 25.94 26.60 27.27 27.95 28.65 29.42 30.20% of Revenue 1.86% 2.18% 3.13% 1.84% 1.94% 6.01% 5.88% 5.90% 6.45% 1.67% 6.22% 6.45% 6.33% 6.55% 1.69% 1.75% 1.78% 1.81% 1.84% 1.87% 1.90% 1.93% 1.96%

Accrued Charges 163.20 172.50 130.90 138.20 171.70 156.10 174.40 171.39 172.16 172.16 172.74 180.33 180.37 177.86 177.86 187.62 200.99 214.46 227.21 239.75 252.29 264.60 276.87Days Charges Outstanding 95.71 97.72 67.88 67.25 77.98 70.05 76.67 72.95 72.32 74.80 73.43 74.88 72.36 70.91 72.89 72.86 74.11 75.37 76.61 77.90 79.14 80.60 81.65

% of Revenue 8.16% 8.28% 5.87% 5.94% 6.82% 23.41% 25.79% 25.21% 24.37% 6.31% 24.52% 25.17% 24.99% 23.87% 6.16% 6.15% 6.25% 6.35% 6.45% 6.55% 6.65% 6.75% 6.85%Income Taxes Payable 17.00 14.90 13.90 8.10 6.60 9.50 14.50 15.64 16.25 16.25 16.20 16.48 16.60 17.14 17.14 18.91 21.55 24.65 26.77 29.65 33.01 36.06 39.21

Days Taxes Outstanding 24.59 19.64 16.29 8.63 6.68 8.95 13.38 14.99 15.20 15.31 14.97 14.90 14.95 15.16 15.48 16.05 17.23 18.66 19.33 20.49 21.91 23.13 24.13% of Revenue .85% .71% .62% .35% .26% 1.42% 2.14% 2.30% 2.30% .60% 2.30% 2.30% 2.30% 2.30% .59% .62% .67% .73% .76% .81% .87% .92% .97%

Deferred Revenue 3.40 3.00 3.00 5.20 6.90 - - - - - - - - - - - - - - - - - - % of Revenue .17% .14% .13% .22% .27% - - - - - - - - - - - - - - - - - - Client Fund Obligations 3479.90 3513.90 4494.40 4037.704167.10 4030.10 4000.30 4072.35 4474.69 4474.69 4281.75 4315.29 4499.60 4712.19 4712.19 5070.84 5374.98 5655.32 5910.56 6157.24 6396.08 6625.64 6856.25

% of Revenue 173.93% 168.59% 201.56% 173.57% 165.43% 604.39% 591.50% 599.00% 633.40% 163.94% 607.80% 602.33% 623.40% 632.40% 163.18% 166.22% 167.14% 167.45% 167.79% 168.22% 168.59% 169.02% 169.63%Other Liabilities 41.20 38.60 33.80 34.30 37.80 48.00 50.30 50.99 52.98 52.98 52.83 53.73 54.13 55.88 55.88 59.18 62.39 65.52 68.34 71.01 73.60 76.05 78.41% of Revenue 2.06% 1.85% 1.52% 1.47% 1.50% 7.20% 7.44% 7.50% 7.50% 1.94% 7.50% 7.50% 7.50% 7.50% 1.94% 1.94% 1.94% 1.94% 1.94% 1.94% 1.94% 1.94% 1.94%

Total Current Liabilities $3,742.00 $3,788.30 $4,745.70 $4,266.20 $4,438.90 $4,283.80 $4,279.30 $4,350.48 $4,761.66 $4,761.66 $4,567.34 $4,612.04 $4,796.39 $5,011.89 $5,011.89 $5,389.94 $5,717.15 $6,021.08 $6,297.69 $6,566.09 $6,827.06 $7,078.01 $7,329.96% of Revenue 187.03% 181.75% 212.83% 183.40% 176.22% 642.44% 632.75% 639.91% 674.02% 174.46% 648.34% 643.75% 664.52% 672.62% 173.55% 176.68% 177.78% 178.28% 178.78% 179.39% 179.95% 180.56% 181.35%


UOIG 16

Appendix 5 – Discounted Cash Flows Analysis Assumptions

Discounted Free Cash Flow Assumptions

Tax Rate 35.00% Terminal Growth Rate 3.00%

Risk Free Rate 1.95% Terminal Value 24,685

Beta 0.79 PV of Terminal Value 12,292

Market Risk Premium 6.45% Sum of PV Free Cash Flows 6,082

% Equity 100.00% Firm Value 18,374

% Debt 0.00% Total Debt 0

Cost of Debt 0.00% Cash & Cash Equivalents 529

CAPM 7.06% Market Capitalization 18,374

WACC 7.06% Fully Diluted Shares 363

Terminal Risk Free Rate 2.51%Implied Price $50.62

Terminal CAPM 7.62%Current Price $47.73

Terminal WACC 7.62%Undervalued 6.05%

Source Implied Price Weighting

Discounted Cash Flow Analysis $50.62 50%

Comparable Analysis 52.04 50%

Weighted Implied Price $51.33

Current Price $47.73

Undervalued 7.54%

Considerations

Avg. Industry Debt / Equity 10.00%

Avg. Industry Tax Rate 34.41%

Current Reinvestment Rate (3.51%)

Reinvestment Rate in Year 2019E -0.43%

Implied Return on Capital in Perpetuity Reinvest More

Terminal Value as a % of Total 66.9%

Implied 2015E EBITDA Multiple 15.4x

Implied Multiple in Year 2024E 6.7x

Free Cash Flow Growth Rate in Year 2024E 4.94%


UOIG 17

Appendix 6 –Sensitivity Analysis

Implied Price Undervalued/(Overvalued)

Terminal Growth Rate Terminal Growth Rate

51 2.0% 2.5% 3.0% 3.5% 4.0% 0 2.0% 2.5% 3.0% 3.5% 4.0%

0.70 49.68 53.44 58.14 64.17 72.19 0.70 4.08% 11.96% 21.80% 34.43% 51.24%

0.75 46.60 49.82 53.77 58.76 65.23 0.75 (2.37%) 4.37% 12.66%23.11% 36.67%

0.79 44.32 47.16 50.62 54.92 60.40 0.79 (6.99%) (1.00%) 6.28% 15.33% 26.89%

0.85 41.45 43.85 46.74 50.28 54.70 0.85 (13.17%) (8.12%) (2.07%) 5.34% 14.59%

0.90 39.27 41.37 43.87 46.89 50.61 0.90 (17.73%) (13.33%) (8.09%) (1.76%) 6.03%

Implied Price Undervalued/(Overvalued)


51 2.0% 2.5% 3.0% 3.5% 4.0% 0 2.0% 2.5% 3.0% 3.5% 4.0%

6.95% 44.40 47.24 50.70 55.00 60.49 6.95% (6.98%) (1.02%) 6.22% 15.23% 26.73%

7.00% 44.36 47.20 50.66 54.96 60.45 7.00% (7.06%) (1.11%) 6.14% 15.15% 26.64%

7.06% 44.31 47.16 50.61 54.91 60.40 7.06% (7.16%) (1.20%) 6.04% 15.05% 26.55%

7.10% 44.28 47.12 50.58 54.88 60.37 7.10% (7.22%) (1.27%) 5.98% 14.98% 26.48%

7.15% 44.24 47.09 50.54 54.84 60.33 7.15% (7.31%) (1.35%) 5.90% 14.90% 26.40%

Undervalued/(Overvalued) Undervalued/(Overvalued)


$50.62 2.00% 2.50% 3.00% 3.50% 4.00% 0 2.0% 2.5% 3.0% 3.5% 4.0%

1.85% 44.40 47.24 50.70 54.99 60.48 1.85% (6.99%) (1.03%) 6.21% 15.22% 26.72%

1.90% 44.36 47.20 50.66 54.96 60.44 1.90% (7.07%) (1.11%) 6.13% 15.14% 26.64%

1.95% 44.32 47.16 50.62 54.92 60.40 1.95% (7.15%) (1.20%) 6.05% 15.06% 26.55%

2.00% 44.28 47.12 50.58 54.88 60.37 2.00% (7.23%) (1.28%) 5.97% 14.97% 26.47%

2.05% 44.24 47.08 50.54 54.84 60.33 2.05% (7.31%) (1.36%) 5.89% 14.89% 26.39%

Additional Sensitivity Tables Additional Senstivity Tables


51 2.0% 2.5% 3.0% 3.5% 4.0% 6.05% 2.00% 2.50% 3.00% 3.50% 4.00%

6.35% 44.97 47.92 51.51 56.00 61.76 6.35% (5.78%) .39% 7.92%17.33% 29.39%

6.40% 44.64 47.53 51.06 55.45 61.07 6.40% (6.47%) (.41%) 6.98% 16.18% 27.95%

6.45% 44.32 47.16 50.62 54.92 60.40 6.45% (7.15%) (1.20%) 6.05% 15.06% 26.55%

6.50% 44.00 46.79 50.18 54.39 59.75 6.50% (7.82%) (1.97%) 5.14% 13.95% 25.18%

6.55% 43.68 46.43 49.75 53.87 59.11 6.55% (8.48%) (2.73%) 4.24% 12.87% 23.84%

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UOIG 18

Appendix 7 – Sources

BusinessWire FactSet Federal Reserve Economic Data Financial Visualizations Website IBIS World Investor’s Business Daily Google Images Morningstar Paychex, Inc. 10-K Paychex, Inc. 10-Q Paychex, Inc. Second Quarter Earnings Conference Call Paychex, Inc. Website Wall Street Journal Yahoo Finance

Final PAYX Report

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