Paychex Reflects Dismal Broader Economic Outlook

Right before the holidays, on December 17, Paychex, the leading payroll and personnel services provider with annual revenue of $2.06 billion, reported second quarter earnings that fell below analyst expectations. But what is even more telling is the gloomy snapshot Paychex provides of the economy. Let’s take a closer look.

Paychex Inc. reported Q2 revenue of $524.2 million, up 3% but short of analyst estimates of $533 million. Net income was $140.2 million or $0.39 per share, down 5%. Analysts were expecting earnings of $0.40 per share. Revenue for the first half of the fiscal year was $1.06 billion, versus $1.01 billion last year.

The company cited the effect of the credit crisis and weakening economic conditions for its poor performance. Its CEO, Jonathon Judge said, “Over the past six months, we experienced [the number of] companies going out of business increasing 12%, new business starts declining 13%, checks per client decreasing 1.5%, and we saw lower levels of new hire reporting.” Investment income declined 75%, continuing the declining trend seen in Q1. Interest on funds held for clients decreased 36% to $20 million mainly due to lower interest rates earned on short-term investments.

Its liquidity position however continues to remain strong with $479 million in cash and investments with no debt. It increased its margins from 37.5% last year to 38.1%. It increased its sales headcount and is investing in strategic growth areas like health insurance.

By segment, Payroll Services revenue grew 4% to $376.1 million mainly due to price increases and growth in the utilization of ancillary payroll services. Human Resource Services (HRS) revenue grew 11% to $128.3 million but was adversely affected by revenue declines within retirement services and workers’ compensation.

For fiscal year 2009 that ends May 31, 2009, Paychex has revised its outlook. It now expects revenue to grow in the range of 2 to 4%, down from the earlier range of 6 to 8%. Net income is now expected to fall 7 to 5% compared to the earlier growth forecast of 2 to 4%. Interest on funds held for clients is now expected to fall 45 to 40% versus Q1 projection of 20 to 25% decline.

By segment, Payroll Services revenue is expected to grow between 3% and 5%. HRS revenue is expected to grow between 12% and 15%.

The stock is currently trading around $26 with a market cap of $9 billion. It hit its 52-week low of $23.22 on November 21.

This is the first quarterly result that reflects the shabby state of the American economy. Nowhere more than in payroll does the story look so dismal, yet so transparent.

And yet, I hope the deep recession and layoffs will also bring forth people’s ingenuity, and most of all, I hope for entrepreneurship. Read my new Forbes column, Advice For Laid off Engineers, which profiles people who went from being laid off to becoming successful entrepreneurs.