Paychex Will Get Strong Competition From Intuit

On September 23, payroll processing company Paychex (NASDAQ:PAYX) reported its first quarter results. Although there was no improvement in the company’s key indicators, one positive aspect of the results is that this quarter is the first in the past four quarters in which the decline in checks per client has slowed significantly. Intuit recently acquired SaaS payroll company PayCycle, with the help of which it is looking to increase its penetration in the small business payroll market. Let’s take a closer look.

Q1 revenue was down 6% to $500.2 million, short of analyst estimates of $502.9 million. Net income was down 17% to $123.6 million or $0.34 per share. Analysts expected earnings of $0.34 per share. Q4 coverage is available here.

Payroll Services revenue decreased 6% to $354.4 million as the weak economy affected client growth, check volume, and revenue per check. Checks per client declined 5% in the quarter, versus 5.2% in Q4, 4.3% in Q3, 2.1% in Q2, and 1.2% in Q109. Paychex’s new client sales or new business starts decreased 13% q-o-q, compared to a 27% decrease in the fourth quarter of fiscal 2009 and 19% for the full year 2009. Clients lost due to companies going out of business increased 1%, compared to a 19% increase in the fourth quarter and 17% for the full year 2009.

Human Resource Services revenue increased 1% to $132.1 million with a 10% increase in comprehensive human resource outsourcing services clients and a 5% increase in workers’ compensation insurance clients. However, the weak economy has hurt revenue in the company’s retirement services and comprehensive human resource outsourcing segments.

Low interest rates continued to affect income from funds held for clients. For the first quarter, interest on funds held for clients decreased 43% to $13.7 million and investment income decreased 70% to $0.9 million.

Total expenses decreased 1% to $310.3 million as a result of cost control measures and a stable headcount. The company ended the quarter with about 12,400 employees compared to 12,500 last year. Paychex has a strong liquidity position with cash and total corporate investments of $634 million and no debt.

Paychex has about 600,000 clients, and its target market is the 7.9 million small businesses that have fewer than 100 employees. Only 15% to 20% of this market outsources its payroll processes, giving Paychex a huge growth opportunity. The SaaS model presents a good way to sell to small businesses and Intuit has emerged as a major threat to Paychex with its acquisition of the online payroll provider PayCycle, which was at the top of my list of SaaS acquisition prospects for Intuit. Read my interview with Pay Cycle CEO Jim Heeger to understand how the PayCycle acquisition changes Intuit’s equation in the payroll processing space.

In general, the payroll processing space is ripe for an overhaul via extensive SaaS usage. PayChex has been slow to adopt. This is where, Intuit has a potent weapon in PayCycle. PayCycle targets small business with fewer than 20 employees and has about 80,000 customers. Paychex controls more than 40% of the market for businesses with fewer than 20 employees. Intuit is likely to attack this business with PayCycle.

Its other major competitor, ADP, targets a different segment of the market, enterprises. I recently suggested that ADP should acquire Salary.com, which has about 3,500 enterprise customers. Paychex has a strong balance sheet, and it should look at strengthening its position in the market with some SaaS acquisitions in the talent management space.

Paychex has revised its fiscal 2010 revenue outlook. The company now expects revenue to decline 2% to 5% to a range of $1.98 billion to $2.04 billion, compared to its previous guidance of a 1% to 4% decline.

Paychex expects 2010 earnings to decline 10% to 12% on revenue decline of 1% to 4%. Analysts expected earnings of $1.46 a share, down 3%, on revenue of $2.09 billion, flat with the previous year. The stock is currently trading around $29 with market cap of about $10.5 billion. It hit a 52-week high of $31.54 on September 23.