沛齊 (PAYX) 2001 Q4 法說會逐字稿

Welcome everyone to the Paychex year-end and fourth quarter results conference call. All lines have been placed on mute to protect any background noise. After the speakers' remarks, there will be a question and answer period. If you would like to ask a question during this time, simply press * then the #1 on your keypad and questions will be taken in the order that they are received. If you would like to withdraw your question, please press * then the #2 on your keypad. Thank you Mr. Morphy, you may begin your conference.

Thank you for joining us for our year-end press release. Also with us today is Tom Golisano, our Chairman, President, and CEO. On the completion of the review of our financial results, we will conduct a question and answer session. This morning we released our financial results for the year ended May 31, 2001. If you need a copy of the release, it can be obtained by calling 716 383 3406 or accessing our website at www.paychex.com at our investor relations' page. We have also filed a Form 8-K with the SEC this morning, which will provide additional discussion and analysis of the results for the past three years. This is also available on our website. In addition, this teleconference is being broadcast over the Internet, and will be archived and available for access on the website until July 2nd, 2001. Please refer to our website for access to all recent news releases, current financial informations, related SEC filings, and Investor Relations presentations. The year-end earnings release is summarized as follows. We enjoyed another strong quarter and year-end with total revenue growth in the fourth quarter was right on our expectations at 16%, which in turn generated a 31% increase in net income. For the full year fiscal 2001, revenues increased 19% accompanied by net income growth of 34%. This was our 10th consecutive year of 30% + net income growth. Quarterly earnings per share were $0.18 versus $0.14 a year ago, up 31% on an un-rounded basis. EPS for the year was $0.68 versus $0.51, up 33% on an un-rounded basis. We will now refer to the third page of the release, the consolidated income statement. Payroll service revenues for the fourth quarter increased 14% to $179.2 million and by 16% to $688.7 million on a full year basis. The increases are primarily related to the addition of new clients for development of new services, price increases, and increased utilization of ancillary services for both new and existing clients. As on May 31, 2001, 83% of our clients utilized tax pay and 53% utilized the company's employee pay services.

Revenue growth for our major market services, payroll offering remained strong as revenue increased 56% and 58% for the fourth quarter in 12-month periods to $13.5 million and $47.4 million respectively. The payroll service revenue comparisons for the fourth quarter in full year fiscal 2001 are impacted by having two less billing days in 2001 and the fact the last quarter of fiscal 2000 contained higher than normal payroll services revenue growth at 23%. We anticipate fiscal 2002's growth and payroll service revenue to be in the range of 16% to 18% as we all have some more billing days, easier comparisons, and expect better results while we continue to move our sales emphasis to new client units to total revenue generated. The human resource and benefit segment now accounts for over 11% of total revenues. Human resource and benefit service revenue increased 24% and 31% in the fourth quarter in 12-month period. These increases in service revenue are primarily related to increase in recurring revenues streams from such products as 401-K record keeping, workers compensation insurance, section 125, past, and PDO. 401-K record keeping revenue increased 26% and 36% in the fourth quarter and 12 months period to $11.5 million and fully $43.0 million respectively. In May 31, 2001, over 19,000 clients utilized the company's record keeping service in client employee funds managed externally exceeded $1.7 billion. Paychex's administrative service and the company's professional employer organization are comprehensive services that include payroll, employer compliance, employee benefit administration, and risk management out-sourcing services, and are designed to make it easier for businesses to manage their payroll and benefit costs.

At the end of fiscal 2001, the past client base is larger then the PDO client base, and together these businesses serve over 60,000 client employees. For fiscal 2002, human resource and benefits revenue is expected to grow at a rate slightly higher than in fiscal 2001. Interest on funds help to clients grew 25% and 42% in the first quarter in 12-month periods. The lower growth in the fourth quarter reflects the expected effect of the changed interest rates that have occurred since January 2001. Increased utilization of tax pay and employee pay services and net realized gains on the sale of available per sale securities drove the increases for the full year period benefitting from higher comparable average rate of return. Net realized gains included an interest on funds help to clients with $2.5 million to $5.7 million in the three and 12-month periods compared with net realized losses of $1.3 million and $2.9 million in the respective prior year periods. In the last half of fiscal 2001, market rates of interest have declined significantly with the federal funds rate decreasing 2.50% points from January through May of 2001. The current yield on AAA municipal bonds has declined from 4.96% at May 31, 2000 to 3.44% at May 31, 2001. Due to the decrease in interest rates, we expect interests and funds help for clients for the full year fiscal 2002 would be lower than in fiscal 2001. As mentioned earlier, total revenues increased 16% and 19% for the fourth quarter in 12-month periods respectively. Operating costs increased 13% and 15% for the fourth quarter and full year periods. SG&A expenses increased 9% and 13% for the respective fourth quarter and 12-month periods. Combined operating costs and SG&A costs would yield a year-over-over increase of 11% and 14% for the quarter and year-to-date periods respectively. Remember, the fourth quarter of fiscal 2000 contained higher than normal growth in these expenses that a quarter-over-quarter growth rate of 22%. This higher growth rate was due to the impact of MMS and past expansion efforts. The fiscal 2002, combined operating and SG&A cost are expected to grow at a rate slightly below the full year growth rate experienced in fiscal 2001. Fourth quarter and 12 month operating income increased 25% and 30% respectively. Operating margins increased to 38% and 39% for the three and 12-month periods, up from 355 and 36% in the respective prior year periods. These increases reflect the continued ability to add and increase use of profitable ancillary services and leverage our infrastructure to grow profits faster than revenue growth.

Investment income increased 74% for the quarter and 66% for the 12-month period, till the continued growth on our total cash and corporate investments position and nebulize gains on the sale of available per sale securities. The full year period also benefited from higher comparable average rates of return. Net realized gains were $1.3 million and $1.7 million in the three and 12 months of fiscal 2001 comparable to net realized losses of $0.1 million and $0.8 million in the respective prior year periods. As a result of the decrease in interest rate, we expect investment income for fiscal 2002 to grow at a rate significantly lower than in fiscal 2001. Our effective income tax rate was 29.5% and 30.0% for the fourth quarter and 12-month periods compared to 31.0% for the respective prior year periods. The slight decrease in the effective tax rate is due to growth in tax-exempt income exceeding the growth in taxable income and other tax reduction opportunities. Tax exemption income is drived primarily from income earned from municipal debt securities. Looking forward, we expect the fiscal 2002 effective income tax rate to approximate 31.0%. As mentioned earlier, net income increased 31% in the fourth quarter and 34% in the 12-month period when compared with the same periods last year. Looking ahead for fiscal 2002, the interest rate reductions will impact the year-over-year net income growth. The company expects to continue generating record revenues and net income with total revenue growth in the range of 16-18%. We would now like to move to the balance sheet.

Moving to page 4 of the press release, our balance sheet is very consistent with May 31, 2000 first half growth during the year. Total cash and corporate investments have grown to $614 million. Total available sale investments including corporate investments and funds help for clients i.e. money received from clients that would normally been dispersed to employees and taxing authorities included unrealized gains of $20.5 million in May 31, 2001 compared with unrealized losses of $13.4 million in May 31, 2000. The move from an unrealized loss position to an unrealized gain position is due to the current interest rates being below levels of last May plus increase in the market value of held investments. Our net profit in equipment balance increased by $21 million during the 12-month period with capital expenditures of $45 million and depreciation expense of $24 million. In May 2001, the company purchased a 135,000 square foot office building in the Rochester New York area for approximately $5 million. This facility will house a centralized information technology data center and various other support functions. As a result of purchase in this facility, we are delaying previously announced plans to construct a 300,000 square foot building at an estimated cost of $40 million.

The fiscal 2002, capital expenditures are expected to be in the range of $35-40 million and depreciation expense is expected to approximate $28 million. Total stockholders equity increased to $758 million at May 31, 2001 with $123 million in dividends paid during the 12 months of fiscal 2001, a pay out of 48% of net income. Return in equity for the past 12 months was 38%. The cumulated other comprehensive loss balance on May 31, 2000 of $8.6 million has changed to an income balance on May 31, 2001 of $13.1 million, which reflects the previously discussed increase in the market value of our available per sale portfolio. We will now move to the last page of release, which contains segment information for our payroll and human resource benefits business segments including our corporate functions. In our discussions regarding the consolidated income statement, we already provided revenue explanations for each of the segments. During the past year, we have been combining more and more of the human resource and benefits, tax pay, and employee pay support functions, to better service our customers and improve our efficiencies. These consolidations have diminished our ability to continue to actively depict segment-operating results between the pay roll and human resource and benefits segments and will cause a change in our internal management reporting. In fiscal 2002, we expect to combine pay roll and human resource benefits into one reportable segment. At the present time, we do not anticipate any changes to our revenue disclosure. Payroll operating income increased 17% in the fourth quarter and 21% in the 12-months period. Human resource and benefits operating income increased 73% for the fourth quarter and 62% for the 12-months period. Quarter-over-quarter percentage comparisons in human resource and benefit segment may vary significantly through out the year and in any one quarter results may not be indicative of expected full year or future results. Corporate expenses increased 1.7% to $17.8 million from $17.5 million for the fourth quarter. For the full year, corporate expenses decreased 0.3% to $67.7 million. Corporate expenses remained relatively flat throughout fiscal 2001 with additional employees and other expenditures to support the growth of the company's service operations in sales force have been offset by lower spending and national marketing efforts in other areas. We expect the growth in corporate expenses to be in the range of 10% to 13% in fiscal 2002, investment rates of return. We continued to receive many questions about the potential impact of change in interest rates. The purpose of the following comments did provide some concise as well as some informative information relating to change in interest rates. Recent actions by the Federal placed much more emphasis on interest rate as a trend of rising rates in fiscal 2000 has been replaced by a trend of decreasing rate in the last half of fiscal 2001 in the potential for further rate reductions. We refer to you to our recently Form 8-K, which is available on our website for detailed information regarding our investment portfolios and the effect of change in interest rates. The following comments represent a summary of the items presented in our SEC filings. In simple terms, increases and decreases in interest rates quickly affect earnings from short-term funds and overtime affect earnings in the available for sale portfolio. The earnings in the available for sale portfolio do not reflect changes in rates, until the investments are sold or mature and the proceeds are reinvested at current rates. The immediate impact of change in interest rates on short-term funds may be temporarily offset by realized gains or losses from transactions in the companies available for sale portfolio.

In fiscal 2001, our total investment portfolio including both corporate investments and funds help for clients averaged $2.3 billion versus $1.8 billion in fiscal 2000. We expect a total investment portfolio to average $2.6 billion in fiscal 2002. Our normal and anticipated allocation is approximately 50% short term and 50% intermediate term. We averaged a ratio of short-term investments as generally less than 30 days where the average duration of the intermediate terms investments is three years. If interest rates change, the market value of our available for sale securities portfolio moves in the opposite direction. Unrealized gains are generated when rates decrease and vice versa. As of May 31, 2001, the company had $1.3 billion invested in available for sales securities at fair value. With weighted average tax event yields to maturity of 4.3%, assuming a hypothetical decrease in interest rates of 25 basis point, given the May 31, 2001 portfolio of securities, the resulting potential increase in fair value would be in the range of $7.5-8.5 million. Conversely, a corresponding increase in interest rates would result in the comparable decrease in fair value. These are balance sheet variations only as the income statement is not affected until there is an actual transaction in the available for sale portfolio. We estimate the earnings effect that the 25-basis point change in interest rates, which is 17-basis points and tax exemption. At this point in time, it equates to approximately $3 million for fiscal 2002. As previously mentioned, unrealized gains and available for sale portfolio were $20.5 million at May 31, 2001. The exact effect of change in interest rates is difficult to determine due to many factors involved. These factors include - but are not limited to - daily interest rate changes, seasonal variations in investment balances, actual duration of short and long-term investments, a proportional mix of taxable and tax investments and changes in tax in the exempt municipal rates, which are not synchronized or simultaneous. Changes in rates are minimized in the short-term, but effect the rate changes normally produced unrealized gains or losses in the reverse direction of the rate changes within our available for sale securities portfolio. You should be aware that certain written and oral statements made by the company's management constitute forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements should be evaluated and related to certain risk factors, which could cause actual results to differ materially from anticipated results. Please review our Safe Harbor statement at the end of page 2 of the press release or discussion of forward-looking statements and the related risk factors. This time I will turn the meeting over to Tom Golisano who will provide some comments before we go to the question period.

Thank you John and as usual you did a great job of portraying our financial picture for the year. Generally speaking, and I am sure that every body has gotten the scripts so far and I hope they have. The number one issue from a variable point of view is that interest rates and its impact on our revenue and profitability for next year. John has already done a great job of explaining it. This should be a one-year anomaly and if you do the Math, you could probably quickly come to the conclusion that we are not going to be on the profit growth rates that we traditionally get in and of course this is a one-year anomaly and after that things should be back to business as usual. Basic businesses of pay roll sales and human resource sales activity all remain very positive, we see no degradation in our ability to sell or retain plan at this point, and currently our checks per client is just about where we expect it to be, no material changes at this point. So, everything is moving well in all cylinders except for this issue revolving around interest rates, which we pretty much explained. Based on that, we can now take questions from anybody related to ask his question. Cynthia?

I would like to remind everyone in order to ask their questions, simply press the * and the #1 in your keypad now. If you are on a speakerphone, please pick up your handset before asking your question. Your first question comes from Greg Gold from Goldman Sachs.

Hi, this is John Matthews for Greg, just a quick one. Can you talk a little bit, I know you don't talk about quarterly, but perhaps now year end can we talk about some of the level of new sales in core payroll business and than also in the TEL business.

Our sales activity in our payroll service is just about where we expected them. Our revenue generation per sales representative this year was above our quarter, internal quarter, so, we are very happy with it. From a unit's perspective, you know, we do not get involved on that discussion much any more because the definition for a unit has changed. From a revenue generation perspective, both in core payroll and tax pay and directed positive add on, we were very happy and pleased and we seem to be getting off to a good start during the month of June. So, we are pretty happy. Our PEL activity for the last 24 months, we have done extremely well, we have exceeded our internal sales expectations. I don't know if I can tell you exactly why that is happening and in fact we are very happy with our management team down in quarter with PBS, and we are doing much better than we had all anticipated. We had in the top line new employee growth, but on bottom line profitability growth.

John let me add to that because I might have missed this. When we look at this business down at PEL ... we really think that PEL is just being floored in Georgia. We are lot more excited about is the fact that our past client base now exceeds the PEL base and we do serve over 60,000 employees in one of these two formats. So, those are moving quite well.

Thanks for that and one just one quick followup. Have you seen any impact of bankruptcies in the small business market and is that affecting your retention rate?

We see no significant or any impact at all from clients going out of business is the reason for the loss client, it is pretty much straight forward and status quo over the last couple of years.

Thank you.

Your next question comes from Adam Waldo with CSFB.

Good morning. Thanks very much for taking my questions Tom and John; Tom is it fair to say that based on your preparatory comment that you remain committed to your long-term five-year targets of 17 and 19% topline and 25% EPS growth?

Well, we have already said that for this fiscal year that we have just started we are in the 15 to 18% range on revenue growth. We are very comfortable with that. I think, when we get back to a normal year-over-year comparison, it will all be in equal because that is possible but everything else be in equal, which we should be able to take it up ___00:22:03 and when we take that up in ________00:22:05, our traditional formula of 17 and 19 on a topline and 25% on the bottom line I don't see why it would not continue to apply.

Thanks, John, can you take a minute, and give us sense for what sales force productivity, growth goals in fiscal 2002 underline your revenues guidance of 16-18% growth?

Can you repeat Adam?

I am sorry, I wonder if you could take a minute and outline for us, what sales force productivity growth targets underline your guidance of 16-18% revenue growth for fiscal 2002.

Basically, what we do with our sales organization is assign them a dollar revenue quarter.

Okay and it is based on a series of products, first of all primary quarter payroll service, direct positive tax pay, premium only cafeteria plan, and also referrals for 401-K, and past product. Okay, what we do that is, we do on per representative basis, and we had taken our sales force up to about 880 sales people. And we multiplied that revenue per sales reps times to number of reps, which gives us a revenue generation expectation for the year and that is the basic foundation for determining what we think our revenue growth, will be.

Right, Tom what sort of growth then are you targeting in revenue per average representative across the business in fiscal 2002?

We don't generally divulge that number.

Okay.

I don't think it is good idea to do it here.

Okay. Final question is, you have historically posted very, very strong and consistent EBITDA margin expansion driven by axillary service sales and continued leverage in the core business. Can you give us a sense for whether fiscal 2001s level of EBITDA margin improved and should be sustainable in the fiscal 2002?

We expect to still see improvement, whether it be as great as the experience this past year when the effect in the interest rates might not be a bit, but as we look at out business and we do our plan looking out, we still believe as long as we can get the ancillaries, which we have been very successful and should continue ... margin expansion is still a very much durable.

Okay, and you are still getting 60-70% durable contribution margins on most of those ancillaries, is that right?

That's a good neighborhood.

Okay, thank very much.

Next question comes from Pat Burton with Solomon Smith Barney.

Hi, my question relates to Johns comment on the interest rates, the detail you went into with the unrealized gains being created when the rates put on the short end. What will be the gaining factor - as you determined - to take those gains or not take those gains and we had a similar rate as the last two quarters of this fiscal year? Thanks.

Basically, when you look at the gains, a fair amount of the gains happens when we trade in the portfolio, which we do on a regular basis looking at how we think we should invest. Obviously, if we want to take in more gains we can do that by turning it. I think from a range of expectations, you would not see, I think the most you could ever see in a quarter is probably about 5 million; I don't think that would happen very often. Looking into next year rate now, we would not visualize, recognize all the $20 million may be some more in the half of that range, but right now it is too early to tell. You also have to realize that this number can bounce around if, and it is as high as 20 million or less this month, and as low as 15 million, I think the rate curves are better direction rate now. So wait and see what happens, but it is going to give you little bit of guideline, but it really depends on how things progress and what happens with rates, which I think all we would agree is still a changing atmosphere.

And a followup for Tom, in the major market section, what would be the rate of growth you would forecast for next year, I was surprised that it is still running at 50%. Thanks.

Yeah, we had very good sales here in major markets. Our revenue generation brought that up to, I believe, over $45 million as an enterprise and we were very happy with it. The rate of expansion in the sales force, I think we took it from 75 to just under a 100 peoples in 98 to 200 people. We are opening up seven new markets. We see no specific or even nonspecific reaction from our major competitors in this arena in the ADT. Our client generation is about 30% internal, clients transferring from core over to major markets, one third from automatic data, and the rest from all the other sources combined. We are very high on the product. We are continuing to make enhancements towards operation in our service organization that has gotten a lot stronger in the last 12 months. So, business is great and we are going to continue to be aggressive in the year-end.

Thank you.

Your next question comes from Robert Mania with CIBC.

Hi, good morning guys, a couple of quick housekeeping items. The HRSP revenue for the fourth quarter, the growth was little bit slower than I was expecting, can you give us a little commentary on what the market environment there is?

The market environment remains very good. You have to understand that this business is smaller than our other ones, so it kind of bounces around a little more, it is also sometimes based on the timing of various other revenue pieces in there, I think it is little bit different in the fourth quarter and I think last years fourth quarter was very strong. So, it is nothing unusual here.

Okay, you are saying that next year it should be up slightly year on a year?

Yes.

Okay, and then just in case, you know, rate continued to drop every 50 basis points every time, in that case which unlikely happens at some point, but how much cost can we take out of the equation in order to offset that somewhat, can you help us on that?

Well, I don't think we anticipate having any more decreases than we have already had, I think the amount of cost that we can take out the equation are not going to be significant at this point because the last thing I think we want to do because of the short term interest rate is to slow down the growth of our organization particularly in sales. So, I don't be very candid with you, I think if we lose some other 50 basis points or 100 basis points, we would continue to watch our penny as close as we could do, but I don't think you would be any new action taken because of anomaly.

Okay, and one last item on the corporate expense line of next year, it is going to be up roughly 13% you said?

10-13%.

Okay, thank you.

Your next question comes from Steven Ladder with Cohen.

Yes, good morning. Could you give us some feel for what your employment growth is likely to be for the full year of 2002 and do you anticipate any income or unusual expenses at this point? I see you put off the new headquarters building, which would have undoubtedly had some expenses.

Yeah, we put off the headquarters building not because we did not want a new building or did not need this space, but we found that this other opportunity that from an economic perspective was so much better than building a new one. So, we took advantage of it. Our employment growth rate ... now were up to about 7300 employees for all of our sales organization, all of our new hires are in place, and have been over the last 60 days and going forward we will have some operational employment growth particularly in our branches, but it would probably be some where in the 6-8-10% range numbers significant.

Okay, and just a followup, John you mentioned that the number of payroll base would be the same in fiscal 2002 as in the 2001, Is there any distortion by quarter that you can see right now?

No. No I don't see anything right now.

Okay, thank you.

Your next question comes from Greg Giber with AG Edwards.

Good morning, I was wondering ... on your 401-K record keeping service, you say that you have had a revenue of $43 million during the year, as I understand that some of that comes from fees to the employer and the rest comes as a percentage of management fee. Could give me a break down of what that is and how it compares to a year ago, and that how much came from management fees?

Well, right now, the break down on management fees is the fees that we charged to clients. Right now, I think we have approximately $1.5 billion under our clients' management of fund and if you multiply that by - what we call - the accurate range of 30 basis points that is a return to Paychex. So, it is $43 million total revenue, probably somewhere around $3.5-4 million of the fees, coming from the main managers, now as time goes as we add more plans as employees and employers continue to make contributions, and soon they have somewhat of an upward stand from the stock market, of course that basis point calculation will continue to become more and more meaningful percentage wise. As matter of fact, if we were to start a new 401-K plan today for a small employer and about the sixth year of that plan is when the revenue that we charge to clients is matched by the revenue that we received from the money managers. So, basically in the sixth year of the plan we are doing about the same amount of work for the employer, but our revenue will actually be double based on the collection from the money manager.

Thank you, I wonder if you could also on your plans, if you could tell me what the sort, how far you grow, what would be a geographic scope of that PEL that was just floored in Georgia, how many states is the past product and what are you expansion plans there?

Okay right now, we have past product availability in all branch markets of Paychex. In all branch offices, we have a customer service representative organization that is in place to service our clients and currently we have 45 dedicated sales representative that are going to exclusively sell the past product. You may have heard also when we say the fact that the average revenue per client for the past product is approximately $11,000 per year. This means that we get full revenue for all of our payroll products, our HR products as well as a new profit sooner, component called the customer service representative and a ratio of customer service representative is about 1 to every 40 clients. We probably will have a equally aggressive growth at our sales organization next year assuming that we continue to enjoy the results we have had so far. We are very upbeat in about this past product offering as potential for this company long-term.

Thank you.

Next question comes from Karthik Mehta with MidWest Research.

Morning, just two questions. Can you tell me in this environment, do you still continue to get price increase in about what percentage and in terms of cross selling new products, what products right now are doing the best? Thanks.

The first question about price increase yes, Paychex has had a policy of price increase every year, and they have been historically fairly modest in the 3-4% range, we passed on the price increase to our entire client base May 1st, and quite frankly we have had very small if any client reaction what so ever. The ability to sell cross services or ancillary services as we would refer to them varies greatly, of course in payroll 90% of our new clients now are taking tax payments service and in direct deposit where we have had the biggest gain, over 70% of our new clients are now taking some sort of employee pay method generally direct deposit or the Paychex official check. Our sales representative also refer 401-K clients and that base has grown over 19,000 clients and the payroll sales organization is very instrumental in moving the 401-K record keeping client. Incrementally, the product has probably caused the most fear as this is going as workers compensation insurance. We are general agent for workers compensation insurance, the average revenue is about $460 year, and looks very much like tax pay to direct deposit. And once installed is highly profitable. We have a little over 16,000 clients currently after year and a half to two years of work, but we are selling over a 1000 new clients a month on workers compensation service. Those are the ones that are causing these segment levels out there and of course there are several of them.

Next question comes from Randy Lemon with Robert W Baird.

Good morning. A quick clarification, how much of that number of days are pay periods, that fact should we read into the fourth quarter core payroll growth numbers?

We are not going to specify that, we talked about that, some of the aberration, not all of it, really when you go back last year, the quarter was red hot, every possible advantage you could have had was there and that's why we had the strong growth percentage, it was 23%.

Okay. Should MMS help to reaccelerate that number as we go in to 2002?

It is hard to talk about re-acceleration in the environment we are in today, but I think we are very comfortable with the guidance we have given you and there is a lot of factors involved in that ... not just one like Internet. It is a whole lot of things; we have got a good penetration of ancillaries and lot of growth and lot of things. So, it is combination.

Okay. Tom, we talked about after the fact payroll a couple of quarters ago, were you noticing any effect on overall productivity from that initiative?

No, the major benefit appears to be with after the fact payroll is it is creating a new opportunity for our sales representatives to reacquaint themselves with certain CPA. And many of our sales representatives are using this as the client generation, our regular core client generation purpose, which is fine. We are selling after the fact payroll client and everybody is more excited about the fact that it is helping us solve new quarter payroll problem.

Then, based on the tax rate guidance, this was the shift from the tax-exempted taxable amount. What impact does that shift have on your expected revenue growth for fiscal 2002?

Well, really this is not a shift from the type of investment. It is the fact that the rate went down this year, because the revenue growth that came out of float money was greater than we anticipated, so the rate was moved down a little bit. Going back to next year, we are going to get the opposites and this rate really is reduction in the growth of float income, as opposed to any change in taxable versus tax exemptions. We haven't changed our philosophy at all.

Understood. Thanks. One last question on corporate spending, are there any due initiatives? It seems like 10-13% will sort of be at high-end of what had been discussed before. I am wondering if there are any initiatives that you see out there, that you are taking advantage of?

Nothing major. I think, looking at these three months ago. We are hopeful we could keep our corporate expenses down a little more as you went through budget process, and as Tom mentioned earlier, we are not looking to stifle our growth because of the interest rate environment. We are trying to make the right investments. When we got down to the end of the budget process, we realized that we are going to have to spend a little more than we had hoped, but we thought it was for all the right things.

Okay. Thank you very much.

Your next question comes from Jeff Cary with FAC capital. Mr. Cary, please go ahead. The next question comes from David Farina with William Blair.

Good morning. Can you just give me a sales representative count for payroll as you plan of having next year?

$880.

880? Okay, thank you. Tom, you made a comment, may be statement that you raised the price ___ 00:38:38.

Just three years ago, David, we switched to ...did you hear that?

I did not, I am sorry.

Just three years ago, we switched to giving client increases across the entire base.

Okay. Great! Then, lastly you have a chance to look through the tax law of change that has come down, is there anything you remember that might be of interest to you guys?

This is the fact that the Federal government is going to give up to $1500 worth of tax credits to any small employer, who puts in place of 401-K plan. This takes an effect from January 1st. The sales force is obviously very happy to hear it, but outside of that ... the normal consternation of tax law changes created the 401-K as the biggest. Back to the sales force, sales force does not include the MMSP.

Okay. Thank you.

Your next question comes from Kevin Weith with Hope Riddler.

Thank you. Your cash flow continued to average very positively here. Either the same client used their cash flow to increase their dividend at a very high rate or are there some acquisitions that may peak your interest still on costs?

Right now, our dividend pay out to our shareholders is about 48% and unless our profit growth drives into those proportions, I think it is safe to say that we are not going to continue on that 50% rate anymore. At 48%, we feel that that is about where the line in this end should be. As far as the acquisitions are concerned, Paychex has always been to look out for acquisitions. We probably acquire, may be 8 to 10 to 12 small payroll processors a year with 200 or 300 clients or less. Other than that, there is nothing really much on horizon in payroll processing that we think might be viable. As far as the other lines of businesses we look at them occasionally, but unless they are directly related to what we do, we seem to have very little interest. I am afraid the cash situation would just probably continue to grow.

Okay. Just three other question, I had with net usage by your clients, is that increasing and to what degree if that is happening considerably I would believe it is, does that help your margins? In other words, to generate the data from them directly as opposed to having a phone call made?

Oh! We think that is myths that having the customer do their own input rather aided by using the Internet or by using the PC, because of the type supporting organization requires us to have relative to dealing with issues around modems and file storage and all those types of things. We have about 16,000 to 18,000 clients using PC input and quite frankly our ratio to employee service those 16-18,000 clients is about the same as it is for the people using telephone or FAX. So, we don't see that as a real economic benefit to us to have a lot of clients using Internet for their payroll.

So, you just provided basically the service to them because that is the way they want to do it?

Absolutely.

Okay. Thank you.

Your next question comes from Charles Tracton with Adam ___00:42:06.

Thank you. One of the things you said in the resumption of mid-teens growth of the payroll service business was the easier comparison you got coming up in this year. Sounds like the easiest comparisons were started in the Q3 in the February quarter. Do you think the year-over-year growth payroll will be more geared towards the back half of the year? May be it is gone 18, 17, 14, 13 this year, and then may be 14, 15, 16, 18 somewhat like that next year, how do you see that curve?

Year will be pretty consistent throughout ... I cant speak eventually how it happens, but we don't see some of the bouncing around, but it is in our planning process and it could change when actual events happen.

Right. You also mentioned earlier in your prepared comments that you are going to consolidate the PEL and payroll line items in your eventual statements, is that right?

Yes. We are going to combine those, but the reason doesn't relate to the PEL, but it relates to the fact that this past six months, we combined a lot of functions of ENS which was in pure payroll, with the HR because of lot of similar products were the same and they work as the same, so we can no longer really accurately figure out the cost. In fact the past now and every branch compounded this and with the revenue less than around 10% total, we are dealing with pretty much the same customers, which doesn't really serve any purpose in ... I am not even sure if you said you already could do it very accurately, so we will continue to show the revenue descriptions, which I think are much more important.

Okay. So, you will break up the revenue and not just the income.

It might be in the end, but we will continue to give you the revenue information you are getting.

Was cash was flat this quarter, do you have your cash flow from operations on hand there?

Cash was flat because last year we had some aberrations with how the billing cycle ended at the end of the quarter, some of the types of the expenses we had quarter over quarter with expansions. Last year's cash flow looked stronger in the balance sheet than it was and this year it looks a little less, but I can assure you not much has changed in the cash flow and it continues to come in at a very nice pace.

Okay. I was just seeing your working capital was about flat, would it be safe to say that your cash flow from operations was somewhere around $65 million this last quarter?

Yes.

Okay. Thank you.

your next question comes from Chris Josephine with HB Waught.

My question has been answered. Thank you.

Your next question comes from Trip Roosevelt with Maverick

Hi. How are you doing? I am trying to understand your revenue guidance, can you may be break down the revenue growth ... is it coming from net, new client additions or ancillary service revenue or price increase ... I am trying to understand the dynamics of the topline growth, just to understand what are you working for in these estimates? One other thing I am having trouble understanding is ... what is happening to your enduser net subscribers and what feels like economy that is shrinking? Do you intend to have net additions or net attractions and I am trying to understand a mix of revenue here.

That is going to be a tough question for us to answer. Let me see if I can accomplish it. Our sales organization is given a dollar quarter of revenue. The dollar quarter of revenue is based on several assumptions and that is first of all, what is the current pricing is of our products, whatever emphasis we may be placing both in our quarter and in our incentives and in the ancillary services, and of course adding core customers. Our revenue generation today per sales representative is significantly higher than it used to be three, five, or seven years ago. Our core unit generation per sales representative is slightly lower than what it might have been three, five, or seven years ago, so what has happened over the course of the last half decades that the sales representative are producing much more revenue than they used to, but in core payroll limits it is slightly less than what they used to. The end result we think is very, very positive for Paychex and the way we come up with our revenue assumptions, of course, is based on the history per sales representative ... any new products that we may be adding to the bag of products and of course the number of sales people that we have. That is how we come up with the revenue generation. If you look at it, there are three components - new core payroll sales, small, or modest price increase in the ancillary services - over the last five or seven years, the participation of the ancillary services percentage wise has gotten larger.

Right. That makes sense ... that is a good model. What do you expect in this environment that we are in right now? What are you seeing this quarter? What do you expect going forward in terms of the economy and when you have the strength, do more and more people look out source or people actually trying to consolidate and may be taking your core business away?

That is a very high thing for us to answer; I would say that you write on both counts. More people have tendency to out source and at the same time more people may not be forming new business or they may be closing existing business. The last time we went through this in the 1989-90 time frame, it did not seem to impair our abilities or retain client on a net basis.

Okay. Great! Thanks a lot.

The next question comes from Jim Cassien with Bear Stearns.

Hi, Tom. Based on John's comments in the before and kind of following up on that last question, there is a lot more focus on tapping existing customers as opposed to adding new customers. Should we revamping into the opportunity today versus say 4 or 5 years ago for getting new customers?

For getting new payroll customers?

Yeah, new payroll customers.

You can read in to it Jim, but I think it is a big mistake. I think you should focus on what we are focussing on we think it is best for the company and its employees in general this revenue growth. We have 375,000 plus payroll clients. We only had 19,000 in ahead of our 401-k plan. We only have 180,000 who have direct deposits; can you believe that in 2001? So, the average tuning in certain ancillary services is huge. I am going to go back to our core unit question for a moment. I don't think anybody would be wise if they were beginning to question or noticing the fact that may be we are getting penetrated in core payroll services because we are not. The core market files to 19%, all the payroll process combined; I think are less than 20% penetration. We got a long way to go in core unit and anybody who thinks we are taking our eye off that ball will be making a huge mistake.

I just wanted to make sure. You were talking of the interest rate impact, it just seems like the industry should start moving towards fee for service and it sounds like there was no backlash against your price increase. Can you start charging fee for service for the tax?

I think if you look at the history of our pricing on tax paying and direct deposits, especially tax paid, you will see that a higher percentage of our revenue from that service now is in fee as opposed to interest. It used to be pretty well balanced. Right now, it is about 2/3rd, 1/3rd fee. The reality of this situation Jim, even though you make a good point is that customers seldom question if ever the fact that they are losing float income. So, from a processor perspective, it is a lot easier for us to have this source of revenue from float income as opposed to fee. Yes, we have got through two-year period where the federal government inflicted theses ups and then downs on it, but if things sink back to some normalized rate of consistency, it should be a non-event going forward.

Right. Thanks Tom.

Thanks Jim.

The next question comes from Jennifer Klein with Merrill Lynch.

Hi. Thanks. Deferred revenue growth next year ... I know that the majority of that is from a lower interest rate environments, but what are you guys figuring for the economic environment outside of that, I mean things in terms of economic growth and what are you assuming in ... and what is that factoring in to the revenue growth?

Because we have seen little or no impact on our checks per client, in our ability to sell and retain clients, we are not projecting anything that is relatively different to what we have done all along.

Can you give us the checks per client number?

14.1 employees per client.

Okay. And you were talking about that Paychex process, I mean has that been trending up at all?

The number of checks processed? No, it has been very consistent on a per client basis.

Okay. Thanks.

Your next question comes from Karl Turn with Phoenix Investment Management.

Tom, can you in a three to five year time frame, kind of top down overview. What are the potential revenue from some of the key ancillary products and may be touch on the core payroll processing, and in that three to five year time frame, what could it be in terms of revenue and profit contributions?

This is all speculation we must admit. I don't see any reason why we would expect any major significant change in our ability to sell core payroll point. We have a sales organization now, almost approaching a 1000 people. Company B our great competitor in automatic data has a sales organization in the market place of over 2000, and they have obviously continued to be successful, and we think we are going to continue to be successful. With 375,000 clients, we only have 6% market penetration in the market that we have a presence. We think the Internet has helped us get into some market places where we don't have a physical presence and I think that would be a plus. The ancillary services that we can tie on to the payroll sale now are now very significant. As I mentioned, of only 19000 401-K client only 16000 plus workers complied. This tremendous opportunity will implore with our ancillary services. Three to five years ago, I probably would have said Paychex may have been product core. Today, we are on brink of going through at least five-year period, the total execution of what we have now. We didn't develop another service or another product. I think we can keep this going for 10 years quite candidly. Three to five years, it is going to be focused on selling core payroll clients and selling all these as ancillary services with core base.

And may be margins, have you reached the top in margins, overall for the company, not much room to go?

I am afraid that, I am not afraid, I guess I am happy that because of the way we process many of our ancillary services particularly tax paid, direct deposit, and 401-k workers compensation, each incremental revenue into these client base is very, very profitable. They are highly automated and highly electronic processing. So, as long as we continue to sell more and more ancillary services, our profit percentages will continue to go up. To where it can go is anybody's guess.

Thank you.

Your next question comes from Mac Zentlin with Lupra & Co.

Good morning. You mentioned about the impact of the lower interest rates on your float income ... first quarter it was about $0.83 for the 2002 year. Can you comment on that number at this point?

No. We have given you guidance on the income statement, all the elements, and we did not ever really comment on specific EPS estimate.

Is it fair to say that the earnings growth will slow down from this year?

Yes. We said that earlier in the call and Tom re-affirmed it. In fact, the interest rate is going to have an impact than our year over year net income growth.

Okay. But beyond that you have no place to go.

If you take the time to go through all the guidance that we have, you can get through number that we think is pretty close to what it will be.

Okay. Thank you.

The next question comes from Adam Waldo with CSFB.

A couple of follow-up items. John, you have handed the PEL direct cost bills in the quarter or was that in the AK?

From the AK.

Okay. I will get it there.

Not very important. We don't track it at all here.

Understood. Can you also just give us an update in terms of your thought process about international expansion? Should we expect that company to study over the next several years expanding into European or Asian markets or should we continue to think of the company as focussing primarily on the North American market?

I will just say that you should focus the company as only being interested in the US market at this point, but having said that I will tell you I have a team of two people right out now over in Western Europe taking a look at the potential opportunities. I think the odds are probably against something involving and if it does involve it probably would take a year to just get it into motion. So, it is an area that we think that it is a part of our ... doing our homework if you will to investigate the rest of some key markets and Western Europe is definitely one of them. So, we are going to do that, but I think it is a leak right now to say that we are going to be operated in foreign market in a very short time.

Tom, if you enter foreign market, is your predisposition to Greenfield or to expand by a small acquisition?

We are not to the point of even trying to make that kind of determination yet. We are keeping our minds open in both ways.

Okay. Thank you.

Next question comes from Jeff Pierre from FAC capital

Hi, can you hear me? Question is could you just repeat your guidance ... you had made some comments about growth in operating costs in SG&A 2002 over 2001. Can you just repeat what that was?

We gave guidance on revenue 16-18% about total in favor. The guidance on corporate expenses, the guidance on operating expense, and we gave guidance on tax rate.

No, no, I am asking operating expenses. Can you just reiterate what your guidance was?

I believe the growth would be approximately same as last year.

Which was 13% or so?

Yes.

Okay. So if I run through all these, I am coming up with an earnings number, well below what the Street is and sort of in line sales growth and earnings growth. Is that kind of what you are looking at?

I don't think that it is substantially below what the Street is.

Okay. If I run through all the numbers that you gave ... sales growth and earnings growth, should that equate in 2002. Is that kind of right range?

I don't understand.

Sales growth being up 16-18% earnings in with the similar amount?

No, we didn't.

The references are to the numbers I sort of came up with ... were you just seeing that come up in your guidance?

I don't know, I don't know what number you have got so how could I answer that question?

Okay. All right, I will just run through the numbers again then.

Thank you.

Your next question comes from Brett Sachakini from Deutsche.

Thanks. Good morning John, I have another question following on some numbers that you gave earlier. Could you just explain again the differential in the increase, I think it was 24% plus increase in the interest on funds help for client versus the core 13.8% payroll increase year-over-year?

Once you have got float money, one doesn't. We gave guidance on the total payroll number. We did not give guidance on the float number itself except to say that next year gross float income would be less than it was this year.

Great! I am just trying to find out if in fact obviously it is difficult year-over-year comparison on the float. How could that be up so much greater than what payroll business was? Did you say that there was some sale of net-realize gains in that number?

I talked about the difficult comparison. I really was not talking about the float. The float income is strictly a function of the year-over-year increase in interest rate, in the fourth quarter; the rate comparison wasn't as favorable because last year by this time most of the rate increases were in. We did get some little bit of a kick on the realized gains, which we disclosed, but in this last quarter that you have got some year-over-year rate improvement going forward, only the rates are lower.

Okay. I just want to understand; you disclosed net realized gains that were $1.3 million in the quarter and $1.7 million for the full year. Right?

That is an investment income, not ENS.

Okay, ENS, what was that?

The number is about $3.5, but they are within the papers, yeah I can look at it, it is $3.5 million. It is disclosed.

Okay. That is fine. Great! Thank you.

Next comes from Andrew Jeffery with Roberts & Stevens.

Good morning. I am just trying to get my arms around the mechanics of one of the dynamics in your numbers, maybe you can help me, when I look at ... this may just be a way of reiterating to the prior question, I apologize, if I look at payroll revenues excluding ENS investments there has been a clear trend in fiscal 2001, towards sequential year-over-year quarterly growth on relatively consistent comparisons with the exception of the fourth quarter. Can you just discuss the dynamics that drive the core payroll X investment income revenue in light of the fact do you say most of the metrics ... not all the metrics on a proclaimed basis seem to be relatively consistent in this economic environment?

Basically, in light of the payroll, you have got a lot of factors in here, I think we are trying to get a little more detail that it is impossible to answer that questions which we have got in the payroll business, it is somewhat the tax pay maturing. Now, we think some of this is going to get a little better next year. Obviously, as Tom talked on tax pay we are going to be little more 01:01:15 than interest rate, we have got the ancillaries growing and we have got these factors in the business ... that the float income has been broken out for some time now, and basically you have got what is going on the payroll there.

So, is it safe to say that the dynamic of the mechanics we are seeing here is that you are having relatively consistent performance in results in that core payroll business and in maturation of the tax pay is what is resulting in the slower growth rate versus some other external macroeconomic factor that is affecting the number of Paychex per client or employment level in general.

No, we have not seen any change in the number of checks per client, okay. Basically, what we are seeing is a shift. Many of the products that the payrolls sales representatives sell now, and this is one of the reasons why we are combining the P&L part of our two divisions. Our human resource service is related. They are referring and recommending 401-K plans, they are referring and recommending workers compensation, they are referring and recommending pass. These are all revenue generators for our payroll sales people. Okay. So, the payroll revenue being created by our sales people all does not go into, just the payroll line. It also goes into the human resource line; both the revenue and profitability of course. So, our productivity per representative on the core unit basis is still very, very good and just slightly up than what it was two or three years ago. Just as the revenue generation by the sales representatives is more false over two disciplines now, HRS and core payroll and even now the revenue generations is going up by the per payroll representative basis. The revenue is not totally all directed at payroll process as it used to be. Does that make sense?

Okay. Thank you.

Now a followup question from Jeff Pierre from SAC Capital.

I just wanted to try to ask my question the other way, you were talking about - correct me if I am wrong - sales growth of 16-18%, you were talking about interest and events in income being down year-over-year and you are talking about operating in SG&A growth and costs up 13-14%. Are those inputs correct?

I believe so.

If you run those through, you get sales growth obviously of 16-18 to get operating income growth of 14-15%, so am I missing something here?

In fact, operating expense growth brings income.

Operating income of 13-14% similar to last year, correct?

Expense growth, obviously we are going to get continued margin expansion, so, the operating income is going to grow greater than revenues.

Okay, I guess I am not understanding, because you are having lower spread income, correct?

Yes.

All right, if I run through all those numbers, I still come up with an operating income number similar to the sales growth number.

Well all I know is that I know what our financial plan looks like and I don't get the same result that you have and we are trying to do this and apply very quickly, which I don't think is easy to do and we have looked at this, I don't have the numbers in front of me, so nothing I can do about it.

All right. Can I call and walk through with it?

Do you want to talk to him, I have the limits of FD and what it is, but what I can answer them to talk to you.

Okay, thanks.

Another followup question from Steven Weber from SG Cohen.

John, I just wanted to make sure, when you said growth float revenue from the ENS would be less than in fiscal 2001 that's excluding any capital gains realizations?

It is excluding what I would say is the reason, but I cannot tell you about the capital gains or I don't have the ability to see in the future, but we do expect gross interest on funds helped the clients to be some what less than $83 million.

And will that include some capital gains that all I want to make sure?

Yes.

Okay, thank you.

Your next question comes from Scott Pollara from Banc of America.

Hi, actually nice quarter guys. I have a question for you. With the respect to the interest income can you discuss in terms of the revenue what kind of marginal contribution - I mean are there really any costs associated with that or with the impact in the reduction in interest rates be felt dollar per dollar on the bottom line?

The effect in interest rate is effective dollar to dollar. It is not that there are no costs. It is basically pricing that fluctuates based on rates. Obviously, we have costs that relate to tax pay, direct deposits and rest of the products. What the disadvantage of floor pricing is that, the floor pricing floats with market rates, not based on something else. This is little bit of our control, now and a question was asked earlier and we wish we could price this differently, and I guess in some ways we would, but the very nature of how we perform these services causes float income to exist. For that, we take the money earlier and we hold it and I don't know any way to change that. Okay, and I think we have not really changed pricing too much one way or the other.

Let me ask a question in a different way. In the last fiscal year, fiscal 2001, your pretax profit actually increased about $80 million, a little less than $80 million, 35 of which came from increases in interest income. Now, I know that historically because you guys have been able to increase the average revenue per customer so consistently that the operating margins have expanded on the year-over-year basis. Do you think of that as an example, next as we look towards next year, given that interest income probably won't increase the whole lot in aggregate ... are there additional opportunities to expand the operating margin excluding the interest rate impact that go above and beyond the levels that you have been able to do this year?

I said one thing you know, we sit here and we look at the income statement, when we look at each piece and try to look at it, without looking at the other pieces. Obviously, we went into our planning process with the management team. We have many choices how we invest, what we cut back and many things we do. Those decisions may be based upon the environment, we think we are going to get. So sometimes we could invest more, you saw that last year in the fourth quarter. So, when you take these piece by piece, you think that 35 main is just a pure profit. It's just another revenue part of the business, so we look at the whole thing, we look at what opportunities we are going to have, we look at the things, we are going to be a little bit harder, we balanced the short term with a long term and you get a lot of factors here. I think we look at this on a piece by piece and only reflect that way it will lead most of this to a wrong answer, which is why we have given the guidance we have and if is going to tied in total and we think it is reasonable for what is reasonable to expect.

Okay, very fair. Thank you.

We have a followup question from Trip Roosevelt from Maverick.

Hi, actually this is John Drake going for Trip, in response to Jeff Pierre's question earlier in the call, you mentioned that the recent EPS will growth fashion and revenue was due to margin expansion, I was hoping you could just may be expand on that comment for us a little bit?

The margin expansion is going to continue to come directly from where it has come from the past. We are able to leverage our ancillaries when it comes to infrastructure growth, we are very tough on our people, we expect efficiency to grow, we have a great model in how we do ancillaries in centralized in Rochester, we continued to see good expansion there. It is pretty much the same story that has been in the past. We have gone through a very detailed planning process and we have seen the margins expand there, despite these issues of interest, so it is really more the same.

So, you are talking about the operating margins or the gross margins?

I actually look at the pretax margin, I really do not sit here and reflect what I got some thing at operating expense SG&A, we are looking at a business that we are trying to grow, we are very focussed on the net income growth and all these little pieces really add up to the total, you have to understand, in a business like ours, it is even difficult sometimes to say what is exactly SG&A, what is operating, we are looking at some those categories. But our goal in the end is that the great business at the bottom-line.

Okay, thanks a lot.

At this time, there are no further questions.

Well, we would like to thank you all. It has been a great pleasure. One thing, for those who think their questions have been answered, we did set a record, I don't think we have ever had over 200 people on this call. So, it has been a great day for Paychex. I hope it is a great day for you and wish you all a great summer and take care.

This concludes our conference. You may now disconnect.