沛齊 (PAYX) 2002 Q2 法說會逐字稿

Thank you for standing by. All participants will be on listen-only into the question and -- until the question and answer session of the call this conference is being recorded if he request of Paychex. If anyone has objections, please disconnect at this time. John Morphy is going to come on the line now. Sir, you may begin.

Thank you for joining us for the second quarter press release.

Also with us today is Thomas Golisano our President and CEO. We'll conduct a question and answer session at the end. This morning, we released our financial results for the quarter ended November 30, 2001. If you need a copy of the release call 585-383-3406. Or by accessing our web site at www.paychex.com in our investor relations home page. We've filed our second quarter form 10Q with the SCC available on our web site. In addition this teleconference is being broadcasted over the internet and will be archived and available for access on our web site until December 26th, 2001. Please refer to the web site for current financial information, related SCC filings and investor relation's presentation. The earnings release summarizes as follows. For the second quarter and first six months of fiscal 2002, total revenue growth was 12% and 14% respectively which generated the net income of 11 and 15%. Quarterly earnings per share were 18 cents versus 16 cents a year ago, up 11% on an unrounded basis. Year to date, earnings per share were 37 cents versus 32 cents a year ago up 15% on an unrounded basis. Economic conditions. Our results have been impacted by the decline in U.S. Economic conditions. We first experienced the effects of the economic recession in the first quarter of fiscal 2002, and these effects have heightened during the second quarter. In response to declining economic conditions, the Federal Reserve lowered the Federal Funds Rate 11 times since January 2001 to 1.75% which represents a cumulative 475 basis-point reduction.

The impact of the rate cuts on year-over-year comparisons for interest on funds held for clients and corporate investment income is expected to be more significant in the second half of the year. Year-over-year comparisons for this revenue source and corporate investment income source combined were up 14% and 2% for the first and second quarters of fiscal 2002 respectively. Year-over-year comparisons for these two income sources are currently projected to be down approximately 30% for the second half of fiscal 2002. The decrease in interest rates is resulted in the market value of our available for sale portfolios rapidly changing over the past year. As rates decline, the market value of held investments increases over cost and vice versa. It should be noted the timing of Fed Funds Rate changes and the movement in returns on our available for sale securities frequently do not move in tandem. Over the past 12 months, the end of the month unrealized gain balance was at a low of $13 million in the end of last December. A high of $36 million as recently as the end of October. And now stands at approximately $6 million here on December 17th, 2001. $16 million on December 17th, 2001. The recent reduction to $16 million reflects the fact intermediate term interest rates have increased since November 30th, 2001 in prior teleconference calls, we've discussed in detail the effects of changing interest rates. For those of you who'd like to become more familiar with this area, please refer to the SCC filings for more information. Further information on average balances and rates will be covered later in this presentation. After the effects of volatile interest rates, the most significant impact of a recessionary economy on Paychex is lower checks per client as our existing clients reduce the size of their work forces.

During the second quarter of fiscal 2002, we experienced a 4.3% decline in checks per client compared to a 2.6% decline which occurred during the first quarter. For the first six months, the decline totals 3.3%. During the full recession of the early 1990s, the company experienced an approximate 3% total reduction in checks per client. Income before taxes remains strong at 43% of revenues during the first half of fiscal 2002 compared with 42% for the same period last year. If the interest rates and checks per client conditions experienced in fiscal 2000 had prevailed throughout fiscal 2001 and the first half of fiscal 2002, net income growth for fiscal 2001 would have been approximately 25% compared with a reported 34% growth as we had benefits from interest rates. Net income growth for the first half of fiscal 2002 would have been approximately 25% compared with what we're reporting today of 15%. These calculations completely eliminated the effect of recognized gains and losses on our investment portfolios through the comparative periods. You'll now refer to the third page of the release, the consolidated income statement. Total service revenues increased 14% and 15% in the second quarter and 6-month period to $217.5 million and $433.7 million respectively. Service revenues consist of service fees earned from our payroll and human resource and benefits product lines. Payroll service revenues for the second quarter and six months increased 13% and 14% to $188.5 million and $377.9 million respectively. The increases are related primarily to growth in the client base, increased utilization of ancillary services, and price increases.

As of November 30th, 2001, 84% of our clients utilize tax pay and a 55% utilize the company's employee pay services. Major market services revenue increased 56% and 59% for the second quarter and 6-month periods to $16.6 million and $32.2 million respectively. Human resource and benefit service revenue increased 23% and 22% in the second quarter and 6-month periods to $29.0 million and $55.8 million respectively. The increases are primarily related to growth and retirement services clients and in client employees served by the company's past and PEO bundled services. Retirement service revenue increased 30% and 28% in the second quarter and 6-month periods to $13.6 million and $25.9 million respectively. Paychex administrate services passed and the Company's Professional Employer Organization, PEO, are comprehensive services that include payroll, employer compliance, employee benefit administration and risk management outsourcing services that are designed to make it easier for businesses to manage their payroll and benefits' cost. Sales of past and PEO products have been strong with administrative fee revenue for these products increasing 43% and 45% in the second quarter and 6-month period of fiscal 2002 compared with the respective prior year periods. Interest on funds held for clients decreased 11% and 2% for the second quarter and 6-month period compared with respective prior year periods. The decreases are the result of lower interest rates in fiscal 2002, to some extent being offset by net realized gains on the sale for available sale securities and average than higher funds balances.

Average return of 3.1% and 3.4% in the second quarter and first six months of fiscal 2002 compared with 4.8% in both of the respective prior year periods. Net realized gains on the sale of available for sale securities were $2.2 million and $5.4 million in the second quarter and six months of fiscal 2002 compared with net realized losses of $.1 million and $.2 million in average respective periods. Average port folio balances totaled $1.70 billion and $1.54 billion for 6 months ending November 30, 2001, and 2000 respectively. Reinvestment rates for the portfolio are approximately 2.8% at the present time compared to 3.4% in May 31, 2001, and 5% at May 31, 2000. Interest on funds held for clients reflects higher utilization of tax pay and a employee pay services by new and existing clients. Combined operating SDA expenses increased 14% and 13% in the second quarter and 6-month period compared with the respective prior year periods. This reflects increases in personnel, information technology and facility costs necessary to support the growth of the company. There were approximately 7,400 employees at November 30, 2001 compared with 6,900 at November 30, 2000. During fiscal 2001, in order to enhance customer service, we implemented initiatives to decrease the number of clients service per payroll specialists. Salaries of payroll specialists were increased to improve retention. In addition, we've increased personnel for the product line due to expansion efforts in fiscal 2001. These initiatives were implemented with the higher expenses on year-over-year growth rates should be less in the second half of fiscal 2002.

Operating income increased 9% and 14% in the second quarter and 6-month periods to $91.1 million and $184.8 million respectively. Investment income increased 37% for the second quarter in 6-month periods. The increases are due to net realized gains on the sale for sale securities and balances offset by lower interest rates in fiscal 2002. Net realized gains were $1.8 million and $2.8 million in the second quarter and six months of fiscal 2002 compared with net realized losses of $.1 million and $.2 million in the respective prior periods. Average daily balances invested were $.65 billion and $.05 billion for the 6 months ending November 30, 2001 and 2000 respectively. The increase in portfolio balances were driven by additional net cash inflows from operations. Corporate investment portfolio earned an average return of 4.0% for the second quarter and 4.1% for the 6-month period compared to 4.6% in the respective prior year periods. Our affective income tax rate was 30.8% in the second quarter and six month periods of fiscal 2002 compared with compared with 30.5% in the prior year periods. As mentioned earlier that income increased 11% and 15% for the second quarter and first six months of fiscal 2002 when compared with the same periods last year. The U.S. economic conditions and interest rate trends which we discussed earlier represent uncertainties which we expect will continue for sometime to effect total revenue growth. For fiscal 2002, we project payroll service revenue to grow in the range of 11% to 13% and human resource and benefit service revenue growth in the range of 20% to 23%. Total service revenue growth is anticipated to be in the range of 13% to 15%.

Taking the aforementioned factors into consideration and assuming no further deterioration to interest rates or current economic conditions, total revenue growth and net income growth for fiscal 2002 is anticipated to be in the range of 9% to 11%. We would now like to move onto page four of our press release, the balance sheet. You'll find the balance sheet is very consistent with May 31, 2000 plus our growth during the first half of fiscal 2002. Total cash in corporate investments have grown to $660 million. The net property balance equipment activity during the 6-month period reported capital expenditures of $26 million and depreciated expense $13 million. For 2002, capital expenditure ranges are expected to be to $50 million to $55 million including additional expenditures including for a new data center in Rochester, New York. The expense is projected to be in the range of $28 to $30 million. Total stockholders equity increased to $847 million at November 30,2001 with $75 million in dividends paid during the six months of payout of 54% of net income. The return in equity for the past 12 months was 35%. The accumulated other comprehensive income balance of May 31, 2001 of $13.1 million is in creased to $16.1 million in November 30th, which reflects the previously-discussed increase in the market value of our available for sale portfolio. Safe harbor. 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 in light of certain risk factors which could cause actual results to differ materially from anticipated results. Please review our safe harbor statement on page 2 of the press release for our

discussion of forward-looking statements and the related risk factors. At this time, I would like to turn the meeting over to Tom Golisano.

Thank you, John. Um, in the arena of our sales organizations, both HR and core payroll and major market services, the optimism going forward is pretty positive. We're within a very acceptable ranges of quota achievement for not only new sales' activity but also for client retention. As John has so on aptly reviewed, the major impacts on us are external rather than internal. Internally, we seem to be doing fine. John talked about the payroll specialist lot. Our payroll specialist turnover, we've obtained the lowest turnover rate I can remember in the company. We're happy with that. That'll bode well for client retention. One other thing I might mention, we get a tremendous number of questions relative to our checks per client as an economic barometer and so forth. We're going into a period now for the last half of December, and the month of January where it'll be very difficult for us to get a very good reading on this activity primarily because of the mix of year-end bonus checks and unusual pay items. And because of new client activity in the month of January being so large and generally it's above 20,000 new clients added for our core payroll services alone, it is hard for us to fathom where we are until we get to the first couple of weeks in February. So with that, we'll open it up for questions and fire away.

At this time, we're ready to begin the formal question and answer session. If you'd like to ask question, please press star 1. You'll be announced prior to asking your question. To withdraw your question, please press star 2. To ask a question, please press star 1. One moment, please. Our first question comes from Stephen Weber of SG Cowen. You may ask your question.

Good morning. A couple of questions, John, you were going so fast. Can you tell us what the return was on the client fund portfolio in the second quarter? Okay basically, we have a lot of numbers. Every number I read with the exception of the discussion where the portfolio, unrealized gains of range which goes from 13 to 36, now sits at 16 is sitting in our 10Q which is on our web site.

Right.

I would recommend you look there because there's so much data there. It's best looked where you can spend time at it. If you think something is missing, please call me after the call.

Secondly, you've indicated the expense growth should be less in the second half. In your previous 10Q, you've talked about the year being close to what it was last year. Are you looking at less expense growth for the full year now than you did before?

Yes. We're reevaluated, obviously we're not getting the revenue we'd like to get so we reevaluated recently every single expense item. We haven't done anything, I would say was irrational. We looked at things to do without harming the business and they were taken care of. We actually went into the year -- because we were optimistic and this thing came on us quickly in the first quarter. We were over on payroll specialists. While we had record retention rates, we had just enough turnover to help us facilitate getting back to the right number.

Can you give us any kind of range in what you think expenses will grow for the year?

I reflect back to what we've disclosed. We pride ourselves on the 10Q being there. That's what it's come to after a lot of discussion with Tom and our financial people. So it's all in there.

Okay, thank you.

Our next question is from Robert Maina of CIBC.

Good morning, guys. Happy holidays to you.

Thank you.

I got a question for you on the payroll growth, 12.8% if I've done my math right. Can you give us an idea what it would have been had it not been for the reduced pays to control?

When you're talking about 4.3% of our check volume decline, it probably -- it is very safe to say that 4.3% in check volume wouldn't effect our revenue growth by 4.3% because the last check we charge to our client for is the least amount of revenue and the least expense to the client. So you probably discount that probably by 25% or 30%. So if you had, you know, 70% back to --

To the 12.8%?

-- yeah, 70% of the 4.3% --

Okay.

-- back to the revenue growth, I think you'd be fairly close by doing that got that?

Yeah, I'll catch it off line and go through the math again. One other follow-up question on the HR business. I see you guys brought down your expectations for the second half after you cut them in the first quarter. Again, I know -- I guess patient control is some issue there but can you us clarity in what is happening that market?

You talking about the HR market?

Yeah, you said that growth will be in the range of 20% or 23%?

Yeah, as we mentioned on our last call, our initial spurt into 401(k) sales in the first three months of the year were a little disappointing. We had a significant growth in our sales' organization. And I think we overestimated our abilities to get those people wrapped up. What we've seen in the last three months is dramatic improvement. And we think going forward if we were starting the fiscal year over, we'd be at over quota or close to quota. So we got off to a shaky start on the 401K sales in the first three or four months but we're on target now. We feel pretty good about it. Our past product is doing pretty well. Our major market services product offering sales achievement-wise is doing very well.

The growth in HR is also impacted not very dramatically but a bit by the fact that obviously when you get in a recession, workers comp doesn't perform quite as well as we'd like. On the performance factor which is in there, it's not quite as strong as anticipated. You have a couple of factors in there. The 401K pass PEO continue to do pretty well.

Thank you, guys.

Uh-huh.

Adam Fresh of UBS Warburg, you may ask your question.

Thank you, good morning. John, going forward, the assumptions you've made for growth so forth, can you tell us what the underlying assumptions were in terms of the number of checks written or the retention or anything like that?

We basically assumed the deterioration we've got here will continue. We didn't accelerate it. Don't see anything that will cause us to do that what we generally do on these numbers is give you interest rates where they are. We don't assume things getting worse, because what happens is, we may even say what they are, nobody will remember what they are so we kind of do the forecast. Things stay where they are. This is what we think it'll be. If things get better, we'll see advantages. If things get worse, we'll see that too. It kind of keeps everybody in the same spot.

Okay. So looking at it and jud ging from your experiences in that market for awhile, do you think -- are you seeing things that say it can't get any worse? Are you thinking we're at the bottom here and maybe things don't necessarily improve in the next couple months but they won't necessarily get worse?

This is Tom, in fairness to John, John wasn't even here during the 1989 and '90 recession. What we've seen in the last six months has been the most dramatic thing I've ever seen in my 25 years here. For me to speculate on whether or not it'll get worse, I don't dare do that the Federal Government has done a lot of things to spur the economy going on but sometimes it takes a long time for those things to have a real impact. I don't want to sound like I'm trying to be an economist or something like that but what I want to tell you it's been the most dramatic I've ever seen and I won't begin to guess whether or not it'll get worse or not.

Last question for John here. On the bottom line, what are you looking for in terms of EPS. Are you sticking with your prior numbers, and can we take a shot at fiscal '03 at all?

Disclosure 9 to 11 on net income and revenue. And we don't have much share dilutions. That ties it in pretty close. As far as fiscal 2003. I don't know how I would know what that is. Just looking at these factors and interest rates and those things, I think we've given you an awful lot of data you can look at. You have to run your models.

Okay, so, I'm sorry, what did you say for EPS for fiscal '02?

The guide share, the revenue growth would be somewhere around 9-11.

Both 9-11? Okay. Thank you.

Uh-huh.

Randy Mehl of Robert Baird & Company.

Good morning. MMS continues to do great. How much of that business is coming from your small business customers at this point?

About 1/3, Randy.

Around 1/3? Okay --

That percentage moves around depending on the time of the quarter, believe it or not. Most of our clients are in MMS because they're larger companies prefer to wait to a beginning a new calender quarter to begin their services with us. So during the quarter, we'll get more conversions from our core system, because we have an automated way to do it. But at the beginning of the quarter, most of our conversions will be brand new clients to us.

Uh-huh. Okay, and you commented on sales force optimism. How would you characterize the pricing environment right now?

Except for a couple anomalies, I don't think it's bad at all. I think it's been as usual. The folks at data are more aggressive at year end than usually are. They're always aggressive at year end to their credit. Outside of a couple isolated incidents with them, we think it's pretty much status quo.

You don't expect anything there to weigh on unit growth or retention at that the point?

Not for pricing issues. None of that, no.

Okay. And I guess just to ask one more question about something that's not in the Q in terms of the numbers. Based the revenue guidance, it seems like we'll either get gross margin comparisons to improving or the SGNA growth at something less than 10% in order to get to that net income growth guidance. I don't know, John, if you can -- if there are reasonable assumptions you can throw out below the revenue line.

Basically, we're get cutting down on expenses. We have favorable comparisons. But you have to realize you really have to do the comparisons without floating income which is the way I think you did do it. The float income is too volatile. And what you'll see is in the last two quarters which is where the area is, you'll see float income down pretty significantly. When you take the two areas combined. That's because we'll be comparing against gains for the first time.

Right so we've had gross margins excluding float income, we're down for the second quarter in a row now obviously due to the checks per client decline, should that reverse itself? You know, by the end of the year? Or is that expected to flatten out?

I think SGNA will get better you might have consistent things. But, again, you're looking at both operating expenses and SGNA separately and we've talked several times that I don't look at them separately because we have classifications between them. They're historical, we've left them where they were. We don't manage -- we kind of manage every cost, but we don't sit there and say we want that particular lineup in the change. We're focused on what is our operating -- not operating -- the pretax income. How is that moving? And if we've got anomalies and other individual lines, we don't worry about that. That's why you get these things bouncing around. The best way to look at them, I think, is combined.

So the combined is coming down. And that's the key?

I couldn't take that out of pieces work but --

And congratulations on the new area code. Rochester.

Thank you, Randy. Randy, I'd like to make one more comment on your question. The folks that have followed us for quite awhile know we go through a fairly intensive budgeting process every March and April. And for the first time, because of the economic conditions, we actually went through the entire process again in October and November in anticipation of the tight economy. So I think we've done a fairly good job of bleeding out expenses that aren't necessary to try to tie into the economic world we're in today.

Okay, so these numbers have been scrubbed, not very recently?

Yes.

Yes.

Thank you very much.

Greg Gould of Goldman Sachs, you may ask your question.

Thank you. John, on the float income, I know you've mentioned interest, what's built into your model is the assumption that interest rates stay where they are. What does that translate into the float yield? It was 3.1% in the quarter. The reinvestment is 2.8%. Can you give us a sense for how that translates into float yield for the February and May quarters?

I think the yield will still go down, because the reinvestment percentage that went up is recent. It happened in the last ten days. I think the yield will still continue to go down a little bit. Now, one thing we were fortunate on, I wish every one of our managers did it, but a recent amount of the money and the gains we took was then reinvested in shorter than our normal duration, so we'll actually have a situation as time moves out that we actually took gains and will be able to reinvest the money for a good part of the period that we took the gains on at a higher rate than what we took the gain at. So. Not a higher rate but the higher rate than what the reinvestment rate was at the time. But these things are moving around a lot. I think we're giving you more data but it's hard to say precisely what will happen in here. And we've given you the reinvestment rate. You know what the Fed Funds' rate is doing and actually some of you have accessed people that know much more about this than we do in your respective firms.

I guess the float yield can come down below 3% and that would -- and you'd still be able to hit your -- the guidance that you just gave us, is that correct?

We float yield -- the float yield that would occur normally because our portfolio is maturing, et cetera, without further interest rate decreases has been built into our model.

Okay, one other question, Tom and John, on the demographics for the clients you're signing and the one that has are leaving, are there any differences now versus in prior quarters? Are they bigger? Smaller? More stable? Less stable types of clients?

Two very subtle but at this point, marginal impact differences, Greg, but I'll tell what you they are. In the first one, we've seen a flattening out of an issue that we call frequency. 20 years ago, the majority of American companies paid weekly. The trend over the last 20 years is to go bi-weekly or semimonthly. For the first name our history during the last several months, we've seen a flattening out of that change. In other words, our predictability in terms of the clients that are weekly, bi-weekly, semiweekly or monthly is at a higher level because of this flattening out. That's good news. The second part of it is for the first time in a long time during the last three to six months, the average-sized client we're signing is slightly larger. I'm not sure that's totally good news, because I think one of the things that's impacted that is maybe the number of new business starts are lower, so our sales' organization is a little bit more oriented towards existing companies than newer companies. Other than that right now, they have a marginal impact though, Greg. You should note that.

Okay. Thanks.

Yep.

Adam Waldo of Lehman Brothers you may ask your question.

Good morning, gentlemen. John as you look at the potential timing and magnitude of booking into revenue and future quarters, the unrealized corporate security gains, what sort of assumptions have you made in the new guidance or are you giving that guidance without assumptions of future portfolio gains?

We've said for some time the most we thought we'd recognize in a quarter is around the $4 million mark. That's where we've been for the last four when you take both portfolios together, the NSPs and the corporate investment companies. When you look to the next two quarters, we're in that range of, you know, you're looking at somewhere between $2.5 and $4 million. If you go lower lower than that it could affect the numbers slightly. But $1 million isn't a big number.

Okay, can you give us an update in terms of either what rate your sales foresight count grew in the quarter? The pay payroll segment?

We put it in place near the beginning of the fiscal year, April and May of the succeeding year.

Okay.

Which are the last two months. It was in the traditional range of 8%.

It'll be fair to assume, Tom, there's been relatively low sequential addition in head count than in the last quarter?

Basically what Paychex has done over the last ten and 15 years is show our incremental growth to sales people in the March and April time frames of each fiscal year.

Last question. You continue to have a high-class problem of being overcapitalized in terms of your corporate securities portfolio in terms of market and cash flow securities. What are the market processes with respect to potentially reinvesting those monies in different ways to boost your return on equity or return on investment capital? Our general board philosophy, and it's very consistent with my philosophy, is we'll continue to stay as very conservative as we possibly can. We don't -- and that means AA, AAA, municipal bonds and we don't think we're interested in changing that philosophy at this point.

Okay, thank you very much.

All right.

Pat Burton of Salomon Smith Barney, you may request your question.

Hi, two questions. Number one, have you seen any increase in client bankruptcies within the portfolio? Do you expect that going forward given the economy? And the number two, Tom, just a theoretical question, when rates someday come back, would you think of putting hedges in place so the next time they go down after that, it's less confusing or from an economic standpoint do you not want to do that? Thanks.

Let me answer the first question. Our client retention for our core payroll specialists as clients is very well within an acceptable range. We've been monitoring very closely our service levels. We survey our clients on a periodic basis, actually on a monthly basis and we seem to be going very much in the right direction in that arena. I'll let John answer the second question.

We don't believe in hedging, because we know there's always some cost attached to hedging. And who knows where rates are going. So we believe the only reason you'd hedge would be to spend some money to get more predictability and you don't know whether the predictability you'll give yourself was a plus or a minus, we've quickly learned here the rate machine can move very rapidly and nobody really knows which direction it's going to go. Maybe when it starts moving, you'll know, but that means you only know for short periods of time. I think it's unlikely we would hedge.

As a follow-up. Did the recent tax laws changes for companies under $10 million in revenue have any effect on the float, John?

No.

Okay, thank you.

Greg Gieber of A.G. Edwards you may ask your question.

On retention, apart from retention, are you seeing a rise in bankruptcies? How does that compare to past recessions?

The one thing we've seen in the area of client retention as to reason why is the category that the clients tell us that they're either cutting back or they have too few employees or something of that nature. We've seen that go up. We've seen that go up fairly significantly. You shouldn't get too carried away with that one, because that's one of the minor reasons we lose clients. Obviously, the biggest one is the fact that clients go out of business or are merged out or sold or something of that nature. We've seen a slight uptick in that. Um, you know, I don't think it's anything to get excited about at this point.

Okay, Tom, can you go back to your earlier experiences, you said it was a lot worse than the '90-'91 downturn. If you think back to that period, you have some sense about how long after the economy bottomed, you know, pace for control increase in your business turned around. Was it coincidence? Was there a slight lag?

Quite frankly, it was bigger than a slight lag. It was quite a lag. Now, remember, Paychex was 1/3 of the size it is today back in 1989, 1990. But I don't think we ever got to the point where -- we could identify to the point and say we're back to normal it took years. There were small marginal increases and there were no more declines. I think what Paychex resolved to earningswise and revenuewise, we had a lower base here to start with and we compounded our growth on top of that. I think that's what will happen this time. To say we lost 4.3% of our check volume this quarter and next quarter, it'll be back or in three quarters it'll be back, I wouldn't do that at all. I would think in terms of year-over-year growth now rather than we'll have some great recovery that will magically turn this all around. I'm just not oriented to thinking that way.

One last question. Your payout ratio continues to rise. Certainly this year. Do you have some sense as to where you might want to level out your payout ratio?

Are you talking about the dividend rate?

Yes.

Well, I think right now we're a little over 50%, 52 or 53 or 54%. I think that the company would be hard pressed to go beyond that level. We've been very aggressive over the last 10 or 11 years and I know cash continues to grow. But I don't think that the board is oriented to going past the ratio we're at now. Or the relative percentage we're at now.

Thank you.

Sure.

Brian Keen of Financial Securities, you may ask your question.

Of Prudential, thank you. I want to drill down a little bit. I want to get a better understanding of new sales. What is new sales? How many new clients do we typically add in a year? Has there been a change in that? Same thing with retention. If we had 375,000 clients, have we seen -- which typical retention rates looked like in the past, let's say, five years, I assume those rates would have to fall further now since there are more bankruptcies and there are more people deciding to do more things with the payroll. I want to get a better color on that. Thanks.

Lost clients, we've been on a pattern over the last 15 years I'd say. The best way to measure lost clients is the percentage of the base we started with we started the fiscal year with 375,000 clients. During the next 12 months, we will lose somewhere between 21% and 22.5% of the beginning base it also includes any sales we may have made during the 12-month period that only stayed in business or stayed on our service less than the 12 months. Okay? We give you a little history. We had five consecutive years where it was all record client retention until last year. Last year we had to buzz up. This year I think on a percentage basis, we'll be better than we were last year. As far as sales activity, there's been a significant switch in a little bit of our philosophy on the sales activity. Years ago up to about three or four years ago, we were very oriented to all of our accumulation of data in our sales organization based a number of payroll customers we. Today, we're very focused on the revenue. Our revenue production per salesperson today is much higher this year than has been in prior years. It's grown each year. Part of the reason for it, we've added additional products that our sales people are selling to the same customers. So a combination of increasing the number of sales people and more focused look at revenue production rather than unit production. To answer your question very specifically, though, um, you can multiply 880 sales people times 120 units or 125 units and you'll see it's a little over 100,000 companies.

And that stays pretty consistent depending on how many sales people you have regardless of where the economy goes?

It appears to be so far, yes. This was true in '89-'90 and appears so far this year.

And just finally, I want to understand pricing, because there was some buzz about pricing being cut. Is there -- have you guys changed kind of your pricing so to speak due to what other competitors are doing? Or are you giving bigger price breaks on 401K products or workers comp just to try to drive through sales?

I'd say if there's any pricing -- no, I hate to use the word "Pressure" because that's an inaccurate word. Too strong. If there's a look at that I would say it's definitely in the core payroll area and the major markets payroll area. As I mentioned earlier on the call, our friends at automatic data are generally very aggressive to this time of the year. To their credit. Obviously, we try to be as aggressive as we can we can. Outside of isolated cases, we think it's business pretty much as usual.

Okay, great. Thanks.

Yep.

Penny King of Merrill Lynch, you may ask your question.

I see -- they actually having a harder time selling? I would think that's a harder bit of a sale with less profitability among most of your client base right now.

I can't say I agree with you. That's not what we're seeing. It might help with one of the Federal Legislations that were passed last summer. It actually gave small companies a credit if they enacted a 401K plan. If there's been a downsize in 401K perceived activity, it's been offset by the Federal Legislation that's helped us.

And is that true? What about the other services that may not be benefiting from government regulations?

As I said, along the line through our product line, we've seemed to be fairly happy with where we are.

Okay, great, thanks.

Uh-huh.

Michael Baker of Raymond James. You may ask your question.

My questions have been answered, thank you.

David Farina of William Blair. You may ask your question.

Thank you. John and Tom, as we look at your float income as, you know, is there any way you can adjust the fee you get from your clients by letting them keep the float and we can have less in volatility or perhaps maybe a price increase on tax pay? Is that possible? I mean, so we have less of an interest rate every year?

David, I guess I would say we wish we could. But here is the real deal. Our clients are very not inclined, very much not inclined to -- very much not inclined to look at the float income we receive as part of their cost. When we give them a price increase on the fee basis for our service they're noteworthy of that. When it comes to the float income, it's a nonevent to them. So if we did what you've suggested and made a stronger orientation towards fee income and get less involved in the float income, I think we'd have a negative reaction from our customers.

The other problems, there's no way to evenly replace the float income because the float income happens naturally off the way we do the product. And I think to start adjusting and kind of saying, well, I'll adjust the fee income based on what float is doing, that's a two-edged sword.

Fair enough. One follow-up. In your Q, you mentioned you increased the prices of your Your -- or excuse me, the salaries of your support reps and you also lowered the number of customers they cover. Were you having some support issues in terms of how you did that or did you think that was the right thing to do?

We have 375,000 clients, David, you obviously have a bell curve of satisfaction. What we've been trying to do is two things: Reduce our payroll specialist turnover which in turn gives us a better client service level. It's just a continuing crusade, if you will, to continue to make our service better. And you do that by reducing your turnover and by reducing the stress level on the people delivering services by lowering the number of customers they have to deal with.

Okay, thank you.

Sure.

David Grossman of Thomas Weisel and Partners, you may ask your question.

Thanks, Tom, you mentioned sales force optimism going into the big selling season. Can you give us a little more color in terms of what they're seeing and what they're kind of expectations. I know it's early but if you can give us a sense from what they're telling you.

I listened in on one of our management conference calls the other day and I know this is only part of the country, but there's no question in my mind with the benefit of hindsight that September 11th made a lot of decisions. Many decisions were just put off whether it's payroll processing or any other part of the economy. What we've seen talking to our New York City and Metropolitan New York Sales' organization which is a big part of our activity, is that this fear of what will happen next has dissipated greatly. People are starting to get back to business as usual. They're very optimistic in the greater New York metropolitan area. And I think to some degree, this is true in the rest of the country. We haven't had a second event of any significance since September 11th and I think people are sort of getting back to normal.

You imply there may have been a demand for the time frame?

Say that again?

Does that suggest there's pent up demand that may be realized?

To some degree. I won't take it to the bank yet. I'm just giving you sort of second and third-type here -- hearsay comments. This is what our people are saying.

An extension of that. Has the number of clients stayed steady at 375 the last three quarters.

We won't comment on that. We don't give the client numbers. Obviously our client base downs grow. We'll only give that out now once a year or whatever.

Okay. John, one other question on the margins. If they were to vary going forward, would the primary catalyst exclude the interest and capital gains be more function of expenses or more function of mix or --

It's really, our margin gains -- first of all, calculate them without the float incomes and the gains wandering all over the place. Our gains and margin comes strictly really from introducing highly-profitable ancillary growth such as direct deposit, workers comp, tax pay, which doesn't grow very much, 401K. Now, we'll pressure expenses. One thing we add risk here on in looking forward is when checks per client are falling, then we have a factor in here that we don't normally have, because our check count usually stays very constant. When checks her client fall, the problem is while it's the lower revenue per check, it's certainly the more profitable check because it's rated on the end to the same client. We have a trend here that will make some of this a little more difficult. Right now, it's hard to see how it'll play out. Those are the factors that are kind of in play. We can control expenses but if the revenue moves a little too much on us, then we'll get some deterioration. One thing we felt very good about in the last six months was despite all of these things going on in this environment, pretax was 1% or maybe a rounded 1% but it was better than it was a year ago. We think that was a great accomplishment.

Great, thank you.

Charles Trafton of Adams, Harkness & Hill. You May ask your question.

Good morning. Sales force was up 8% year for year in total FDEs. What about the retention of that and -- what about the retention of that and if it's growing in the low single digits, does that mean you've hired 12% and have had 20% attrition? What kind of qualitative or quantitatively.

Our rate on the core sales people usually averages or resides in the range of 34 to 38%. A couple years ago, we had one that was slightly higher than that for the last two years and it looks the way it is tracking this year, we'll be in the mid-30s again.

About on track?

Historically. We wish we could bring it down to 25. If anybody could give us an idea of how do that economically, we'd love to hear it.

Right.

Traditionally the mid-30s is where we are. And obviously anything over 36 or 37 bothers us.

You've increased your compensation with the payroll specialists and the client service managers, what about among the sales force? Is that something you've considered or done?

We've had modifications even this year in the compensation but the biggest modification we had is two or three years ago. But you're continually fine tuning that. I would say this year was not enough money to be so noteworthy.

Right, and then last question. Looking around the country, are there any major metropolitan areas or regional markets that are doing particularly better or worse for you aside from the New York comment? Any new markets you've entered in this year that you want to comment on?

The new markets we enter into on an annual basis are relatively small markets. You know, we have a presence in 103 largest metro areas in the country.

Right.

When we go into our 104 through 105th and so forth, they'll be fairly small cities and it also takes awhile for those smaller cities to have an impact in their growth to any significant margin because it takes us months and years to build up client bases in a critical mass in those branches to get them to the point where they make a real contribution. The growth comes from the major metropolitan areas we already exist in.

The Southeast appears to be the strongest economically in terms of new business starts. Is that a strong or weak market there?

Our sales management in the Southeast is one of the shining stars.

Right. Thank you.

Okay.

Mark Marcon of Wacovia. You may ask your question.

I want to drill down a bit with regards to the -- you know, the checks process per employer. With a 4.3% decline this quarter, is that relative to a year ago or relative to the end of last year.

A year ago. Compared to a year ago.

Against a year ago. And then in terms of your assumptions going forward is that -- are you assuming is that -- you assuming you'll continue to see sequential declines from that or will it stay flat?

We've assumed it'll stay flat. Because we don't know.

Okay, so, the overall -- if it did decline more sequentially, how much of an impact would that have do you think?

Tom talked about how you look at the percentage and evaluate. The 70% he gave was an accurate number. And you've found we just -- we feel we disclose a lot of things. We stay in this stuff and we don't want to get into conjecture because we don't know more than anybody else.

Sure, sure. That makes sense. With regards to your market expansion initiatives, one of the things you mentioned on your -- during the stockholder's meeting was looking overseas. Can you give us color in terms of how that's proceeding in Europe? I know that's early. But how is it proceeding?

It is proceeding. And to be candid with you, you've identified -- we've identified 1/2 dozen of a small handful of small processing companies in one particular country. I think we'll pursue them in an acquisition mode. We won't acquire anything that has more than 500 clients. So it'll be strictly a toe in the water approach with this thing. And my guess is it'll probably happen but I'm not absolutely sure it'll happen. We're looking at 1/2 dozen small payroll processors.

Great. Do you typically pay the same prices over there than you do here?

We don't know. We never bought one over there.

So you haven't seen much in terms of pricing or where they're going to yet?

No.

Great. Are you seeing other initiatives in terms of, you know, you have the huge cash balance that keeps growing every quarter in terms of other places to invest it you know, besides --

I don't know. I think I casually mentioned at our last conference call, we started this new service for garnishments, and we've been pleasantly surprised at the activity level. There's been a pinned up demand by our clients to handle garnishments. That's a real positive. Other than that, our saturation levels, even in payroll, are all so small percentagewise we just think for now and for the next several years, it'll be -- we have a great product range now and a great product line and now it's up to us to get the sales process. I don't think you'll see too much more coming out new.

Okay, great, thanks a lot.

Greg Capelli of Credit Suites First boston. Go ahead.

Would you guys consider starting up or is it more realistic to think that it would more likely come in the form of an acquisition?

We think our best approach is a very small acquisition. We don't know enough at this point to start up from scratch. And we think for the nominal amount of money it'll take to acquire a small client base and the knowledge to get us going, it's a much better approach.

Okay. Just to follow up quickly on the question about the sale cycle and the 401K, you know, being pretty stable. Tom, would you say that's true for the core client business. Are you implying that both are stable?

On the sales' cycle?

Yeah.

I'm not sure I understand what you mean. My comments around 401K sales are the fact that our sales' organization because we grew it so large percentagewise at the beginning of the fiscal year, we didn't get off to a per salesman -- or person basis as good as a start as we thought we would. But now we've caught it up. I don't know if we'll make up the lost ground, fortunately it's not a big deal. We expanded 8% to 10% every year. We have built into it what it'll take to get new sales people up to a good level.

Okay and we can assume that the timing and signing new clients is about the same in terms of the length of the sales' cycle?

For the length of the sales' cycle?

Yes.

Core, yes. 80% of the decisions are made in the first sales goal.

Great, thanks a lot.

It hasn't changed.

Thank you.

Scott Thompson of [Martag] and Caldwell, you may ask your question.

Thanks. Couple of clarifications. Can first of all, on the guidance, when you assume no further deterioration in the economy, as we know, the unemployment rate is typically a lagging indicator, so I was hopeful you might tell us what sort of unemployment rate you were modeling for say over the next 6 to 18 months.

Again, you're asking us the same question. I don't mind you asking them over and over again. But we have no way of knowing that stuff. We're not modeling unemployment rates. We're looking at our business and what we can see and what we think we can affect. We leave things as they are. Our guess is as good as yours. All I know is whatever I guess, I'll be wrong. We kind of stay where we are. We're in a period here where the visibility isn't where it usually has been for us. I think we've given you significant disclosure on all of the subjects especially the volatile ones. The rest of us will have our own opinion. We'll read things everyday. What we see, whether we read is true or not, I don't know. I think you need to form your own opinion. That's the only way looking at this. We spent time in a recession before anyone would admit we were in one. That's the best we can do.

Fair enough. Secondly, actually you all expecting to see EPS growth this fiscal year, but as we know, the last recession, you all have reported two consecutive years of flat -- of flat earnings, so I guess my question is: given the severity of this recession versus the last one seems to be a bit worse, why do you think you all could produce positive EPS growth this time?

Couple of reasons. The first thing, if you can think about our pricing schemes for our payroll service clients, back in 1989 and 1990, we did not have any of the ancillary services like tax pay, automated direct deposit, workers comp and those types of things that we have today. And what that means is a smaller percentage of our revenue comes from actually processing payroll checks in a much higher percentage of it now comes from the fact we have all of the other ancillary services and most of the ancillary services are priced in a way that the number of checks did not materially impact the revenue from the client that we receive because it's a flat fee type of thing. For example, the tax pay and direct deposit, so forth. So our pricing structure and our array of products is totally different today from what it was nine or ten years ago. And, of course, our human resources services aren't impacted directly from a recession as payroll processing is. And those things continue to remain fairly strong. So we have a much different pricing arrangement today. We have a much different breakdown of products and services that is totally different from what it was ten or 11 years ago. The other thing that was different about the '89-'90 thing is we were in a development stage of tax pay and we put a huge effort into the effort -- into that program that year as well as we had a major expansion of our sales force. Somewhere around 30% to 33% in that time frame which was the worst timing in the world and we paid a big price for it. So that type of thing or exposure doesn't exist today as it did in '89-'90.

Thank you.

Sure.

Brandt Sakakeeny, of Deutsche Bank, you may ask your question.

Thank you, good morning. Can you talk more about the major market segment. I was surprised about how strong it did in this environment.

We've been on now an hour and five minutes. The most I'll take is two more questions. At this time, I'll have Tom answer that question.

The major market activity seems to be very strong. 1/3 of the clients converted to major market services. Our companies that were on a core payroll service found a feature of our market service to be attractive to them. We moved it over to them. Even though EDP has a strong hold on this market, relative to our size and the growth rates we have in major markets, we're very, very happy with it we have 100 person sales' organization. I would say probably 60 or 65% of that sales' organization came to us through the core organization and their very accomplished sales force. They have a very good job relatively speaking. We've also -- the other thing that's happened, when we started in the major market area, we had a software package that we acquired that had a lot of weaknesses in it. And over the years, we've been able to greatly improve the service level and the sort of the problems that we had with the software on a functional basis. All of that is quoted very well. The combination of a better product today, the combination of a really fairly strong sales' force compared to the payroll sales organization and the fact that the market is out there for it.

So, Tom can I conclude that then the 2/3 of the clients that didn't come from the existing business, were those new clients or were those wins from ADP?

I would say right now we're running about 60-40 ADP versus all the other methods.

Okay and how many new to payroll just for the first time? Outsource from the payroll from the first time?

About 1/3 of them.

Great. Thank you.

Okay.

David Rydell of Salomon Smith Barney may ask your question.

Good morning. Gentlemen. To focus in on the PEO and PAS business for a minute if you could. Are you seeing in that business the impact of the economic uncertainty with customers signing up for business. Or is that being outweighed with the market trends?

The PEO that we have in Florida and Georgia is doing extremely well. They are over their quota numbers both in revenue generation and profitability. Our past product is also doing very well. Going through the experience of trying to forecast how well or what kind of sales activity we'll have in our first full year of having a dedicated sales force, and that's always a challenge. We came up with speculative numbers. We're doing very well against the speculative numbers. We didn't know what kind of sales' activity on a per person basis we'll have on this product. I can tell you [inaudible] by itself, the PEO product and the PAS product are doing very well. There's interesting legislation pending in front of the federal government that may also make the PEO world a little better than it is today. It has to do with segregating out certain fringe benefits such as 401K by individual companies rather than as a PEO in any event, most are doing very well. Do we have a good comparison about how will PEO is doing against PAS at this point? The only place we sell both services are in Florida. It's too early to tell yet.

Any impact from the health benefits' trends?

Well, all that gyration causes a lot of consternation and also creates a lot of, you know, anxiety and intensity that must be applied to the arena by a PEO including ourselves. We think we're doing very well with it. You know, other than that I can't say much.

Great, thank you very much.

Our final question comes from [Ashlynn] Shivakar from Salomon Smith barney.

Hi, just had a question -- follow-up question on the average daily balance, float balance you have. Do you have see any trends in that in the next few quarters based on the tax reform so on and so forth?

The payroll tax holiday they talked about which I don't know what the status -- I hope it's dead -- is so right for abuse that I would think it'll have a difficult time putting in. It's a big problem for the people who do their own let alone the payroll providers. We don't see anything. You have to realize also when you look at these things, we were talking about the FICA tax that were there. Not the federal withholdings. You have to make dramatic changes in the tax tax structure of the country to change those things. I don't think we'll see those. We don't see anything that will dramatically change that. It could effect float balances slightly. I don't see anything major. Even on the payroll tax holiday, I think I calculated the potential effect on a worse case and it was something less than $3 million. It was much ado about nothing. The government needs to do what it needs to do. On our business, the effective changes will be minimal if any.

Thank you.