沛齊 (PAYX) 2002 Q4 法說會逐字稿

Good morning. Welcome to the Paychex results year end conference call. All will be on listen only mode until the question session of the conference. If anyone has an objection, they may disconnect at this time.

I would like to introduce your speakers for today's call, Mr. John Morphy, Chief Financial Officer, and Thomas Golisano, Chief Executive Officer. Mr. Morphy, you may begin.

Thank you for joining us for our fourth quarter and fiscal year end press release. Today we have just end 200 people on the phone. Also with us today is Tom Golisano, our Chairman, President, and CEO.

Upon 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 quarter ended May 31, 2002, and filed a Form 8-K with the SEC that provides additional discussion and analysis of our results for the past three years.

Fourth quarter earnings release SEC filings, and our recent news releases, current financial information and updated investor relations presentation can be obtained by accessing our website at WWW.Paychex.Com at our investor relations home page.

This is being broadcast over the internet. It will be archived and accessible by the internet until July 2, 2002. For the fourth quarter and fiscal year ended May 31, 2002, total revenue growth was 7 percent and 10 percent, respectively. That income growth was 1 percent for the fourth quarter and 8 percent for the year. Quarterly earnings per share were 18 cents in the fourth quarter of fiscal 2002 and fiscal 2001 up 1 percent at an unround basis.

Year-to-date earnings per share were 73 cents versus 68 cents a year ago, up 8 percent on an unrounded basis. Our results continue to be impacted by recessionary economic conditions in the United States. In response to the declining economic conditions, the Federal Reserve has lowered the federal funds rate 11 times since January 2001 to 1.75 percent which represents a cumulative 475 basis point reduction. The last reduction the federal funds rate occurred in December, 2001. The impact of the rate cut on year-over-year comparisons for interest on funds held for clients in corporate investment income more significant in our third and fourth quarters.

Year-over-year comparisons for interest on funds held for clients and corporate income combined were up 14 percent and 2 percent for the first and second quarters of fiscal 2002, respectively. But were down 30 percent and 33 percent for the third and fourth quarters and down 15 percent for the fiscal year.

In addition to the effects of volatile interest rates, the impact of a recessionary economy has resulted in a lower number of checks per client as our existing clients reduce their work forces. In the fourth quarter of fiscal 2002, the company experienced a 3.0 percent year-over-year decline in checks per client compared to 4.8 percent in the third quarter, 4.3 percent in the second quarter, and 2.6 percent in the first quarter. For the 2002 fiscal year checks for clients declined 3.7 percent, compared to the recession of the early 1990s when the company experienced a total reduction in checks per client of approximately 3 percent.

Despite the above factors, the income before taxes remained 41 percent of total revenues during fiscal 2002 compared with 42 percent in fiscal 2001 and 38 percent in fiscal 2000. In addition, we continue to leverage our infrastructure as operating income when you exclude interest on funds held for clients as a percentage of total service revenues with 34 percent in fiscal 2002 compared with 32 percent in fiscal 2001 and 30 percent in fiscal 2000.

We estimate that if the interest rates and checks per client conditions experience in fiscal 2000 that continued throughout fiscal 2001 and fiscal 2001, net income growth for 2001 would have been approximately 25 percent compared with actual growth of 34 percent and net income growth for fiscal 2002 would have been approximately 20 percent compared with actual growth of 8 percent.

We will now refer to the third page of the release, the consolidated income statement. Total service revenues increased 12 percent and 13 percent in the fourth quarter and full year period to $230.5 million and $892.2 million, respectively. Service revenues consist of service fees earned from our payroll and human resource and benefits product line. Payroll service revenues for the fourth quarters in nine months increased 10 percent and 12 percent to 196.5 million and $770.2 million respectively.

increases are related primarily to growth in the client based, increased use of ancillary services, and price increases. As of May 31, 2002, 85 percent of our clients utilized tax base and 57 percent utilized the company's employee paid services.

Major market service revenue increased 51 percent for both the fourth quarter and 12-month period to $20.3 million and $71.7 million, respectively. Approximately 1/3 of our new major market services clients are converging from the company's core payroll services. We now provide M and S services in over 60 markets covering approximately 85 percent of our total client base.

Human resource and benefit service revenues increased 27 percent and 25 percent in the fourth quarter and 12-month period to $34.0 million and $121.9 million, respectively. The increases are primarily related to growth in retirement services clients and client employees served by the company's past PEO bundled services. Retirement services revenue increased 31 percent and 30 percent in the fourth quarter and 12-month period to $15.2 million and $56.5 million, respectively. May 31, 2002 we had over 23, 000 retirement services clients.

Paychex administrative service past 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 costs. Sales of past and PEO products have been strong with administrative fee revenue from those products increasing 37 percent and 41 percent in the fourth quarter and 12-month periods of fiscal 2002 compared with the respective prior year periods. As of May 31, 2002, our past and PEO product service over 80,000 client employees.

Interest on funds held for clients decreased 39 percent and 25 percent for the fourth quarter and 12-month period compared with respective prior periods. The decreases are as a result of lower interest rates in fiscal 2002 offset somewhat by higher average portfolio balance. Net realized gains in the sale and available for sales securities included in interest (inaudible) fund to 1.5 million for the fourth quarter from 2.5 million in the (inaudible) quarter.

I apologize here. We're making the call and we've got a call coming in on the other line. Net realized gains increased to $9.2 million for the 12-month period compared with 5.7 million in the respective prior year period. The funds result for clients portfolio earned an average rate of return of 2.4 percent and 2.9 percent in the fourth quarter and full year fiscal 2002 compared with 4.3 percent and 4.6 percent for the same periods last year. Average daily portfolio balance totals $2.0 billion and $1.9 billion for the fourth quarter in the year ended May 31, 2002 compared with $1.9 billion and $1.7 billion in the respective prior year periods. The increase reflects high utilization of tax pay and employee pay services by new and existing clients.

I just want to take a second. Tara?

Yes.

Is everything still fine here? I just wanted to make sure we didn't lose anybody.

No, sir, everything is fine.

Thank you.

You're welcome.

(Inaudible) and SG and A expenses increased 8 percent and 11 percent in the fourth quarter, 12-month period, compared with respective prior year periods. This reflects increases in personnel, information technology, and facility cost to support the growth of the company. There are approximately 7400 employees at May 31, 2002, compared with 7300 at May 31, 2001. Fourth quarter and 12-month operating income increased 5 percent and 8 percent, respectively.

Investment income decreased 16 percent for the fourth quarter and increased 15 percent for the year. The decrease for the quarter is primarily due to lower average interest rates earned. The increase for the year was due to net realized gains on the sales available for sales securities and the increase in average daily invested balances offset by lower average interest rates in fiscal 2002. Net Realized gains were $1.5 million and $6.7 million in the fourth quarter and 12-month periods of fiscal 2002, compared with $1.3 million and $1.7 million in respective prior year periods.

Average daily balances invested were $740 million and $685 million for the fourth quarter and 12 months ended May 31, 2002 compared with $640 million and $575 million the respective prior year period. The increases in the average portfolio balances were driven by additional net cash inflows from operations. Proffered investment portfolio earned an average rate of return of 3.4 percent for the fourth quarter and 3.7 percent for the 12-month period compared with 4.4 percent and 4.5 percent in the respective prior year periods. For those of you who spend a lot of time tracking on these exact balances and numbers, we have enclosed a table in our Form 8-K where this data is very prominently disclosed, and we would refer you to that to make sure you have all the correct numbers.

Our effective income tax rate was 30.5 percent for the fourth quarter and 12-month period of fiscal 2002 compared with 29.5 percent and 30.0 percent in respective prior year period. Fiscal 2003 effective income tax rate is expected to approximate 31.0 percent. As mentioned earlier, net income increased 1 percent and 8 percent for the fourth quarter and 12-month period of fiscal 2002 when compared to the same period last year.

Looking forward, we are not sure how long the challenge in economic conditions and interest rate comparisons will last. On an encouraging note, while year-over-year checks per client continues to reflect declines, we are beginning to see indications of improving check conditions in our client base. We have based our fiscal 2003 expectations on current economic conditions remaining in place with no significant changes. Accordingly, for fiscal 2003, we project payroll service revenue to grow in the range of 9 to 11 percent and human resource and benefit service revenue growth in the range of 17 to 19 percent. Total service revenue growth is anticipated to be in the range of 10 to 12 percent.

We expect interest on (inaudible) for clients and corporate investment income combined to be down approximately 15 percent. 15 percent down expectation is based upon the expectation that realized gains will not be very available after our first quarter.

Taking aforementioned factors into consideration, we anticipate achieving record total revenues and net income for fiscal 2003 and estimate total revenue growth to be in the range of 8 to 10 percent with net income growth approximating or slightly less than total revenue growth.

We now move to page 4 of the press release, our balance sheet, which is very consistent with our May 31, 2001, Funtell (phonetic) growth during the past year. All cash and corporate investments have grown to $725 million. Our total available for sale investment, including corporate investments reflected and Funtell (phonetic) for clients reflected unrealized gains of $26.7 million and May 31, 2002 compared with unrealized gains of $20.5 million at May 31, 2001, unrealized losses of 13.4 million at May 31, 2000. The decrease in interest rate environment drove the improvement in the market value of the available for sale portfolio.

A powerful interest rate market has resulted in significant changes in the market value for available for sale portfolio. During fiscal 2002 the unrealized gain position ranged from a low of $7.5 million that happened during the first - fourth quarter to a high of $35.9 million during the second quarter. The unrealized gain position was $31.5 million on June 20th, a few days ago. So you can see that the market rates have been moving rather abruptly if we recognize our low of $7.5 million about 6 or 7 weeks ago, but as of just the recent few days ago was back up to $31.5 million.

Our net property and equipment balance activity during the year reflects capital expenditures of $54 million and depreciation expense of 27 million. For fiscal 2003, capital expenditures are expected to be in the range of $65 to $70 million, including the purchase of a 220,000 square foot facility in Rochester, New York, which is expected to be completed in the first quarter of fiscal 2003.

The past 12 months we have purchased two buildings in the Rochester area. The first was Webster, announced some time ago that would allow us to expand our facilities on a much more cost-effective manner than our original plan to expand our corporate headquarters. Appreciation expense for fiscal 2003 is projected to be in the range of $33 to $35 million.

(Inaudible) stockholders equity increased to $924 million May 31, 2002, with $157 million in dividends paid during fiscal 2002, a payout of 57 percent of net income. A return in equity for the past 12 months was a strong 32 percent. Accumulated other comprehensive income balance at May 31, 2001 of $13.1 million has increased to $17 million at May 31, 2002 which reflects the previously discussed increase in the market of our available for sale portfolio.

Investment rates of return. With the volatile interest rate environment we often receive many questions about the potential impact of changing interest rates. We refer you to our Form A-K which was filed with the FCC this morning under the section entitled Market Risk Factors for further discussion of interest rates and the related risks. The A-K includes a table disclosing the average investment balances, rates of return, realized gains and losses in the portfolio, unrealized gains and losses in the portfolio, portfolio duration, and the weight of the average yield to maturity of available for sale securities.

To summarize, changes and interest rates quickly impact earnings on short-term investments. The overtime impact of earnings on available for sales securities as current holdings are sold or matured and are reinvested at current rates. Exact impact of changing interest rates on the company is difficult to determine due to many factors.

However, we estimate that a 25 basis point change in taxable interest rate, 17 basis points after - on a tax-exempt basis, will have an effect of $3.0 million on our earnings in the next 12-month period.

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 related risk factors.

At this time I'll turn the meeting over to Tom Golisano, our Chairman and CEO, will provide his comments on the first quarter and the fourth quarter before we open the meeting for questions.

Thank you, John. First, I'll cover all of our key areas relative to sales and (inaudible) hang on just a second. We've got another phone line ringing.

Our core payroll sales organization had a fairly good year considering the environment out there. We didn't sell as many clients as we anticipated, but the great news was the average size client we sold this year for the first time in our history actually jumped in size. The annualized revenue was actually up 10 percent. I think that's as a result of the fact referrals were down because of new or lesser than average new business startups, so consequently our sales organization gravitated to existing companies.

On a client retention, we think we did surprisingly well considering the economic involvement. We were within 1 percentage point of our all-time record client retention so we're very happy about that.

Our MMS sales organization, major market sales organization, was the star of the company this year. Their achieved their quotas, the gross rate in revenue was up almost 50 percent and we are expanding the product next year to about 14 new markets. (Inaudible) is going to grow about 25 percent. Our core sales organization, our growth rate is somewhere going to be between 6 and 8 percent of core payroll sales.

401-K, we got off to a slower start than we anticipated in the year. We never really did make it up, but we finished the year fairly strong with 24,000 clients in our 401-K recordkeeping service.

Workers' comp was strong all year long. We ended up the year with about 25,000 clients. We expand the number of carriers to five, and that market, even sales effort, is going great.

Our past product, we're approaching 2000 clients and combined between our past product and our PEO, we have approximately 80,000 employees covered. All four sales organizations next year are geared and ready to go. All the people have been hired, all the growth has been put in place, so we think we're in great shape.

John mentioned a little bit of the good news, the fact that our average checks per client stopped its decline. In fact, we had a slight bit of recovery. One quarter doesn't make a year, obviously, but certainly it's a positive sign. So with that, we'll turn it over, Tara, for you and for questions.

Thank you. At this time we'll begin the question-and-answer session. If you'd like to ask a question, please press star one. You will be announced prior to asking your question. To withdraw your question, you may press star two. Once again, to ask a question, please press star one. One moment, please.

Our first question will coming from Jennifer Dugan of Merrill Lynch. You may ask your question.

Thanks. Last quarter you reported you had a net positive competitive pay glaze with some pricing pressure. What was the situation this quarter?

Take-aways from - I'm not sure I understand.

For core new sales that you had been having competitive wins versus 80 P (phonetic) and it actually had a few take-aways as well.

You're probably referring to a year-end 80 PK (phonetic) from the calender year end, 80 PK (phonetic) very aggressive and coming after some of our clients and we responded and we think we've fared very well, but that pressure level, that intensity has dissipated over time. I think it was a sort of one time sort of year end event and we haven't incurred much unusual level of competitiveness than we usually have to endure. So I think it was a one time thing at the end of the calendar year and things are pretty much back to normal.

In terms of the pricing as well, is that back to normal or is pricing still a little bit below average?

Paychex is respective. I certainly can't speak for ADT. We probably upped our discounting a little bit to respond, but I'll tell you in the overall scope of things (inaudible).

Okay. Great. Thanks.

Greg Capelli (phonetic of Credit Suisse First Boston. You may ask your question.

Thanks. Hi, Tom and John. It's Greg and Josh. Could you give us a little more color about the progression through the quarter on the checks per client, perhaps where you ended versus entered the quarter?

I would say, first of all, I think our comments, John, if I'm correct, include the first two or three weeks of June. It started probably in the tail end of April. Noticed that certainly in May and it seemed to - I'm sorry, in April and it seemed to accelerate a little bit in - I'm sorry. Started in April, accelerated a little bit in May, and the first two weeks of June looked very, very positive.

Okay. And then just in a fiscal three guidance to the kind of assume an improvement from here with the numbers that you gave on the revenue side?

We did the budget. It was in line with what kind of happened the May period. We've just completed that process. Our expectations for next year are not based on any significant improvement. Maybe a little bit in the last half but first half we remain cautious. Running the company based on things not changing. We didn't want to put the ability to spend in the budget and find out we didn't have the revenues to support it.

One final question. Tom, have you guys done any tweaking at all in the quarter to the sales force just in terms of the structure or pay over the past quarter or so?

Yeah, we've done a couple of things, primarily at the major city level we found out the management of our organization a bit. We used to have the position - I'll give you an order: (inaudible) rep, district sales manager, metro sales manager, loan sales manager. Basically what we've done is eliminated the metro manger position, put in place more senior sales managers and a few more district sales managers.

The net result is economically about a wash, but we've reduced the level of management at the city level, which we think is going to have a very, very positive impact. We did tweak the compensation levels a little bit for our sales reps but nothing significant.

Okay. Great. Thanks a lot.

Jim Kusane (phonetic) of Bear Stearns. You may ask your question.

Thanks. Hi Tom, John. John, can you give us the retention in the quarter and the full year and how that compares with a year ago?

Don't generally give exact numbers on pension but they're in the range where they've been historically. We see a little change, bankruptcies, but we're not seeing a lot of difference. We actually did see some improvement this year in view of the fact we think our operation had a much better operation than it did a year ago, but Tom will probably throw a few comments.

Jim, there's no question our branch manager and operations did a better job this year than last year. We measure it by clients that we lose due to poor service; we measure it by customer complaints at the corporate level and so forth. We had a far better year this year than last year, and I think that's the reason our client retention actually, consider the economic condition, was better than we expected. I did say earlier we were within 1 percentage point of our overall record for client retention. We're pretty happy about that.

Despite the increase in bankruptcies?

Right.

And historically what portion of your new sales have come from new business startups.

45 to 47 percent.

And this year what was it?

Gee, I wish I could give you that calculation. I know it's down. I can't give it to you. I don't want to guess. We know there were fewer startups and that did affect us.

Okay. Great. Thanks.

Greg Seeber (phonetic) of AG Edwards. You may ask your question.

Gentlemen, I'd like to follow up on this somewhat positive note proving (inaudible) derivative and asked if you've seen any other metrics such as average size of check per client, indications there may be overtime or hours worked on the job are increasing. Or maybe just, you know, new startups, do you see anything else that's showing signs of bottoming out.

No, I can't say we have. The only thing we can say we feel comfortable about because we have a very accurate count on is our checks per client. Anything else would be intuitive and quite frankly I don't feel strongly enough about any prior to make any kind of declarative statement about our economy.

Could you on your guidance give a little more comment on deceleration and HR and benefits services. You're taking out 25, now taking down to the high teens. How much is simply growing base or how much, you know, because you had a pretty good fourth quarter up 27 percent.

I think the base is just getting larger and obviously we're trying to manage, if you will, our revenue and profitability growth over the year and I think to be on safe ground we decided to bring it down a few points. We're not being as aggressive in building our HR and sales organization this year as we were last year. Did a quantum jump in sales reps. This year we're being more conservative.

Don't you normally around May put forth a price increase and have you done so and has it helped?

We put in the price increase the first week in May as we traditionally have. I think it's somewhere around if we were to pick a number, 3 percent, 3 1/2 percent, somewhere in total, fairly conservative. We've had about zero client reaction to it.

Thank you very much.

Randy Mel of Robert W. Baird. You may ask your question.

Yeah, good morning. Just wanted to ask about the core payroll growth assumption. I think I heard 9 to 11 percent. You came in at about 10 percent in the quarter, and maybe just comment on why that shouldn't improve throughout the year, just based on comparisons getting a bit easier than they were in the fourth quarter.

Randy, we haven't built in boom tech (phonetic) conditions. We have a little here but not enough. We have some signs that are encouraging, but to make a stronger statement than that. But where the revenue growth is you've got tax pay, maturity sitting there a little bit, so we've been conservative. We think we're well within realistic numbers but we decided very much in our planning process we were not going to artificially push the revenue model and have it not show up. We've obviously battled a full 12 months here, budget prices with revenue being below expectations mostly outside our control. We've got people on a pretty tight leash on expenses.

And what will the increase in total payroll sales force be going into the year?

The official number of sales territories is going to be about 900, but the organization will be deeper than that because we usually keep bench strength (phonetic) so there will be 900 territories.

And that's -

About 855 or something like that, I think, (phonetic).

Okay. And then unit growth looks like around 4 percent, although I know you're not giving exact numbers. Just wondering what the trend was in the fourth quarter there.

About the same.

Yeah.

So it left the year, roughly at about 4 percent

we have to round in some numbers there, but yeah, you're close.

And final question. Very good cost reduction in the quarter to help out with the margin. What was the source of those and should we expect anything more? Are there any other efficiencies you might be able to get?

As a source, Randy, was at the fifth point of the fiscal year we sat down and did a rebudgeting process, mainly because of the economic conditions and we brought a lot of self-restraint rolled into our spending, and what you see in the fourth quarter was obviously a part of that.

Actually, Randy, those numbers are actually a little bit better than what you see because once the economy has brought to us on our direct deposit products, they've also expanded it greatly, is percentagewise we're okay but our year-over-year losses money (inaudible), we lose it because the stars are in the wrong place. But when you look at the cost we actually can control completely. We did a very, very good job, and right now we are doing a much better job even on the other ones, on the receivables, so we felt real good about those margin improvements, in fact, throughout the slow income.

I'm sorry, could you explain the losses again.

Basically as you're moving money, direct deposit account or a ready check, you think you have the money and you find out you don't, so you get a lock on the payroll. And the number of clients it happened are very few, the dollars are higher than in prior years, not alarming, and the profit margin is still very high, but the economy, a few more people are in troubled times and wind up going the wrong way.

Do you understand that, Randy?

Yeah, I do. Okay. Thank you very much. I appreciate it.

Adam Waldo of Lehman Brothers. You may ask your question.

Good morning, Tom and John. Thank you very much for taking my questions. Reviewing your very detailed fiscal 2003 guidance this morning's AK filing, as I went through my modeling the midpoint of your revenue guide (inaudible) service bureau revenue segments and using your 15 percent estimate for year-over-year decline in E and S investment revenue in fiscal '03 I come out with revenue growth outlet for fiscal '03 at the high end of your total revenue guidance of 8 to 10 percent revenue growth. Is that a fair assumption to be using?

The guidance what we gave is what we gave. We don't extrapolate the - you can extrapolate the numbers. We felt we gave quite a bit of guidance here, more than we sometimes give because we want to make sure people have a clear understanding, but we don't really comment to say what's the specific number.

Okay. John, can you give a little more color as to the assumptions made around payroll service bureau unit pricing, that new client change in (inaudible) per client change in your fiscal '03 service bureau revenue guidance range of 10 to 12 percent growth, would you be modeling through that 3, 3 1/2 percent price increase and 3 percent year-over-year decline checks per client and then the balance being essentially net new clients?

Basically model of the pricing increase that Tom talked about and did not show very much improving check conditions although a little bit we probably saw in the beginning here probably in there, might be a little bit at the back end when you hope the economy is better but not sure and a little more penetration or reasonable penetration in direct deposit. (Inaudible) sometimes the growth, got other ancillaries that are in that that we look at and that's pretty much what we rolled up. We didn't do anything unusual. The budget is a very detailed process. We actually budged the checks level at the branch level so an awful lot of effort put into it and usually it's pretty predictable.

Fantastic. Now, you're essentially at about $31 million or so in unrealized gains today. Can you update us on your thought process in terms of taking unrealized gains over the course of '03? I think you said you'd assumed basically the gains wouldn't be available beyond the first quarter. What led you to that view?

Basically the gain situation is one that's changing. I'm not sure a freight train will go with it. You're down to 7 1/2 million we were doing the budget problems. We basically forecasted in the first quarter when things got a little bit better the gain taking would be similar to what it's been in the last four quarters. That means you're in the 3 to 4 million-dollar range.

The second, third, and fourth quarters, we don't know what we're going to face. Again, we took the conservative posture and we didn't put anything in. Now, since there are 32 million right now, could I give you a different answer? I suppose I could, but I'm going to stick with where we are. We really hope those gains in a way go away because we'll be in a better economy if they go away.

So right now that's where we are. That's subject to change but you've got a situation where only six to seven weeks ago that $31 million was 7. I wish I was Houdini, I could predict what would happen, but I don't. Right now we're looking for, we said 15 percent, probably got a reasonable number in the first quarter, similar to what we've been doing, and very little, if anything, in the last three quarters.

That's very helpful. And then finally any updates in terms of your thinking on hedging interest rate risk in the future or repurchasing stock, given your strong balance sheet position.

I don't see us hedging. We look at it. Still believing we've got to give something up to get it. While perfect predictability might be worth something, we don't think to hedge much past a year. It gets difficult. Buying the stock back, we still do those analyses and it's very hard to get it to be positive or very much. We continue to look for ways to use cash and we'll see what happens. I don't see anything that's a big change from when we've been doing.

Do you have handy the D and A in the quarter?

What do you mean?

The D and A, I'm sorry, expense in the quarter.

Depreciation amortization.

It's in the A-K.

I must have miss it.

Greg Gould of Goldman Sachs. You may ask your question.

Two questions. First, I didn't hear it in the earlier part of the presentation, Tom or John, the new client, net new client growth for the fiscal year ended 2002, I think in the past you had mentioned that you would give us the year end numbers. Can you do that?

What we're saying basically, Greg, is that our client base is 390,000 plus.

No more precision in that number?

No. We don't want to mislead you with it.

Okay. The more question is more on a higher level one. Are you seeing any signs of saturation in the market at all? I know half the clients come from new business startups, so that won't be an area that's saturated, but are you seeing any signs of further maturation in the market?

Greg, absolutely not, and I'll tell you what makes me so strong in that answer. I don't know if you heard me earlier say our major market sales organization was the star of the company this year.

Right.

Changing over (inaudible), even in these economic conditions, If ever there was a part of our company product line that could be reaching maturation it would be the 50 to 500 client range, and absolutely we're not seeing that happen even at that level. So we don't think it's an issue at all.

And sales productivity, you're increasing the sales force and MMS by 25 percent. Would the overall productivity continue to rise so that revenue growth would be in excess of that?

Yes. Our sales force this year, I believe, their productivity went up significantly over the prior year. I think and our budget process we're speculating it stayed the same. But we are increasing the number of the sales people by about 25 percent or 25 people, actually.

Okay. Thank you.

Mark Marken of Wachovia Securities. You may ask your question.

Good morning. I was wondering, what was your all-time high in terms of client retention?

20 1/2 percent, I think.

20 1/2 to 21.

20 1/2 to 21 in terms of turnover?

In client base loss.

Right. And you recently made an announcement with regards to Croel (phonetic). I'm wondering if you could give us a little bit of color in terms of that arrangement. And obviously, you know, some companies are going out and expanding their services offerings.

We made an arrangement with Croel (phonetic), we're partnering with them, and they do background checks for prospective employees of our clients. It's a mainstay of our Paychex administrative services and PEO Products and we're thinking about considering expanding it to the rest of our client base. Basically that's what it is. The working relationship, they provide the service and we do revenue sharing with them.

Okay. And where will that revenue show up? It will be in your HR services?

Yeah.

Okay. Great. And with regards to your, you know, your mature sales people, are you continuing, you know, the people who have been with your organization, you know, three years or longer, are sales quotas staying basically the same for those folks or are they continuing to move up as well?

Well, our sales quotas now are generally revenue based.

Right.

And I think the expectations for the next year is approximately the same level they were this year except maybe 3 to 5 percent increase. The quotas assigned to our beginning sales people, we're modifying them a little bit as part of our program to improve our sales person's retention during the eight months where we have our highest turnover level. Our other than that it's pretty much status quo.

Any change in turnover levels, either among your sales people or among your payroll specialists?

We're pretty consistent with the year before, somewhere in the high 30s, core payroll sales people. And our service givers, and I'm not sure I can totally explain this other than the fact that a lot of people have been putting a lot of effort in it, we had our lowest turnover rate in our payroll specialist in the history of the company, and it continues on a monthly basis to track even better. Very happy with that.

All right. Thank you very much.

Brian Keen of Prudential Securities. You may ask your question.

Good morning. First question, how much does tax pay make up of the payroll service revenue?

Tax pay average revenue these days is about $450 per client per year, and our core payroll services revenue per client per year is about 1400. If you want to take $450 and divide it into 1450 or 1900 or whatever it is, give a percentage. Employee pay's another 450.

Employee pay was what, John?

Another 450.

Another 450.

Like a (inaudible) is the float (inaudible) change dramatically. The float on direct deposit now is very low, kind of goes back to when we lost a day of float when the Feds changed the rules sometime ago, we have the lower rate and the float on tax pay is down to about 20 or 25 percent of the revenue.

The rest is made up of payroll services.

(Inaudible.)

Okay.

Just want to follow up with something, Tom. You said referral size were down but average client size was up and then you had an explanation of that. Could you help me through that again, why you thought that might be?

Generally, approximately two-thirds traditionally of our client sales have been through client referral or CPA referral. Generally speaking these have a tendency to be brand-new companies. An entrepreneur went to an accountant, said I'm starting a new company, the accountant says, Well, you better get a payroll service, call Paychex. When new business starts are down, the referral aid is down and consequently your sales people then instead of directing their efforts at referrals will go out and start are cold calling the business base in their territory. And because those are existing business, they have a tendency to be larger in number of employees than brand-new startups.

That's new calls, are those coming from, you know, people who are already on a service bureau or are they brand new, people that were doing it in-house or just a mix?

It's a mix, but the bulk of them have got to be people doing their own in-house rather than adding another service.

Okay. Great.

Adam Fritsch of UBS Warburg. You may ask your question.

Good morning. Tom, you said before - I'm sorry, John, revenues are going to grow faster than the net income. Does that have to do with potentially the duration getting a little higher on the (inaudible) balance and therefore interest income will be lower?

No. You've got the interest income in there but one of the effects is that you have the checks for clients phenomenon, hopefully it's stabilizing. that those last checks, we lose them. Some of them are the high profit ones.

One thing we have done during this period is we have not shut down the very important investments we want to make or we're going to. Only a couple of data centers this coming year. We took on a facilities that's not going to have a lot of extra costs and then we got a great deal on Rochester here in the last few weeks, that picked up a little bit of expense, not alarming. But you have a few pieces in here where you're investing in things. We're going to continue to invest long because we believe the long-term future is very good, that's impacting at a slightly - all in all, though, we still really hope it will be closer to the same, but you've got rates, a little bit of checks, a little bit of investment. No one single factor, but they're all sitting there.

Okay. Other thing, sequentially, the pays per control, I know it was better year-over-year improvement versus the third quarter. Do you have the data to really tell us how things were progressing in the third quarter over the fourth? I know they're getting better year over year.

This data (inaudible) not ready to say anything has changed materially, we're just telling you things that are - maybe the sun is coming out. But when you look at the calendar the fiscal year end quarter, the 228 quarter, you've got bonus checks and other things in there. When we compare we're really looking year over year and we saw a little bit of improvement there, but still we've got some decline. But we're encouraged, I think we've said as much as we can say. We've seen some signs, nothing so depend or strong you just sit back and say wow, but it's nice to see things not declining.

I would agree. And the last question, would you just give us a general update on the duration curve, where you think it might be going with it the next 6 to 12 months, what you're going to do with the portfolio?

Our policy is very strong for the investment community and we have tended not to maneuver on that. We're a little bit shorter on the duration right now only because it's hard to invest in some of these rates. We're not going to change that too much. Float income is float income. There will be times when it's more favorable, right now it's less than favorable, but we run a business really based on the services and our float income is volatile. I don't know of a better way to price the product. It's a benefit that's build in to the way we do things. Some days you just like it more than you like others.

So you don't have any real plans to change the duration much?

No.

I guess my last question, is you said the fiscal paroling (phonetic) steady with 2000 net income would have grown 20 percent this year versus 25 last year. What does that assume for top line growth?

We didn't disclose that. We basically just wanted to look at the factors of how the checks came out, how the interest rate come out.

We didn't add anything in there when we did that calculation for additional sales activity or anything like that. It was strictly tech volume lock, the interest we locked in and such.

We do it to really give you a perspective of how those things have affected us.

So I guess what I'm asking, maybe ask it a different way, is net income growth only going to be falling (inaudible) 20 percent this year, all things considered equal, versus 25 percent last year, does that say anything about where the direction of the business is going in terms of operating leverage, or is that assuming the business you've lost?

We're still getting some operating leverage, but I think - and we're still going to see improvement. But whether it can stay at the same exact rates it was at when we were smaller - I think our size is getting up there which makes things a little bit more challenging too. We're getting up there. You have some trends that will change a little bit. We have said for some time that 30 percent plus years aren't likely to happen. I think we have a very strong business, a very good business, but it's one that's getting bigger and you have some of the normal things that happen when you do that.

So the normal growth rates in a couple of years, to 20 to 25 percent feasible.

I think a general feeling is a normal economic environment is revenue growth should be 14 and 17 percent. If we do 14 to 17 percent on the top line we'll do 20 or plus.

Okay. You broke up there at the end.

20 percent plus.

Okay. Thanks, guys.

Matthew Roswell of Legg Mason. You may ask your question.

My question has been answered. Thank you.

George Sutton of RBC Capital Markets. You may ask your question.

My question has not been answered. Curious about your cash levels and any sort of thoughts around potential acquisitions given the weakness that obviously a lot of folks are seeing in the market. Are you looking at that as an opportunity, are you looking at deals? Did you look at CBS Payroll, for example?

We had known about CBS Payrolls for some period of time. We probably would not have been interested at the level the organization was interested in. We continue to do small acquisitions under 200 or under 300 clients. We do them as a matter of course. I think this year in the last 12 months, John, we had -

40 or 50.

40 or 50 separate transactions under 2 to 300 employees?

Right, clients.

The opportunity for making large acquisitions in our world is just not plentiful because of obviously the limited scope of regional and national players.

What about some of the private players out there that could expand your capability? Is that under any consideration?

For example?

Someone on the time and attendance side for example or some of the beyond payroll areas.

Funny you raise that particular one because that's one we're thinking about currently. We've been using a variety of distributors of time and attendance vehicles, and right now we're under consideration of whether we should refocus that, one, as to maybe own it.

So the answer is yes.

It could be yes on that one. We're a long ways from doing anything serious.

Thanks, guys.

Evan Weber of SG Cohen. You may ask your question.

One, if I could just follow up. Did you say you bought 40 or 50 operators with, say a couple hundred clients?

No, we bought 40 to 50 with under 200 clients. Some might only have 20.

Because if you multiplied that out it became a fairly big fraction of the increase in the number of clients you talked about. So okay.

A couple of questions. Number one, I just wanted a little more clarity, John I apologize. Where you think that you're building in sort of 3 percent year on year checks per client decline for the year or would you say I'm building in sort of the current level of checks per client going forth on some sort of seasonally adjusted basis?

We took where we were in April which is probably about a 3 percent decline, give or take a little bit, and that's what the - just hold it constant and go and you didn't show us anything better.

Okay.

I want to go back on this acquisition because I don't want anybody misled here. We do these. Some may only be 10 clients. We don't buy any companies, we just buy clients, and basically we know about what the pricing will be and pricing has gotten better for us in the last 12 months. We know we'll only pay for what we get. We have pretty strong retention periods of 120 days in global pay and we turn.

Now, we do a little bit of due diligence in the field, but just so you understand the magnitude here, you can turn this in my office. My assistant, Jan Shuler, does a great job. Working together, it takes about 15 minutes to do one of these. They go pretty quickly.

You ought to be in the M and A business. A follow up, a couple of questions, John. One, is there any - when we look on a quarter basis are there any variations in the number of billing days or anything that would cause any distortion in the quarters?

No, we had some (inaudible). We didn't have anything there the calendar is straightened out.

And then my last question is, if you were during this period if you were successful in really going after established companies of which there are a very large number in your kind of sphere, and the startups were low, why wouldn't you be investing a little bit more right now in the sales force and trying to do both if you were on the assumption that there were going to get a little better economically? We ought to see some more startups, et cetera. We wouldn't you be trying to do that because somewhere down the line in the not too distant future it would give you a real jump start.

I don't think we have the level of comfort to say things are going to get significantly better in the next 12 months. When we made the decision on the sales force growth, particularly the core, it was based on what we thought the productivity in the sales force was going to be. It was based - obviously the cost of the sales organizations is an important part of our budget and we - it had to be part of a balance of growth or revenue and earnings and we struck a balance that we think we're very, very comfortable with relative to where we think the growth rate is going to be and what it's going to take the organization to accomplish to make sure that happens.

Okay. So you're just trying to manage it real conservatively, then.

Absolutely.

Okay. Thank you.

Rory O'Neill of PNC Advisors. You may ask your question.

Thank you, and good morning. Just two questions, basically a follow-up to two other questions that were asked. On the top line, 8 to 10 percent revenue projections, can you give us a feel, then, for what type of acquisition activity is built into that number and secondly, I guess, and you talked a little bit about the penetration level and the core payroll services (inaudible) your view what the penetration level is in businesses of under 100 employees at the present time.

Sure. First of all, the organization activity, (inaudible) I think this year given about 40 would number We don't build the big solid numbers (inaudible) acquisition of budgeting.

The penetration in the one to 100 employee range, there's still approximately 6 million businesses out there in the markets that we serve, and that is 103 of those markets, Ajax (phonetic) has 390,000 plus. We think ADT (phonetic) is approaching half a million. (Inaudible) players and it still comes out only about 12 to 14 percent of the total market place. John and I were looking the other day at one of our key areas, of course, for Paychex is the 5 to 19 category and we anticipate that the penetration level even in that area, which is I think is highly penetrated I think for the industry was under 25 percent, John So even if that 5 to 19 category, which is a terrific part of our world, we've got a long, long way to go.

Thank you.

David Grossman of Thomas Weisel Partners. You may ask your question.

Hi, two quick questions. First, Tom, if I did my math right, it looks like we're billing $19 a year per client. Can you just give us a sense of how that's been trending over the last 12 to 18 months?

That's probably not correct. If - what you've got to do is start with $1,400 for the quarter payroll plan, add $450, 85 percent or 90 percent of the time because that's the percentage of the companies that take tax pay and then add 75 percent of the time of the companies that we sell that take direct deposit or employee pay option, and I think you'll come up to higher than 1900. Probably closer to 2000 or 2100.

Okay. If we take that total, then, can you give us a sense for how the 2100 has been trending the past 12 to 18 months?

No question, over time it's been trending up, mainly because of the fact that our penetration level with tax pay and our penetration level with direct deposits have grown so dramatically over the years.

If you look back at Paychex in 1990, the year we started tax pay, our average revenue per client was probably around $1100 and now it's grown all the way up to - you can see the core service has grown to about $1400, but the ancillary is bringing up over $2,000, the two ancillaries. So the revenue per client has been fairly dramatic over the last decade.

Okay. And just one last follow-up on the comments you made about the checks per client. Any granularity in terms of what impact mix may be having or geographic or still too early to make any conclusions?

Way too early. Quite frankly, I don't think we've looked at it geographically.

Great. Thank you.

Shannon Cowen of TCW. You may ask your question.

My question is answered. Thanks.

Brent (inaudible) of Deutsche Banc. You may ask your question.

Hi, good morning, Tom and John. Two quick questions. John, I think I heard you say earlier that about a third of the growth in major markets came from migrating existing clients. Were the remaining two-thirds wins from competitors, or were those sort of first-time payroll outsourcers And then that's the first question.

Second question is, what tax rate should we assume for '03? Thanks.

The MMS client sales is about 30 percent from automatic data, about 25 percent conversion of Paychex clients who have outgrown our pay service, our core payroll service, and the rest of a combination of all other competitors and people doing their payroll in some sort of in-house automation. I would say as a balance of the last two, it's probably 50-50 between in-house automation and some other payroll processor.

Great.

31 percent. 31.0.

And just one other question on the major markets. Is - the 50 to 500 is obviously a pretty big range. Are you saying a lot sort of in the 50 to 100 range and fewer in the 200 or 300 or 500? Could you give us a little more clarity there.

It's definitely going to be much more directed toward low (inaudible). I think your average size client has about employees. The reason for that is because the higher you get in the number of employees, the fewer the companies are that have that many.

Right.

So when you find 50 to 100, you're going to find probably 50 to 100 employees are probably 80 percent of that marketplace.

Okay. Okay. Thank you.

Marta Nichols of Bank of America Securities. You may ask your question.

Thanks a lot. I just wanted to ask the margin question a little bit differently. Could you give us a sense of what the relative margins of your MMS and core payrolls are? If not explicitly, is there a 500 basis point or 100 basis point difference in terms of the markup that you can put on an employee there?

And the kind of related question to that is the fact that your margins are deteriorating a little bit, I think you suggested, John, a number of reasons why that can be happening, but can it relate to the fact that MMS is growing so much faster than core payroll at this point and your margins on that business may be somewhat lower?

First of all, I don't believe I said our margins are deteriorating. That's not happening. Our margins are continuing to improve at a little bit of impact on the checks per client when that goes down because that's most profitable. But everything else is positive. We're making some investments that affect, things but really nothing no do with this business change.

Now, you look at market changes in core, the only reason there's a different profit level really doesn't have to do so much as the major market software versus core software, MMS is larger clients. We've long talked about the fact we'd rather do ten tens than one one-hundreds. Doesn't mean we don't want to do the one one-hundreds, but we like ten tens better because they're easier to sell, easier to service, and you get a greater margin because the revenue per check is higher.

The MMS impact difference is the same thing ADT has. On the upper end you don't get as much per check, you render service, you get little benefits of volume, but it's not enough to offset that. We're very comfortable with our margins at MMS. We don't believe we're seeing any margin deterioration related that. Some of the slowdown is things that we don't have control over, but we still expect we'll continue to leverage this business as time goes on. Naturally when you take the float income out, you'll see in the past 12 months we've leveraged in a very, very difficult time. It went from 30 percent three years to 32 to 34, so we almost had the same improvement we've had from the last few years when you factor out the floater interest income.

I guess I didn't mean to imply that margins were deteriorating just due to any specific things other than the things that you were highlighting, things like your investments and so forth. Can you quantify at all the amount of the investments that you're having to make that are flowing for your P and L in fiscal '03 for the data center and buildings in Rochester?

The data center I think we said was going to be in the $30 million range when we got done, and it looks pretty close to that.

And that's capital after expense?

(Inaudible) eventually, but they don't happen right away. We did not disclose the building cost on either one of the two buildings, but cost, we're spending, I would say, less than half for more space than if we had expanded on our current site at corporate headquarters. The building we got in Webster is every bit as nice as the one we have our corporate headquarters in. I was just in it. The cost is so low it's almost embarrassing.

The other facility we did not get quite as good a deal, but we got a very good deal there because they built a very nice facility, some with manufacturing space that we can turn into office space quite easily because they had a high level degree of manufacturing. They were building a world class facility based on the fiber markets being very strong. They never really occupied most of the building. They're looking to get rid of it, and quite frankly, there aren't very many people in Rochester area that have cash and have growing businesses. So it's an opportunity and we took advantage of it.

Terrific. Thanks a lot.

Eric Fell of (inaudible) Capital. You may ask your question.

Hi, thanks. Struck me a little odd when you mentioned a potential acquisition that you walked away from because it seemed too expensive. Given that your stock trade is 37 times earnings over 23 times EBITDA, it seems odd to me that just about any acquisition would not be accretive. What's the valuation cutoff that you utilize, you know, management fits and everything else just strictly on an evaluation basis? Where do you turn down any acquisitions? Thanks.

We look at every deal on a deal-by-deal basis. Obviously for something that's big, probably willing to do more than something that's real small. It's got to look like it fits in. All those factors go into it, and we knew about the one you mentioned and just didn't seem that attractive to us. And we don't feel like we have to do acquisitions. If we see something that makes sense, we'll do it. And that one just didn't make a lot of sense based on what it was and how it was structured.

If I could add to that, there's two reasons for us to consider an acquisition. One is to consider sales volume and the other is some sort of strategic benefit. One of the issues you had with a company such as CBS is what strategic benefit do they bring us versus client revenue? And usually regional players are one branch or one city player, it's strictly a client volume type of thing. The philosophy is much different than buying an organization that was national because that has a much different strategic appeal to it.

We bought Rapid Pay sometime ago. It's been a while ago now, but they were a company that had some national presence and we said a pretty good price for it at the time for whatever we thought it was and it worked out quite well.

What are some representative multiples that you've been paying for acquisition, either EBITDA or earnings?

One-time buying, the market right now is somewhere in 101,35 and I see it softening. Are there deals out there that go beyond that? Yes. Sometimes we participate, sometimes we don't. Sometimes we can get it at a much lower level. We're not talking about bit ones here. We're talking about ones - we had one not too long ago. I think there was about 75 clients.

I know who was competing with us, and that sales guy said, John, you've got to go to 190. I said, I'm not going to 190. Tell them 125 and I bet you get that because they won't want to sell it to the other party. Sure enough, we got it at 125. It's really a fragmented thing we do. It's not life blood at this stage. But if somebody walks along and will give us some clients for a reasonable price and we know our retention opportunities, we take advantage of it. Other deals we continue to look at things, but we don't feel by any means we have to do anything. If something comes by and makes sense, we'll do it.

Okay. Thanks.

Ashwinser Baker (phonetic) of Salomon Smith Barney you may ask your question.

Thanks for taking my question. Questions on the average investment assumptions that you had, I'm not sure you addressed that for the coming fiscal year.

I think it's disclosed in the A-K.

Okay. Thanks.

It's right there. I think we gave a number on each piece.

For fiscal to currency? Okay.

Mark Marken of Wachovia Securities. You may ask your question.

Quick follow-up. Pays for control still around 14 per client?

Minus about 3 percent. 14.1 minus 3 percent is about the accurate number.

Okay. And what - you just went through the budgeting process. You're being conservative, which everybody appreciates. You know, if we did have a change in the economic environment and let's say that, you know, payroll or pays per control increased by 1 percent, relative to where they currently are, can you give us a feel for what that would do in terms of revenue and more importantly in terms of the high incremental profits and what that would do on the bottom line or at least the operating profit line if you did have that kind of a change.

I think 1 percent would translate probably into $4 or $5 million dollars of additional revenue.

1 percent would equal probably about 80 percent revenue realization because just like when the checks went down, your actual revenue per check went up slightly, the other way it goes down slightly and if that happens, what happens is going to the bottom line because we weren't able to cut costs when that happened, we won't increase costs.

I'd say 80 percent of that, $5 or $7 million, whatever it is for 1 percent, 80 percent of that would go to the bottom line.

So it would be $5 to $7 million in incremental revenue of which 80 percent would go down, at least, to the pre-tax line? I'm sorry?

At least 80.

At least 80. Okay. Great. And just to follow up in terms of the questions with regards to the size of clients, in terms of new clients, brand-new business formation, have you seen any changes with regards to the size of clients that are where you've just got a brand-new business formation? Are they smaller now or about the same size as before?

I'd say they're about the same as before. We've seen no tactical difference there.

Thanks very much.

At this time there are no further questions.

Okay. We would again like to thank you very much for your interest in Paychex. We hope all of you have a great and enjoyable summer and not too hot and not too cold. So take care.