沛齊 (PAYX) 2003 Q1 法說會逐字稿

Good morning.

Welcome to the Paychex, Inc. first quarter fiscal 2002 earnings release conference call.

All participants will be able to listen only until the question and answer session of today's call.

This conference is being recorded at direct request of Paychex, Inc..

If you have any objections, you may disconnect at this time.

I would now like to introduce one of your speakers for today, Mr.John Morphy, chief financial officer of Paychex, Inc..

Sir, you may begin.

Thank you for joining us for our first quarter press release.

Also with us today is Tom Golisano, our Chairman, President and CEO.

Upon the completion of review of our financial results, we'll conduct a question and answer session.

Yesterday at 4:30 pm, we released our financial results for the quarter ended August 31, 2002, as well as disclosing our intention to acquire Advantage Payroll Services, Inc.

If you need a copy of this release, it can be obtained by calling 585-383-3406.

Or by accessing our website at www.paychex.com.

And our investor relations homepage.

This morning we also filed with the SEC our form 10-Q for the first quarter ended August 31, 2002.

This filing is available on our website; in addition, this teleconference is being broadcast over the Internet, and will be archived and available for access on our website until September 26, 2002.

Please refer it our website for access to all recent news releases, current financial information, related SEC filings, and investor relations presentations.

The revised investor relations presentation will be on the web in the next few days.

The earnings released is summarized as follows.

For the first quarter of fiscal 2003, total revenue and net income grew 8%.

Quarterly earnings per share were 20 cents in the first quarter of fiscal 2003, versus 19 cents a year ago, up 8% on a unrounded basis.

Wall Street consensus was around 19 cents.

Our results continue to be adversely impacted by the difficult economic conditions in the United States, and the effect of lower interest rates on earnings from our funds held for clients and our corporate investment portfolios.

We also announced we have entered into an agreement to acquire Advantage Payroll Services, Inc. for approximately $240 million in cash.

In addition, we will expend approximately $75 million for the reduction of preferred stock and the repayment of outstanding loan balances.

Advantage is a privately owned payroll processor that serves over 49,000 small to midsized businesses throughout the United States.

All approvals have been secured, and this acquisition is scheduled to close in the next couple days.

The acquisition provides us the opportunity to offer current Advantage clients a much broader array of Paychex products, especially in the human resource area.

Further leverage our infrastructure and expand our geographic coverage into areas not currently served by Paychex.

I would like to now refer to the fourth page of release, the consolidated income statement.

Total service revenues increased 11% for the first quarter, to $239.4 million.

Service revenues consist of service fees earned from our payroll and human resource and benefit product lines.

Payroll service revenues for the first quarter increased 78% to $205.5 million.

The increase is related primarily to growth in the client base, increased utilization of ancillary service, and price increases.

Payroll service revenues were negatively impacted by a 2.1% year over year decline in checks per client.

The declining check volume trend peaked in the third quarter of fiscal 2002, and began to improve in the fourth quarter of fiscal 2002.

The year over year reductions in checks per client for the first through fourth quarters of fiscal 2002, respectively, were 2.6%, 4.3%, 4.8% and 3.0% in the fourth quarter.

As of August 31, 2002, 86% of our clients utilized Taxpay and 15% utilized the company's Employee Pay Services.

Major market services revenue increased 42% in the first quarter to 22.2 million.

Approximately one-third of our new major market services clients are conversions from the company's core payroll service.

Human resource and benefit service revenue increased a strong 27% in the first quarter to $33.9 million.

The increase is primarily related to growth and retirement services clients, and in client employees served by the company's past and PEO bundled services.

Retirement services revenue increased 26% in the first quarter to 15.6 million.

In August 31, 2002, we had over 23,000 retirement services clients.

The strong revenue growth in the first quarter also benefited from our slow start in the first quarter of fiscal 2002.

Paychex administrative services passed, and the company's professional employer organization, PEO, our 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 revenues from these products increasing 41% in the first quarter of fiscal 2003, compared with respective prior year period.

As of August 31, 2002, our past and PEO products serviced over 86,000 client employees.

Interest on funds held for clients decreased 29% for the first quarter, compared with the prior year period.

The decrease is the result of lower average interest rates earned in fiscal 2003, and the decrease in net realized gains on the sale of available for sale securities off somewhat -- offset somewhat by higher average portfolio balances.

Funds held for clients portfolio earned an average rate of return of 2.5%, in the first quarter fiscal 2003, compared with 3.6% for the first quarter last year.

Net realized gains on the sale of available for sale securities included an interest for funds held for clients decreased to 1.6 million for the first quarter, from 3.2 million in the prior year quarter.

Average daily portfolio balances totaled 1.85 billion for the first quarter of fiscal 2003, compared with 1.73 billion for the prior year period.

Increase reflects higher utilization of Taxpay and Employee Pay Services services by both new and existing clients.

Combined operating and SG&A expenses increased 6% in the first quarter compared with the prior year period.

This reflects increases in personnel, information technology, and facility costs to support the growth of company.

There were approximately 7,450 employees at August 31, 2002, compared with 7,300 at August 31, 2001.

The year over year expense growth also benefited from the fact prior year expense were higher than normal in the first quarter of fiscal 2002.

First quarter operating income increased 9%.

We continue to leverage our infrastructure as operating income, excluding interest on funds held from clients, as a percentage of total service revenues was 37% for the first quarter compared with 35% for the prior year quarter.

Investment income increased 11% for the first quarter, due to higher net realized gains on the sale of available for sale securities and higher average portfolio balances offset by lower average interest rates earned.

Net realized gains were 2.4 million in the first quarter of fiscal 2003, compared with net realized gains of 1 million for the prior year period.

Average daily balances invested were 750 million for the first quarter compared and 650 million for the prior year first quarter.

The increase in average portfolio balance was driven by additional net cash inflows from operations.

The corporate investment portfolio earned an average rate of return of 3.3% for the first quarter compared with 4.1% for the first quarter of last year.

Our effective income tax rate was 31.5% for the first quarter of fiscal 2003, compared with 30.7% for the same period last year.

The increase in the effective tax rate is the result of lower levels of tax exempt income on funds held for clients and corporate investments.

Fiscal 2003 effective income tax rate is expected to approximate 31.5%.

As mentioned earlier, net income increased 8% for the quarter of fiscal 2003 compared with the same period last year.

Looking forward, we are uncertain how long the challenging economic conditions and difficult interest rate comparisons will last.

The federal reserve has lowered the federal funds rate 11 times since January 2001, to 1.75%, which represents a cumulative 475 basis point reduction.

The last reduction of the federal funds rate occurred in December, 2001.

For the first quarter of fiscal 2003, combined interest on funds held for clients and corporate investment income was down 17% from the prior year quarter.

Total realized gains were 4 million in the first quarter of fiscal 2003, compared to 4.2 million in the same period last year.

At the present time, including the sale of investments to finance the Advantage acquisition, our unrealized gain position is slightly more than 40 million.

The raising of the funds for the acquisition resulted in realized gains of 7 million that will be recognized in the second quarter of fiscal 2003.

Other than those gains, we expect actual realized gains for the rest of the year to be much less than those recognized in comparable periods in fiscal 2002.

In addition to the effects of volatile interest rates, current economic conditions have resulted in a lower number of checks per client, as our existing clients reduce their workforces.

As previously mentioned, in the first quarter of fiscal 2000,, the company experienced a 2.1% year over year decline in checks per client.

For the 2002 fiscal year, checks per client declined 3.7%.

During the recession of the early 90s, the company experienced a total reduction in checks per client of approximately 3%.

We hope we have seen the peak in this decline, in the third quarter of fiscal 2002.

The slight improvement we experienced in the fourth quarter of fiscal 2002 has continued in the first quarter of fiscal 2003.

Income before taxes remains strong at 44% of total revenues for the first quarter, compared with 43% for the prior year quarter.

Our full-year fiscal 2003 expectations remain very close to what we released last June, and are based upon current economic conditions continuing with no significant changes.

They also exclude the impact of the Advantage acquisition that we'll discuss in a few moments.

Accordingly, for the full year fiscal 2003, we project payroll service revenue to grow in the range of 9 and 11%, and human resource and benefits service revenue growth in the range of 18 to 20%.

Total service revenue growth is anticipated to be in the range of 10 to 12%.

We expect interest on funds held for clients and and corporate investment income combined to be down approximately 15%.

Taking these 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%, with net income growth slightly less than total revenue growth.

We expect the acquisition of Advantage to add approximately 75 million in revenue over the next 12 months.

Now, you should be aware that's the next 12 months, not necessarily the last nine we have left in the fiscal year.

However, in the fiscal year ended May 31, 2003, we anticipate that the acquisition will be slightly dilutive as the earnings from Advantage plus the realized gains from raising funds to purchase Advantage -- those are approximately 7 million -- will not offset the lost investment income from the acquisition -- that's expected to be approximately 11 million -- and the amortization of intangibles --those are right now projected to be in the 12 to 13 million range, but are subject to our obtaining external opinions on evaluation -- in the expense of assimilating the acquisition.

So we therefore expect future earnings to be accretive with a little bit of dilution in the current fiscal year.

Moving to page five of our press release, our balance sheet is very consistent with May 31, 2002, plus our growth during the first quarter of fiscal 2003.

Total cash and corporate investments have grown to 784 million, and will be in the 475 million range after the acquisition.

Our total available for sale investments, including corporate investments and funds held for clients, reflect unrealized gains of 42.4 million at August 31, 2002, compared with unrealized gains of 26.7 million and 31.9 million at May 31, 2002, and August 31, 2001, respectively.

The decrease in interest rate environment drove the improvement in the market value of the available for sale portfolio.

The volatile interest rate market is resulted in significant changes in the market value of our available for sale portfolios.

During the first quarter of fiscal 2003, the unrealized gain position ranged from approximately 26 million to 44.3 million.

The unused gain position was 40.3 million at September 16, 2002.

Our net property and equipment balance activity during the quarter reflected capital expenditures of 22 million, and depreciation expense of 7 million.

For fiscal 2003, capital expenditures are expected in the range of 65 million to 70 million, including the purchase of a 220,000 square foot facility in Rochester, New York, which was completed in the first quarter of fiscal 2003.

In the last 15 months we have purchased two excellent facilities in Rochester area that enabled us to discontinue our plans to make a substantial addition to our corporate headquarters building.

The revised plans will result in spending approximately 25 million less than our original plan.

Depreciation expense for fiscal 2003 is expected to be in the range of 33 million to 35 million.

Total stockholders equity increased to 972 million at August 31, 2002.

With 41 million in dividends paid during the first quarter of fiscal 2003, a payout of 54% of net income.

A return in equity for the past 12 months was 31%.

The accumulated other comprehensive income balance at May 31, 2002, of 17.0 million, is increased to 27.1 million at August 31, 2002, which reflects the previously discussed increase in the market value of our available for sale portfolio.

With the volatile interest rate environment, we received many questions about potential impact of changing interest rates.

Please refer to our form 10-Q, which was filed with the SEC this morning, under the section entitled Market Risk Factors, for further discussion of interest rates and the related risks.

You'll also find that there's significant discussion there on average rates, prior year balances, et cetera.

Safe Harbor: You should be a aware that certain written and oral statements mailed 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 from anticipated results.

Please review our Safe Harbor statement on page three of the press release for discussion of forward-looking statements and the related risks factors.

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

Good morning, everybody.

First a couple comments on the quarter.

We were pretty pleased with our sales results, our payroll sales numbers were slightly below our intention, but generally pretty pleased.

Our HRS sales organization was above original intention.

So in balance we feel very good about what is happening saleswise.

In the arena of [INAUDIBLE] client retention, which of course, is very important, we were right on target, maybe couple of tiny fractions off, but very, very happy.

One of things that we have seen further improvement in is our payroll specialist retention.

Our rate of turnover is in the lowest probably in the history of Paychex these days.

A lot of effort is focused on payroll specialists, the job itself, as it relates to training, recruiting, et cetera.

So we look very good there.

Our sales rep retention in payroll and MMS and in HRS also is doing very well, much better for the first three months this year than the first three months of last year.

So we're pleased on that.

The big news of course is Advantage.

Obviously, first of all I'd like to greet all the people from Advantage.

Over the last several years, they've done a tremendous job of building a significant organization in the payroll processing world.

To go from where they were five or six years ago to having 49,000 clients is quite an accomplishment.

Obviously, the reasons that they were attractive to us is the fact that they have a very compatible client base.

Their client base looks very close to ours, very similar to ours, and they also -- we have very similar branch organizations.

There's good branch overlay.

They do provide us with an opportunity to open up some new markets that Paychex hasn't been involved in, and they already have existing client bases to give us a good start there.

So the branch overlay looks very good.

We're impressed with the people that we've met, and even a lot of the people we haven't met,based on their reputation and what they've been able to accomplish.

Obviously, Advantage, with having 40 offices, had a national footprint, and that certainly was of interest to us.

They've been a good competitor in the field, and now we are emerging our efforts together for a stronger sales organization.

So with that, I think now, John, we'll open this up to questions.

Thank you, sir.

At this time we're ready to begin the formal question and answer session.

If you'd like to ask a question, please press star 1.

You will be announced prior to asking your question.

To withdraw your question, please press star 2.

Once again, to ask a question, please press star 1.

Our first question comes from Mr. Greg Gold from Goldman Sachs.

Sir, you may ask your question.

Hi.

It's John Mathis for Greg.

John, maybe can you walk us through why Advantage is such a good acquisition, and what the steps for integration will be and at what point you think it will start to become accretive?

Thanks.

Alright, thanks Greg.

I think the first thing is when you have a acquisition that has a compatible client base, the real benefit that you get is, if you can emerge processing operations, and you know a lot about our profit margins and our operating payroll, that we should be able to bring the same results to the Advantage revenue to Paychex as far as operating margins.

So if you look at the acquisition just as what it can do to our incremental profitability.

It becomes obvious it's a good move for us.

Fact they've been a significant competitor out there and now we don't have to contend with them as a competitor is obviously a sales advantage for ourselves.

And third, the IT organization that they have, we understand they have some very good people we think we'll be able to integrate some of those people into our organization, and I think that would help us, as well as some of the sales and sales management.

They have a sales organization of about 175 people, and based on my understanding and feeling today that everyone one of those people that is successful with their job and wants to work with us will have --certainly have a place for us.

So that will be additional help.

Third -- or fourth, I think they've had some great system ideas over the past and their IT organization.

And we'll be taking a look at those to see what benefit they may have.

Also, the fact that we can expand our marketplace for all of our HRS services, particularly 401(k).

That is also an additional opportunity.

So the combination of operating margins and applying that to the Advantage revenue, the opportunity for acquiring -- having better or good people, available to us, that helps, and the fact that the competitive environment, at least in these 41 markets will be slightly different.

When do we think it will be accretive?

I think you have to give us maybe two quarters to get much of this new volume brought into our processing system.

Although a significant amount of their volume, we're going to leave on their processing system.

We're going to take a look at the profit margins of some of our larger branches, of their larger branches, excuse me, and they do have some licensees we'll continue doing processing for.

That's also a profit for us.

So give us about two quarters, maybe three, and we should have this thing totally integrated and operating in maximum.

Okay.

One other follow-up real quick.

On the MMS business, can you talk about the outlook there and maybe a little more color on how that's performing?

MMS is right on target this year.

You know, we expanded the sales organization and the number of new locations.

I think the sales organization expansion was about 25%.

We're very happy with where MMS is and where it seems to be going.

So there's no surprises there other than pleasant ones.

Okay.

Thank you.

Mr. Adam Waldo from Lehman Brothers, you may ask your question.

Good morning, Tom and John, how are you all?

A few questions on Advantage, if I may.

Both as we look at your overall corporate development strategy in this acquisition particularly, Tom, you've articulated a goal first and foremost to use the company's corporate involvement capacity to [INAUDIBLE] your acquisition for subsequent organic growth.

Secondarily, I think historically, domestic acquisitions and thirdly, potentially, stock buy back, although I think historically you've been lukewarm to those.

I wonder if you could just recap for us how you're making on those three initiatives, evolves in the Advantage deal.

Well, as far as Europe is concerned, we're proceeding with that.

We've identified some potential prospects for acquisitions.

They are very tiny companies, comparatively speaking, to an Advantage.

And we are doing this because we want to take a very slow and methodical approach to Europe.

Because we understand there is significant cultural differences and processing differences.

So the Advantage acquisition will not have an impact on western Europe.

We're going to continue with it.

As far as acquisitions here in the United States, you know Paychex , maybe comparatively speaking, has not been as aggressive in others organizations in acquisitions, even though we've been doing between 15 and 25 a year, generally they have client bases of less than a couple hundred clients.

We've had about for our five acquisitions over our history between a thousand and 3,000.

And of course, when you look at the overall it doesn't seem that material at this point.

But the Advantage acquisition brought together a lot of opportunity for us, and obviously to obtain the operating margins on their revenue and incorporate that every day into our financial statements is one.

The competitive environment is second.

And third, the acquisition of more qualified people that have a solid history in this world, is certainly a real benefit.

As far as the stock purchase, stock repurchase, Paychex has, at least at this point ,not ever done anything in that arena.

Our attitude is basically that we're not inclined to do it, we're not saying we wouldn't to it under any circumstances.

But at this point, we're not inclined do it.

Okay, if we can focus in on the Advantage deal, then.

I think a couple of potential synergies exist, Tom, and I wonder if you can comment on them significantly.

One is, historically the Advantage sales force was relatively underspanned in terms of, quote, a relative to your own, and that was a clear strategy of Charlie Lathrop in building the organization.

I wonder to what extent you see the opportunity to increase quota, as advantage towards Paychex norms and over what time, and the time frame we can expect that, is possible; and secondly, to what extent you could quantify for us the cross-selling opportunity that Advantage has.

Historically they haven't had much penetration on the retirement side or the HR benefits side.

Well, as far as the sales organization is concerned, my guess is that our productivity -- and I can't say that specifically at this second -- per rep on a unit basis might be higher.

But I can tell you in the same breath that there's a direct correlation between the sales productivity of a sales prep the number of existing clients and their territory.

Mainly because both organizations sell highly through referral processes, through existing clients and CPAs.

Bringing in 49,000 new clients into Paychex automatically tells me that we should increase the size of our sales force accordingly.

Now, with -- if you looking at the ratio of 49,000 clients to 175 salespeople, you might say that the Paychex sales reps have more clients on their territory than the Advantage people do.

So consequently, we're going to -- our attitude is to bring them all into the organization and to assign them territories.

And where it works it will be great and and in some cases, it may not work.

I mean, just like you have general conditions with any sales organization.

But our attitude is very positive towards that sales organization in bringing them into the fold with Paychex.

I'm sure there's a number of them too that used to be Paychex sales reps, as far as the daily activity.

As far as cross-selling opportunities, when you have 50,000 new clients available to sell workers compensation or 401(k)s plans or Paychex administrative services to, obviously you can guess our MMS or I'm sorry, our HRS sales organization has got a wild -- wide smile on their face today based on this acquisition because it's 49,000 new opportunities for them.

So they're quite happy about it.

Do I think we're going to disproportionate amount of new sales for 401(k) out of workers comp out of this advantage group?

Probably not.

But still it's a huge opportunity for HRSP.

Okay and if you can try to give us a sense for what sort of variable contribution margin you would expect on the Advantage revenue base when you think you've got it fully integrated, that would probably be helpful to us from a bottling standpoint..

Well, I think the -- there's no reason why the revenue that comes into us from the Advantage merger or acquisition, that we shouldn't achieve the same operating margins on that revenue that we achieve on our own.

Okay.

Now, generally speaking, I would say there might be a little pricing differences, depending on city to city comparison, but over time we'll bring those into line.

Okay.

And does this is affect your head count addition plans either for aggregate corporate staff, or sales force head count over the balance of fiscal '03, if so in what fashion.

Not really.

I don't think anything is going to change of any material nature there.

Thank you.

Greg Capelli from Credit Suisse First Boston, you may ask your question.

Hi, guys, it's Greg and Josh.

I guess, you know, Tom, can I ask you, is there any thought to maybe using Advantage as another distribution channel, maybe even keeping the name, and then, John, just follow-up, could you come up with an IRR at this point, what you think this thing can generate, sort of long-term for you guys?

I'm guessing, with as much defense, as well as your thoughts, it will be value created over time.

Let me answer the first one.

You know, obviously, we have some requirements in the Advantage contracts to maintain trademarks and labels with the associates.

I think that -- and Tom will comment more in a second -- it also allows us to evaluate whether there are some more channels of distribution, different ways to distribute our products since you have another one here.

We haven't gotten through that whole thought process yet, and we will.

When you talk about internal rate of return, we didn't really go calculating exact amount.

We have a pretty good idea of what payroll companies are worth.

When we buy individual clients, obviously we pay less than this, but this was a unique opportunity to get 50,000 clients in one time.

It was an ability to also get 50,000 clients that had very little use of our human resources system type products.

And we know we can leverage this in with our scale and see lots of opportunities here, and we'll sort through them and turn them into reality over the next 12 months.

I can get you one example --- one of the relationships Advantage has with the organization called Napster, New England business services, where there's a processing arrangement with the NEBS organization that's been very success Thank you.

That may provide with us a new model for forming other alliances throughout the country, for both Paychex and Advantage commonly, obviously.

That might be very interesting.

But certainly they did a great job with the New England business services relationship and it's been very, very productive for both parties.

Okay, then just as far as potentially using them as a separate distribution channel, any thought to that?

Using --.

Advantage -- As a separate distribution channel?

Not other than what John mentioned, that we have the ongoing relationship, the associate and any ongoing relationships with organization like NEBS.

Okay, understand.

Just one more question.

Given the impressive margin [INAUDIBLE] in the quarter, can you offer some additional color on the HRR business services division?

Well, other than the fact I mentioned their sales activity was very strong in the first quarter, and as we've said many, many times, HRS the incremental revenue on those products is very profitable and profitable because we're very efficient and effective in delivering the service because we do the payroll.

So incremental revenue, particularly in 401(k) record keeping, is probably more profitable than incremental revenue is into our payroll group so we're very happy sales have been strong and hope it continues, and get the benefit of those high margins out of it.

Other thing that happened is whenever we make changes, we learn this every time and it gets rejustified in the sales force -- a little over a year ago, we split the sales force in HR into the past PEO part, and the 401(k) part, and we didn't get off to a real good start a year ago.

Right now we're seeing the benefits of doing some of those decisions.

So as usual, we make a change, it generally takes a little longer because we're pretty aggressive on how fast we want it to work, but now have it moving quite well.

Okay, thanks a lot.

I appreciate it.

Mr. Steven Weber from SG Cohen Securities Corp, You may ask your question.

Yes, good morning.

Couple of questions.

You've talked about doing 75 million -- I'm talk talking about Advantage now, you're talking about doing 75 million dollars, if you sort of took the -- when they had the S 1 out there, and I know that was a seasonal quarter.

But they were in 80 million dollar annualized rate.

Can you give us some of the underlying assumptions about how you get to 75 million?

What -- do you expect a loose -- what do you expect to lose in clients when you do conversions?

What happens to growth?

What happens to these associates?

And then associatively, are there any policies, accounting policies or things that have to be changed in some -- in material way to put these two companies together?

First off, I don't see any accounting policies issues whatsoever at all.

The thing we do have to determine is what is going to be the intangibles that have to be amortized.

Right now I think that will be somewhere around 100 million.

We haven't got an exact idea on the life yet.

We got some ranges, and I gave you an approximation and I hope it will high on what goodwill --or not-- what the amortization will be.

Now when you look at the revenue number of 75 million and I know they had 80, first off we like to underpromise and overdeliver a little bit.

We took a conservative approach.

The next thing I think is the year goes on you're not going to be able to know what the revenue is.

Now, we'll know what the revenue is on the Advantage clients that are still there.

We don't expect any significant retention problems.

We got to make sure we do the right service.

We convert them, we provide them values similar to what they've been provided and we can provide more value with our ancillaries.

But Steve, eventually the sales forces are going to be integrated.

So you're in the areas where it's pure Paychex, that sales force which was selling Advantage will start to sell Paychex.

And because it will do that, there's revenues that would have been in their 80 million that won't occur.

They'll occur, but they'll be in my number.

So right now we wanted to put out a conservative number what their estimate was.

We gave it a little hair cut from what they said because of the changes in sales, and that's our best estimate at the present time.

Okay.

Just a follow-up.

If they have it about a 9 million dollar tax loss carry forward.

Can you avail yourself of that, or do you lose that?

We believe we'll not only be able to avail ours of that tax loss carrying forward, in this particular deal there's probably almost another 10 million tax loss carry forward, that will be created as a result of warrant agreements, option exercises, and things that will take place just before we bought them.

Right now, the good news for us is there's three or four expense that are pretty sizable, and if they went public they were going to affect their financial statements rather dramatically but they're going to occur before the crossover point so we're going to wind up with some pretty good opportunities on tax laws, carry forwards.

Our tax people are pretty aggressive in this area.

We just got to make sure we keep structures in the right place to enable us to avail ourselves of them.

Okay.

So that is -- is that -- I would assume that's pretty helpful of -- to making this thing accretive, two to three-quarters out.

We didn't put that in yet because I didn't start determining when we think we can avail ourselves of those.

So we've adopted a conservative view.

I think we talked about accretive, it's going to be a plus.

But at the moment we're not saying this is something that is substantially changes earnings one way or the other.

I think the real change is going to take place in the marketplace, where our conditions will be more favorable, and that is something that is almost impossible to quantify exactly.

Okay.

One last question., John.

Are you -- will there be any kind of restructuring charges or one-time charges, and will you -- do you have any idea how much that would be, and are you going to spell those out, as I assume they're happening this quarter?

We obviously, if we have those, will spell them out.

For me to say there will be absolutely none of those would probably be way too optimistic.

I don't know exactly what they're going to be because until we really assimilate the people situation, you just don't know.

I don't think they have significant facilities expense that's going to cause big problems.

It's really how do you merge the organizations together with the people.

Until you know all those things, because right now we want to try to utilize as many of their people as possible.

We're going to have to evaluate it and see where it goes.

I don't see it being a huge, huge number, but to say it will be zero isn't the right answer either.

Okay.

Thank you very much.

Mr. Adam Frisch from UBS Warburg, you may ask your question.

Thanks.

Jason Covingburg here for Adam.

I just want to ask a question on the product that Advantage brings to the table, and you can talk about any sort of synergies in terms of product features and functions that may exist with Paychex products, and how will you sort of integrate the two?

Or will that be a very gradual process?

For the most part, and I say for the most part because Advantage is still processing payrolls software from companies that they acquired.

There was the acquired other payroll processors and they continued to run their payrolls net software.

First of all, those are probably the first clients that will want to convert to the Paychex system.

And it will be generally, pretty much a manual process and will be kind of concentrated in maybe four or five cities.

That is probably the most difficult part of this situation.

From a assimilation point of view.

For the bulk of their clients that are processed on the Advantage payroll system, we'll take a look at each of the cities, city by city, and determine the best approach.

Certainly, we may come up with the conclusion since we're going to maintain the Advantage software for some significant period time, that there may be some branches we may leave right on the Advantage software, even though we have a branch --or Paychex branch present in that city.

It will depend on the size of the branch, et cetera.

Obviously, branches that have, you know, six or 800 clients or less, we'll probably move them quickly over to the Paychex system.

But we have not come to any dramatic conclusions at this point as to how fast we'll do it and how we're exactly going to do it.

We've got some ideas, but until we spend more time with the Advantage people and more understand their system, we're not going to jump to any conclusions.

But overall, this kind of a conversion based on the resources of both organizations over a nationwide network of 103 branches that we have, it's a job, but we think it's a very doable job and controllable job.

John mentioned obviously the number-one issue always in a situation like this is client retention.

So we're going to be very focused on that.

The other thing that's an issue, we're coming up on calendar year end, which is a very busy time for payroll processors.

There's a good chance that very little will be done until after the first of January.

Because of the high volume of work, not only within our organization but also within Advantage's.

So we think it would be pressing too hard to try to get too much down between now and January, so we're going to be very conservative between now and then and then we'll understand it more after year end then we'll probably get more aggressive.

Okay.

That makes sense.

And outside of the acquisition, can you just comment on essential increases in penetration rates or Taxpay and Employee Pay that continue to creep up like a percentage point or so each quarter, which is great to say, but at what point do you think you may hit sort of a saturation level, particularly with Taxpay?

Okay, we've been talking about Taxpay for quite some time.

Our quoted numbers has been 83 to 87%.

We've gotten above that.

Right.

I think 90% is the maximum.

I think you're just going to see it continue to creep a little bit towards 90.

Employee pay at 55% I think can easily get to 70%, and if the, kind of the arena or the environment in this country changes where banks finally push for more Direct Deposit pause of check fraud, direct deposit would get as high as Taxpay.

But I can't say that will happen without a little help in the environment saying you can force a person on a direct deposit.

The direct deposit penetration of 55% is overstated in a way because we have transaction fees on that product and the transaction fees are not fully penetrated on the 55% because we don't charge when a person basically uses their own check and signs it.

That trend is moving away from that.

So right now, I think Taxpay is getting close to maturity.

We'll grow with the client base, whereas direct deposit I still think has quite a bit of room to run.

Great, thanks, guys.

Brian King from Prudential Securities, you may ask your question.

Good morning.

Just want to go back on the quarter, the operating margins obviously were higher than we expected.

I think, John, you mentioned maybe two things resulting in this, one was that there were higher expense in one Q '02 so that made the comps, you know, a little bit easier, and the second maybe was a reduction in head count.

I just want to get clear.

What happened was we went into last year as usual, optimistic.

We had a budget, and you know, the recession kind of came on very quickly in the low end in the third quarter.

And that unfortunately the third and fourth quarter we get in there is when we staff up for the next year.

We had about 100 extra people and payroll specialists and other jobs in the field, we don't lay people off, so we worked our way through that problem in the first three to four months.

So I think we got some very good leverage into first quarter because last year we had expenses we shouldn't have.

Little better than what we anticipated, but we now have the costs under control.

So going forward you might not see the same degree of leveraging, but our goal is always to keep the growth and people at or below client base growth, and we're going to continue to try to do that.

Okay.

And then just want to make sure, was there any other besides Advantage, any other accusations made in the quarter.

We do just -- and I don't want to get the same thing I got started last quarter, we continue to do the small client acquisitions but again, they're very small.

They're not material.

In the course of a year we're trying to add, you know, over 100,000 new clients.

We may purchase somewhere between 1500 and 3,000.

There weren't any major ones in quarter.

Okay.

And finally on Advantage, I think,Tom, you mentioned that they give you the opportunity to get into new markets.

What did you mean by that?

They operate in about three or four geographic areas that we do not have a presence with our payroll product.

So they give us a basic clients we will, you know, proceed to head on to that we might not have ordinarily.

For example, in Portland, Maine, where -- or Auburn, Maine, they have a significant client base.

I think there's three or four other cities around the country, that we hadn't gotten to the point of opening the processing center there, but they through acquisition or through sales process had created a significant client base in some of those areas.

So we will maintain those offices, and encourage them and help them grow.

Now if you have a facilities or offices in the same area, will you probably end up closing one of them down?

Is that--

The physical facility, probably, yes.

But then on that, there could be interesting things there because you can take an area like Chicago, where we have I think over 10,000 clients and I think they have three or four thousand, you might decide that fully consolidated, you might try to take advantage of it but doesn't mean you might not have two facilities.

To expand on what John said, in central new Jersey, which processes a lot of clients out of Manhattan, in the same facility, we actually have two branches in the same metropolitan area and they're both of such size that we get the operating margins out of each that we desire, but at the same time the manager and responsibility is spread, and the geographics location of two situations is much better than having just one larger one.

That may happen in a couple places.

Okay, great.

Nice quarter.

Thank you.

Thank you.

Tim Cassain from Bear Stearns, you may ask your question.

Yeah, thanks.

Hi Tom, hi, John.

Not to get too micro, but can you give us a sense of what the intra-quarter trends were in the checks per client?

That stuck, basically.

Seemed they were improving the past two quarters?

Basically, the improvement we saw in the fourth quarter continued, and it got what I -- and I had to sit down and I talked with one of my finance people, and I said, okay, usually like to look them in their eyeballs, and it's improving but it's very slight.

So if I had anything to say about what I see in the economy now, it's stuck.

Not going up, not going down.

You know, new sales activities okay.

Retentions okay.

Losses -- we're kind of where we are and that's why you'll note that we do our forecast and our forward-looking statements based on current business conditions, and if you look at what we're saying is what's going to happen at the end of the year compared to three months ago, it's almost identical, except for a slight improvement on the human resource sales, where we got off to a little bit better start than we anticipated.

Okay.

And Tom, what is your gut?

I mean, you are starting to see improvement in a temporary help numbers?

Do you think six to minutes months , you're going to see real--

I'm where John is -- stuck.

We're happy we saw this slight improvement down to 2.1% decline from 3-6 but I tell you, I wouldn't take anything more than that to the bank.

Got you.

Okay, thanks.

Robert Maniat from CIBC World Markets, you may ask your question.

Yes.

Good morning, guys.

Couple of questions.

Taking a look at the sales reps to date, they have I guess you said, roughly, they have 175, can you give us an idea what retention you're anticipating in your numbers?

The 175 I believe does include their middle management and senior management people that are assigned to sales.

Are you talking about initially or over a 12 --?

Over a 12-month period.

Over a 12-month period?

My guess is that -- it is strictly a guess at it moment, but my guess is that we should retain at least over 12-month period between 70 and 75% of them.

You know, there's going to be a get acquainted period, and there's going to be a sort of measurement period.

They're going to measure us and we're going to measure them.

Sure.

Then we'll start to wield its way.

But I would be disappointed if it wasn't 70 or 75% retention after 12-month period.

Maybe I'm too optimistic.

Based on turnover levels, that may be optimistic.

You have our turnover, which creates opportunities.

I think their turnover is less than ours, which is a good thing, and hopefully will help us.

But this, you know, this thing can work its way out pretty quickly.

Other thing we have going for us, the first three months or first quarter of our fiscal year is when is we have the highest annualized turnover rate.

Because the salespeople are so successful in November, December, January, February selling period, the retention levels are actually higher in those four months than the rest of the year.

So we got that working for us.

Do you anticipate or historically, acquisitions this size, do you -- have you historically paid down retention bonuses, anything which we should try to factor into our margin analysis?

That's under consideration now.

But I don't think it will be significant.

So I don't think you have to be concerned about it.

Okay.

And if you look at the 49,000 customers, this is probably difficult to answer, but any idea what historical retention is on customers?

They have been stating publicly in preparation for IPO and privately to us that they expect their client retention numbers to be consistent with ours.

So we don't anticipate any surprises.

You might see something in their offering that would indicate the retention is better than ours.

They calculate it slightly different.

If you calculate their retention on the same basis we do.

It's almost identical.

But you don't expect any additional flipage because of, you know,f the acquisition and some of the moving pieces that go into this?

If we engineer this right and commandeer it right, there should not be any significant issue relative to retention.

I think we've been through enough times, and actually the Advantage people have been through this enough times, that we think we know what has to be done.

The level and speed of which we can do it.

And you know, obviously, client retention is the key to this thing.

If you don't do a good job of client retention on acquisition like this, it's bad news.

Sure.

And one last question.

On the margins which, again, everyone else said very impressive, just trying to get a feel.

Was any margin improvement due to better cost containment in a tough market that you can you know, pinpoint?

Sure, our people -- we would be kicking them if they weren't watching.

Were they watching closer than normal?

What would you say there?

I'd say they're watching it closer than normal.

We watch costs closely at all times time -- all the time.

But a year ago we said we hired people ahead of the curve, this year we're not ahead of the curve.

As a matter of fact, I think in every area of sales and one area you don't wand to be under in, we're under on people.

People are trying to do without.

I am looking at John Morphy's credenza and see a book over there that says "Managing In A Downsized economy."

I think we've been tuned in on this issue.

I appreciate your time.

Okay.

Jennifer Dugan, from Merrill Lynch.

You may ask your question.

Thanks.

You mentioned in the prepared comments that sales in the core payroll area were a little below plan.

And can you can tell us a little about why you think that is and if there's anything you can do to correct is or if it's just the market environment?

Well, it's probably a combination of market environment and probably something to do with Paychex management.

Obviously, when you have a sales organization as large as ours, it all doesn't perform at the level you expect it to perform.

So we have our weak spots.

We're working, on them.

But it's nothing we feel that we -- that is dramatic.

It's just the everyday sales process.

And I would say if any of the factors that impacted our sales productivity right now, it's the -- not as much formation of brand-new businesses.

And we can see that in our CPA referrals that they're not as referring as many CPAs.

So what our sales force has done and has been doing for over a year, you know, they always go to the path of least resistance, and that now is selling more existing clients than new clients, or new businesses I mean.

And that is showed up in a different way, which was a surprise to us.

In that the average revenue per client per year that our payroll sales force was selling today is significantly higher than it was a year or two years ago.

So I think the combination of less business formations, selling slightly larger clients because we're selling more existing businesses, and you know, the general economic development has us where we are.

We don't feel concerned about it.

We work at it every day, of course.

Okay.

And is there anything new going on in the pricing environment or the competitive environment?

Seems the last couple quarters there was back and forth initiatives taken by you and ADP.

Is that still going on.

What you're referring to is, generally speaking, at the end of the calendar quarter.

ADP gets much more aggressive going after Paychex clients, and generally the mode they use is pricing.

We responded -- generally we ignored it up until about last year and thought they got overly aggressive and we responded last year with programs of our own.

Right now, we're just waiting to see what happens.

To this date, we have seen nothing unusual coming out of either ADP or any of the other competitors.

Okay, great.

Thank you.

Martin Nichols from Bank of America Securities, you may ask your question.

Hi, this is Jason Shue for Marty Nichols.

I'm just with a follow-up question to Jennifer's.

We're seeing a lot of pressing pressure in the outsourcing business in general.

I was wondering, can you give us a little outlook for your pricing for core payroll, major market services and H&R benefits?

Well, we have not changed our pricing scheme over the years.

And when it comes to our anniversary date of price increases, and we do them on a yearly basis now, we are generally in the range of you know, under core payroll processing of 2 1/2 to 3 1/2%, something like that.

We were consistent with that this year.

We saw no unusual reaction to that activity.

So we don't think much has changed.

I look at our discount figures relative to the percentage of our clients that we're selling that have some sort of smaller minor discount.

It's inched up a little bit over the last few years, but nothing that we're alarmed at at this point.

Do you see any significant difference between major market services and core payroll?

Terms of pricing?

No.

I'd say both of them are pretty consistent.

Our Major Market Services Payroll salespeople are generally tend to be more experienced and more skilled.

So I think in that environment, the sales force will rely less on some sort of discounting process because they're better skilled salespeople and more experienced than say, our core sales people tend to be younger and less experienced.

Okay, one more follow-up question.

About Advantage payroll.

You mentioned that they had strong retention rates.

Are their turnover rates similar to yours?

Well if you calculate them on the same basis, you know, the same type of calculation, you'll see that they're very similar.

And you know, or maybe you don't know, but Paychex over the last couple years has been very happy with its client retention rates.

They're obviously doing the same thing.

Any trends in client business failure rates at all?

Not that we can measure.

To tell your candidly, we look at why we lose clients, and the percentage of clients lost to being out of business and so forth, hasn't change materially in the last few years.

Okay.

Great.

Thanks.

George Sutton from CIBC Capital Markets.

It's -- RVC.

But with respect to the competitive environment, you mentioned that Advantage was a very good competitor.

Can you explain how they were a good competitor?

Were they aggressive on price?

Did they offer a good product?

I'm just trying to understand how the environment improves with adding them to your fold.

Well, in 41 states cities across the country they had a competitive sales organization, and now it's going to be one sales organization.

Their product is, I would say, has been very good, and their sales activity and processes are very similar and concept and theory and in practicality to Paychex.

I mean, they worked with CBA, they worked with client referrals, they did all of those things that we've been doing for three decades and they did a very good job of it.

So -- and in most cases, from what I can tell, I can't give you the final detail, but in most cases it appear their pricing was less than Paychex.

Paychex has been sort of the price leader in the low end of the market for the last 15 for 20 years and our competitors tend to price their products, you know, 5, 10, 15, 20% less than our ours.

I think Advantage fell into that scenario.

Okay, great, and you had touched on this but I just want to see if we can get more granular.

Mentioned fewer referrals into the CPA channel, you had mentioned that last quarter as well -- are seeing any change there?

You mentioned that your folks were getting more proactive about making outbound calls or more cold calls.

Is that still the case?

Have you seen any real change there?

No.

We're pretty much on exactly what I said then and I think it still applies today, because we're getting less new business referrals from CBAs because they're less new businesses being formed.

Our sales force will now take a different path.

And not overall because CPA referrals are still a huge part of what we do.

But they're just not as big as they were a year or two ago.

I think when our economy gets back on track I think you'll see that activity resume at the levels we were used to because we worked that arena very hard.

Okay.

Then lastly, ADP had their analyst meeting yesterday, and they talked about how they restructured their sales to focus more on the by to 100 market.

Have you seen any impact from that, and you know, they're trying to move obviously more of those customers up market in the more products.

I couldn't tell you from my chair that I've seen anything significant happen in the marketplace with AD, and in the last 12 months, relative to what you're saying, or actually relative to anything.

Except that unusual spurt of high competitiveness in the last two or three months of the calendar year last year, everything has been sort of status quo with us and ADP.

Okay.

Great job.

Thanks.

Randy Mills from Robert W. Baird, you may ask your question.

Good job on the solid quarter.

And the acquisition.

And I know a few other companies that can probably benefit from John's book. [ laughter ]

Well, we all got a copy of it, Randy.

John, you mentioned in your remarks that Advantage would add new products and expand the infrastructure.

I'm trying to listen for the new products.

Advantage will take advantage of our new products.

Okay.

So--

They don't have any products that we don't have.

Okay.

Thanks for clarifying that.

One thing will help is, I think our work efforts comp package is similar to theirs but better with the same insurance company, so.

So there will be some things that will go together very naturally.

Right.

And okay.

Then in terms of -- it sounds like you're not prepared at this point to provide any assumptions for cost integration or value of the client base or the amortization period of that intangible.

The best we could.

You have to realize on this particular acquisition, we are both limited a little bit in what we could look at, although we know what they'll look like to some extent because their business is similar to ours, because of the fact that this thing had to be kept very quiet.

The Advantage people really did not want to have a leak and then have a deal not happen.

That's why we announced this, the closing, actually, is supposed to be tomorrow.

Right.

Okay.

So at some point, we'll obviously be getting more detail -- I would assume your questions will become more detailed and our answers will become nor detailed in the next call.

Any interim period we're looking at?

I think we if had something that was material, we could consider that.

It's not been our nature, but more and more companies are having calls sometimes inside the period.

If we felt that we got to that point, we would do that.

But we would be very careful in announcing the release because sometimes when you announce a special news release, in these times, people want to believe something bad is coming more than something good is coming.

We don't need to spook the world.

Think a little bit maybe -- more update on pass, how many clients, how your turnover is tracking there and how comfortable you are with the product at this point.

And maybe a geographically have you expanded with that recently?

Randy, every day that goes by, our confidence level of our definition of our product improves.

I mean, there's just no question about it.

And you know, we expanded sales organization, the products now available in all cities, although we don't have one sales rep in every city, sometimes we have a sales rep that covers two cities close to each other.

But our confidence level has never been higher in the definition of the product.

We're seeing it in the client retention levels.

You know, we're obviously up over 2,000 clients, I believe.

Where we are on the pricing, we had some trepidations for a period of time, for a few months earlier in the year about our pricing, but as time has gone by we've gotten more and more comfortable with it that we're priced right, and the one area that we're working very hard and this is futuristic, so I mean, it's nothing that you can take to the bank, but one of things that small business is crying for across the country is a better approach to health insurance.

And we've got a team of team working on that.

We've got some potential ideas on how we might pull it off at the right partnerships.

We're still a long way from it -- like I said you can't take if from the bank.

But the other thing -- area relative to past is., that I want to mention is the PEO market.

PEO market has changed in the last year or some and that is with some of the employers taking -- some of the PEO companies taking such large hits from workers comp carriers.

And it's obviously forced a number of PEOs out of business.

We're getting a significant number of calls from PEOs that want to sell their enterprise.

So we can see that world is changed dramatically in the last 12 to 18 months.

You've probably seen some of the financial results and some of the companies in the world.

That makes us even more assured and confident we're taking the right path with the pass product.

And I think as time goes on, it will be a very, very important and huge part of Paychex.

I'm sorry, John corrected me, we have 4,000 clients.

Okay.

And what has kept your -- sounds like your PEO performances has also good, while it's been a difficult environment for others.

That's because what's happened here is we, from the beginning, we took the high road.

We have a group of managers down there that actually we got out of the MBS acquisition, plus a real good Paychex salesperson, and basically they're mature in the business and what we have done is the business for the others has been more difficult, instead of saying, let's go chase everything, we've taken advantage of that and have really taken clients, but we have gotten picky about who we're taking and we're now running I think clearly the best quality PEO down there and we're avoiding a lot of problems because we've done that.

I think John is right on with those comments.

The scenario that you might be willing to expand either via acquisition or opening -- .

We would not -- I don't think we would ever buy another PEO.

There's just too many risks in them, there's too many things, you can do diligence until the cows come home, you don't know what you're getting.

We've got sales penetration every place else.

There's no reason to buy anything.

Great.

Thanks a lot.

Okay, Randy.

Grant Patskini from Deutsch Bank, you may ask your question.

Thank you.

Good morning.

Can you comment on -- I think you said earlier that Slang a couple acquisitions.

Are they running running one general ledger or one IT system or is there also a kind of integration that has to happen there first before you integrate them on to your systems?

They've done a very good job of -- the key that got us interested in some of them was looking at them.

They did a lot of small acquisitions of clients, but the consolidation of them is pretty much accomplished.

They have over 40,000 clients on one payroll system.

They're on one ledger system, and they're pretty united on their IT too.

So there aren't any real consolidation issues.

They've got a few pieces sitting there but we can deal with those easily.

Great, and actually, a question for you, Tom, given obviously the day to day operations of Paychex as well as the integration, plus your rates for governor, can you help us understand how you're allocating your time among all three?

It depends on the week!

Obviously, with our win over Mr. Pataki in the primary, it's elevated a little bit.

The general election's November 5th, so we have seven more weeks of this process.

But quite frankly, nothing has changed.

To answer your question specifically, probably in Paychex two or three days a week for at least part of the day, if not the whole day.

The rest of the time I'm traveling and I spend a lot of my weekend time doing campaign strategies and that type of thing.

But fortunately, as I've mentioned before, we have a strong management team here at Paychex.

They're very experienced, and they know what their responsibilities are, they're getting the the job done, and I spend -- I communicate with them on the telephone and so forth.

So it's going pretty well at this moment.

Right.

Thanks, good luck there.

Thank you.

Mark Markon from Wachovia Securities, you may ask your question.

Good morning.

Congrats on the very soft quarter.

Wondering about Advantage, just in terms of how we should think about a time line there.

I'm assuming that you're going to change -- you know, it sounds like you're going to change the name to Paychex across all the operations.

Wondering when we should expect to see that occur.

And then, as it looks like it's going to be a -- from your earlier statements, maybe accretive, you know, two, three-quarters out.

I'm wondering in terms of HR side, do you need -- in items of selling the additional HR services, do you need to get them on to the clients on to your system before you can start selling the HR services, or you can sell it even if they're staying on their current system?

And then, you know, obviously there's a huge -- you know, their pricing is a little different.

Their margins are significantly different than yours.

How long do you think it would take before you could actually get them up to your level of margins?

Um -- Lots of questions.

Right.

A lot of questions, and I think I got them.

The first one is the name.

I think we're going to address the name situation on a city by city basis.

There is no point in going out into a city and making a huge announcement about this acquisition and do a name change when we're not going to do a client conversion for several months so we'll take this one city at a time, as far as the client base is concerned, as it relates to Advantage.

The second thing, selling HR products, you made a very good point.

The success of our HRS products basically is based on the fact we do the payroll.

And if we're not preparing the payroll on the payroll system that Paychex utilizes for large part of its client base, we're certainly not going to be able to start selling clients.

Additionally ancillary service that are required the client to be on the payroll system.

So it indeed creates an atmosphere where as soon as we can get the clients converted, the better off we are in selling ancillary service.

But your point is right on.

It's very difficult to sell the ancillary services on a payroll system where we don't control, you know, the process.

As far as the pricing is concerned, I think that will also be on a city by city basis.

Paychex has multiple pricing schedules across the United States, depending on the marketplace.

And I think until we understand Advantage's pricing policies, better than we do today, we will then soon be trying to duplicate their pricing schemes along our lines.

And that means it will vary from city to city, depending on the type of market it is.

And also, if one city you have a 20% gap and another city you have a 3% gap, obviously that solution is very easy.

But in that 20% gap city, that means we're probably going to have to transition over a period of time, because we don't want to have clients feel we're taking advantage of them, obviously, by giving them a 20% price increase.

So it will be a city by city look.

Have to look at it carefully by market to market, both on the name if the pricing.

In terms of -- and I know it's hard to say, but what would be an optimistic timetable for getting them up to your sort of margin level?

You mean -- well, once they're converted, actually when you add this much volume to our existing volume, it actually can drive our margin percentages up over what they are currently are.

And that's what we think will happen.

Now, how long will that realistically take?

I don't know.

My guess is we'll start seeing the benefits in four to six months.

Four to six months.

But I mean, in terms of total, would that be more like a year to two years?

No, I would say more than a year is too long.

I mean, our goal would be try to do it within a year.

Great.

Is there any -- during the early stages, would you potentially run duplicate systems?

We're going to keep both systems going.

Almost for infinity.

Because we have our obligations to the associates that Advantage deals with, these are licensees they provide payroll processing to.

And based on our contract with the Advantage corporation, the purchase, it's part of our responsibility to keep that going.

Now, over years we don't expect to expand a number of licensees.

And as licensees move on, there may come a point where committee don't have to maintain those systems.

Would you keep their payroll specialists?

Absolutely.

All of the field personnel, particularly -- we're adding 49,000 new clients to our customer base.

We need the personnel that is not only familiar with the clients but just to handle the volume on a daily basis.

And they're actually pretty good too.

Yeah.

So, the field operation for sure is very, very important that we retain as many of those people as we can.

Okay.

Great.

And then with regards to your core operations excluding the impact of this, you're obviously -- you know, you beat consensus by a penny here, off to a good start for this fiscal year.

Doesn't sound like you're changing the guidance for the back half of this year.

Or for the entire year.

Is there anything that could cause -- I mean other than significant macro, deterioration, in terms of core operations is there any reason why we shouldn't continue to see a steady improvement in terms of operating results?

I think the operating results will continue to improve within reason.

But there's no doubt in this first quarter some of that extra penny is a result of really controlling expenses, which also improve the margins.

And I think in times like this to make a prediction as to what will happen, I don't know.

I mean, you know, EDS I guess today announced their new business is -- not the recurring business.

So I think you got lots of factors going on right now.

And we continue so say what we think will happen based on current conditions, and don't conjecture on the others because we simply don't know.

It wasn't too long ago where we were under some heat from some people for not making next year -- this year's projections better because they said interest rates are going up for sure that.

That obviously did not happen.

So we don't know any more than somebody else does some we try to stay conservative, and we'll see what happens, and we'll manage this business the best we can in these times.

I'm just wondering, John, if conditions don't change, if you're perhaps being -- you are being conservative --

Positions don't change.

My belief is those numbers are what we'll do.

And you know, our history has been we're a little bit conservative, but we're not overly so conservative that we go way over numbers.

I try to walk right down the middle of the road.

I tell my people in accounting when we forecast something, I want a little more chance you'll be above it, but I don't want that to be the only results you can get.

And so I think we'll do well, but I don't think anything significant is going to change from what we're looking at.

Okay.

Great.

Thank you very much.

Mr. Chuck Webster from Kenrow Capital.

Thank you.

Just a few quick questions.

I'm assuming based on an answer to Randy's questions that this was not an option with Advantage?

Well, to the best our knowledge, it wasn't.

When did discussions begin?

Discussions were last June, and we came to a -- an agreement pretty quickly.

The time-lapse that took place was -- took us a while to get the contract agreed to.

We had confidentiality issues we wanted to make sure we had, and then Hart Scott took longer than we thought because we put the application down there during the holiday season.

So I don't think the fact it took longer than we thought had anything to do with concerns by anybody, just this process always take longer than you think.

And we want to make sure we all had our T's crossed and I's dotted and that's what happened but to the best of my knowledging there was no option.

What role will Mr. Lathrop play in Paychex?

Mr. Lathrop has committed himself to stay with the organization.

To make sure we have a very, very successful transition; from that point his options are open.

We realize that.

I think he feels strongly that is what his position as many I think there will be a, you know, period of time where we get to know each other better, then decision primarily will probably be his.

Because obviously this gentleman has built it to what it became.

I'm sure if he was interested in working here, I'm sure we'd be interested in having I'm.

John, I know you haven't gotten too specific, but goodwill amortization, do you think that this is acretive?

In the next three or four quarters?

Without goodwill solmization?

Yes.

Probably.

I would say so.

Without that, it's a big number.

And then last question, on the base business, Cap Ex, now that you've got these two buildings behind you, where do you in this goes on a annualized basis?

I would hope we get back down around 40 million.

But the IT people always amaze me.

They got stuff they always want.

I'm only kidding on that.

But it should go down.

We got a fair amount of buildings cost and we got a fair amount of data center consolidation.

Those projects should really start to wind down in this calendar period.

So we should get back to more normal levels, which to me would be in the 40 million range.

Okay.

Thank you very much.

Mr. David Grossman from Thomas Weisel Partners, you may ask your question.

Mr. Grossman?

Your line is open, sir.

Hello?

David?

Yes, you there?

Yeah.

Go ahead.

I'm sorry about that.

I was wondering -- I think I didn't get all the metrics you laid out for Advantage.

I think you had 75 million in revenues, 12 to 13 million in intangibles.

Were there a couple other numbers that you provided?

We announced that there was 11 million in lost interest, 7 million in gains were taken, and we expect goodwill and intangible amortization to be around 12 million.

But I -- I mean, that's the best estimate I have right now.

And hopefully, I'm a little bit high, but I don't know, because I don't have the expert valuation which we can't get until -- we can get it now but I can start the work.

We had some people look at it, but I don't have that number.

Those are the numbers we gave.

Got it.

Okay, and maybe a question for you, Tom.

Maybe I missed this.

But when you look at the penetration rates in Advantage's, you know, client base for some of the ancillary services that you provided, and maybe they provide as well, how do they compare to your own?

Well, with Taxpay and direct deposit they're very similar to where we are.

Where we have an extra added opportunity is in the area of workers comp and 401(k).

We've been into the workers comp arena longer than they have so we probably have a higher client penetration, and we've obviously been in the 401(k) business a significant period of time.

And that's an opportunity I don't think they enjoy right now.

So consequently, for workers comp and 401(k), it's a whole new wide-open ballgame we don't see any major incremental benefit from either Taxpay or direct deposit, although as John mentioned earlier direct deposit is going to continue to grow significantly as a product.

And I would assume that it's going to grow significantly there with the Advantage base as well.

And on the 401(k) side, when they don't have a -- does it typically mean the client doesn't have it or something else?

It means Advantage is not doing 401(k) record keeping.

But we do know that in their client base, the use is very low. and I think that's a direct result in our client base we sell 60 to 70% so we almost control the market in 401(k).

So we know their client base has less 401(k)s than ours, simply because somebody like Paychex hasn't been selling into it.

I see.

And I think Tom, you mentioned on this geographics side that there were three or four geographies where, you know, they are and you're not.

How significant are those markets?

I think if I were to add up clients in those markets, it would probably be about 2500 clients, maybe 3,000.

But when you divide that by 4 markets, that's a significant base to begin a branch office or to build upon.

So that's a real plus opportunity here.

Okay.

Great, thank you.

Mr. David Ferrina, from William Blair company, you may ask your question.

I'm all set, thank you.

Unless somebody has a pressing question, we've been on a hour and a half.

We greatly appreciate your interest in Paychex so we'll open up for a couple more if somebody has got something.

Mr. Charles Trapton from Adams Hartman.

Sir, you may ask your question.

Thank you.

Are you guys going to expect the conversion costs that Advantage used to have in their P&L, or are knows not included?

I don't think have you any choice but to expense.

Right.

But aren't they going to be over by sometime in the next 12 months?

Expenses are ratcheting down very quickly.

They don't have much left.

You've also got to realize that some things that were material to them aren't that large to us.

Right.

What kind of client retention payout might you pay in the next year, have you set aside a certain amount?

Client retention payout?

I don't --

You know, like a bonus for them if they retain a certain amount of clients.

No.

Nothing?

No.

That's part of the price negotiations.

There was nothing in our current contract that based the purchase price based on client retention.

In other words, Paychex is going in as an entity and taking over full responsibility for that.

Okay, last question, how is your 401(k) new sales coming in the last four or six months?

401(k) new sales in the first fiscal quarter were very strong.

As John mentioned, you know, we had a change in our sales management organization at last year, and it started in the first quarter, and obviously that impact our ability to sell.

But we're starting to see the benefits now of the work that was done last year.

And we started off this calendar -- or this fiscal quarter very strongly in 401(k) sales.

Great.

Thank you very much.

Right.

Adam Waldo from Lehman brothers, you may ask your quesiton.

Guys, thanks for the comprehensiveness of the call.

One other quick question.

Where did you close the quarter in terms every head count by principal line of business?

Same level that we gave in the investor relations presentation.

We don't add many salespeople.

During the quarter most are added maybe right around year end, May 31.

We don't change it much because we establish territories, so you really can't change it too much.

Thank you.

Our last question comes from Mr. Robert Maniat from CIBC World Market.

I'm all set.

Thank you.

Okay.

At this point, we'll close the meeting.

Again, we really appreciate your interest in Paychex.

And it's a kind of a great day here for Paychex.

We had I think real good results considering the environment we're in.

Not quite up to our normal standard what we'd like to do, but we don't control world events.

And at the same time, we have made an acquisition we feel real good about, and look forward to a lot of success in the future.

So thank you very much.

And I hope you all have a great day.