沛齊 (PAYX) 2003 Q2 法說會逐字稿

Good afternoon and thank you for standing by. afternoon and thank you for standing by.

Welcome to the Paychex second quarter earnings conference call.

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

This call is being recorded at the request of Paychex.

If anyone has any objections, you may disconnect at this time.

I would like to introduce your presenter for today's call, Mr. John Morphy, Chief Financial Officer.

Mr. Morphy, you may begin.

Thank you for joining us for a second quarter of press release.

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.

We released our financial results for the quarter ending November 30, 2002 this afternoon after the market closed.

If you need a copy of the release, it can be obtained by calling 585-383-3406 or by accessing our web site at paychex.com at our Investor Relations home page.

Also this afternoon, we filed, with the SEC, our form 10-Q for the second quarter ended November 30, 2002.

This filing is available on our web site.

In addition, this teleconference is being broadcast over the Internet and will be archived and available for access on our web site until December 26, 2002.

Please refer to our web site for access to all recent news releases, current financial information, related SEC filings and investor relations presentation.

This quarter, we again made the press release at 4 p.m.

We would normally have this conference call tomorrow morning, but we thought we would experiment with a conference call just after the press release.

I would appreciate your opinions on the best method so please email me at jmorphy@paychex.com stating at what time you prefer the press release and what time do you prefer the conference call and we will take that into consideration for our third quarter release.

The second quarter results include the results of the Advantage acquisition since September 20, 2002 when we closed.

Advantage results are described in detail at the beginning of the press release to enable readers of our financial statements to easily and accurately understand the affect of the Advantage acquisition on our financial statements.

The earnings release is summarized as follows: for the second quarter and first six months of fiscal 2003, total revenue growth was 15% and 11% respectively, which in turn generated an increase in net income of 9% and 8%.

Quarterly earnings per share were 20 cents versus 18 cents a year ago up 9% on an unrounded basis.

Year-to-date earnings per share was 40 cents versus 37 cents a year ago up 8% on an unrounded basis.

Our financial growth continues to be adversely impacted by the difficult economic conditions in the United States and the effective lower interest rates on earnings from our funds held for clients and corporate investment portfolios.

Acquisition of Advantage.

On September 20, Paychex completed the acquisition of Advantage Payroll Services, Inc., a comprehensive payroll processor that serves small to mid-size businesses throughout the United States.

The purchase price was $240 million in cash.

We also paid 74 million for the redemption of preferred stock and repayment of outstanding debt of Advantage.

This acquisition provided Paychex with 49,000 new clients.

Results of operations for the three and six month period ending November 30, 2002, include the results of Advantage since the date of acquisition.

For the second quarter, Advantage revenues included 14.1 million in service revenue and 1.2 million in interest on funds held for clients.

Advantage operating and SG&A expenses were 14.3 million, including 1.6 million of intangible asset amortization.

Advantage operating income was 1.0 million.

During the second quarter, we had two other items that directly related to the purchase of Advantage.

The first was the recognition of 7 million of gains related to the sale of corporate investments to fund the acquisition.

This number is very close to the number we mentioned in September.

The second event was using corporate investments to fund this acquisition, reduce second quarter investment income by 2 million.

Our integration of Advantage is well under way.

In simple terms, as time passes by, we become even more positive about this acquisition.

Our sales force integration is complete.

Our sales force and Advantages have been rationalized as we absorbed about one half of the Advantage sales force, 75 people, into our core payroll, MMS or HRS sales forces.

We continue to evaluate the operations of Advantage and final plans to integrate, but maximize client retention are being developed.

Advantage operations are more efficient than we originally thought and are operating quite well.

We have slowed the moving of clients from the Advantage platform to the Paychex platform to ensure we deliver consistent service that maximizes client retention.

In summary, the acquisition of Advantage resulted in one cent of earnings per share accretion for the second quarter, mostly related to the one-time gains recognition and is expected to result in one cent of earnings per share dilution in each of the third and fourth quarters of fiscal 2003.

We expect the results of Advantage, thereafter, to be accretive.

We will now refer to the fourth page of the release, the consolidated income statement.

Total service revenues increased 18% and 14% in the second quarter and six month periods to 255.7 million and 495.1 million respectively.

Service revenues consistent of service fees earned from our Payroll and Human Resource and Benefits product lines.

Payroll service revenues for the second quarter in six months increased 17% and 13% to 220.0 million and 425.5 million, respectively.

The increases are related primarily to the revenues from Advantage, growth in the client base, increased utilization of ancillary services, and price increases.

Payroll service revenues continue to be impacted by year-over-year decreases in checks per client.

The year-over-year reductions in checks per client, excluding Advantage, for the first and second quarters of fiscal 2003 were 2.1% and .8%, respectively.

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

So the trend that we mentioned, that peaked in last year's third quarter, continues here in fiscal 2003.

As of November 30, 2002, 86% of all clients utilized our tax filing and payment services and 58% utilized the employee payment services.

The utilization of Taxpay and Employee Payment Services by Advantage customers was very similar to our core payroll customer.

Major Market Services revenue increased 44% and 43% for the second quarter and six month periods to 23.9 million and 46.0 million, respectively.

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 23% and 25% for the second quarter and six-month periods to 35.6 million and 69.5 million, respectively.

The increases are primarily related to growth and retirement services clients and in client employees served by the Company's past and PEO bundled services.

Retirement Services revenue increased 20% and 23% in the second quarter and six month period to 16.3 million and 31.9 million, respectively.

At November 30, 2002, we had over 26,000 Retirement Services clients.

Paychex Administrative Services and the Company's Professional Employer Organization are comprehensive services that include payroll, employer compliance, employee benefit administration and risk management outsourcing services and are designed to make it easier for businesses to manage their payroll and benefits cost.

Sales of PAS and PEO products have been strong with administrative fee revenue from these products increasing 42% in both the second quarter and six month periods of fiscal 2003.

As of November 30, 2002, our PAS and PEO products serviced over 92,000 client employees.

Interest on funds held for clients decreased 15% and 23% for the second quarter and six month periods of fiscal 2003.

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

Average daily portfolio balances totaled 1.97 billion and 1.91 billion for the three and six month periods ended November 30, 2002, compared to 1.71 billion and 1.72 billion in the respective fiscal 2002 periods.

The funds held for clients portfolio earned an average rate of return of 2.5% in the second quarter and first six months of fiscal 2003, compared with 3.1% and 3.3% and the respective prior year periods.

During fiscal 2002, funds held for clients portfolio earned an average rate of 2.9% for the full year.

Net realized gains on the sale of available-for-sale securities included for interest on funds held for clients decreased to .6 million and 2.3 million for the second quarter and six month periods, compared with 2.2 million and 5.4 million in the respective prior year periods.

Combined operating and SG&A expenses increased 20% in the second quarter and 13% for the six month period over the prior year periods.

This reflects increases in personnel, information technology and facility costs to support the growth of the Company and also the addition of the Advantage operations.

Excluding Advantage from these expenses, they would have increased 9% and 8% for the second quarter and six month periods.

There were approximately 8250 employees at November 30, 2002, compared with 7,400 at November 30, 2001.

Operating income increased 9% for both the second quarter and six month periods.

Operating income, excluding interest on funds held for clients, as a percentage of total service revenues remains strong at 34% and 35% for the second quarter and six months of fiscal 2003, compared with 35% for the prior year periods.

Excluding Advantage, operating income, excluding interest on funds held on clients, was 36% and 37% for the quarter and year-to-date periods, respectively.

Investment income increased 39% and 25% for the second quarter and six month periods due to higher net realized gains and the sale of available-for-sale securities offset by a decrease in average daily invested balances and lower average interest rates earned in fiscal 2003.

Average daily balances invested were 512 million and 631 million in the second quarter and six months of fiscal 2003, compared with 663 million and 655 million for the respective prior year periods.

The corporate investment portfolio earned an average rate of return of 3.4% for the second quarter in six months, compared with 4.0% in the respective prior year periods.

The fiscal 2002 average rate of return for the complete year was 3.7%.

Net realized gains were 7.2 million and 9.6 million in the second quarter and first six months of fiscal 2003, compared with net realized gains of 1.8 million and 2.8 million in the respective prior year periods.

The increases in realized gains and lower average portfolio balance are the result of the sale of investments in the corporate investment portfolio utilized to fund the acquisition of Advantage.

Our effective income tax rate was 32.5% and 32.0% for the second quarter and first six months of fiscal 2003, compared with 30.8% for both respective prior year periods.

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

The fiscal 2003 effective income tax rate is expected to approximate 32.0%.

As mentioned earlier, net income increased 9% and 8% for the second quarter in first six months of fiscal 2003, compared with the same periods last year.

We are not sure how long the challenging economic conditions and interest rate comparisons will last.

In response to economic conditions, the Federal Reserve has lowered the federal funds rate 12 times since January 2001 to 1.25%, which represents a cumulative 525 basis point reduction.

The last reduction in the federal funds rate occurred in November 2002.

The first half of fiscal 2003 combined interest on funds held for clients in corporate investment income was down 7% from the prior year period.

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 work forces.

The first half of fiscal 2003, the Company experienced a 1.6% year-over-year decline in checks per client, again, excluding Advantage.

In 2002, the year-over-year decline was 3.7%.

Despite the above factors, income before taxes remained very strong at 41% and 43% of total revenues for the second quarter and six month periods compared with 43% for the respective prior year periods.

We have based full year fiscal 2003 expectations on current economic and interest rate conditions continuing with no significant changes.

Our guidance from last quarter for fiscal 2003 remains virtually the same as the most recent reduction in interest rates by the fed was offset by slightly better than anticipated results from Advantage.

The environment we observed at the end of the first quarter is virtually the same as we see exiting the second quarter.

Accordingly, for the full year fiscal 2003, we project Payroll Service revenue to grow in the range of 14 to 16% and Human Resource and Benefits Service revenue to grow in the range of 19 to 21%.

Total service revenue growth is anticipated to be in the range of 15 to 17%.

We expect interest on funds held for clients and corporate investment income combined to be down approximately 15 to 20%.

Taking these factors into consideration, we anticipate achieving record total revenues in net income for fiscal 2003 with estimated total revenue growth to be in the range of 13 to 15% including approximately 50 to 55 million from Advantage with net income growth in the upper single digits.

Excluding Advantage, we estimate total revenue growth in fiscal 2003 to be in the range of 8 to 10% with net income growth slightly less than total revenue growth.

These words, again, are virtually the same as we stated last quarter.

We would like now to move to the balance sheet.

Moving to page 5 of our press release, you see that the balance sheet since May 31, 2002 reflects our growth during the first six months of fiscal 2003, plus the impact of Advantage.

Cash in corporate investments total 470 million.

The decrease since May 31 reflects the cash used to acquire Advantage.

Our total available-for-sale investments including corporate investments and funds held for clients, reflected unrealized gains of 29.9 million at November 30, 2002 compared with unrealized gains of 26.7 million at May 31, 2002.

The decreasing interest rate environment has driven the improvement in the market value of the available-for-sale portfolio.

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

During the first six months of fiscal 2003, the unrealized gain position ranged from approximately 22.3 million to as high as 46.3 million.

The unrealized gain position was 35.8 million on December 16, 2002.

As we have stated in our last press release, again, we do not anticipate recognizing any significant realized gain in the last half of fiscal 2003.

The rate reductions are going to be here for some time, and we have decided to let some of these unfavorable comparisons, the difficult ones, exist and eventually they will improve as time takes place.

Our net property and equipment balance activity during the six month period reflected capital expenditures of 37 million and depreciation expense of 16 million.

For fiscal 2003, capital expenditures are expected to approximate 65 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.

Depreciation expense for fiscal 2003 is projected to approximate 35 million.

The Company recorded 244 million of good will and 59 million of intangible assets from the acquisition of Advantage.

Intangible assets primarily represent the Advantage client list and also license agreements with associate offices, which are going to be amortized over periods ranging from seven to 12 years using either accelerated or straight-line methods.

Good will recorded from the purchase of Advantage will not be amortized but instead be tested for impairment on an annual basis.

The impairment test will be based upon a total company basis as we are in one single business segment.

Amortization estimates for the next several years are disclosed, by year, in our form 10-Q filed this afternoon.

Total stockholders equity increased to 1 billion.

Thomas Golisano thinks this is a very nice round number.

At November 30, 2002, with 83 million in dividends paid during the first six months of fiscal 2003, a payout of 55% of net income.

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

Accumulated other comprehensive income balance at May 31, 2002 of 17 million has increased to 19.1 million at November 30, 2002, which reflects the previously discussed increase in the market value or available-for-sale portfolio.

Investment rates of return.

With the volatile interest rate environment, we often receive many questions about the potential impacts of changing interest rates.

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

The exact impact of changing interest rates on the Company is difficult to determine due to many factors.

However, we estimate that 25 basis-point change in taxable interest rate, 17-point impact on tax exempt securities will have an effect of approximately 3.0 million on earnings for the next 12-month period.

Again, we have taken into consideration the recent 50 basis-point drop which was offset by some better results on what we anticipate from Advantage.

Safe Harbor Statement.

You should be aware that certain written and oral statements, made by the Company's management, constitute forward-looking statements as defined in the prior 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 3 of the press release for our discussion of forward-looking statements and the related risk factors.

I will now turn the meeting over to Thomas Golisano who will provide his comments and then we will open for questions.

Thank you, John.

The first thing I would like to do is thank the 4 million people in New York that helped me with my career decision.

Secondly, as you know, we are going into our strong selling season, a very important selling season, and all indications are that there are no surprises out there.

Everything seems to be status quo.

Our goals for the month of January are quite high.

Hopefully we will be selling over 20,000 clients as we have done in prior years.

Our salespeople turn over and our core payroll products continue to look very good.

On an annualized basis it's between the low 30s and 35%.

And you know this is an improvement over what we have had over the last two or three years.

So we seem very happy there.

Our 40K sales organization, our HRS sales organization continues to do well, as John mentioned by the earlier results.

The area of client retention, for all of our services, we are very well within the comfortable range of client retention that we have expected and forecasted over the course of this year.

The Advantage acquisition, as John mentioned, we have fully integrated the sales organization to the level it is going to be integrated and now we are starting to work on the client side.

We have slowed down our ambition levels on client transition over our payroll system, mainly because we just want to be absolutely sure we do it the best way we can.

Our competition is out there as always watching for us or anybody that makes an acquisition like this to start having operational troubles.

And we are going to do everything we can to mitigate anything of that nature.

I want to compliment the Advantage management team and staff.

They have been very cooperative.

We have been very impressed with their people and their dedication and efforts to make this transition as comfortable and as pleasant as possible.

So on all fronts, generally speaking, there is nothing new at Paychex.

Our consistent results speak for themselves and at this point I think we will open it up for questions

Thank you.

At this time we are ready to begin the formal question-and-answer session.

If you would like to ask a question you may press star 1 on your touch-tone phone.

You will be announced prior to asking your question.

To withdraw your question, you may press star 2.

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

Our first question comes from Adam Waldo with Lehman Brothers.

You may ask your question.

Good afternoon, Tom and John.

How are you?

Good.

A couple of questions, Tom, if I may on the client and sales force side.

You said in your prepared remarks you are targeting about 20,000 new clients sold for respectively fiscal 2004 at the start.

No, that's -- the month of January --.

Pardon me, I am sorry.

The month of January fiscal 2003.

Okay, my mistake.

Sorry about that.

So, if you sort of think about the sales force targets that you set this year, what would that annualize out to in terms of a rate of increasing gross client additions?

Year-over-year?

We don't talk about client growth, as we said before, except at the end of the year and, you know, the other factor in here is we look at net client growth and losses.

So right now retention is doing a little better than we anticipated.

Client sales are pretty close to what we had hoped for.

And I was talking that over 20,000 clients just for core, not including MMS or on line payroll either.

Just core payroll.

Okay.

Did you continue to see about 3% average -- realize price increases on core payroll in the latest quarter, year-over-year.

3 to 4 depending on the size of the clients.

3 to 4 depending on the size of the client.

Okay.

John, a question on the Apay float.

How much of that did you get to invest for what portion of the quarter and where was your flow to the aggregate as you exited the quarter?

We gave you all the numbers that we -- .

Oh, it's in the queue, okay.

It's in the queue.

I think what happened is, I think Advantage hit about -- I am going to go about a billion dollars of float money.

Some of it was invested in short-term stuff. [unintelligible] rates as good as we get.

The rest was in some different long-term -- I think they were taxables.

That money has all been moved into our investment devices.

The float income that we earned in the quarter was about 1.2 million.

That's the number I gave earlier.

We have that under control so things are there.

You also find that the average balance on float went up a little bit this quarter when it normally stays flat because this is the weakest quarter for float money.

We have it under control.

It is going pretty well and we continue to believe everything will be fine.

Looks to be going well.

Final question.

Checks per client, you know, where were you trending if you can give us a sense month-to-month during the quarter.

I know that is not a particularly meaningful stat.

If the November levels were to hold for fiscal 3Q, what kind of rate of year-over-year change might we expect?

Let me answer that.

I don't think that is a good idea to look at numbers just by month.

Okay.

Because it's such a variation between a four-week month and a five-week month and I think November was a five-week month.

And when you have about a third of your -- I'm sorry, 60% of your clients pay either biweekly or semi monthly, in a five-week month it gets very distorted.

I would have to go through a fairly significant calculation process to give you an accurate answer, so I am not going to give you one now.

And what has happened here on this, some of this improvement we get is really the result of the comparisons are slightly easier.

But what we have seen is same thing we said last quarter.

We see the economy right now kind of on stuck.

It's not getting better, not getting worse.

Nice it is not getting worse.

The trends we saw kind of are continuing, and we haven't really seen much aberration of anything lately.

Okay, thanks, gentlemen.

Sure.

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

Thanks, it's Jason [unintelligible] here for Adam.

Two quick questions.

First, recalling back to this time last year, I seem to recall that were some discounting price wars, if you will, between yourselves, maybe some of the competitors or more so from the competitors, trying to poach clients around the end of the year.

Did you see any sort of that type of dynamic this year, and if so, did it have any material impact?

Yes, we have seen the dynamic this year.

But I can tell you it is far less intense this year than it was last year.

There is a couple specific geographic parts of the country where it seems to be louder and stronger than others, but I would say overall, the intensity level is definitely lower this year on that type of thing.

So, we don't feel it will have any impact, pro or con, relative to the year-end activity.

Usual suspects there in terms of who is engaging in that?

Only one suspect.

I should say usual suspect, excuse me.

Definitely the intensity is less this year on this issue than it was last year.

Okay, so no real material impact on your retention rates or anything like that.

Unless we get some surprises, but I doubt it very much.

Right, right.

Okay.

In terms of bankruptcies.

What are you seeing there.

Any changes sequentially versus last quarter?

As John said, the percentage of clients that are lost for bankruptcy, out of business, sold, mergers remain kind of consistent and standard, or consistent.

So, I don't think there is anything new happening there either.

Okay, thanks for your comments

Steven Weber, you may ask your question with SG Cohen.

Yes, good afternoon.

Is there anything that you see that is affecting the seasonality of the business going forward?

Is there any distortion in terms of the numbers of days in the ensuing quarters or anything that might have been involved with Advantage in a way they kept their books?

No, basically Advantage was on the same year-end we were on, expect they had a 52-53-week year which we actually almost operate the same thing except we adjust it out rather than having the extra week fall every six or seven years.

Days are pretty consistent.

Steve, I have been on a lot of acquisitions, this one has really had no surprises.

I think part of the reason is we bought something that -- it is like buying your left hand.

When I talked about the little more favorable performance, they were on the cuspid of being able to make money.

We made money in the first quarter we had them and that includes all those sales cost still being left with them.

So, it's not like I waved the wand and moved some stuff around.

The better results we are getting though -- there is a couple of things we thought we were going to have to absorb ourselves that the beginning balance sheet picked up because our plans for this subsidiary are so well-defined we knew which things we needed to do or not do.

So overall, we are real pleased with it, and it's been very consistent, and it surely was on its way to being a very good national competitor.

I think also to add to it, the fact that they were about to be or wanted to be or considered being a public corporation.

A lot of the groundwork was done that made this acquisition a lot more comfortable for us.

One other question if I could.

How is -- how is the penetration of your account base progressing with your 401(k) service and your workers' comp?

My recollection is things were a little slower earlier on worker's comp.

Any of that changed?

Not materially. 401(k) year-over-year comparisons and workers' comp year-over-year comparisons are very strong.

We think we are going to be very happy with the year-end result, fiscal year-end results with both those products.

Even though we have got 25,000 clients on workers' comp, we have only been in the business two or three years, so we are still going through learning curves and dealing with carriers and as you can probably guess, workers' comp, probably of all the products we sell, is probably the most volatile as it relates to the carriers.

By "volatile" I am talking about their interest level and concern levels about being in certain states based on state mandates of coverages, state mandates of benefits, and state rulings on rates.

So we are getting better and better in dealing with that and understanding that, but if you look at it over on a year-over-year comparison, we think we are doing great.

How about the 401K, Tom?

Same thing there.

We don't have the supplier volatility obviously, but our year-over-year comparison growth is very strong this year.

So we are going to be quite happy I think.

Right.

And lastly, on the PAS.

Paychex Administrative Services, we continue to be happy there too.

We are between PAS and the PEO, we are approaching 5,000 clients, somewhere between 4,500 to 5,000 clients.

John mentioned we have almost 100,000 employees covered.

Both of those units, the PAS and PEO continue to do very well.

Six months to a year ago, we had some questions in our mind about our pricing scheme on PAS, but we have decided that where we have got it is where we want it to be.

Everything is sort of status quo there.

Okay, thank you

Greg Gold with Goldman Sachs, you may ask your question.

Hi.

It's John Mathis for Greg.

John, on Advantage, did any of that revenue roll into MMS?

No.

Can you take us through -- actually you integrated the sales force, what are the next steps and what can we look forward to through the rest of the integration the rest of the year?

Are you talking fiscal year?

I think you will see a gradual assimilation of their clients into our core payroll processing system.

We are -- we have the Advantage -- it is a play on words, of not having to do it quickly, and, of course, we are going to maintain that system for some period of time because we have the responsibility and opportunity in dealing with the associates.

So we have the luxury of taking our time.

We are not concerned at all that the fact that we are having to maintain these two systems is going to have any material impact on our profitability.

Over time, regardless of what system these clients are on, assuming we get the pricing as much in line as we can, there is no reason why the margin should be that much different, regardless of the fact we hit them on two systems.

Tom, what are your assumptions on client retention from the acquisition?

Right now it looks great.

In fact, I am laughing a little bit because we looked at the numbers.

The retention level was a little higher for Advantage this month than it was for Paychex.

So it looks fine right at this point.

But I have got to tell you what we did -- we did not send out letters or sent messages to clients where there was going to be a lot of revolution in their processing or change in their processing.

So to every -- most of the Advantage clients, they are not anticipating nor will they have any significant change in their processing.

The other thing I mentioned, the Advantage employee base we are very impressed with, they are doing a great job.

They are hard-working people and they feel very responsible so we are happy about that.

Tom, any issues you expect around the franchise portion of Advantage and how that will be integrated?

Whenever you have licensees and I tell you, we have a lot of experience with this now, there is always a lot of trepidations on their part because they don't know what we are going to be doing to them, and the fact of the matter in this case is we don't plan to do anything to them.

We have talked to two or three of them about the potential acquisition, but nothing material has happened yet.

Okay, thanks very much.

Sure.

Jennifer Dugan with Merrill Lynch, you may ask your question.

Thanks.

Can you tell us what portion of the Advantage base you would expect to transfer on to the Paychex platform over the next 12 months?

Over the next 12 months?

That's hard to say but I would guess a majority of the clients.

The majority.

That doesn't mean it's necessarily going to be over 75 or 80%.

If we are -- have the luxury of being able to by client by client decide whether it is in the best interest of that client to stay with Advantage or move over to Paychex.

Obviously, one of the things that you always find in a situation like this, Advantage was providing certain reports and certain features and benefits that their clients liked and that we may not have available.

So we are going to take it slow and easy.

But to answer your question, I would be surprised if it is significantly over 65 or 70 or 75%.

One thing on this, I think one of the things, the first thing you worry about is, on the conversion, is margins.

One of the reasons their margins overall was not as great as ours, first reason is they sold for less than us.

We quoted about 30%.

That we will solve over time and we can solve it whether they are on the Paychex system or they are on the Advantage system.

Next thing is their selling expenses were much higher than ours because they had not reached the maturity of having a recurring revenue stream to the degree we were at, so we have basically eliminated those selling costs, put them in the Paychex where we hope to sell more, but we aren't selling the Advantage product in very many places now except where we really had no presence.

When you come to their operating costs, their operating costs aren't too bad, they are not as good as ours, but we will have to maintain those operations anyway because of the fact we have the associates and the NEBS deal.

So clients staying on the system a little bit longer really is not a financial drain nor is it going to be a tremendous financial leverage as we move them over.

So we already believe very quickly and the one thing I felt good about, I remember the last call when Tom talked about how fast we were going to get accretive.

I just about swallowed my tongue when he said beginning of next year.

But right now we firmly believe we will be accretive by then because of these issues we will solve and we don't see this as a big deal as to whether they are on our base or theirs.

You guys mentioned that you sort of slowed down your originally-anticipated pace of conversions.

So was it really, you know, these reasons why you guys are deciding not to rush it.

It's not any kind of specific feedback or some kind of an indication of churn from the Advantage clients that is causing you guys to slow down.

Not at all.

Not at all.

Like I said a few seconds ago, their client retention last month was actually better than Paychex.

That is not the issue.

The issue is, we have this luxury to be able to do it this way and we will take advantage of it.

My belief is that most Advantage customers don't even know that Advantage got bought.

That's also true.

Okay, great, thanks.

Randy [unintelligible] with Robert W. Baird, you may ask your question.

Hi, Tom and John and good job on the early progress in this integration and your core results.

I want to talk about a couple of things.

First of all, acceleration in core payroll growth and fee business of just the core Paychex.

Should we expect that to continue?

You had a little bit of acceleration this quarter.

Should we expect that to continue throughout the rest of the year?

Randy, going into the third fiscal quarter, the big selling year, the last thing I want to do is allow myself or John to make that kind of a prediction, only because the size of the activity is so large and, you know, I just don't want to play with that number.

I guess let me ask it a different way.

It sounds like the competitive environment is a little bit better for you, and I am just wondering are there other factors out there that have opened up selling opportunities this year that you didn't have last year that might help out toward the end of the year that's making you confident about January?

Well, the two factors -- the one I mentioned is the intensity is the competitive level out there is one thing.

The second thing we have to remember is we don't have 150 Advantage salespeople selling against us this year, too.

You also have to remember I don't think it was horrendous when you go the year-over-year comparison, there had to be some 9/11 impact in here last year in this quarter.

Yeah, that's also true.

Okay, when you look at the fee operating income of core Paychex, 36%, obviously a very high number and a good comparison, where were the improvements made in the core part of the organization to get there?

Well, we are watching people.

We got -- we went through last year where, unfortunately, our plan didn't see the -- well, I think we knew the recession was coming but we didn't plan too much on it.

For one thing, if you tell too many people you have a recession coming it gives people lots of reasons to miss goals and we don't like that.

Most of it is we are watching our costs, our people.

We have done some things to beef up operations.

You got turnover down on the payroll specialist.

A staff that is great.

It's over 70% of our payroll specialists are seniors.

Used to be 30% or 40% was great.

We see some things coming in line, our customer satisfaction, scores are getting better so we have a couple of years back there where we weren't quite where we would like to be and we are seeing some good progress and we have made some changes in ops people and we think we are on a good track.

Are there more efficiencies you think you can get going forward or are you pretty much done with finding those opportunities?

There are always opportunities, Randy, but, you know, obviously, the big one here is the impact of not having the 150 Advantage salespeople out there against us, and how well we handle the Advantage integration.

Okay, just one more on the 401(k) business.

Tom, you talked about being happy with where that is.

That did seem to drop off in terms of its growth rate in the quarter, and I am wondering if -- if it's the new sales activity that's giving -- given you confidence, you know, in that business, maintaining the growth rate in that business.

Well, what has given me the confidence is looking at the year-over-year growth rates and units on a monthly and quarterly basis.

Okay.

Two things to make that a little more difficult.

When you feel good about it.

We are getting the bigger size that always eventually enters the fray and let's face it, the stock market conditions are not as favorable to create 401(k) formation as they were.

I think we still get 401(k) but we had a little more wind at our back than we used to have but we feel real good with these results.

I noticed the deterioration in stock market conditions.

I'm sure you did.

Okay, so when I look at that though, 20% I think was the year-over-year number and that's obviously coming down from much higher levels.

The prior year -- is 20% realistic for Retirement Services going forward?

Or should we see that come down a bit?

I am a little hesitant to answer, Randy, and I tell you why.

We have made some modifications of the product offering that are very positive, so such is the ability to have the clients having a much broader option for choosing money managers.

So I -- the only thing I want to say about it is, we are very confident where it is and where it is going.

Okay.

Thank you very much.

I appreciate it.

Brian King with Financial Securities, you may ask your question.

Yeah, hello.

First question is on Advantage.

It looks like Advantage was accretive of penny and now the next couple of quarters it will be dilutive a penny.

What are the costs that are -- that are causing that?

It would have been diluted in the quarter except we got $7 million off the gains when we raised the money to pay for it.

Okay.

So the $7 million, though -- but the $7 million is not in that revenue line of 14.1?

No, the $7 million is all down in corporate investment income because we obviously sold our corporate investment portfolio to finance the acquisition.

We have a one-time thing.

We talked about that on the call that the dilution was going to be about two cents for the year so actually we are thinking that it's a little better than that right now but it was going to be that term you guys like lumpy.

And it is lumpy because you have quarterly bounces just because of the way the 7 million came in.

Okay.

That 20,000 customer base that you are targeting, I guess for the month of January, what -- what is that year-over-year just so we can get a sense.

Is that up from last January or would that be about flat or --.

Depends on where we fall, between 20 and 25,000.

Let me just say we have sold over 20,000 the last two January's.

And I can assure you that Tom didn't let them have a goal that was less than the prior year.

Okay, that's all I had.

Thanks.

Okay.

Pat Burton with Solomon Smith Barney, you may ask your question.

Hi, thanks for taking the call.

The question is have you had any initial success selling benefits into the Advantage payroll base?

Thanks.

You mean like 401(k) and that type of thing?

Yeah, any kind of your add-on services into their client base or is it too early to tell.

Well, it's too early because the fact is that we haven't converted any of the clients yet, and I don't think we we are going to be able to sell any of those services in until clients start getting converted because we don't have the interfaces to go along with the Advantage payroll system, into our workers' comp or 401(k).

I know those things are under consideration and we will probably be making decisions whether or not we want to integrate off Advantage system or just wait for the client.

But at this point there is no activity at all.

Okay.

Thank you.

Greg Capelli with CFSB, you may ask your question.

Hi guys, Greg and Josh.

Tom, I wanted to touch base on the sales force a little bit.

Are you doing anything different to bring up sales force retention specifically.

Have you restructured comp or is it just the economy making it easier to keep good people.

We would like to think it is the efforts we have done.

We have modified training again.

We have modified the compensation.

We are allowing the payroll reps to enjoy a little more of cross-selling revenue with HRS.

It's a continual tweaking process.

I think the other thing that we did this year that is significant, is we took out a layer of management between the sales organization and upper management, and I think that's been helpful.

And I can tell you that there's been a tremendous amount of focus on it by our sales management team.

So, it is not one thing.

I think it is a combination of all of those and maybe the economy is helping as well.

Okay.

That's helpful.

A quick one on the competitive landscape -- we had heard from competitors they were seeing into it more.

I just wanted to know if you -- in the past you said you really don't see them too much, but are you seeing them get more aggressive at this point?

No.

Obviously with the acquisition of CVS down in the southwest and now they are bearing the Intuit name, I guess you could say those people would probably say we see Intuit more often.

But on a national level the answer is no.

One final one on the PAS and PEO, obviously growing like a weed in those businesses.

What is the impact of health-care costs had on these two businesses?

Well, I can tell you, I think as an industry, it's had a tremendous impact both workers' comp and health insurance.

I am particularly proud of our organization because we have done a wonderful job of client selection and we have had the luxury, again, of not having to be so aggressive with our sales targets.

So, we have done a very good job on client selection but I can tell you workers' comp is going to continue to be an issue relative to PEOs and I bet you the number of PEO opportunities for us to acquire just seems like they are there all the time.

So it is an industry that is definitely having a difficult time.

We have chosen not to be aggressive in any way in acquiring other PEOs.

At the same time, we are very happy with ours, and I can tell you they are doing a great job not only in profitability but with client retention, but there is also that shadow of workers' comp issues behind us.

Okay, I understand.

Thanks a lot, I appreciate it.

Tom Cassain with Bear Stearns, you may ask your question.

Thanks.

Tom, if we stay in a low rate environment, do you see the payroll industry moving towards higher fees for tax filings?

It doesn't seem you or ADP or [unintelligible] are getting compensated as much for the service these days.

I think you have probably seen an increase of fees from all of us over the last three or four years.

It's sort of been part of the process, but I don't see any extraordinary or unusual aggressiveness on the fee side.

Now, remember, we are at the low end of the market, and the fee and interest income or fee in interest sharing, if you will, with larger companies is a much different situation because it is actually a negotiated item between the processor and the client.

But at the low end, none of that exists, so we have been fairly modest with price increases on the fee side, but we have planned to do nothing extraordinary with those price increases because of low interest rates.

Okay.

And competitive factors are holding you back there?

Not necessarily competitive factors.

One thing -- our client doesn't quite understand they are really paying this.

It is really a lot of small numbers adding up to a big one.

The other problem is I think the minute you tell them, you know, we are going to charge you more because rates are lower, they are going to say what are you going to do when rates are high.

Rates weren't high too long ago.

So I think we decided just to stay off the subject and they are what they are and, you know, some days you like them when they are high and some days you don't like them when they are low, but what we really want it a stronger economy.

John, can you talk about the margins in the major market segment relative to the traditional?

I think what you have to realize, the major markets margins are basically no different from our core ones when you are at a client that size.

It is the same thing back -- I would rather do ten 10s than one 100s.

Doesn't mean I don't want to do the 100s, I just have a preference.

The margins are fine but the revenue per check comes down.

It's the story.

If you have got revenue per check in a core client it's probably in the 250 range.

Major markets might be in the $1.25 range.

You go to the upper end where ADP is, it is probably somewhere around 50 cents.

That's the function.

We are doing fine.

And the reason -- other reason I know we are in the combined branches, we still got margin growth despite the fact we have major markets now it's probably going to go over 100 million this year.

You can't take a product that goes over 100 million and have margin improvement if the thing is not doing pretty well.

Great, thanks.

David Corina with William Blair and Company, you may ask your question.

Yeah, hi.

One quick one, Tom and John, with interest rates so low, you always prefer dividends with 50% of your earnings.

Any rethinking of that versus share buyback?

No.

We probably -- we discussed it at every board meeting, Dave, and we will probably discuss it next month, but there doesn't seem to be a lot of momentum behind that kind of a decision.

Fair enough, thank you.

Grant [unintelligible] with Deutsche Banc, you may ask your question.

Thanks, hi John and Tom.

Quick question for you.

John, I missed in the second-half guidance, can you just revisit which interest rate assumptions and the checks per client assumptions are you making for that guidance.

Thanks.

Same one as always, stuck.

We don't anticipate any future rate increase or decreases so the 50 basis points have been built in.

Check conditions are assumed.

Right now we're right on the trend we are, we are pretty much stuck.

Okay, great.

I guess just one follow-up to that checks for control I think Adam had asked you in terms of sequential performance.

Did that turn positive?

Do you expect it to turn positive at all here?

Basically, what you have to realize if you go back two years, checks per client are still less than they were two years ago.

They went down a little bit in the quarter but that acceleration of speed has changed dramatically and the [unintelligible] we think you're going to see.

So those things are going to get a little better as the comparisons get better and hopefully it will get better.

I wish I could tell you I knew when, but I don't.

And again -- and I appreciate you asking this question.

And it's okay.

Is we will continue to forecast based on where we are.

Because once you start changing all those factors, and you are changing factors, nobody knows where you are, and I think one of the things that we have worked hard on is to have our financial statements as transparent as possible.

We want them clear.

We gave you a lot of information on Advantage this time.

We will give it as long as we can but as we assimilate this acquisition it will be harder and harder.

We want to make sure when you project your second half, you can clearly kind of know what was paycheck, what is the Advantage curve because we are not going to earn a lot of money on it but things are going fine and we will continue to do those things.

Okay, great.

Thanks very much.

Mark Markem with Wachovia Securities, you may ask your question.

Good evening.

With regard to Advantage, Tom and John, you mentioned during the last call that it may not take too long to get the margins up to, you know, Paychex's levels.

I am wondering, you know, any refinement on the thought there or what kind of a time line?

No.

The only thing we are going to say is, you know, over the next 12 months, more than half of these clients will probably be converted.

There is no reason -- without -- with minor price increases that we are incremental revenue here shouldn't bring us approximately or better or higher margins than what we are getting currently in our core revenue.

Now, remember, if the pricing is lower to our clients, that does not translate into lower margins percentage-wise because incremental revenue is much more profitable.

We are getting a huge influx of incremental revenue now without changing our infrastructure costs.

So --

So -- I mean you could get on the whole their margins up to Paychex's levels in 12 months?

No.

No.

But, our margins overall could go up because the incremental revenue is so much -- so much more profitable.

Right, right.

I got that part, I was just -- I was wondering if you -- at what point would you expect their margins to approximate your margins.

Their margins are not up to as high as Paychex's are.

Sure.

They are over our operating income margin.

Follow me?

Yep.

Okay.

So how long do I think it is going to take?

I don't know if we will ever be able to measure it fully, but depending on how fast we convert, I don't know if it is that much of a factor, but I think -- the best way for me to answer this without hedging is we don't know.

All we know is the incremental revenue will be very profitable and overall margins are going to be up.

Why don't we just leave it at that.

Okay.

That's fine.

With regards to the, you know, to the interest rate assumption with regards to interest rates on -- both on funds held for clients as well as corporate, can you tell us what sort of rates you were achieving in the last month, and I am assuming that would be the rate we would see.

A lot of it is in the 10-Q.

We gave you the average rates.

You will find that the short-term rate hardly changed at all until the feds finally changed the 50 basis points which was toward the end.

Right, that's why I was asking about towards the end of the quarter.

What we are finding in interest rates, right now we kind of stick to what goes into the disclosure because the darn thing gets so complicated and changing all the time that we spend a lot of time here deciding, what is that we are going to put on these sheets of paper and we put it out there and you always have the best and the most we are going to say so that's kind of where we are.

Okay, are you seeing anything in terms of ADP reorganized their sales force?

Any changes there?

And any, you know --.

Nothing that would have materially impact us and everything we heard impacting them is just hearsay so we have no comment on that.

Last question, when it comes time to raise prices, do you think we can go to another 3% or 4%?

Well, you know, we have been on that pattern ever since the early '80s, and quite frankly and candidly, I don't see anything at least on our horizon that would impact our thinking on that.

Great.

Thank you very much.

Greg Gold with Goldman Sachs, you may ask your question.

Thanks.

A question on the MMS business.

Are you guys seeing any [unintelligible] the type of customer or the revenue per customer in the new signings?

You know we missed part of it, you got blocked out there.

Can you repeat it.

Sorry, on MMS, are you seeing any change in the type of customer demographic for new signings either revenue per customer or size of client?

No.

No, it's been very consistent.

Okay.

And sales force productivity overall, are there any changes over the past couple of quarters in terms of the number of clients you are signing up.

This is not just MMS but firm-wide.

No, we have been very consistent, quite frankly.

And if there's any bumps or positive bumps, we have had one or two each way.

So year-over-year overall, we are pretty much in the same realm we were before.

Okay, thank you.

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

Hi, thanks.

Two quick questions.

First, John, you had mentioned something about the dynamic and the float going up sequentially related to the Advantage acquisition.

As we look into the February quarter, would we expect it then to go up again sequentially?

Yeah, probably -- you have to understand float is seasonal, the best quarter is the one ended 2/28 because you have got the bonus check and the next quarter, best one, is May 31st because you still have FICA and all the social security taxes.

The worst one is the third quarter.

The worst one is the quarter we are in.

The summer quarter and the last quarter are the two worst ones.

Then you would expect to it to go sequentially?

No, I expect them to go up sequentially in their third quarter.

Our third quarter.

Our third quarter.

Now, the gross number may not because we have got this reduction but the balances should go up.

Okay, I see.

The other thing you mentioned an opening adjustment to the balance sheet for -- I am not sure what you were referring to.

It is basically when you value the beginning balance sheet, there is some severance agreements that were offered to some of their senior people, but we knew what was going to happen to every single -- all but maybe two.

So we were under the rules allowed to accrue that as opposed to expense later.

Sure, can you give us an idea how much that was?

No.

But I gave you an idea it was [unintelligible] well, you can figure out, it's about a penny.

So within that range.

Great, thank you

Greg Giber with AG Edwards, you may ask your question.

I want to turn back to the Major Market Services for a minute.

Is that now fully nationally or do you still have more markets you plan to move that into.

No, we still have 15 or 20 markets we plan to move major markets in and I'm sure we'll do it soon, be adding some next year probably during the summer.

We are covering about 85% of the client base.

Okay.

You have indicated on Major Market Services at about a third of your signees come from your existing client base.

How much of that is true cannibalization -- do you have any idea how much of it is true cannibalization and how much of it are clients you would probably have lost simply because the other system just wasn't sufficiently powerful enough for them?

We really resist our client -- our sales force moving clients over just for the fun of it.

The way we set up our commission structures, we think we do a really good job of enforcing it.

So I would say most the candidates -- most of the clients are -- almost all of the clients that were moved over to MMS were done for good reason.

We are very conscious of this issue of our MMS salespeople just making sales by moving them.

So, we have set up parameters in the commission program and incentive program that does not allow that to happen.

Also, I think we do a pretty good job of tracking why the clients have been shifted over.

And generally it's because there are features and benefits of the MMS system that the core system doesn't have, and people want to take advantage of it.

But I don't think you should assume that if a person didn't have that opportunity, they would leave.

Okay.

Some would, but not -- it is not a high proportion.

On Advantage, the revenue report, how much of that came strictly from associates or the franchisees, which I assume is all sort of a license or royalty number.

I guess I could go find out the number, I don't know it off hand but my belief is associates probably contributed slightly less than -- about 10%, 10 to 15% of revenue.

As you eventually move everybody, all the inhouse and non-associate clients off the old Advantage payroll, will that still be profitable to maintain the franchise program?

I understand you are still maintaining the Rapid Pay system, but that may not be profitable for you.

Well, first of all, the long-term goal of Paychex is to bring all of these systems under one umbrella.

But as time goes on, I think you will see some of the associates -- there is not that many of them.

Only ten of them, I guess, that will -- some of them will just sort of dissipate.

We may acquire them.

Somebody else may acquire them.

Some days there will probably be a day of reckoning where we have to decide, gee, it just doesn't pay for us to maintain this system anymore and maybe flip them over to the Paychex system which is always the possibility if they are interested in that.

Surely logic will tell you that we will not be doing this 10 or 15 or 20 years from now.

I gave an answer and realized I was wrong.

The associate revenue would be 15% to 20% of the total.

Okay.

But it is still sizable enough that -- we can find a way to keep that profitable.

I mean, if you wind up with it moving down, you can process it all in one place which most of it is processed now and we have branches that have less than 3,000 clients that are very profitable.

You actually do the processing too?

The associate -- basically what an associate does is all they do is -- they do the selling and the taking of the payroll function but even then it's not quite the degree that we do.

They do it pretty well.

They are doing fine.

Okay.

But -- now are you still maintaining the Rapid Pay system or have you dropped that?

No, we are still maintaining that.

Okay, thank you.

Marta Nichols with Banc of America Securities, you may ask your question.

Hi, thanks.

I wanted to flush out some of the questions that Grant had a little bit more.

You said that you are assuming, in your guidance, that you have the same number of checks per client going forward, and I want to understand.

You are assuming the same number of checks per client in future quarters than you had in the most recent quarter.

You have to be careful here.

Okay.

Tom said one problem here -- this calculation, first off, is not easy to do because you have all different kinds of things going on.

You know, you might have a 4th of July, that does one thing.

We are comparing them.

What we have done is actually compare week by week.

Weeks don't even fall in the same month.

So what we are basically saying is if we go forward, the trends we are seeing we have left the same.

Now this is complicated and we track it.

We basically say this thing is slowing and that trend is continuing, but it isn't like we built any improvement in, we are just seeing -- it's kind of leveling out.

So it is not like it is a big factor in this calculation.

I mean a lot of our money comes off of recurring revenues and checks, while this impacted us pretty significantly a year ago, impact right now is not as great especially when you get down to .8% in the quarter.

I guess my point is, given that we are going up some of the worst year-over-year declines in checks per client in the next couple of quarters and assuming you are maintaining some steady stay relative to where you are now, is the implication there that we should be seeing positive comps in checks per client in the next couple of quarters.

No, the problem is I am still selling -- my checks per client calculation today is still less than it was two years ago.

I did a comparison.

Now, it's down as much because most of that decrease already took place.

What we haven't seen yet -- let's say our average checks per client is 13 -- not 13, it was 14 off of what this is, we haven't seen that improved yet and prior recessions show that may not come back quickly.

That is something we can't predict.

We don't know.

If all of a sudden these people rehire these people, the same thing we lost, we would get back.

My belief is this recovery will come slowly.

Even right now we hope we will eventually see signs of positive things.

The best word to describe it is really "stuck."

Okay, and you mentioned also some features and benefits of the Advantage system that clients like that you don't necessarily have available.

Can you flush out what those are a little bit more and are those features that you can ultimately add to your own system, technology --.

The first question we would ask -- would there be enough numbers and request for this type of reporting and that certainly is questionable.

The way the Advantage system was designed, they had the ability to create a lot of ancillary reports.

So, you had clients that, you know, took that liberty.

But if you were to take -- try to take one or two or three or four or five of the key reports, you will probably find out that it doesn't have a lot of universal requests for it.

So -- and then I think over time, since we are working obviously all the time on modifications to our payroll system, we may incorporate some of them.

The other factor is, there is a lot of things in our payroll system that were not in the Advantage system.

We will have to bring the two things together.

Okay.

And then finally a non-operational question.

Does the -- does the taxability of dividends and the move to potential really remove the double taxation of dividends have any influence on your dividend policy?

No --

Would that change the way that you would consider using cash at all?

Or would it just make the fact that dividends has been your primary distribution of cash to your shareholders more attractive.

I know one shareholder who would be very happy with it.

Yeah, I know.

I don't think it will impact from the Company's perspective at all.

We think at 50% of earnings that -- that is sort of a stratosphere that we will probably not violate any further because it is so significant.

Right.

Okay, thanks.

Glen Green with [unintelligible] Equity Partners, you may ask your question.

Thank you, one quick question, you alluded to the 30% price discount on the Advantage customer base.

Have you started to raise prices on that yet?

And you can talk sort of the timing and how you plan on rolling out those price increases.

No we haven't, but I have a feeling that the decision would probably be made to make it consistent with the dates of our other price increases.

We think we picked the most strategic time of the year to increase prices.

So, my assumption would be that we will probably do the same thing with Advantage too.

And is it sort of like you will do a gradual price increase or just really want to get them up to your level?

Oh, no, no.

We feel very much going to be a gradual.

Okay, great.

Thanks.

Robert [unintelligible] with Solomon Smith Barney, you may ask your question.

Hi.

Just a couple of questions.

First, the competitive landscape in the five employee and less market.

If you could give us a sense of the market presence and share of off-the-shelf, do-it-yourself payroll and some of these really small regional payroll outsourcers versus you guys?

And the second part of the question is, just on your 401(k) fee structure and some of the trends there.

401(k) fee structure is pretty much similar to our core payroll structure.

We seem to have modest price increases on an annual basis but fairly modest, certainly less than 3 or 4 -- certainly less than 4 or 5%.

Do you get a percentage -- a percentage based on assets managed by say a fidelity.

That's done by contract, and that is an ongoing contract.

It is not renegotiated, and it is based on the total amount of money under management.

So that continues to go up as the investments go up.

Okay.

Now back to your earlier question.

You know, the one-to-four market is huge.

And I think it is about 7 -- 70% or 73% of the businesses out there.

So, because it's so huge and because there is such turnover in clients in that arena, it is really hard to get your hands around what is really going on.

Certainly I can tell you that a lot more people are using automated general ledger software to do their payroll.

It might be as simple as writing payroll checks out of the accounts payable system.

We see a lot of companies in the one-to-four range doing that and then at the end of the quarter and at the end of the year, the accountant comes in and does all the payroll tax returns.

I mean that's still -- the only difference there is 15 or 20 years ago, people used to write their payroll checks out of their manual accounts payable system or out of the payroll book.

Okay.

So, yes, more people are using some level of automation to write payroll checks, not necessarily out of a payroll system or payroll software system.

Do you see any kind of retreat from that segment?

Could that kind of explain your moves in the MMS segment?

Oh, no.

One-third of our clients have between one and four employees.

And the basic principle -- the lower the number of employees the higher the revenue per check.

Even though it is a small amount of employees from a profitability perspective and an ease of handling, these clients are very, very important to us.

But the other thing that goes along with it is they do have a very high turnover rate.

And that's because there are start-ups, and there are small businesses and you know the volatility of that type of thing.

Do you see a lot of -- do you see much competition from these very small regional players who underprice you guys in ADP by --

No, that's nothing new.

I think Paychex and ADP have been the price leaders as long as Paychex has been a force in the marketplace over the last 15 or 20 years.

Generally speaking, our two companies -- these two companies are the price leaders, and the single-city players and some the regional players have a tendency to underprice us anywhere from 10% to 20%.

I think Advantage was probably the most aggressive that we have seen out there.

You don't see any traction from these very small guys, do you?

Not of any consequence, no.

Okay, thanks.

Adam Waldo with Lehman Brothers, you may ask your question..

Just a couple quick follow-up questions on the sales force, Tom.

Have you all migrated the Apay sales reps you kept the 75 or so yet over to the historic Paychex quota system and to the extent that you haven't, could you give us a sense of your migration plans on that?

Well, the salespeople that we retained obviously are ones we have very high promise for, some of them may have already been Paychex sales rep, and on a city-by-city basis, we are integrating them in.

Don't forget, Paychex has 103 sales offices, and when you are bringing in 70 or 75 people, it's less than one sales office.

So it's not so much that you would have a general outline or strategic plan that would be universally applied.

What we did was pick the people that we thought would be appropriate and then we left it up to the local management to decide how they are going to handle that person.

So each Paychex sales office head has the discretion of whether or not to move the individual Apay reps coming in to his or her purview onto the Paychex quota system.

Is that a fair thing for me to surmise?

Yeah, but remember even with our increased retention of salespeople, it doesn't take very long in a office that has 25 or 30 reps to require a new one because of turnover.

So, by the time we get these people trained and ready to go on our system, they will probably be -- have the territory available for them to move right into.

Got it.

Okay.

So the thought would be to move them into open territories of traditional Paychex size under a traditional Paychex quotas as become available.

We have a high confidence level these people and their success level.

There is no reason that as soon as the first territory comes open, we put them right into it.

Okay.

Final question, head count if I caught you right in the prepared remarks, was up about 800 sequentially across the company.

As you look out for the back half of the year, where do you think as you proceed with the integration process, your head count might sort of normalize out?

Well, I don't know what level of normalization is because I didn't dissect that number myself.

Okay.

I assume that was after John and all the salespeople.

All the Advantage people.

The 100 -- approximately 100 that we didn't keep.

I think what will happen from them -- from now on, it will be fairly stable.

Stable or slightly less probably for rest of the year.

Now some of that is going to depend on what happens with that sales force and what we decide to do with hiring next year's addition to the sales force, and where we put that.

You know with being a little heavier right now, we may sit here and not put the bubble -- it shouldn't change appreciably.

Okay.

Finally a number of sources at Apay indicated to me that maybe as much as two-thirds of the salespeople you were keeping were moving on to the HR and benefits side versus core payroll.

Is that a fair assumption to have or is that inaccurate?

No.

Most of them are going into the core payroll system.

Okay.

Thanks a lot.

Michael Baker with Raymond James, you may ask your question.

Yes, I was wondering Tom and John, if you could update us with respect to the health and welfare benefit.

Are you seeing any opportunities for new product development there.

Obviously, I know you have the PEO solution.

Are there other solutions you are considering?

We are always under consideration in the health area, let me tell you, because we know somewhere out there there is an opportunity.

And we have been working on a couple of ideas, but we are not ready to talk about anything at this point.

Just one follow-up there.

There has been talk about risk adjusted premium processing platforms that might induce more competition amongst health plans.

Have you seen -- have you "A," seen that time approach, and "B," any success to it.

Haven't seen it so I don't know.

Okay, thank you.

Steven Weber with SG Cowen, you may ask your question.

Yes, I just want a clarification.

In looking through your 10Q you indicate that you expect the combined interest on float and corporate fund to be down 15 to 20%.

That is all in, including the Advantage?

Yup.

Okay.

Can you just give us kind of a feel what you think the run rate, John of the corporate income would be, say in the third and fourth quarter?

Is that going to be down like 3 or 4 million dollars if you don't have --

[unintelligible] gains in there.

Yeah.

The second is the cash we have is down, so it's going to be down.

Okay.

Part of it is going to happen there than probably up in the other end.

Okay, thank you very much.

At this time, we have no more questions.

Okay, basically, again, we thank you for participating in the call, your interest in Paychex.

I look forward to your email telling me which method you like better.

I thought the questions were good today and the interest.

We hope all of you and your families have a safe and enjoyable holiday season.

So take care and from Tom and I, good luck.

Thank you.