沛齊 (PAYX) 2003 Q3 法說會逐字稿

Good morning.

And welcome to the Paychex's third quarter earnings release conference call.

All participants will be able to listen only until the question and answer session.

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 John Morphy, Chief Financial Officer.

Sir, you may begin.

Thank you for joining us for our third quarter 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 ended February 28, 2003 yesterday 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 website at www.paychex.com at our investor relations home page.

We have also filed our form 10Q for the third quarter ended February 28, 2003.

This filing is available on our website right now.

In addition, this teleconference is being broadcast over the Internet and will be available archived and available for access on our website until March 28, 2003.

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

The earnings release is summarized as follows.

For the third quarter and first 9 months of fiscal 2003, total revenue growth was 19% and 14% respectively which, in turn, generated an increase in net income of 7% and 8%.

Quarterly earnings per share were 19 cents versus 18 cents a year ago, up 7% on an unrounded basis.

The quarterly EPS was right in line with our expectations of third and fourth quarter EPS for fiscal 2003 being slightly below the reported EPS for the first and second quarters of fiscal 2003.

Year-to-date earnings per share were 59 cents versus 54 cents a year ago, up 8% on an unrounded basis.

Operating income exclusive of interest on funds held for clients and investment income was up an impressive 21% for the quarter and 18% for the first 9 months of the current year.

We continue to be very pleased with our results in these difficult times of significantly lower interest rates accompanied by difficult economic conditions in the United States.

This past Monday, we announced the acquisition of Interpay, a wholly owned subsidiary of Fleet Boston.

This acquisition is expected to close in the first week of April 2003, as all required approvals, including [KARTIK MEHTA] have been received.

Prior to taking questions our chairman and CEO, Thomas Golisano, will provide his comments on the Interpay acquisition as well as an update on the integration of our September acquisition of Advantage.

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

Total service revenues increased 20% and 16% in the third quarter and nine month periods to $274.3 million and $769.4 million respectively.

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

Payroll service revenues for the third quarter and 9 months increased 20% and 15% to $235.3 million and $660.8 million respectively.

The increases are relate yet to revenue growth from Advantage, organic client based growth, increased utilization of ancillary services and price increases.

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

We have adjusted the calculation of checks per client to remove the impact of client payroll frequency.

We believe the slightly revised calculation provides a more accurate indicator of underlying economic demand for our services.

The revised year-over-year reductions in checks per client, excluding Advantage for the first through third quarters of fiscal 2003, were 1.7%, .3% and 1% -- .1% in this last quarter.

The year-over-year reductions in checks per client for the first through fourth quarters of fiscal 2002 revised were 1.9%, 3.8%, 4.1% and 2.6%.

As of February 28, 2003, 87% of all clients utilized our tax filing and payment services and 59% utilized the employee payment services.

Approximately 90% of new clients purchased our tax filing and payment services and 70% of new clients purchased employee payment services.

Major market services revenue increased 42% for both the third quarter and nine-month periods to $27.3 million and $73.3 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 21% and 23% for the third quarter and nine month period to$ 39.0 million and $108.6 million respectively.

Increases are primarily related to growth in retirement services clients and in client employees served by the past and PEO bundled services.

Retirement services revenue increased 15% and 20% in the third quarter and nine month periods to $17.6 million and $49.5 million respectively.

Paychex's administrative services, PAS, and the company's professional services employer, PEO, are comprehensive services that include payroll, employer compliance, employee benefit administration and risk management outsourcing services designed to make it easier for businesses to manage their payroll and benefit costs.

Sales of PAS and PEO products have been strong with administrative fee revenue.

These products increasing 41% and 42% in the third quarter and nine month periods of fiscal 2003.

As of February 28, 2003, our PAS and PEO products serviced over 95,000 client employees.

Interest on funds held for clients decreased 9% and 19% for the third quarter and nine month periods of fiscal 2003.

The 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.

The higher average portfolio balances were driven by the acquisition of Advantage and the growth and utilization of our tax filing and payment services and employee payment services.

Average daily portfolio balances totalled $2.37 billion and $2.07 billion for the three and nine month periods ended February 28, 2003, compared to $1.95 billion and $1.80 billion in the respective fiscal 2002 periods.

The funds held for clients portfolio earned an average rate of return of 2.1% and 2.4% for the third quarter and first 9 months of fiscal 2003 compared with 2.6% and 3.1% in the respective prior year periods.

Net realized gains on the sale of available for sale securities included an interest on funds held for clients decreased decreased to $.7 million and $3.0 million for the third quarter and nine month periods compared to $2.3 million and $7.6 million in the respective prior year periods.

Consolidated operating selling general administrative expenses increased 20% in the third quarter and 15% for the nine-month period over the prior year.

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

There are approximately 8,250 employees at February 28, 2003 compared with 7,300 a year ago.

The impact of Advantage on results is as follows.

For the third quarter fiscal 2003, Advantage revenues included $18.6 million of service revenue and $1.4 million of interest on funds held for clients.

For the period from September 20, 2002, advantage revenues were comprised of $32.7 million of service revenue and $2.6 million of interest on funds held for clients.

Advantage operating, selling, G&A expenses were $17.0 million and $31.3 million respectively for the third quarter and year-to-date periods.

Included in these expenses were intangible, asset amortization of $2.1 million and $3.7 million for the respective quarter and year-to-date periods.

We will again give this level of detail probably in the fourth quarter, but going forward into fiscal 2004, our ability to give the Advantage numbers will be diminished by the fact that more and more of the integration will have taken place.

The acquisition of Advantage resulted in .01 of earnings per share accretion since acquisition is expected to result in 1 cents of earnings per share dilution in the fourth quarter of fiscal 2003.

We expect the results of advantage to be accretive thereafter.

Operating income increased 16% and 11% for the third quarter and nine month periods.

Operating income excluding interest on funds held for clients as a percentage of total service revenues was 32% and 34% for the third quarter and 9 months of fiscal 2003 which was comparable to the respective prior year periods.

Excluding Advantage, operating income, again without the float, was 34% and 36% for the quarter and year-to-date periods compared to 32% and 34% for the same periods in fiscal 2002.

We continue to leverage our operating margins despite the difficult economic conditions that exist today.

Investment income decreased 55% and 2% for the third quarter and nine month periods due to a decrease in average daily investment balances, lower average interest rates earned and the timing of net realized gains on the sale of available for sale securities.

In the second quarter of fiscal 2003, we recognized approximately $7 million of gains relating to the sale of corporate investments to fund the acquisition of advantage.

The use of corporate investments to fund the acquisition reduced investment income by approximately $2.4 million and $4.4 million during the third quarter and nine month periods of fiscal 2003.

Average daily balances invested were $495 million and $585 million in the third quarter and 9 months of fiscal 2003.

That compares with $697 million and $669 million for the respective prior year periods.

The corporate investment portfolio earned an average rate of return of 3.2% and 3.3% for the third quarter and 9 months compared with 3.6% and 3.9% in the respective prior year periods.

There were no realized gains for the third quarter and $9.6 million in net realized gains for the first 9 months of files equal 2003.

This compares with net realized gains of $2.4 million and $5.2 million in the prior year.

Our effective income tax rate was 32.0% for both the third quarter and first 9 months compared with 30.0% and 30.5% in the prior year periods.

The increase in the effective tax rate is a 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 7% and 8% for the third quarter and first 9 months of fiscal 2003 compared with the same periods last year.

Despite the fact that we've had a tough time with interest rates and the economy, income before taxes was 37% and 40% of total revenues for the third quarter and nine month periods compared with 39% and 42% for the respective prior year periods.

In addition, operating income, excluding interest on funds held for clients, increased 21% in the third quarter and 18% in the nine month period to $87.9 million and $263.2 million respectively.

We have based full year fiscal 2003 expectations on current economic and interest rate conditions continuing with no significant changes and excluding the impact of the acquisition of Interpay.

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 benefit revenue service growth 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 18%.

When we've given the guidance on looking forward these percentages should hold very close, even with the Interpay acquisition which will have a slight dilutive effect.

I'm not sure that it will amount to a full penny per share.

I think the guidance we've given here will stay consistent with what we expect to happen.

Taking these factors into consideration we anticipate achieving record total revenue and 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 high single digits.

Moving to page 5 of our press release, our balance sheet since May 31, 2002 reflects our growth during the first 9 months of fiscal 2003, plus the impact of Advantage.

Cash and corporate investments total $552 million.

Our total available for sale investments including corporate investments and funds held for clients reflected unrealized gains of $46.1 million at February 28, 2003, compared with unrealized gains of $26.7 million at May 31, 2002.

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

Things continue to be volatile as the next few comments will show.

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

During the first 9 months of 2003 the unrealized gain position ranged from approximately $22.3 million to $46.3 million.

The unrealized gain position here on March 19th is $39.7 million compared to the $46 million as recently as the end of the quarter.

So the number here continues to bounce up and down pretty frequently.

Our net property and equipment balance activity during the nine month period reflected capital expenditures of $48 million, $8 million of assets acquired with Advantage and depreciation expense of $24 million.

For fiscal 2003, capital expenditure 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 be approximately $35 million.

The company recorded $243 million of goodwill and $59 million of intangible assets from the acquisition of Advantage.

Intangible assets primarily represent client list and license agreements with associate offices which are amortized from periods ranging 7 to 12 years using accelerated or straight line methods.

Goodwill reported from the purchase of Advantage will not be amortized but instead be tested by impairment on an annual bases.

Total stock, stockholder's equity, increased to $1 billion on February 28, 2003, with $124 million in dividends paid during the first 9 months.

A payout of 56% of net income.

A return on equity for the past 12 months was 30%.

Accumulated other comprehensive income balance at May 31, 2002 of $17 million is increased to $29.5 million at the end of the third quarter which reflects the previously discussed increase in the market value of our available for sale portfolio.

Investment rates of return.

The volatile interest rate environment.

We received many questions about the potential impact of changing interest rates.

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

To summarize changes in interest rates quickly impact earnings on short-term investments and over time impact earnings on available for sale securities as current holdings are sold or mature and are reinvested at current rates.

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

However, we estimate that at 25 basis point change in taxable interest rates, 17 on the taxes basis will have an effect of approximately $3.0 million on the earnings in the 12 month period.

You should be aware that certain written and oral statements made by the company's management constitute forward-looking statements as defined in the Private Securities Litigation Reform Act of '95.

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 related risk factors.

I will now turn the meeting over to Tom Golisano who will provide comments on the third quarter as well as a good update on our two recent acquisitions.

Thank you, John.

I am going to talk about the two acquisitions and then I'd like to give a couple comments about our industry which I don't normally do, but I think under the circumstances, it's very, very appropriate.

As John mentioned, first of all, our quarterly results were very much in line with our expectations both in client additions, revenue growth and profitability.

So, things seem to be perking along quite well considering the issues that are out of our control.

First of all as a reminder on Advantage we made the acquisition in September of 2002.

It's 49,000 clients, very much a compatible client base with ours.

Revenue is $80 million on annualized basis.

Third quarter results for the Advantage revenue bear this out.

It was a cash transaction.

It was $240 million.

The first thing we did on this acquisition, of course, was to combine the sales organizations.

Also with a significant focus on client retention.

We are proud to announce after two or three quarters, that our client retention numbers are actually doing a little better than we anticipated.

And we are very happy with that.

Client conversions have started.

They are going along at a relatively even pace.

We are not trying to rush it in any way because we don't have to.

Again with the focus on client retention.

One of the great things about the Advantage acquisition was that we did acquire a great group of employees.

They are very diligent, they are very skilled at what they do and a number of them have already been promoted into significant positions at Paychex.

Up to this point we have no disputable items with the Advantage acquisition.

Interpay, very much a regional payroll processor.

We announced it Monday.

I think the closing will be around the first of April.

They have about 34,000 clients being processed out of 13 branches, mainly in the northeastern United States.

The revenue is about $50 million annualized.

It was again a cash transaction of $155 million.

Very compatible client base.

Average size client slightly smaller than ours at 11 employees versus our 14.

John probably mentioned it will be slightly dilutive in the fourth quarter but accretive in the following quarters after that.

One of the great positives about the Interpay acquisition is the ongoing refer relationship we expect to have with Fleet Bank.

We have negotiated most of the details of this relationship.

The Fleet Bank organization will be referring clients to us in the small business market, and we will be doing the processing, and Fleet and ourselves will be enjoying the revenue on a shared basis.

It's interesting to note that more than 50% of the new Interpay clients added last year in the last 12 months came from Fleet Bank referrals.

So we expect that to be very, very positive going forward.

Over the years, Paychex has gotten a lot of questions and sometimes criticism about the size of our cash position.

We are proud to say that because we maintain that high cash position, we are able to do both of these transactions and when the final payment is made, we'll still have over $400 million in cash with no debt.

So our balance sheet continues to remain strong.

On an industry overview, if you think about what's happened over the last year in our industry, CBS payroll, Advantage, Pro Business and Interpay, which are four strong regional processors or players, have either been acquired or are in the process of being acquired.

We cannot forget there are also hundreds if not thousands of smaller, one-city type payroll processing companies out there.

When you think of the fact that these four organizations are strong regional players or, in the case of Pro Business national player in the larger end market, to have all of this happen in just a short period of time, really is interesting.

One thing I would note that we know for sure in the case of Advantage, pRo Biz and Interpay, that these companies have done a very good job of building their revenue growth but had not really been very successful in the profitability end and I know they were all working towards that end.

As of the day of the acquisitions being announced, none of them were actually making profit of any significant degree.

That makes us feel good because it indicates to us that we do operate in a very cost efficient manner while continuing to offer good customer service.

When I think of the low end of the market, the one to 100 or one to 200 employees, you've heard me say in the past in certain presentations that I consider this a two company industry, mainly between ourselves and Automatic Data and I think all the events that have taken place in the last 12 months continue to reinforce that thought model.

So, with that, I think we'll turn it over to questions.

John?

Okay.

Thank you.

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

If you would like to ask a question, you may press star one.

You will be announced prior to asking your question.

To withdraw your question press star 2 once again, to ask a question, please press star one.

Our first question comes from Brian King of Prudential Securities.

Sir, you may ask your question.

This is Vincent Agro in for Brian King.

I have a question on new sales.

The last quarter you mentioned you were looking to give $20,000 worth of new sales in the month of January.

I wanted to know if that came through?

What your expectations are on this going forward, as well as client retention.

What's going on there?

We are very happy with our client addition sales and our revenue that we've generated from those sales in January and continued on through February.

So there's been no real surprises.

We are operating at a level that's been consistent with the rest of the year.

We didn't get any surprises at all in that big selling season of January and February.

So all 20,000 were signed?

Yes.

What are your expectations for the rest of the year on that?

Well, we don't generally disclose our expectation for unit sales for any specific quarter.

I did that because of the unusual case of January.

But we don't think there's any surprises out there in our ability to sign up new clients and the revenue generated from that.

How about pricing pressure from regional competitors and ADP.

Has that increased or how has that trended over the past quarter?

It's a well-known fact that Paychex and Automatic Data have been the price leaders.

By price leaders I am talking about had the highest prices.

The regional players like Interpay and Advantage, I can't speak for CBS, were generally lower priced than ours.

Obviously, in the market place these companies are no longer a factor, and I think, obviously this should be less competitive pricing pressure.

ADP hasn't done anything out of the ordinary?

It's been pretty normal?

The activity for the last 12 months with ADP has been pretty status quo.

Thanks a lot.

Greg Cappelli of Credit Suisse First Boston, you may ask your question.

Hi, Tom and John.

I just wanted to follow on that.

I thought your comments were interesting, Tom.

Does that mean with Advantage, Interpay, and Pro Business, does that change the way you think about your own pricing strategy going forward?

I don't think so.

You know, one of the crosses to bear when you are the pricing leader, is that you have to make these decisions all the time, and I don't think with having these organizations gone it's going to effect our thinking at all.

We try to keep our price increases in the modest 3% range, 3.5%, maybe and I don't think we'll do anything different from that.

I think our salespeople, not having to obviously go against Interpay and Advantage salespeople any more, probably will have less pressure on them to do any discounting at the time of sale.

Other than that, I don't think it matters much.

We'll probably continue on our standard course.

Okay.

Just one quick follow-up.

Maybe -- you talk about the tone of business a little bit, or new business throughout the quarter.

Was there much volatility?

And maybe just a comment of how things are going so far in this quarter.

You know, other than the things we've already said, nothing much has changed.

The new client, new business formations are down a little bit.

We don't see that changing.

John gave you the numbers on our check activity.

Everything for the last six or nine months has been pretty much status quo.

Sounds like there weren't any major swings throughout the quarter then.

No.

Basically -- we have been talking about being unstuck since last May.

I sat down with a few of my people this morning and we are still unstuck.

You know, people talked about the 300,000 missing jobs in February, check comparison year-over-year on the quarter was only .1% that's the most favorable it's been.

It seems to have worked its way out.

We look at new hire reporting, all those things, we don't see anything happenings.

By the same token we don't see it getting worse.

Thanks a lot, guys.

Mr. James Kissane of Bear Stearns, you may ask your question.

John, in lay terms can you explain the change in the calculation for checks per client?

I was a little confused on it.

I'll tell you what it is.

In the payroll industry there's a slight downward movement in frequencies.

What that means is monthlies, semis, et cetera.

That slight downward pressure was in that check count.

So we took it out.

And what you have now is truly what's happening to the clients' check count based on employees, not affected by the slight decrease you are get the pay rolls are switching more towards by weeklies and semis versus weekly.

John you said you get one-third of your major market customers from your existing base?

That's no change.

That's been pretty consistent.

That will started to trend down, I think a little bit as we get MMS everywhere because generally the higher conversion periods in the front end when you put MMS into a new city.

How much is coming from competition and how much is coming from inhouse?

In terms of the balance of the two-thirds?

About -- more than half of the balance of the two-thirds is coming from competition.

And less than half is coming from inhouse.

Okay.

And Tom, how do you differentiate Paychex in the major market segment?

Is that more intensely competitive in terms of price?

That's an interesting question.

Today I would probably say that they're pretty consistent.

It would be interesting to answer that question in six months or a year because Advantage and Interpay, you know, are now part of our organization.

So right now, I'd say the competitive level on price between the two organizations is about the same.

Okay.

If I can just get one last one since you kind of set it up.

How much lower was Advantage and Interpay and other competitors relative to ADP and Paychex?

On price?

Yes.

It can range anywhere from 10 to 30 per cent.

Advantage was close to 30 on the average.

Interpay I think is going to be in the low 20s on the average.

We don't know exactly yet because -- while we have total access to all the Advantage numbers we don't have that yet on Interpay.

Thank you.

Randy Mare of Robert W. Baird you may ask your question.

Good morning Tom and John.

Not a bad thing to be stuck at 12% fee growth.

I think a lot of companies would take that.

On that note, you've had a couple quarters now where organic service revenue growth has accelerated a bit.

Do we expect, is that something in the comparisons kind of post 9/11, or is that something we should expect to continue over the next couple of quarters?

It's hard to say.

You know, we just keep doing what we are doing.

We are executing.

One of the pleasant surprises in this situation we are in is our retention has been holding real well.

You know we are not far off record levels despite the bankruptcies.

We keep doing our thing here and Randy, I sure hope it would continue, but I don't have the magic wand that says whether it will.

But, you know I'm sitting right next to this guy that likes to see it happen.

John and I kind of looked at each other saying who's going to answer this question.

I will say one thing, our client retention improving during the last 12 months or more has been more of a direct result, I think, of the skill set of our people delivering our services.

And that is indeed true, and I believe it to be true.

The better the quality of your service, the easier it is for you to sell clients.

Obviously we rely on CPA referrals and client referrals.

The more happy clients we have and the more happy CPAs we have, the easier it is for us to sell clients.

So we think the two things are related but I don't think John and I, either one of us are willing to go out on a limb and say this is some exciting new and exciting trend that's happening at Paychex.

We are just going to plug along every day and do the best we can.

The Advantage contribution in the quarter looked like there was a little bit of a difference from what you expected there more on the positive side in this quarter but then you expect as you expected before the slight dilution --

Slightly positive.

What's happened at Advantage, Randy, this thing is going real well.

One thing I feel really good about is, I gotta give the CEO and the CFO of Advantage a real heads up, we have no disputable items with them.

None.

What we said we are going to get is what we got.

We know this business.

It was like buying our left hand and Marty and his team and Walter and his team have done a good job of doing the integration and getting the things going.

We closed five branches.

People are moving into the organization.

It's going real well.

What causes it to be more dilutive this quarter?

Because that's what I said last time.

I don't think it's going to be that dilutive.

We have Interpay, we have Advantage.

Is any one of them a full penny combined?

No.

The fourth quarter has, again take these consolidation factors in and it means that earnings are going to be pretty close to what we said they were going to be.

Quick question on the 401K business, have there been any trends in adoption by new clients?

Revenue growth has obviously slowed quite a bit over the last couple quarters and I'm just wondering if that's just related to growth in the -- the slowing of growth overall, or if that's related to less adoption of 401K by new clients?

I think it's definitely overall economic conditions.

People with this stock market just have not been as enthused and excited about starting 401K plans as they have been when the market's been much more stable and a growing environment.

I think that's about the only issue, Randy.

Other than that, we think everything is pretty much status quo.

I think once things start to stabilize, that number will start to come back.

Getting a 401K plan doesn't have the same urgency today that it had awhile ago.

Is there any way -- is there any reason to think that penetration of your base should stay, maybe in the six to seven percent range versus, you know, going above 10% at some point?

Or should we still think of that --

It's definitely going to continue to go up, Randy.

The question is how long will it take to do it.

Okay.

One thing that will get it to go up, Randy, is we continue to sell 60 to 70% of what's new in the market.

And that percentage is a lot higher than my market shares as client base evolves.

Now, it's also why I know it's pretty much the economic conditions because what we're selling as a percentage hasn't changed much.

We are definitely getting our fair share of what's being formed.

I'm sorry 60 to 70% represents what?

You take the new 401Ks that exist in our client base, 60 to 70 percent of them we get.

Okay.

They only have about a 25% market share in there because there was 401 Ks in there before we got started as well as you get clients that come over that already have them.

Okay.

Thank you very much.

I appreciate it.

Okay.

Grant Sakatimi [ph] of Deutsche Banc you may ask your question.

Good morning Tom and John.

Couple quick housekeeping items.

What was the sales head count number in the quarter?

It's around 900.

It really hasn't changed much.

At times Walter there's a few extra on the Advantage crossover.

We did do some territory formation, but not materially different.

How many will Interpay add, roughly?

They have about 115 salespeople.

I don't want to speculate at this moment how many of them will be retained.

In the case of Advantage it was at least 50%.

Okay.

Tax rate forecast for '04, what should we use?

We haven't done it yet, but I would not lower it.

How about Cap Ex for '04?

Haven't done that yet, either I'm hoping it will be somewhere between -- I'll go a little high, 40 and $50 million.

I guess the final question is, I think you were talking about with respect to the major market segment a third was coming from your existing business.

Of the two-thirds that's new to you, what percentage of that is coming from clients who are outsourcing payroll for the first time versus coming from competitors?

And how has that changed?

And then, with respect to the percentage that's coming from competitors, have you seen any change in that from which competitors they are coming from?

No it's been very consistent over the last two or three years.

Of the new clients that come to us from outside our core product, which is about two-thirds of them, I would say about 60% of them are coming from competition and 40% of them are coming from inhouse.

I would say that probably of the 60% of them that are coming to us from competition about 75 to 80% of them are ADP.

Okay.

And that has stayed consistent over time?

Yes, I think so.

I think you have to remember the number of about 80% sounds astounding.

I don't think anybody should walk away from this call with the impression that ADP is doing a poor job in any way, shape or matter, what that does indicate necessity have a huge client basis in the 55 to 100 employee market and we don't.

And so incrementally it looks very strong.

But as a whole on ADP's perspective it's not that impressive.

Okay.

And just a quick follow up to that.

Who would your --how many employees does your largest client have right now?

I think we have -- the last time I asked that question, we have eight or ten clients with more than 1,000 employees.

And I don't think any of them are over 12,000.

Right.

Perfect.

Thank you.

Okay.

Jennifer Dugan [ph] of Merrill Lynch you may ask your question.

Hi.

I was wondering if you could give us more detail on the integration plans for Interpay.

Will that have to wait until after you have gotten some of the Advantage integration done or are they going to happen concurrently?

I think they will definitely happen concurrently, depending on the branch.

My guess is because of the similarity of the systems and so forth, we'll probably put a little bit more emphasis on the Interpay clients before the Advantage clients.

And the reason for it is we have a ongoing obligation to provide the Advantage software to third parties.

In this case, they call them associates and in their relationship with New England Business Services or NEBS.

We don't have that issue or concern to any large degree with Interpay.

The quicker we can get the Interpay clients off their software the less effort we have to maintain it and expense of maintaining it.

That's the summary now.

When we get through looking at the Interpay software we might change our mind.

There might be some hidden pleasant surprises that we may encounter, but generally speaking that's the plan.

But, until we get a good look at the software and see how it might be applicable, we are going to hedge.

Right.

I think, Jennifer it makes Interpay -- is going to be easier is those clients were actually sold, versus acquired, and they were sold with a pretty good common element with Fleet on top of it.

So the differences between what clients have in the report area is not as significant.

Okay, great.

Also, in Advantage it looked like the margins expanded from about 6 or 7% last quarter up to about 15% this quarter.

What are your sequential expectations going forward in terms of margin expansion there?

Some of that's salespeople, what you are going to find is eventually we'll get this into our base.

The margin change is going to have to eventually come off pricing, but a lot of that expansion is the sales force was less -- was more combined, obviously in this last quarter than it was in the first one.

We continue to really put the emphasis on servicing clients and getting them into our structures and while they are still in the Advantage structures, their cost structures are okay.

Great.

Thanks.

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

Hi, good morning Tom and John.

Tom, congratulations on the bottom of the cycle purchases in the last couple of weeks.

Tom, if we could --

We only funded one of them, though.

The company shareholders only funded one.

I'm sorry.

I didn't mean to create confusion.

Are you going to tell everybody what you are talking about?

The Buffalo Sabres purchase, obviously.

Turning to the business, couple questions on the sales force, if I could, Tom.

Could you give us a sense for whether new sales productivity trends in the key selling this season this year were similar or better to last year?

And have you made any material changes either in compensation systems or in the way you're managing sales force productivity, more importantly in the last few months?

Not in the last few months, but last year the beginning of the fiscal year we are in we did take out a level of management at the field level and I think that's had a positive impact.

Also the other thing that's happened is we've had a significant reduction in our salesperson turnover.

By significant, you know, we have been trending between the 35 to 40 range. 35 to 39 range.

We think we have a good chance to get under that range this year which I think will be real positive.

Not only in payroll but human resource services.

Our salesperson retention in major markets is astoundingly good.

And we are obviously happy about that.

Nothing really new relative to managing the sales organization other than the management structure, nothing in compensation.

Nothing in the way you are sorting of monitoring productivity per hour, those kind of metrics on how sales people in either payroll or the HR benefit segment use their time?

We think we have always done a good job with that not from day one, but probably from day two.

We have a reporting system we call WAR, or weekly activity report.

We can tell you by salesperson the number of calls the number of presentations the number of CPA referrals, the number of closes, et cetera on a daily and weekly bases for every salesperson involved in [KARTIK MEHTA].

Following up on Grant's question, could you give a little more specificity on what sales force head count looks like in the nonpayroll segment as we close the February quarter.

Basically the same as what's disclosed right on the website in our investor presentation.

It really hasn't changed.

Okay.

Great.

Final question -- I'm sorry.

Your question on the sales force productivity.

There are some people occasionally write about our sales force productivity declining somewhat.

We don't have serious declines.

The thing that people always forget to write about, though, is our productivity in the sales force is substantially higher than anybody else in the industry.

We know what Advantage sales people were selling, we know what Interpay people were selling.

Our productivity from a salesperson, sometimes is as much as 30 and 40% higher.

So while we look at those numbers and we don't like to see them go down at all, we also know we are continuing to get much more out of our sales force than other people are.

No question.

Finally, John if I could on the surplus cash side could you give us an update on the funding requirements from your cash balances in terms of the float funding cycle.

Are you still running in call it 250 to $300 million of your surplus cash being required to fund the variability of the float cycle; is that a fair expectation for us to have?

We have had a couple rocky days lately.

Chase Bank had some real problems yesterday and it was not a good day for Chase.

We went through it but that was an example where having the cash helped and having some borrowing ability helped.

The loan won't show up because they basically didn't move the money.

You continue to need that.

It doesn't mean I couldn't live without it, but we are going to continue to find things.

And I'm sure if Tom found another acquisition that consumed the $400 million and I had to live without having I'd have to find a way to live without it.

John, since you opened the door on that one, if Tom finds another value creating acquisition, how are you two thinking about balance sheet leverage, you know, in that context given where cash balances are now?

I think -- if we find things that make sense and the prices are okay, we're going to continue to do them.

Fair enough.

Thank you.

I'd like to add an addendum to that.

If you look at our competitive landscape, significant regional players out there, as of this moment, there aren't any.

So I think that cash position, going forward, is going to continue to climb back up.

You wouldn't expect it to change.

Thank you.

[ KARTIK MEHTA ] Midwest research you may ask your question.

Good morning.

Two questions for you.

Tom, has -- are you seeing any competitive change now that [KARTIK MEHTA ] with the CBS payroll acquisition?

We don't consider Intuit a competitor much at all.

I mean if you talk to our sales organization they very seldom run into Intuit as a processor.

You know, a significant portion, the highest percentage of Intuit's customers were Wells Fargo customers that were really tied to that CRI acquisition that they made several years ago.

And so outside of the State of California, we seldom see or run into Intuit people.

I think there was a recent announcement and I'll stand corrected if I'm wrong that the relationship between Intuit and CRI, has been modified and I'm not sure that Intuit will be processing payrolls for them much longer.

Okay.

Or if they are, the revenue sharing situation is different.

I guess kind of a big picture question here.

It just makes intuitive sense, the market's only 15, 20% penetrated, however you want to define the market, and that there's a lot left in terms of what you can go after.

What do you think is the real saturation point, you know, at what percentage do you think that the market is saturated?

Let me make -- I'll make a few comments on that statement.

First of all, we have to remember when you're talking about 15% penetration, a significant portion of that market place is the one to four market.

And if you take that out, there is still a huge opportunity.

For example in the 5 to 19 employee category, I think the entire market place still is only 25% penetrated there. 25 to 30%.

So it's still a wide open landscape as far as the industry and penetration by the industry.

I think there's some real barriers to entry, or organizations that consider our industry or our business to be viable.

One is it's very difficult, particularly today to get into this industry through acquisition because there just aren't any potential players out there, reasonable potential players, that could be acquired that could give a company a foundation in the payroll processing world.

So your other alternative is to build it, and if I may pat the people from ADP on the back as well as the people from Paychex on the back, we spent 30 years getting this thing into a position where it is.

The first 10 or 15 years, I can tell you, were very, very lean.

I think organizations look at our industry and say gee, it's a great business but I don't know if we want to take all the time it takes to really build critical mass in that small business payroll processing industry.

So I think that's a very natural barrier of entry.

Software development, yeah we got millions and millions of lines of code and it takes a significant and dramatic investment to get your software up to a point where it can be competitive.

So those are the factors.

Quite frankly, I'm looking forward to the next three to five years.

I don't see anything changing.

I think, when you look at this the barriers are much bigger.

I think the thing we learned in this past year that was really informative was the fact that Advantage, Interpay and we're pretty sure about CBS, weren't making any money.

Even at 50,000 clients.

Advantage and Interpay have been in business a long time.

Advantage has been in business longer than Paychex.

So we realize our cost structures are very good, and if you want to make money in this business you're going to have some sell at prices near ours and you're going to have to have cost structures similar to ours.

It's a tough road to hoe and we had great client growth of 11% or 12% in the greatest years.

It's very hard to take on clients at a very accelerated basis.

I guess one follow-up question to the client growth.

Obviously the economy's impacting some of that client growth.

Can you tell, even anecdotally how much of your client growth is being impacted by the poor economy?

We would guess it's two to three points.

I mean we talk about future client growth, we don't talk in terms of 11.

We would like to see 7 to 9 and conservatively shift down to the low end but it's costing two to three.

I would say that's a conservative number, two to three.

Thank you very much.

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

Thanks.

Congratulations on a great quarter in a tough environment.

Speaking about the next three to five years can you talk a little bit about new products, Tom, and where you see the business going and new services you can introduce to mine the installed base?

Thanks.

Sure, Pat.

First of all, I would be foolhardy if I didn't make the comment right now I consider Paychex to be product rich.

Not only with the low penetration level of our core payroll service, but in the areas of 401K recordkeeping, major market services, workers compensation insurance and one of the products I think has the greatest potential for, you know, 10 to 20 years, is Paychex's administrative services.

I believe with the penetration rates that we have achieved that we are still in our infancy in all those four products.

As I talk to our management team and we communicate on this issue, our focus, definitely for the next three to five years and my guess is even longer, are going to be in those four product areas, as well as our core payroll service.

I don't see anything changing.

Some things come along, not on a daily basis, but frequently things like the ability to do electronic garnishments for our clients.

Definitely a revenue and profit producer.

I think as the federal government and the state government continues to make the relationship between the employee and employer more complex, there will be other opportunities.

The things we dream about I think we have gotten good in handling $175 billion in cash this year through tax pay and direct deposit.

We know we have the ability to deduct money from employee's payroll checks and take the money from the employer's account and move it around for various potential services.

Our imagination runs wild on things like selling financial services to our clients' employees.

We think we would be a natural at it.

There's a gate keeper to deal with and that, of course is the employer.

There has to be something in it for them.

We are continuing to work on that aspect.

Just the future of Paychex's administrative services, major market and 401K and workers' comp [KARTIK MEHTA] we've got a big plate.

A real big plate.

And I think we are going to be very busy for the next five to ten years.

Thank you.

Greg Gieber [ph] of AG Edwards, you may ask your question.

I had a few questions on Interpay.

First of all, with Interpay, are you picking up, you said 13 branches, I believe.

Are you picking up any new markets with that or are these all duplicates .

They are pretty much duplicates.

They had -- there might be a couple areas of strength that we weren't as strong in, I think Vermont, new Hampshire.

So it's an enhancement to what we already have.

It's not putting us in a position where we are going to a new market at all.

Of the $50 million forward-looking revenue, how much of that will be service fees and how much interest or alternatively, what is the sort of float that you will be picking up from Interpay?

I don't know exactly, but just assume the float's probably in the same percentage relationship as Advantage.

You won't be far off.

Okay.

Now, if you go through what's happened with advantage and possibly with Interpay, what is -- what are you finding out about your potential to sell additional services into the advantage client base and what do you think might it be at Interpay?

Too early to speculate.

We haven't had enough experience in it.

We've got to go through the creations of interfaces with the Pace Advantage payroll system.

And obviously with Interpay we haven't started to convert clients.

I don't think it's going to be anything significant proportionately different than what it is with our core client base.

There's nothing unique about their client.

So as fast as we get them on to our core payroll system or our major market system we will be able to start selling services like 401K into those markets.

From your perspective I don't think I would speculate anything fantastic happening in the near future, six months to a year.

Okay.

Final question.

Tom, sports teams have very complex payroll demands.

What platform are you using in Buffalo?

We are using our major market services platform, and I think they are a client using that platform.

I'm not totally sure.

But somebody told me they already are a client.

If they are not put them in the penalty box then.

Good luck.

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

Thanks for taking my call.

My question rather.

If you guys could talk a little bit about the acquisition landscape, I think, Tom you said most of the larger regional players have been acquired, there's not too much else out there.

Does that say anything for near term growth, or maybe slowing down a little bit, or anything about the long-term growth implications for the sector?

What are your longer term -- longer term meaning three to five year, growth for your sector just in core payroll, exclusive of the ancillary and auxiliary products.

I think the first thing we have to make note of is the fact that we are not competing with these organizations in the market places.

From a sales perspective, that's very good.

The second perspective, though, is now we've increased our client bases by, you know, 34,000 and 50,000 clients that's 85,000 clients.

As we look forward to next year and the year after, we have to make sure we take advantage of the referral relationships that these extra 85,000 clients are bringing into us.

That's a major portion of our responsibility going forward.

Now, you no, I think it's important that not only us, but our shareholders track us on how well we do that with our client base growth based on the fact we've just added 85,000 clients additionally in one fell swoop.

One year fell swoop, I guess.

The good news is we are not competing against these organizations any more, we can take advantage of the Fleet referral relationship, but secondly, our client base has just gotten significantly larger.

So going forward that's going to be an issue.

I guess the way I should have phrased my question do you see the recent flurry, the flurry of recent acquisitions signifying that growth is slowing?

No, I don't think so at all.

I think if you look at the individual situations, we are involved in, Advantage, Advantage was owned by a venture capitalist company, you know their horizons generally are maybe five to seven years.

I think they reached that horizon, they were looking for the liquidity.

The IPO market was not where they wanted it to be so it seemed like a natural thing for them to acquire it.

Or I mean to sell it.

In the case of Interpay, I don't want to speculate what I think the bank's intentions were, but it's not a very significant portion of the bank's activity.

For what whatever reasons they decided to sell it, we just happened to be there at the right place with the right resources to take advantage of it.

I don't think they perceived, and if you look at their client growth numbers, both of them, that there was a slowing in the market place.

Because they, from a client acquisition perspective, were doing quite well.

They didn't sell these because they couldn't acquire clients.

They sold them because they couldn't acquire clients at the prices they could sell them at competing with us and then make money.

Right.

They also saw opportunities with the prices we paid to make some pretty good profits on the time they owned them.

Will Stein did not want to run that company.

They really wanted to sell it.

I think to some degree Fleet Bank looked at the Interpay sale as potential to, you know, match the benefits -- economic benefit that Advantage had.

So my second question would be what do you think is the three to five year growth rate over your core payroll process in the markets you serve currently?

Well, we are going to-our expectation is we want to grow our core client base six to nine percent.

We think that's very doable.

Obviously the little better off the economy is the easier it should be for us.

I think that will translate into revenue growth if you combine small price increases and ancillary services into 15% category.

If we do 15% category on the top line we're going to do over 20 on the bottom.

Last question here.

In terms of the next couple of quarters it seems like your business has stabilized maybe showing some modest improvement here on still, what I would call, shaky ground with the economy.

Are you seeing anything now that makes you think that the next couple quarters might be stronger than what you are seeing now or are you kind of happy with doing well and not wanting to get too greedy at this point?

I don't think we want to speculate on that.

We're going to do the best we can and your observation is well intended and well taken but we don't want to speculate on anything changing dramatically.

Thanks, guys.

David Farina [ph] of William Blair and Company you may ask your question.

Thank you very much.

Most of our questions have been asked.

John, just a quick one for you.

When you talk about the goodwill and the balance sheet how it gets impairment if you guys lose clients what specifically happens?

Do you have to go back --

No.

The impairment will be in a single industry because we are in a single industry.

The impairment will be tested against the total profitability of Paychex.

The likelihood of any impairment is close to zero.

Fair enough.

Lastly, are you guys still active acquiring, you know, one percent or so of clients little mom and pops around the country?

Yep.

Pricing has gotten better.

So has there been a pick up there as well in terms of --

Hard to say, but, there aren't as many people buying them.

Fair enough.

Okay.

Thank you.

Mark Marcone [ph] of Wachovia Securities you may request your question.

Good morning.

With regards to Advantage payroll, I was wondering, you know, now you've had them under your belt for a little while here, what your expectations are with regards to Advantage getting up to Paychex's profitablitity levels?

Well, based on the fact that we know their pricing was underneath ours, we don't think it would be appropriate for that client base to be hit with significant price increases.

So, if we're working on a 10 to 30% lower level, I think it's going to take us a few years to bring them up to the current pricing of Paychex.

We expect to do that fairly conservatively.

We don't want -- our number one focus, like I said has been client retention.

We think if we did anything significant like tried to make up the gap in a year or two, that would hurt.

And that would hurt our client retention significantly.

So we are going to play it pretty conservative.

So we're looking like three to four years?

I would say that's fairly safe.

Okay.

Great.

And then, I imagine the same could be said for Interpay?

Absolutely.

Okay.

And then with regards to -- with regards to Interpay, can you say, like what sort of gain you might expect to experience when you're selling some securities to raise the cash to --

We don't know, but we are not trying to get gains.

So it won't be $7 million.

It won't be seven?

No.

My guess is highest it will be three to four, but it might not even be that.

So under those circumstances, John, it still won't be that dilutive and Advantage won't be that dilutive --

Guidance we've given is pretty clear.

Okay, great.

With regards to your SG&A as a percentage of sales excluding D&A you actually had some pretty nice leverage here.

It also looks like your total head count is up significantly year-over-year.

I would imagine there might still be some more rationalization.

That's the advantage head count.

One thing here, you know, we really pride ourselves on providing opportunity for our employees and we've picked up a lot of employees here and they are all being given as good a chance as they can to be viable in our organization.

We train them.

The sales force, Walter and his people did a great job of running them all through a training thing figuring out which ones really wanted to participate with us and which ones didn't.

We gave them as much of a chance we can.

Some of the growth in personnel is as a results of that.

Over time it'll rationalize itself to the right place.

At Paychex we have been fortunate we very rarely have had to look at somebody and say we don't have a job for you because we don't have work.

We try to work these things out.

We've gotten some great bang in our customer service specialist which we now have 75%, our Senior Specialist which Tom talked about.

We really think we are delivering some great service right now and we are going to keep the people coming in.

We are not going to disrupt that.

I understand.

I guess what I'm trying to get a sense for is, it seems like you've already gotten some good SG&A leverage.

I'm wondering what that might look like going forward?

Well, that's -- if you're near Tom you have to get SG&A leverage because he doesn't like it when you don't get it.

It's part of the budget process.

I wish I could say we worked as hard at this as you probably think we do.

We have a flavor you can't get expense growth much higher than a couple hundred basis points over client growth.

Once you do that the thing falls in place.

We do this, we look at what's reasonable, I think you're still going to see some leveraging.

I can't tell you how much it will be.

We spent a lot of time looking at next year already.

We feel relatively optimistic as long as the world doesn't change too dramatically.

We know we have more leveraging in there.

That's why Tom says if we get 15% revenue growth we'll get 20 per cent profit growth.

Because we know how the ancillaries work out.

The same token on our SG&A we are not asking our customer service reps to support more clients because we know the service level will go down.

We really get this off ancillary penetration with very little cost and the whole way this model works which is one of the best models I have ever seen.

Great.

Can you say on MMS how many more markets you have to --

We are in almost all of them right now.

There's only a few small ones.

We serve 85 to 90% of the client base.

Great.

Thank you.

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

Thanks.

Tom, you talked a little bit about, you know, nonpayroll services and, you know the prospects for growth, you know in the acquired installed base, et cetera.

Is there anything that could drive growth of ancillary services other than just better economy and better employment growth?

Sure.

And it's one we've spent a lot of time discussing and debating internally, and that is above average growth of the sales organization.

And [KARTIK MEHTA ] 401Ks and major markets in the past.

We are not at liberty now to discuss what our head count is going to be in the sales organization.

If we want to grow incrementally faster or at a more rapid rate we have one of the ways you do it increase the growth of the size of the ails organization.

And those things are under discussion right now.

But we have nothing to announce yet at this point.

And what's the decision that would be made to increase the size of the sales force, what is the economics of that just based on your historical, you know, experience in terms of the time it takes to cover those costs in terms of production and margin, et cetera?

Well, I would say that -- it's hard to quantify it down into a timeframe, but what you have to do, by the time you hire the person, put them through training and they're out in their territory, you can assume it's a minimum of two to three months.

You've got training costs, you have travel costs, you have salary costs and so forth.

Then a new rep in the HR area may generate in their first year -- I'm not going to give you that number.

I was -- I almost told you the amount of revenue we expect them to generate in the first year.

If the margins are where -- on that incremental revenue are where the base is we are probably at a pretty much break-even on that sales rep in the first year.

Then the revenue they generate their first year, in the second year, of course is extremely profitable.

So I guess the answer to your question, a new sales rep, the revenue they bring in and the cost of bringing in the sales rep is pretty much a wash in the first year.

But in the second year it gets very beneficial.

And in the past when you've done this has there been any kind of hiccups in that processor do you think you have that down to a template?

Well, in 198 -- I'm sorry -- yeah, 1989, we got very aggressive in our core payroll sales organization and its growth.

We picked a time just at the beginning of that recession, of course we didn't know the recession was coming, and we did a very poor job of execution that year.

We haven't done anything as dramatic as that, nor do we intend to do anything as dramatic as that.

We think we know now the fragileness of a sales organization with that much change.

But we may be a little bit more aggressive in some of our ancillary services in the growth of the sales organization this year.

It's all speculation at this point.

Great.

Thanks.

Robert Time [ph] of Solomon, Smith Barney.

You may ask your question.

Yes.

Just a couple.

What were interpay's operating margins?

And their average client tax load?

We didn't disclose that.

We said they're about break-even.

Again you probably have a profile.

It's not too different from Advantage and the float, I think the total float money is about $180 million.

That fluctuates so much depending on the day and the end of the month that that's not necessarily a good guideline.

Okay.

And the split between the fees between Fleet and Paychex?

We didn't disclose that.

It's a normal bank referral agreement and we think it's an excellent one and we are looking forward to becoming our best bank agreement we have.

Finally, just on two things.

With only one quarter left in the fiscal year, when do you plan to give fiscal '04 guidance?

And the second question is, you know, ADP expects to be more conservative on its pension plan assumptions and kind of want to get your feedback on what you think your plans are in that area?

We normally don't provide any guidance on '04 until the June release on fiscal 2003.

And the reason is, while we have an idea what it looks like we have still not completed our very thorough budgeting process which will happen over the next two or three months.

We've obviously spent on lot of time looking at it.

So that's when that will happen.

As far as pension assumptions, we don't have any pension plans so we don't have any of those issues.

Okay.

Well, thanks a lot.

Appreciate it.

Oh, actually one more quick question on Ceridian, on the middle market, are you seeing any -- how would you compare their source web middle market product with your middle market platform?

How would we compare it?

Yep.

Well, we think our major market services is a very competitive product, both against ADP, Ceridian and others.

I don't think I could, at this point, give you any prose on -- P-R-O-S-E, on what the differences are.

We know we compete very well against them.

Most of our competition, of course, comes from ADP and that's where we [KARTIK MEHTA].

Thanks again.

Great.

Steven Webber of SG Cowen you may ask your question.

Good morning.

I guess it's good afternoon now.

A couple of things.

Tom, you talked about workers' comp being one of your key initiatives and my recollection is that this thing had a few wobbles here earlier in the year.

Can you just give us some update on how that's going and whether, is this on track to go at a very steep rate?

Secondly, John, you know, could you get -- are there any wrinkles or anything in the Interpay assumptions, accounting policies, tax loss carry forward, any of that kind of stuff?

I'll answer the one.

There are no wrinkles to Interpay.

It's straight forward, nothing elaborate.

It's just like our business.

Pretty simple.

There's some stuff Fleet might have had in there with debt and stuff but it's not coming over.

So they kept pretty simple.

Let me make a comment about workers comp.

First of all, we are up to 29,000 clients [KARTIK MEHTA].

When you think of the fact we have only been in this industry or this business for about three or four years, we think that is absolutely unbelievable penetration.

The other thing about workers comp in most states, it's mandatory.

It's not something that a client can avoid having for the most part.

I think the issue, if there is an issue, is when you have an economy like the one we are having, our underwriters start getting a little nervous and tense and I think it's probably as a result that they know when you have a depressed economies claims start going up.

So on a day-to-day basis we are probably having to deal a little bit more today with their level of nervousness than we have had to in the past.

Do I think it's going to effect this industry or our opportunity long range?

Absolutely not.

It's one of the little idiosyncrasies of that world.

We are constantly negotiating and talking about providers.

For the most part overall we think this is a great place for Paychex to be.

Long-term I firmly believe that buying workers compensation insurance from payroll providers is going to be a very commonly accepted thing.

What makes you think you could get from a penetration of your base on a client -- how much of your client base could you penetrate over the long term?

That's a very speculative question.

I don't think I should deal with it.

You know, I made a couple comments, one everybody for the most part has to have it.

There are some states that are excluded like Ohio where everybody's puts into a state fund.

So, you know, to say what percentage of the companies we might have using our workers comp is a very -- very nebulous question.

We just can't answer it.

Okay.

Thank you.

Adam Waldo of Lehman Brothers you may ask your question.

Thanks for taking the follow-up.

Just a quick question, I guess.

If you could and I know you haven't historically commented on this, John, but could you give us a rough decomposition of the drivers of organic payroll segment revenue growth in the quarter as between net --

As between what?

We lost the call.

Cool.

Go ahead.

Next question comes from John Mathis of Goldman Sachs.

Good morning Tom and John.

I might have missed it.

Could you update us on the international or UK developments?

Sure.

We've actually have been negotiating with a couple of small, very small payroll processors in Europe, Germany and France.

At this point we have not consummated anything and I will probably be safe in telling you that with the situation with Iraq going on, it will probably get neutralized for some period of time until everybody has a clearer understanding about what's going to happen.

So, we've narrowed it down to a few companies.

We have gone through the negotiation process with a couple of them.

And something may happen soon, but I gotta tell you this war thing will probably put it on hold for a little bit.

Okay.

And then, a broader question, Tom, maybe.

Could you, perhaps profile your incoming clients and leaving clients and perhaps what has changed in the profile and how could it change going forward in the event of a macro recovery?

Well, one of the things that changes and we saw at the initial stages of this recession or economic downturn is the average size client we sell got larger.

The reason that happened is your average is affected by the fact that if you have fewer new business starts which tend to be smaller companies, it is going to bring your average up if you're not having many new companies being created and being filled by Paychex.

So, I think as the thing recovers, we will see more new businesses be coming clients percentagewise and probably the average size client will be decline a little bit.

It was a pleasant surprise when we saw the average sale go up and we should not be surprised when we see the average number of employees go down a little bit.

And any change in what you can expect in terms of the attriting [ph] clients?

No.

Traditionally the average client that you lose is smaller than the average client that you have.

And the reason for it is over half of our lost customers are no longer customers because they are out of business.

They have either closed the doors or they've gone bankrupt and sold out.

So consequently the average size customer you'd lose is always smaller than the average size customer that you have.

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

And this will be our last question that we will have.

Go ahead Adam.

Sorry for dropping off by mistake before.

Just very quickly if you could.

Are you at liberty to discuss any thing about the [KARTIK MEHTA].

In terms of the agreement, I don't know the number of years.

Yeah.

In other words, how many years does it run?

Is it contractual, that sort of thing, John?

Contractual.

It's three years.

Okay.

There are sign up periods.

What happens with these things, the contract period really isn't that important.

And the reason is, if the thing works for both parties, it goes forward, and if it doesn't it stops.

Yeah.

Okay.

Thank you.

At this time I think we would to look at ending the call.

I've got a couple of housekeeping things I want to make you well aware of.

First off, we anticipate the fourth quarter release will be around June 23rd or June 24th.

That's pretty consistent.

So we don't get anybody concerned, right now we are looking at the first quarter of next year's first release is going to be around September 23rd or 24th.

We've got some scheduling conflicts here at Paychex between Tom and I. If we get those resolved we are going to try to move the release up.

But it's possible it will be a few days behind normal and I just want to make sure nobody reads anything negative into that.

Because it's just simply a regular release.

So, again, this call is replayable.

And I again want to thank you for taking your time and spending some time with us on Paychex.

And hope you all have a great day.