沛齊 (PAYX) 2004 Q2 法說會逐字稿

完整原文

使用警語:中文譯文來源為 Google 翻譯,僅供參考,實際內容請以英文原文為主

  • Operator

  • Welcome to the Paychex second quarter results conference call.

  • All participants are in a listen-only mode.

  • Today's conference is being recorded.

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

  • I'd like to introduce your speaker for today Mr. John Morphy.

  • Chief Financial Officer.

  • Sir, you may begin.

  • John Morphy - CFO, Senior Vice President

  • Thank you for joining us today for our second quarter press release.

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

  • Upon the completion of the review of our financial results, we will conduct a brief or formalized Q&A session.

  • We released our financial results for the quarter ended November 30, 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 web site at www.Paychex.com, our Investor Relations homepage.

  • We have also filed our form 10Q for the second quarter ended November 30, 2003.

  • This filing is now 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 January 19, 2004.

  • We've expanded that from one week to a month.

  • Please refer to our web site for access to our recent news releases, current financial information, related SEC filings and Investor Relations presentation.

  • The earnings release is summarized as follows.

  • For the second quarter and first six months of fiscal 2004, total revenue growth was 16% and 19% respectively, which in turn generated increases in net income of 8% and 7%.

  • Quarterly earnings per share were 21 cents versus 20 cents a year ago, up 8%, on unrounded basis.

  • Year to date earnings per share were 42 cents versus 40 cents a year ago, up 7% on an unrounded basis.

  • These are right in line with our expectations.

  • Operating income was 16% up and 14% up in the second quarter.

  • And six-month period respectively.

  • Our results of operations for the second quarter of fiscal 2004 were impacted by the fiscal 2003 acquisitions of Advantage and Interpay when these two acquisitions provided Paychex with over 80,000 new clients.

  • The results of operations for the first six months of fiscal 2004 include the results of Advantage and InterPay for the entire period.

  • The results for the prior six-month period include the results of operations from Advantage from the September 20, 2002 date of acquisition.

  • The integration of Advantage and InterPay continues as planned.

  • By the end of fiscal 2003, the sales forces of these companies were combined with the Paychex sales force and the responsibility for their operations and corporate support have been integrated into the management structure of Paychex.

  • Certain branch operations have been integrated into existing Paychex locations with more consolidation expected to occur throughout fiscal 2004.

  • Our primary integration focus has been on client service and retention.

  • The Advantage core system is being retained for the foreseeable future in order to serve its clients affiliated with independantly-owned associate offices and Advantage co-branded products.

  • For InterPay, it is anticipated that approximately 1/3 of the clients will be converted to the Paychex software platforms by the end of December, 2003 and the remaining clients will be converted by December, 2004.

  • The ability to measure the financial results of Advantage and InterPay separately from our consolidated operations continue to diminish as a result of the ongoing integration process.

  • The company estimates, however, that organic service revenue growth without the acquisitions would have been in the range of 11% to 12% for the first half of fiscal 2004.

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

  • Total Service Revenues increased 16% and 20% in the second quarter and six-month period to $297.6 million and $593.5 million, respectively.

  • Service revenues includes service fees earned from the payroll and Human Resource and benefits product lines.

  • Payroll service revenues for the second quarter and six months increased 16% and 20% to $225.0 million and $509.7 million.

  • The increases are related to the acquisitions of Advantage and InterPay in fiscal 2003, organic client-based growth, increased utilization of ancillary services and price increases.

  • Checks per client, excluding Advantage InterPay for the second quarter and first six months of fiscal 2004, were comparable with prior year periods.

  • We did not provide an exact percentage change on checks per client because the client conversions from InterPay has diminished our ability to make the calculation to the nearest tenth of a percent.

  • The more important fact is the change in checks per client as it relates to economic conditions appears to have stabilized.

  • As of November 30, 2003, 88% of all clients utilized their tax filing and payment services and 61% utilized the employee payment services.

  • More than 90% of new clients purchased their tax filing and payment services and approximately 70% of new clients purchased employee payment services.

  • Major market services revenue increased 39% and 41% for the second quarter and six-month period of fiscal 2004 to $33.1 million and $64.7 million respectively.

  • Approximately 1/3 of our new major market services clients are conversions from the payroll service.

  • Human Resource and Benefit Service increased by 19% for the second quarter and 21% for the six-month period to $42.5 million and $83.8 million respectively.

  • The increases are primarily related to growth in Retirement Services clients and in client employees served by our PAS and PEO bundle services.

  • Retirement Services revenue increased 18% and 17% in the second quarter and six-month period for fiscal 2004 to $19.3 million and $37.2 million respectively.

  • At November 30, 2003, we had over 28,000 Retirement Services clients.

  • Paychex Administrative Services PAS and the professional employer organization, 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 benefits cost.

  • Sales of PAS and PEO products have been strong with administrative fee revenue from these products increasing 29% and 30% in the second quarter and six-month period of fiscal 2004.

  • As of November 30, 2003, our PAS and PEO products serviced over 117,000 client employees compared to 103,000 at the end of May, 2003.

  • Interest on funds held for clients increased 11% for the second quarter and 6% for the six-month period of fiscal 2004 to $14.5 million and $27.9 million respectively.

  • Higher net realized gains on the sale of Available for Sale securities and a higher average portfolio balances were offset by lower average interest rates earned in fiscal 2004.

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

  • Average daily portfolio balances for the second quarter and first six months of 2004 were $2.3 billion compared with $2.0 billion and $1.9 billion in the prior year quarter and six-month period.

  • The funds held for clients portfolio earned an average rate of return of 1.8% for the second quarter and first six months of fiscal 2004 compared with 2.5% for the respective prior year periods.

  • Net realized gains on the sale of Available for Sale securities included an interest on funds held for clients increased to $4.4 million and $7.1 million for the second quarter and six-month period of fiscal 2004, compared with net realized gains of $.6 million and $2.3 million for the respective prior year periods.

  • Consolidated operating, selling, general and administrative expenses increased 16% in the second quarter and 22% for the six month period.

  • This is due to additional costs resulting from the acquisitions of Advantage and InterPay and investments in personnel, information technology and facility costs to support the organic growth of the company.

  • In the second and fourth quarters of fiscal 2003, we made additional investments in our direct sales force as we integrated the sales forces of Advantage and InterPay.

  • Also as a result of the acquisitions, amortization of intangible assets increased to $4.2 million and $8.3 million in the second quarter and six-month period of fiscal 2004 from $2.2 million and $2.8 million in the respective prior year periods.

  • The impact of the acquisitions and the investment in the sales force on expense growth should moderate quarter-over-quarter as fiscal 2004 progresses.

  • There are approximately 9,100 employees at November 30, 2003, compared with approximately 8,250 a year ago.

  • Operating income increased 16% for the second quarter and 14% for the first six months of fiscal 2004, to $114.8 million and $229. million respectively.

  • Operating income growth continues to be negatively impacted by the lower average interest rates earned by the funds held for clients portfolio.

  • We will discuss the impact of changing interest rates later on.

  • Operating income, excluding interest on funds held for clients increased 17% and 15% in the second quarter and six-month period to $100.3 million and $202.0 million respectively.

  • Operating income excluding interest on funds held for clients as a percentage of total Service Revenues was 34% in the second quarter and six-month period of fiscal 2004 compared with 34% and 35% in the respective prior year periods.

  • Investment income net decreased 56% for the second quarter and 54% for the six-month period due to a decrease in average daily invested balances resulting from the sale of Corporate Investments to fund the acquisitions, lower average interest rates and lower net realized gains on the sale of Available for Sale securities.

  • Average daily balances invested were $415 million and $400 million in the second quarter and six-months of fiscal 2004, compared with $512 million and $631 million in the respective prior year periods.

  • The Corporate Investment portfolio earned an average rate of return of 2.5% and 2.7% for the second quarter and first six months of fiscal 2004, compared with 3.4% in both the respective prior year periods.

  • There were $2.7 million and $4.2 million in net realized gains for the second quarter and six-month period of fiscal 2004, compared with net realized gains of $7.2 million and $9.6 million in the respective prior year periods.

  • As you remember, the funding of the Advantage acquisition generated $7 million of realized gains in September of 2002.

  • The use of Corporate Investments to fund the two acquisitions resulted in a year-over-year reduction of investment income of approximately $1.9 million for the second quarter and $5.6 million for the year to date period of fiscal 2004.

  • Our effective income tax rate was 32.7% and 32.6% in the second quarter and year to date period of fiscal 2004, compared with 32.5% and 32.0% in the respective prior year periods.

  • The slight increase in the effective tax rate is the result of lower levels of tax exempt income on funds held for clients and Corporate Investments.

  • The full year fiscal 2004 income tax rate is expected to approximate 32.6%.

  • As I mentioned earlier net income increased 8% and 7% for the second quarter and six-months of fiscal 2004.

  • We have based our expectations on current economic and interest rate conditions continued with no significant changes.

  • Accordingly, for fiscal 2004, we project payroll service revenue to grow in the range of 15% to 17% and Human Resource and Benefit Service revenue growth in the range of 20% to 22%.

  • Total service revenue growth is anticipated to be in the range of 16% to 18%.

  • We expect interest on funds held for clients, including realized gains, to be relatively flat in fiscal 2004, while Corporate Investment income is expected to be down approximately 45% to 50% due primarily to the sale of investments to fund the acquisitions in fiscal 2003 and lower interest rates.

  • Based on these factors, we anticipate achieving record total revenues in net income for fiscal 2004.

  • With estimated total revenue growth to be in the range of 15% to 17%, accompanied by net income growth in the high single digits or the 8% to 9% range.

  • This represents a slight decrease in net income expectations due to investing in new locations, Germany and four regional sites in the U.S.

  • Higher sales costs related to a very successful first half on new unit sales.

  • Lower interest rates on the Corporate Investment portfolio and a slightly higher effective tax rate.

  • The impact of lower interest rates will continue to moderate year-over-year growth.

  • In addition, we estimate that growth and operating income, excluding non-interest on funds held for clients for the full year fiscal 2004 will be in the range of 15% to 20%.

  • Moving to page 5 of our press release, our balance sheet, since May 31, 2003, reflects our growth during the first six months of fiscal 2004.

  • Cash and Corporate Investments have grown to $450 million.

  • Our total Available for Sale investments including Corporate Investments and funds held for clients reflected unrealized gains of $21.3 million at November 30, 2003.

  • Compared with unrealized gains of $45.0 million at May 31, 2003.

  • The slight increase in longer term interest rates has driven the reduction in the market value of the Available for Sale portfolio.

  • The volatile interest rate market has resulted in significant changes in the market value or Available for Sale portfolios.

  • During the first six months of 2004, the unrealized gain position ranged from approximately $21.1 million to $49.6 million.

  • The unrealized gain position was $19.0 million at December 15, 2003.

  • For fiscal 2004, capital expenditures are expected to be in the range of 50 to $55 million and depreciation expense for 2004 is projected to be approximately $40 million.

  • The company recorded $395 million of goodwill and $95 million of intangible assets from the acquisition of Advantage and InterPay.

  • Intangible asset amortization is projected to be in the range of 16 to $17 million for fiscal 2004.

  • Goodwill purchased--Goodwill recorded from the purchase of Advantage and InterPay will not be amortized but will be tested for impairment on an ongoing basis, assuming Paychex operates as a single reporting unit.

  • Total stockholders equity increased to $1.2 billion at November 30, 2003, with $87 million in dividends paid during the first six months, a payout of 54% of net income.

  • Our return on equity for the past 12 months was 28%.

  • The accumulated other comprehensive income balance at May 21, 2003 of $28.7 million has decreased to $13.6 million at November 30, 2003, which reflects the previously discussed decrease in the market value of our Available for Sale portfolio.

  • Investment rates have returned.

  • We continue to receive many questions on the impact of changing interest rates.

  • Our investment portfolios and the earnings from these portfolios have been impacted by the decreasing interest rate environment.

  • The federal funds rate, which was at 6.5% at the end of fiscal 2000, has decreased to the current level of 1%.

  • The decrease in interest rate environment has negatively affected net income growth and at the same time generated significant unrealized gains for Available for Sale portfolios.

  • We have mitigated some of the impact of the lower interest rates on earnings by realizing gains from the sale of investments.

  • When interest rates begin to rise, the full impact of higher interest rates will not immediately be reflected in net income due to the interaction of long and short-term interest rate changes accompanied by changes in the market value of the long-term investment portfolio.

  • Increases in interest rates immediately increased earnings on short-term investments, which totaled $1.4 billion at November 30, 2003.

  • And over time will increase earnings on the company's longer term Available for Sale securities, which totaled $1.3 billion, at November 30, 2003.

  • Arranged from the Available for Sale investments, which currently have an average duration of 2.3 years, will not reflect increases in interest rates until the investments are sold or mature and are invested at higher rates.

  • The exact impact of changing interest rates in the company is difficult to determine due to the many factors we have discussed.

  • However, we estimate that a 25 basis point change in taxable interest rates, 17 basis point impact on taxes and securities, will have an effect in the range of 3 to $3.5 million on the earnings for the next 12-month period.

  • An increase in the interest rate environment will also result in the decrease on the unrealized gain position of the investment portfolio and over time could produce an unrealized loss position.

  • Please refer to our recently-filed form 10Q under the market risk factors section for additional discussion of changes in interest rates and interest rate risk.

  • 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 security's 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 Tom Golisano, who will provide his comments before we open for questions.

  • Thomas Golisano - Chairman of the Board, President, CEO

  • Good morning to everybody.

  • The first area I'd like to comment on, of course, is on our sales environment.

  • Our sales engines for both core major market services, our HR products, and our PAS products continue to be very strong.

  • We're very happy and satisfied with the results.

  • Obviously there is a reflection in there of something we mentioned earlier in our fiscal year last quarter about the fact that we are seeing more new business formation.

  • Our client retention continues to remain strong.

  • We're very happy with the -- the range of accomplishment with client retention.

  • Checks per client, as was mentioned in the prior quarter, we had a bump during the first three months of this fiscal year.

  • The prior quarter.

  • That bump did not continue, it didn't go down, but it didn't progress.

  • And as John mentioned it gets more and more difficult for us to -- to measure the checks per client because of the quick and rapid integration of InterPay clients and their average size client was smaller, significantly, than Paychex's average size client.

  • Big selling season coming up.

  • We put on a huge number of clients, traditionally in January we do well over 20,000 new companies coming on our service.

  • At this point, we see no material change whatsoever in the competitive landscape other than the fact, of course, we're not selling against the Advantage and InterPay at this year-end.

  • But no unusual activity from ADP or Seridian or anybody of that nature.

  • John mentioned we're opening four new offices this year-end and four fairly small markets comparatively speaking.

  • We think they're great ceilings for the future and we're also positioning ourselves to get opened up in Germany.

  • That probably won't happen until springtime sometime.

  • Other than that, everything seems to be business as usual, as I said earlier, the sales engines continue to remain strong and we are very optimistic in that area.

  • I guess from this point on we'll take questions.

  • Operator

  • Thank you.

  • We will now begin the question and answer session.

  • If you would like to ask a question, please press star 1, you will be prompted to record your name.

  • To withdraw your question, please press 2.

  • One moment, please, for the first question.

  • Our first question comes from Adam Frisch of UBS.

  • You may ask your question.

  • Jason Kupferberg - Analyst

  • Okay.

  • This is Jason for Adam.

  • A quick question for, probably more so for Tom.

  • Can you just talk about how you're kind of feeling at this point in time versus three months ago with respect to the near-term outlook overall sales, other key operating metrics, it sounds like it's kind of business as usual for you guys, you know, the net income guidance being softened a little bit seems to be explainable, but just talk about sort of the overall environment?

  • And are you more optimistic or about the same as you were three months ago, kind of thinking about the small business environment as a whole?

  • Thomas Golisano - Chairman of the Board, President, CEO

  • We're -- we were very optimistic at the end of the first quarter.

  • I think that is continuing.

  • When I see the growth of this new business area, I mean to me that bodes well for the future.

  • It's obviously it hasn't begun to show up in checks per client from an overall economic perspective.

  • But certainly to me that's an indication that maybe it's on its way.

  • Now, I hate to speculate on this kind of stuff and it's not really my role to.

  • Jason Kupferberg - Analyst

  • Right.

  • Thomas Golisano - Chairman of the Board, President, CEO

  • Taking a look forward, based on the -- the number of new business start-ups, obviously the people out there are feeling a lot more optimistic.

  • We didn't see it reflected in our checks per client this quarter like we did last quarter, but you know, as we mentioned earlier, the margin is now so small and so narrow it's -- it's hard to really get a good handle on the exact direction it's going.

  • But, based on client sales activity, client retention, we had a couple of little nuances that John mentioned, opening the offices and so forth, we feel pretty good about the whole environment out there.

  • Obviously because we don't have to sell against Advantage and InterPay anymore, that's also a real plus.

  • Jason Kupferberg - Analyst

  • Are you seeing any additional pricing power as a result of that?

  • Or is pricing still kind of firm as it was in the past?

  • Thomas Golisano - Chairman of the Board, President, CEO

  • It's a non--event right now.

  • Jason Kupferberg - Analyst

  • It's a wash.

  • Thomas Golisano - Chairman of the Board, President, CEO

  • Okay, more close to what's going on in the past.

  • Jason Kupferberg - Analyst

  • Thanks for the color.

  • Operator

  • Mr. Steven Weber of SG Cowen, you may ask your question.

  • Steve Weber - Analyst

  • Good morning.

  • Could -- in your HR benefits area, you were obviously strong in PAS and PEO and certainly good in the 401(k) stuff.

  • But it seemed to be a little lighter somewhere and could you just remark whether there was some blip or what's happening here?

  • Because you seem to have pulled down that growth guidance just a tad.

  • Thomas Golisano - Chairman of the Board, President, CEO

  • This is Tom.

  • I -- we have no material changes in any of our sales projections or activity for any of our products.

  • So...

  • I don't know exactly what you're referring to.

  • John, can you shed light on this?

  • John Morphy - CFO, Senior Vice President

  • The 401(k) is still off a little, it isn't quite where we'd like to it be.

  • The PAS, PEO is doing absolutely wonderful.

  • The 401(k), it's the environment.

  • And just we thought we'd get it to kick back up again and you've got these problems with the mutual funds and how they're trading after hours.

  • We just continue to keep kicking ourselves and telling small business, you know, don't trust the big guys.

  • Pretty much we're in line with where we were.

  • Sometimes the PEO at worker's comp can affect some things, but nothing big or sudden.

  • Thomas Golisano - Chairman of the Board, President, CEO

  • Let me add something to that 401(k) comment.

  • I think we cannot forget the fact that we may not be exactly where we wanted to be sales wise, but year-over-year we are up significantly in our 401(k) activity over last year.

  • Steve Weber - Analyst

  • Okay.

  • And, John or Tom, with the unrealized gains in your portfolio dwindling down as these rates creep up, have you changed your posture on how you want to take gains in the second half?

  • Or even in '05?

  • John Morphy - CFO, Senior Vice President

  • I don't think we've changed our posture on how we would take them this year and we'd probably stay close to trying to keep the rates close, but it depends on what happens.

  • Okay.

  • I mean, you know, right now there's a lot of speculation on rates, sometimes you say they won't change, but they may.

  • I think the issue that we've got the disclosure on, I think the issue on the gains really comes out in the future.

  • I think as rates go up, we're going to get the benefit on the short-term, but it's going to take a little while to get net income to be equal to operating income because you're going to not have the gains that we've had the last few years and have to work those off accompanied by the fact that the long-term portfolio won't feel the immediate effect until you basically work it off.

  • Although, fortunately we're down to a 2.3 average duration, so that's not a real long-term event.

  • But I think the message here is that rates -- the impact of rates is going to be with us a little longer than we'd like, but again, it's one of the things we just simply can't do anything about.

  • That's why most of our focus is really on can we keep generating around 15% operating income without float because that's really what the strength of the business is and the rates will be what the rates are going to be.

  • Steve Weber - Analyst

  • Okay.

  • Thank you very much.

  • Operator

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

  • Adam Waldo - Analyst

  • Good morning, and season greetings, Tom and John.

  • Thomas Golisano - Chairman of the Board, President, CEO

  • Thank you.

  • Adam Waldo - Analyst

  • Starting off with Tom, just a little more color on the sales force, if you would, Tom.

  • Did you see a rate of growth year-over-year in gross new client sales in the November quarter that was in excess of sales force head count growth?

  • As you saw in the August quarter...

  • Thomas Golisano - Chairman of the Board, President, CEO

  • Pretty consistent from quarter-to-quarter.

  • We obviously added a lot of new sales people at the beginning of the fiscal year and their productivity levels seems to be consistent during the first six-month period as we were very optimistic at the end of the first period, we remain so now.

  • Adam Waldo - Analyst

  • Okay.

  • And then secondly on the sales force, Tom, any thinking in terms of additional head count adds for the balance of the fiscal year, or are we pretty much set at current head-count levels?

  • Thomas Golisano - Chairman of the Board, President, CEO

  • We're going to follow consistant patterns and probably stay at the level we are until probably the March or April timeframe, then we will start expanding it again.

  • I don't see anything changing our thinking at this moment.

  • Adam Waldo - Analyst

  • Okay.

  • And then just quickly for John.

  • John, any more color you can provide in terms of revenue growth rate range expected for service bureau revenue within the payroll segment and excluding MMS?

  • John Morphy - CFO, Senior Vice President

  • The guidance we gave is what we gave.

  • I don't think we give any more than that in, you know, it's -- we get pretty specific, so I don't think we give any more than we've already given.

  • Adam Waldo - Analyst

  • Okay, thank you.

  • Operator

  • Mr. Bryan Keane of Prudential.

  • You may ask your question.

  • Brian Keane - Analyst

  • Yeah, hi, good morning.

  • I just wanted to clarify the -- the slight provision in net income it sounds like you're investing more in Germany and I think you mentioned four new locations.

  • I guess that was different than what you originally budgeted?

  • And can you explain, you know, why the extra spending in those areas?

  • John Morphy - CFO, Senior Vice President

  • Well, it's actually -- it's a few things, you listed two.

  • Those aren't by themselves wouldn't cause the change.

  • As we go through the year, we look at things we want to do and right now, while the economy is a little bit better, we are a little bit optimistic in our budget and we're not getting what I would call the plus adjustments.

  • So, what I've got is a few small negative adjustments, which in, total, aren't a lot of money, but they do move that year-over-year growth rate a little bit and you know us, we want to be up front all the time and tell you exactly where we are.

  • The bigger impact is probably some of the selling costs which are over budget because of the fact we're selling so successfully, but those sales don't really impact the year too much, they will impact the following year.

  • So, basically what we've got is three or four items, none of which by themselves are very much, but in total, they're just enough that we felt we should move the guidance down slightly because we want to be up front and at the same time we feel good about where the business is so we felt we should continue to invest.

  • We've been doing that for the last two years.

  • We've really invested heavily despite the economic conditions.

  • We believe there will be a better tomorrow and we want to be very well presented to take care of it.

  • Brian Keane - Analyst

  • Those four new locations, are those in areas that Paychex just weren't, you know, weren't in?

  • Or is that part of the expansion of InterPay, Advantage, keeping those locations?

  • Or what is that?

  • Thomas Golisano - Chairman of the Board, President, CEO

  • No, they are four entirely new locations to us and are not part of the new locations and offices that were created by those acquisitions.

  • So, these are in addition to.

  • Brian Keane - Analyst

  • Okay.

  • And finally, John, can you talk to us a little bit about operating margins in the future?

  • You know, where -- where will they be or where can they go, you know, once we're in a little better environment?

  • I know obviously people are starting to look at '05, '06, but to look out there, operating margins historically have been in the high 38 range.

  • Can we get back there in the future or do some of these other acquisitions like Advantage and InterPay, probably with smaller margins or lesser margins than Paychex, is that going to keep the margins a little bit lower than that with those levels?

  • John Morphy - CFO, Senior Vice President

  • I think over time we will get back there, exactly how quickly, that's another question.

  • But I think the thing you've got to follow from us is our formulas, basically.

  • We feel very comfortable that we can get 12% revenue growth and yet we're shooting for a little higher than that, but 12% is when we put the little bit of conservativism on it.

  • We can then do 15% plus at the bottom.

  • You know, in this environment, you're probably closer to 15 than you are 20, but depending on what the revenue growth did that would change.

  • I think that assumes you're going to get margin expansion.

  • It's hard for me to say exactly how much it's going to be until we work it, but we're pretty aggressive in not letting costs rise much more than 3 or 400 basis points over client growth.

  • We talk about trying to get the formula to be a 6-8% or 7-9% client growth and 4% price and 3 or 4 ancillary and chop it down for whatever you want to be conservative.

  • That's how I think that works out.

  • One thing I felt good about is we're starting to get back to year-over-year margins already that are close.

  • So, the effects of Advantage and InterPay are starting to be mitigated.

  • I think you will see us get back on that road of margins continuing to go up.

  • Brian Keane - Analyst

  • Okay that's helpful.

  • Thanks.

  • Operator

  • Cindy Shaw of SoundView Technology group.

  • You may ask your question.

  • Cindy Shaw - Analyst

  • Thanks, a couple of questions.

  • One on the tax pay client penetration, you said over a period of quarters that you think you're pretty close to topping out and then that number gets nudged up.

  • I'd be curious if you could comment on why you think it can't go much further just in general?

  • And then on the investment and interest income side it looks like, as I understand it, you're planning on keeping the float income flat year-over-year, but it looks like you took a little more in the most recent quarter than you did in the prior quarter.

  • If there's any change in thinking there, if we might see it go down year-over-year in the next few quarters?

  • And then for fiscal '05, without the gains on the investment portfolio, it seem the tax rate may nudge down I'm guessing maybe 50 basis points.

  • If you could comment on that.

  • John Morphy - CFO, Senior Vice President

  • Okay, you have a lot of questions there.

  • Give me two words on the first one! [ Laughter ]

  • Cindy Shaw - Analyst

  • The first one and this would probably be Tom's department, tax pay -- if you go back far enough in time you were saying you probably topped out in the mid to high 80s and the number is nudging up.

  • What makes you think that you're topped out now and can't take the client penetration much further?

  • Thomas Golisano - Chairman of the Board, President, CEO

  • John is making notes in preparation for the rest of it!

  • I will answer this.

  • I think basically what you have been getting from us is a conservative estimate and as we continue to increase the client penetration on tax pay, we sort of nudge ourselves up, too.

  • I think if you were to ask me three or four year ago or even two years ago, would we get above 90%, my answer would have been no, but I can tell you, as time has progressed, I think it's possible now to get above 90%.

  • I would never have said that two or three years ago.

  • When I look at the percentage of our new clients that are taking tax pay, that percentage continues to grow.

  • So, as long as we give it some time, I think it's possible we could nudge up over that 90% number.

  • We've just traditionally been conservative on it and -- but we're -- I think right now at this moment we're willing to change our positions so we can get to 92 or 93 some day.

  • John Morphy - CFO, Senior Vice President

  • One thing that's helping us, Cindy, is, we--one of the reasons we were at 90 is the certain people we don't want on it because they NSFed us or whatever.

  • Our recovery teams, and the teams that chase these things have gotten much better, better at predicting who might be a problem or dealing with us better.

  • That's probably improved the environment of what's the maximum number we can even get to.

  • I agree with Tom, we will probably get a little over 90.

  • I wouldn't have said that before.

  • But right now we're on course to do that.

  • Still that isn't a huge increase from where we are.

  • And your other two questions.

  • Float, we did have a little bit extra in the quarter.

  • That was because we know the gain situation is going to change.

  • So, we took a little bit more, I would expect in the last half that will be leveled off and it might be a little bit less.

  • But the goals still for the year is to come in the same.

  • As far as the '05 tax rate, right now I would still look at it 32.5, we're in the middle of our strap plan process right now.

  • I don't know what that's going to change to, but I wouldn't change that until I knew something more specific and if I knew that, I would tell you.

  • Cindy Shaw - Analyst

  • Great, thanks very much.

  • And happy holidays.

  • Thomas Golisano - Chairman of the Board, President, CEO

  • Same to you now.

  • Operator

  • Mr. Randy Mehl of Robert W. Baird.

  • You may ask your question.

  • Randall Mehl - Analyst

  • Yes, good morning, Tom and John, I had a follow-up from a previous question and then another question.

  • On the HR benefits, I think there was a question related to the non-401(k) non-PEO, PAS business, meaning section 125 and the worker's comp business and it does look like that was, you know, maybe flat, maybe even down on a year-over-year basis and so I'm wondering if you could give a little color on that.

  • John Morphy - CFO, Senior Vice President

  • Worker's comp, there's been some significant rate reductions that were forced on us in Florida.

  • We just can't pass on.

  • So, that environment right now is not as positive as it was.

  • Off and on we can sell in California, can't sell our worker's comp product in California.

  • Section 125, I would not call a supreme growth product.

  • It's -- it's probably at the maturity somewhere between direct deposit and tax pay, but the thing is it might be about the same, they're really not our growth engines at the moment.

  • We know worker's comp is going to need a better environment.

  • So, we're really focused on the other things, which we think went quite well.

  • Randall Mehl - Analyst

  • Okay.

  • And there is nothing on the horizon you see that will reverse course in the worker's comp business?

  • Thomas Golisano - Chairman of the Board, President, CEO

  • No.

  • As a matter of fact, John, if I may interrupt, I got word from our HRS sales VP, the environment for worker's comp, actually in the last two months has gotten better, particularly in the state of Florida, which is one of our key states so, any optimism that was dampened three, six and nine months ago has sort of been reversed.

  • But the answer to your question, specifically,Randy, we're very optimistic about worker's comp.

  • The cafeteria plans and so forth, we have never anticipated large growth out of them.

  • We do expect growth but not considering the whole, it's not that material.

  • But, worker's comp and 401(k) are doing quite well, even though we haven't hit our sales goal in 401(k).

  • Randall Mehl - Analyst

  • Okay.

  • And then question regarding the sales force: Remind me what the overall growth in core sales force was going into the year?

  • Thomas Golisano - Chairman of the Board, President, CEO

  • I think it was somewhere between 9 and 10%.

  • John Morphy - CFO, Senior Vice President

  • Right.

  • Thomas Golisano - Chairman of the Board, President, CEO

  • It was big -- larger than normal because we assimilated some of the sales people from InterPay and Advantage.

  • Randall Mehl - Analyst

  • Okay.

  • Thomas Golisano - Chairman of the Board, President, CEO

  • And we added our regular amount for -- for our regular growth rate for new sales people that we do every fiscal year.

  • So, I think in total numbers it was well over 90 to 100 people.

  • Percentage wise I think it was like 12% to 13%.

  • If you add the people from InterPay and MMS and Advantage.

  • Randall Mehl - Analyst

  • Okay.

  • And it doesn't seem that you're tracking that level of unit growth.

  • I know you're not talking in terms of unit growth, but it seems like that would be significantly less than that --

  • John Morphy - CFO, Senior Vice President

  • Here's the key, this is a very important key.

  • It shows our sales.

  • When you start off the year we added 80,000 clients.

  • Those 80,000 clients will have a normal attrition factor on them, we'll just say it was 20%, okay?

  • The problem is they don't produce the same number of sales leads because they weren't using Paychex products.

  • We also know that the combined sales force that we have today is less than the combined sales force of Advantage, InterPay and Paychex.

  • So, basically to get 5% unit growth, our sales unit growth has got to be up about 20% for the year, which it is.

  • But it's because those clients aren't referring.

  • So, we're up substantially on the sales growth, but because of the way the acquisition numbers roll in, that's still generates only about 5% client growth.

  • We actually are real happy with the sales efforts.

  • Thomas Golisano - Chairman of the Board, President, CEO

  • If I can put that in different terms.

  • We not only had to deal with increase in our client growth because of our -- the normal or regular Paychex sales activity, but we added 85,000 new clients into the base at one time.

  • And obviously we need, you know, try to accomplish client growth on top of that number, as well.

  • And as John mentioned, one of the things you have to deal with is the fact that all of these clients from Advantage and InterPay have not been in a referral mode to Paychex.

  • So, we don't get percentage-wise the same number of referrals from those clients, at least initially, that we do from existing Paychex clients.

  • So, when you roll that together and you look at where we are, we are absolutely delighted.

  • We are going to have client growth, even though we added those 85,000 clients all at one time.

  • Randall Mehl - Analyst

  • Okay, that's understood.

  • So, going into the next year beyond, assuming no significant acquisitions, could we assume that growth in the core sales force will track unit growth?

  • Thomas Golisano - Chairman of the Board, President, CEO

  • I would say that -- that that is a very solid assumption.

  • Randall Mehl - Analyst

  • Okay.

  • Thank you very much.

  • I appreciate it.

  • Operator

  • Mr. -- excuse me, Miss Jennifer Dugan of Merrill Lynch, you may ask your question.

  • Jennifer Dugan - Analyst

  • Yeah, thanks.

  • I wondered if you could give us a litlle bit of color on your plans or your strategy for cross-selling some of the HR add-on services into the converted base of Advantage and InterPay clients?

  • Maybe, can you quantify either in unit terms or in penetration rate terms?

  • Thomas Golisano - Chairman of the Board, President, CEO

  • It depends on the particular product and obviously in the category of tax pay and direct deposit, not only did they have their own tax pay direct deposit programs, but we've been able to increase our penetration with those products.

  • In the other product areas like 401(k), record keeping and other, the cafeteria plans and so forth, it's -- we have not been able to start selling too many of those types of services because of the fact that so many of their clients are still on their pre-existing payroll software.

  • Jennifer Dugan - Analyst

  • Yeah.

  • Thomas Golisano - Chairman of the Board, President, CEO

  • Okay, so we're going through building the integration processes and going through a very rapid conversion of clients, particularly in InterPay.

  • So, to say that we are -- today where we're going to be and a year or two years from now, we are not there.

  • But probably within that period of time we should have the same type of penetration rates with the ancillary products into the advantage and InterPay client base that we have with our core base.

  • Jennifer Dugan - Analyst

  • Okay.

  • Thomas Golisano - Chairman of the Board, President, CEO

  • Because of system issues and priorities and so forth, we just aren't able to go from point "A" to point "B" immediately.

  • Jennifer Dugan - Analyst

  • But as they get converted onto the Paychex system, obviously there's a great opportunity there, I think for you guys to be really aggressive with the cross sales.

  • Do you have a plan in place specifically for that?

  • As people get converted to start trying to cross sell them things like 401(k)?

  • Thomas Golisano - Chairman of the Board, President, CEO

  • Not to sound glib, but I can tell you we don't really need a plan because our HR sales organization is waiting with baited breath to get into these clients.

  • And they track very carefully.

  • As we convert them they know it creates a new opportunity for them to go out and see these clients.

  • So, the plan is sort of a natural plan and that is our sales organization anticipating, with much anticipation, the fact that they go out and start seeing these clients and they are great new prospects for them.

  • Jennifer Dugan - Analyst

  • Okay, great, thanks.

  • Operator

  • Mr. Gregory Cappelli of Credit Suisse First Boston.

  • You may ask your question.

  • Greg Cappelli - Analyst

  • Hi, Tom and John.

  • Just wanted to kind of follow up on Advantage and InterPay and maybe get an idea of what pricing is looking like there now?

  • And where you see it, you know, throughout the year?

  • Thomas Golisano - Chairman of the Board, President, CEO

  • Advantage and InterPay traditionally were priced anywhere from 15% to 30% to 35% less than Paychex.

  • And if you were to look at their financial statements that would probably give you a good understanding as to why they were in a non--money making mode as opposed to us at a profit level.

  • Now, our plan has been to obviously, over time, bring those prices more in line with the standard Paychex product.

  • How long that's going to take, two, three, four years?

  • So, going forward one of the benefits that we have, where our traditional Paychex clients, we might only raise their prices 3% or 3.5%, maybe 4%.

  • The Advantage InterPay clients will probablyl endure higher price increases, maybe, 7%, 8%, 9% for two, three or four years.

  • We've gone through one of those already.

  • We've seen insignificant client reaction to that type of program.

  • It's going to take us probably three or four years to get their pricing in line with us.

  • That's going to be one of the longer term advantages or benefits financially of this assimilation.

  • Greg Cappelli - Analyst

  • Okay.

  • And Tom, does that have anything to do -- you guys mentioned a very good point when going through the productivity of the new, sort of new look of the sales force.

  • Does that have anything to do with the referral being lower from those saels people?

  • Or just not having been with the organization long enough?

  • Thomas Golisano - Chairman of the Board, President, CEO

  • It's -- it's not having been with the organization long enough and it's a fact that these clients either have been converted to a new system or anticipate being converted to a new system and it puts a little concern and there -- you know, it's going to take a little time to gain their confidence level before those referrals get back up to a regular rate.

  • Greg Cappelli - Analyst

  • Okay, thanks.

  • One quick follow-up I know you get this once a quarter, it seems like, on the call, but I wondered if you could comment on just sort of the competitive position of Intuit at this point and if you're seeing any more or less out of them right now?

  • Thomas Golisano - Chairman of the Board, President, CEO

  • No.

  • We're not seeing either more or less.

  • Obviously they made those two acquisitions of CRI and CBS and most of the sales focus that we've seen has been sort of in those geographic areas.

  • We know that they've been out in some places attempting to hire sales people.

  • But other than that, our sales organization does not consider them as an issue at this date and would have no idea on when that might ever happen.

  • The major focus competitively is still ADP.

  • Greg Cappelli - Analyst

  • Okay, good enough, thanks.

  • Operator

  • Mr. Robert Tung of Smith Barney.

  • You may ask your question.

  • Patrick Burton - Analyst

  • Hi, this is actually Pat Burton.

  • A question for both of you guys.

  • In terms of the acquisition program, can you just give us an update where you stand there, particularly outside of the United States?

  • Thanks.

  • Thomas Golisano - Chairman of the Board, President, CEO

  • Well, there isn't much to buy outside the U.S.

  • We're starting in Germany really at organic.

  • We've looked at some things, they want way too much money and there aren't that many of them.

  • In the U.S., we're continuing to do what we do is to buy small clients, nothing out of the ordinary there.

  • Activity is about normal, price levels are less than they were but as we've said before, there really aren't any substantial acquisitions out there to do, so, acquisition activity ritght now is on the low side.

  • Patrick Burton - Analyst

  • Okay, thank you.

  • Operator

  • Mr. Gregory Gould of Goldman Sachs.

  • You may ask your question.

  • Gregory Gould - Analyst

  • Thanks.

  • John, just on -- maybe to try to get a little more color on the new sales, I think in the past we've talked about 5% new sales growth, net new sales growth as being a very good number.

  • You mentioned that costs are a little bit higher for sales, so, should we conclude that new sales growth so far is above that 5%?

  • John Morphy - CFO, Senior Vice President

  • Just sales growth year-over-year, I said earlier, is about 20%.

  • Gregory Gould - Analyst

  • Sorry, the net growth.

  • John Morphy - CFO, Senior Vice President

  • The net, the goal we said for the year is to get around 5% net.

  • And we're on target to do that.

  • Gregory Gould - Analyst

  • Okay.

  • John Morphy - CFO, Senior Vice President

  • Achieving that is going to take a tremendous sales effort.

  • We knew that going in.

  • Gregory Gould - Analyst

  • So, then, why was new sales -- I'm sorry, sales expense a little bit higher in a contributor to the 1% slightly lower net income growth?

  • John Morphy - CFO, Senior Vice President

  • We have higher commissions, they're a little bit over the plan.

  • Gregory Gould - Analyst

  • Okay.

  • John Morphy - CFO, Senior Vice President

  • And we have a plan on pay that escalates pretty rapidly when you go over plan.

  • Gregory Gould - Analyst

  • Okay.

  • And in terms of the customer, Advantage and InterPay customer base it sounds like attrition is -- is in line to perhaps a little bit better than initial forecasts?

  • John Morphy - CFO, Senior Vice President

  • Slightly better.

  • Thomas Golisano - Chairman of the Board, President, CEO

  • Yeah, but definitely in line and consistent with ours.

  • We're pretty happy with that process.

  • We've got about 10 or 11,000 clients converted in the last eight or nine months for InterPay and we expect to have that entire client base done by next year.

  • Gregory Gould - Analyst

  • Okay.

  • Thank you.

  • Operator

  • Mr. David Farina of William Blair and Company.

  • You may ask your question.

  • David Farina - Analyst

  • Good morning.

  • Tom and John, you know, you're going to some pretty small cities with these new offices.

  • Is this, you know, you kind of hit the top 100, obviously, cities like Chattanooga aren't exactly huge places.

  • Is that a change in strategy to open a lot more offices in kind of mid-tier cities? or is it sort of opportunistic?

  • And what is the cost of doing office these days?

  • Thomas Golisano - Chairman of the Board, President, CEO

  • The cost of doing office, Dave, hasn't changed that much.

  • A lot of it has to do with the fact that we have centralized computerzation now and that type of thing.

  • So it actually hasn't changed much in the last five to six years.

  • A lot of the growth in location for Paychex over the last five years has been in sales offices.

  • And these generally are places that are pretty convenient to a sister city where processing was being done.

  • This is a little bit of a departure this year because these cities are a little bit more remote and we -- we've gone through sort of a mental evolution to the fact that we're back to the point where we think that having an operations presence helps the sales presence -- helps the sales situation in a new marketplace.

  • So, considering the fact that these cities have business populations in excess of 12 to 15 to $18,000, when I think back about 5 or 10 years ago, those are the types of cities we were targeting then.

  • So, these places have grown and probably will continue to grow.

  • So, even though they're what you would call a secondary city today and they definitely are compared to the rest, with their growth rates and with the business population where they are now, we consider them to be very good opportunities.

  • David Farina - Analyst

  • So, do you suspect there's, you know, five more years out there or is it a sort of a one-time deduction.

  • Thomas Golisano - Chairman of the Board, President, CEO

  • I think we're already starting to line up the next five.

  • David Farina - Analyst

  • Okay.

  • Thank you.

  • Operator

  • Mr. Brandt Sakakeeny of Deutsche Banc.

  • You may ask your question.

  • Brandt Sakakeeny - Analyst

  • Thanks, hi, good morning.

  • Actually, I'm sorry, I missed one point.

  • The major market segment growth, can you just repeat what that was?

  • John Morphy - CFO, Senior Vice President

  • Around 40%.

  • Brandt Sakakeeny - Analyst

  • Okay.

  • Great.

  • And just on the DSOs, I noticed it looked like by my calculation there was a slight uptick.

  • Was that just a timing issue or anything behind that?

  • John Morphy - CFO, Senior Vice President

  • No, it is the timing where the billing is at end of the month.

  • I can aassure you receivables were one of the best there is.

  • Brandt Sakakeeny - Analyst

  • Okay, Great.

  • Thanks.

  • That's all I had.

  • Operator

  • Miss Marta Nichols of Banc of America Securities.

  • You may ask your question.

  • Marta Nichols - Analyst

  • Good morning, thanks.

  • I'm wondering just back to a comment that you guys made earlier about tax pay and employee pay.

  • The numbers that you're providing us right now, are those just for the core Paychex business?

  • And don't yet include the penetration of the products, in InterPay and Advantage, given a lot of clients are not yet using those services?

  • John Morphy - CFO, Senior Vice President

  • I think the status is based just on core, but you have to realize that in Advantage and InterPay, their penetration levels of tax pay and direct deposit were very close to ours.

  • The area where there wasn't much penetration is in the Human Resource products.

  • Marta Nichols - Analyst

  • Okay.

  • And on that point, you mentioned that the section 125 product maturity would be somewhere between essentially what it is for tax pay and employee pay, I think.

  • Can you tell us where you're at in terms of penetration on that product now?

  • John Morphy - CFO, Senior Vice President

  • No, I don't know the exact percentage.

  • If I had to say what I thought it would become, tax pay, obviously, is mature and I think section 125 is a bit -- it's nothing, it's been around longer than direct deposit, we've worked that base pretty well, so it's somewhere between those two.

  • Marta Nichols - Analyst

  • Okay.

  • And then finally: You know, I think your comment on acquisitions may have actually answered the question, but can you just talk a little bit about whether you've seen any changes in the competitive landscape outside of the big obvious guys like ADP and Siridien, and Intuit, are you seeing anything in specific local markets that's changed over the last few months?

  • Thomas Golisano - Chairman of the Board, President, CEO

  • No, nothing of any significance.

  • As I said earlier, there are hundreds, if not thousands of payroll processors out there and there has been no organization on a local level or on a regional level and certainly on a national level that is evolving to even get our attention, quite frankly.

  • John Morphy - CFO, Senior Vice President

  • We do these medium to small-sized acquistions, I mean they're really small, the only competitor today is ADP.

  • Marta Nichols - Analyst

  • Okay, terrific.

  • Thank you.

  • Operator

  • Mr. Glen Greene of Think Equity Partners.

  • You may ask your question.

  • Glenn Greene - Analyst

  • Thank you, just one quick question.

  • I was wondering if you could just discuss the trends and sort of sales force turnover both for the core sales force and the sales force that you've acquired from InterPay and Advantage, what you're seeing there and what kind of rate it's at?

  • Thomas Golisano - Chairman of the Board, President, CEO

  • Well, the sales force turnover-- the sales organizations now for Paychex, Advantage and InterPay have all been assimilated and have been for quite a while.

  • The turnover rate is running comparatively speaking to prior years, very good.

  • Our turnover rate on an annualized basis now is in the low 30s.

  • And we've experienced years in the mid-30s and the high 30s, but right now it's running about as as good as it has run in the last 7 to 10 years that I can remember.

  • And our HRS sales organization has been sort of consistent with the turnover rates we've been experiencing the last three years, slightly higher than the core payroll pay.

  • Glenn Greene - Analyst

  • And one quick question, I think I know the answer, but your company is very diverse according to industry sectors.

  • But are there any industry sectors where you have sort of a disproportion of concentration and something we should be watching for going forward in terms of either formation or hiring trends?

  • Thomas Golisano - Chairman of the Board, President, CEO

  • Not really, when you have got 500,000 clients and they're all small businesses, we have a pretty good cross industry mix.

  • The only thing I would say though, if there's a leaning in any direction, it would be toward the foodservice industry and it's generally because of high turnover and having to deal with the taxation of meals and tips.

  • But that's always been there.

  • There is no change in that.

  • So, from an industry perspective it's across-the-board.

  • There's nothing -- nothing interesting happening in that environment.

  • Glenn Greene - Analyst

  • Okay.

  • Thanks a lot.

  • Operator

  • Mr. Mark Marcon of Wachovia Securities.

  • You may ask your question.

  • Mark Marcon - Analyst

  • Good morning.

  • I was wondering, with regards to the selling costs, can you give us a little -- are we going to see kind of the same level of increase going into Q3 that we've seen in -- in prior years, you know, in the -- in the SG&A costs?

  • Is that going to be fairly similar?

  • John Morphy - CFO, Senior Vice President

  • In Q3 you will see costs jump up just as the revenues do with a little more of the year-end processing charges so, you know, third quarter is always full of things that are a little bit different than normal.

  • The revenues will be higher, the costs will be up higher, too.

  • Thomas Golisano - Chairman of the Board, President, CEO

  • Just to qualify that a little bit for you.

  • In the month of January we will put on in excess of 20% of all the clients we're going to put on for the year, just in the month of January.

  • That's what pushes that sales cost up during the third quarter.

  • Mark Marcon - Analyst

  • Got it.

  • Great.

  • And then I imagine it's also a pretty big selling season for 401(k) and for PAS, PEO.

  • Can you talk a little bit about that?

  • And is it possible that we might see a -- an acceleration in this coming quarter relative to the growth rate that we saw this last quarter?

  • Thomas Golisano - Chairman of the Board, President, CEO

  • I think there's an acceleration in sales activity in 401(k) but it's not as extreme as it is in payroll.

  • For whatever reasons.

  • And I don't think I could actually give you a good reason, but I know it not as extreme.

  • Quite frankly we don't have enough experience with PAS to know.

  • Obviously we will sell more PAS clients in January, probably, than any other month, but is it the same proportion of payroll?

  • We don't have enough sales history and knowledge yet to make that kind of a prediction.

  • Mark Marcon - Analyst

  • Could you -- I mean could you see a real acceleration just in terms of that overall category?

  • Thomas Golisano - Chairman of the Board, President, CEO

  • I -- to influence a -- you know, a -- to come to a conclusion about the sales activity on an ongoing basis and how it's going to impact this company over a period of time, I wouldn't go there.

  • Mark Marcon - Analyst

  • Okay.

  • Thomas Golisano - Chairman of the Board, President, CEO

  • It's just not going to be that significant.

  • John Morphy - CFO, Senior Vice President

  • You will see the normal seasonal adjustment, but to direct that as an acceleration in the economy, I wouldn't -- I couldn't draw that.

  • Mark Marcon - Analyst

  • Okay.

  • And then with regards to the -- to the referrals from -- from the client base, from InterPay and Advantage, what -- what -- what can you do to -- to stimulate that?

  • That seems like it would be a pretty good opportunity.

  • Thomas Golisano - Chairman of the Board, President, CEO

  • It's a great opportunity, but obviously we have to, first of all, make sure these clients have a confidence level in what they're getting from us.

  • Mark Marcon - Analyst

  • Uh-huh.

  • Thomas Golisano - Chairman of the Board, President, CEO

  • And when you put them through a conversion process, you know, sometimes it makes them leery.

  • I think that's very understandable.

  • But at the rate we've been doing this conversion, I think for the ones, for example that have been converted this year, I think once we get through a good year-end, which we anticipate we will have this year, that people's confidence level will be where we want it to be and for the clients that have been converted, we should begin to extract those types of referrals that we're used to.

  • Don't forget we still have 2/3 of the client base to convert yet.

  • So it's going to take a while.

  • Mark Marcon - Analyst

  • Okay.

  • And last question...

  • Can you talk a little bit more granulary about the incremental costs for Germany?

  • It sounds like you're absorbing the costs now but probably won't get any revenues until the back end of next year?

  • Thomas Golisano - Chairman of the Board, President, CEO

  • You're absolutely correct.

  • Quite frankly I think you might be pleasantly surprised at how little this investment takes.

  • We are not making a significant, much less a huge investment in Europe, believe me.

  • And it's not too much different than opening a new branch in the United States, quite frankly.

  • John Morphy - CFO, Senior Vice President

  • Less than a million.

  • Mark Marcon - Analyst

  • Super.

  • Thomas Golisano - Chairman of the Board, President, CEO

  • That's a good answer! [ Laughter ]

  • Mark Marcon - Analyst

  • Great, thanks.

  • John Morphy - CFO, Senior Vice President

  • Less than a million and more than $100,000.

  • Operator

  • Mr. David Grossman of Thomas Weisel Partners.

  • You may ask your question.

  • David Grossman - Analyst

  • Sure, thanks, John, perhaps you kind of answered this indirectly.

  • Can you just review what the major plus and minuses will be on operating expenses next year, independent of sales growth?

  • John Morphy - CFO, Senior Vice President

  • Well, it's the usual ones, I mean we usually -- you're going to, you know, if you get the price and get the unit growth and get some ancillary growth, it's really the leveraging goes off the ancillaries, that will continue.

  • We just don't let branch cost grow much more than client growth plus about 300 basis points which is usually less than the price increase.

  • It's across-the-board.

  • I don't look at selling expenses.

  • On the income statement we have operates expenses, selling expenses and G&A we actually don't even look at them that way.

  • Because, the classifications are so unique, you know, a branch has G&A in it.

  • I don't know that I'd say a branch really has G&A in it but I could never find a better way of doing it.

  • So, I look at the all three of those together; selling costs I can break out pretty well, but the other two I can't.

  • The leveraging will be our natural leverage.

  • I don't think there's a new story here.

  • You will get a little bit more pricing on Advantage, which will help in InterPay.

  • But it's not going to be humongous in one year it's going to take time.

  • You know, the discounting situation on sales right now is relatively okay.

  • I think it's going to be more of the same.

  • David Grossman - Analyst

  • So, there's no, really in terms of infrastructure cost?

  • John Morphy - CFO, Senior Vice President

  • No, we've really eaten a lot of infrastructure cost in the last two years, we did the dual data centers on the computer.

  • Capital is going to go down.

  • We bought some buildings in the (INAUDIBLE) area.

  • Where now most of the remodeling is almost done with those.

  • We're in a good position now, I don't feel like we got any spike costs that we actually have had in the last two years.

  • I think we will continue to get back on that road we're on.

  • David Grossman - Analyst

  • Just on the new sales growth, can you just remind us how that -- kind of the new sales growth you've been experiencing in the first half of the year and the timing of how new sales flow into revenue?

  • John Morphy - CFO, Senior Vice President

  • The problem is, you know, we haven't talked exactly, but, you know, the selling expenses are a pretty significant portion of the first year's revenue.

  • When you start billing the person from day one.

  • Once you get past a certain number of months, obviously, we don't give out the exact number, I actually lose money on the sale in the year I'm in.

  • David Grossman - Analyst

  • Okay.

  • So it's, you know, let's say, yeah 12 months are a reasonable period to sell?

  • John Morphy - CFO, Senior Vice President

  • We haven't given the exact sales number -- you guys have an idea, about what it is, but we've never given exactly what it is.

  • David Grossman - Analyst

  • Okay.

  • Thomas Golisano - Chairman of the Board, President, CEO

  • Another way to look at this, if the average revenue per client is $2,300 a year for the client that uses Taxpay or direct deposit, you divide that by 12 months and take the month of January, for example, when you sell a client in January, assuming you sell it beginning the first week, you only got five months of revenue times, you know, 180 or $200 a month.

  • It's not like you can enjoy the full year's sales activity because we're -- obviously because we're a service business and we bill on a monthly basis.

  • So, when John said earlier new sales activity this year, we really feel the real benefit of that next year.

  • David Grossman - Analyst

  • Right.

  • Got it.

  • Thank you.

  • John Morphy - CFO, Senior Vice President

  • The selling costs thing that you're talking about is the reason pro business couldn't make money, the selling cost acceleration plus they had conversion cost acceleration.

  • Operator

  • Our next question comes from Mr. Adam Waldo of Lehman Brothers.

  • You may ask your question.

  • Adam Waldo - Analyst

  • Just a quick follow-up on overall corporate head count.

  • You know, John, as you look to the rest of fiscal '04 and start to think about FY 05, how should we think about head count growth relationships overall in an absolute sense and relative to revenue growth?

  • John Morphy - CFO, Senior Vice President

  • I would say head count growth to be somewhere between 7% and 9% with 7 more realistic.

  • Adam Waldo - Analyst

  • For FY 05?

  • John Morphy - CFO, Senior Vice President

  • Yep.

  • Adam Waldo - Analyst

  • Okay, and up in the 3% to 4% range this year or a little faster?

  • John Morphy - CFO, Senior Vice President

  • I got all this Advantage InterPay stuff going through, I can give you a number.

  • Adam Waldo - Analyst

  • Okay, thank you all.

  • Operator

  • Mr. Eric Gautse of JP Morgan.

  • You may ask your question.

  • Eric Gautse - Analyst

  • Just one last follow-up here, I guess given the modest reduction in net income guidance or growth there, I guess there are a couple of ways we could do this.

  • We could take most of that delta out of the next quarter, spread it evenly over the next two, as you look at the consensus numbers that are out there today, do you an area where we might want to modify the model?

  • John Morphy - CFO, Senior Vice President

  • I think it's pretty even over the next two.

  • Actually, if you look at it, net income growth in the third quarter and the fourth quarter, we think is going to be higher than what it was in the first half.

  • Eric Gautse - Analyst

  • Uh-huh.

  • John Morphy - CFO, Senior Vice President

  • You know, they're pretty close to the same.

  • Maybe the fourth quarter has more of net income growth than the other.

  • Some of that slightly better favorable comparisons.

  • But when you talk about the %8 or 9%.

  • The problem is net income growth in the first quarter is only 5.8.

  • We just did 8.1.

  • Both quarters coming up should be better than 8.1 and, you know, that's where we hope it to be.

  • Eric Gautse - Analyst

  • Okay.

  • It's not loaded into any one quarter than the delta.

  • We can --

  • John Morphy - CFO, Senior Vice President

  • This business doesn't change that much.

  • Eric Gautse - Analyst

  • Okay.

  • All right.

  • Good enough.

  • Thank you.

  • Operator

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

  • At this time, sir, there are no further questions.

  • John Morphy - CFO, Senior Vice President

  • Okay, I'd like to again thank you all of you for your interest in Paychex.

  • We think we had another successful quarter and hopefully these signs of the economy are going to continue.

  • At this time I'd also like to thank you for being here and hope you and all your families have a very enjoyable, and safe holiday season.