沛齊 (PAYX) 2005 Q4 法說會逐字稿

Welcome and thank you for standing by.

At this time, all participants are in a listen-only mode.

After the presentation, we will conduct a question-and-answer session. [OPERATOR INSTRUCTIONS] Today's conference is being recorded.

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

Now I will turn the meeting over to Mr. John Morphy, Senior Vice President, Chief Financial Officer.

Sir, you may begin.

Thank you for joining us for our fourth quarter and fiscal year end press release.

Also joining us today is Jonathan Judge, our President and CEO.

The teleconference call will be comprised of three sections -- A review of fiscal 2005 financial results, including comments and guidance for fiscal year 2006, overview and comments from John Judge, and lastly, a Q&A session.

Yesterday afternoon, after the market closed, we released our financial results for the fourth quarter and year ended May 31, 2005.

This press release can be obtained by accessing our website at our Investor Relations home page www.paychex.com.

We have filed our Form 8-K with the SEC, which will provide additional discussion and analysis of the results for the past three years.

This filing is also available on our website.

In addition, this teleconference is being broadcast over the Internet and will be archived and available for access on our website until July 27th, 2005.

Please refer to our website for access to all recent news releases, current financial information, SEC filings, and Investor Relations presentations that will be updated in the next week or so.

As usual, we were extremely pleased with our fourth quarter and year-to-date results.

They were ahead of expectations, have established an excellent foundation for fiscal 2006 and beyond, and followed the Paychex' tradition of record total revenues, net income and diluted earnings per share for the 15th straight year.

Putting the 15-year streak in perspective, 1991 revenues were 137 million with net income of 9.6 million.

Today, we generate 9.6 million of profits in a little more than one week.

Fiscal 2005.

An exceptional year as Paychex continues its long-term history of successfully gaining, retaining and servicing clients with a full array of payroll and employee benefits services that are ever expanding in the opportunities they provide to us and our clients.

Fiscal 2005 reflected solid sales and record client retention activity.

We increased our client base 3.5% compared to 3.1% in fiscal 2004.

Organic client growth, exclusive of the Advantage and InterPay acquisitions was 6% in fiscal 2005 compared to 7% in fiscal 2004.

However, fiscal 2004 client growth benefited from an 11% increase in the Core and MMS sales forces compared to 7% in fiscal 2005.

We expect these sales forces to again grow by 7% in fiscal 2006.

We now serve over 522,000 clients.

Our client base growth was slightly lower than our long-term goal of 5%.

It is improving and accompanied by a strong revenue focus by our sales forces, we were able to generate total service revenue growth comparable to our long-term goal of 12%.

Fiscal 2006 guidance is again a comparable 12%.

Operating income growth exclusive of float and unusual items was approximately 15% in fiscal 2005 and is expected to be at the same level in fiscal 2006.

Year end release.

Again, 15th year of record revenue and net income growth.

Total service revenue growth was 12% for the fourth quarter and fiscal year 2005.

Total revenues for fiscal 2005 were 1.4 billion.

Quarterly earnings per diluted share were $0.27 versus $0.16 a year ago, up 65% on an unrounded basis.

Year-to-date diluted earnings per share were $0.97 versus $0.80 a year ago, up 22% on an unrounded basis.

Operating income growth without interest on funds held for clients and unusual items, was approximately 15% for fiscal 2005.

The most significant unusual item impacting operating income was the reserves for pending legal matters recorded in fiscal 2004.

We will now refer to the consolidated income statement.

Payroll service revenues increased 9% for both the fourth quarter and year ended May 31, 2005 to $285.8 million and 1 billion 136.8 million respectively.

The increases are related to organic client based growth, increased utilization of ancillary services, and price increases.

As of May 31, 2005, 90% of all clients utilized our tax filing and payment services and 65% utilized the employee payment services.

Major Market Service revenue increased 26% and 27% for the fourth quarter and fiscal year ended May 31, 2005 to 46.9 million and 177.7 million respectively.

Approximately one-third of the new Major Market Services clients are conversions from our Core Payroll service.

Human Resource and Benefit service revenue increased 28% and 25% for the fourth quarter and fiscal year ended May 31, 2005 to 72.7 million and 247.9 million respectively.

The increases reflect growth in clients for Retirement Services, growth in client employees served by our Paychex Administrative Services and Professional Employer Organization bundled services.

And the benefit of revenue from the April 2004 acquisition of Stromberg Time and Attendance products.

Retirement Services revenue increased 14% and 17% in the fourth quarter and fiscal year ended May 31, 2005 to $23.9 million and 91.4 million respectively.

At May 31, 2005 we had over 33,000 Retirement Services clients, compared with over 29,000 at May 31, 2004.

Sales of PAS and PEO products have been strong, with administrative fee revenue from those products increasing 36% and 39% for the fourth quarter and fiscal year ended May 31, 2005.

As of May 31, 2005, our PAS and PEO products serviced over 225,000 client employees, compared to over 157,000 at the end of May 2004.

Interest on funds held for clients increased 73% and 11% for the fourth quarter and fiscal year ended May 31, 2005 to 20.5 million, 60.4 million respectively.

The increase in interest on funds held for clients is primarily due to higher average portfolio balances due to client based growth, higher average interest rates earned in fiscal 2005, offset by decreases in net realized gains on the sale of available for sale securities.

The third and fourth quarters of fiscal 2005 reflected our first significant increase in interest on funds held for clients since fiscal 2001.

Looking ahead, we expect this trend to continue based upon current interest rate levels.

We provide the following comments related to interest on funds held for clients -- Funds held for clients increased 10% in fiscal 2005.

We expect a 10% increase in fiscal 2006 related to our anticipated client growth, wage growth, and more of our clients taking advantage of our products that affect funds held for clients, especially employee pay.

Our guidance for fiscal 2006 growth in interest on funds held for clients is 25% to 30%.

This is based upon the current Federal Funds rate of 3% being constant throughout fiscal 2006.

A 25 basis point increase in the Federal Funds rate, 17 basis points for tax exempt investments at the beginning of fiscal 2006, would generate additional interest on funds held for clients in a range of 3.7 million to 4.2 million.

To put this in another perspective, if the Fed chooses to raise by 25 basis points this week, it will affect next year's float revenues by about 3.5 million.

Historically, we have recognized realized gains and losses to minimize volatility related to changing interest rates.

Given current accounting interpretations, in order to preserve the accounting treatment on available for sale securities of recording market value fluctuations through comprehensive income instead of through the income statement, we do not expect to realize any losses in investment portfolios in fiscal 2006.

We refer you to our management's discussion and analysis of financial condition and results of operations for a more detailed explanation of the effects of fluctuations in interest rates.

Consolidated operating, selling, general and administrative expenses, exclusive of the fiscal 2004 expense charged to increase the legal reserve, increased 10%.

There are approximately 10,000 employees at May 31, 2005, compared with approximately 9,400 at May 31, 2004.

Investment income net was unchanged for the fourth quarter of fiscal 2005 at 4.3 million.

And decreased 25% for the fiscal year ended May 31, 2005 to 12.4 million respectively.

The decrease for the entire fiscal year is primarily due to lower net realized gains on the sale of available for sale securities, offset somewhat by higher average portfolio balances.

Long-term interest rates were lower in fiscal 2005 further impacting the decrease.

We did see short-term interest rates increase in the fourth quarter of fiscal 2005, helping offset decreases in net realized gains on the sale of available for sale securities.

Our effective income tax rate was 31.0%, and 32.5% in the fourth quarter in fiscal year ended May 31, 2005, compared with 32.7% and 32.6% in respective prior year periods.

The decrease in the effective tax rate are the result of higher levels of tax exempt income earned on funds held for clients and corporate investments.

We expect the effective income tax rate to be 31.5% in fiscal 2006 subject to unanticipated increases, decreases and tax exempt income from investments of funds held for clients in corporate investments.

We will now move to a discussion of our balance sheet at May 31, 2005.

Cash and corporate investments have grown to just over 700 million compared to a little over 500 million a year ago.

Our cash flows from operations increased over 70 million to just over 460 million for the fiscal year ended May 31, 2005 from the same period a year ago.

Our total available for sale investments, including corporate investments and funds held for clients, reflected net unrealized losses of 9.9 million at May 31, 2005 compared with net unrealized losses of 4.2 million at May 31, 2004.

During the fourth quarter of fiscal 2005, interest rates on short-term securities increased while long-term rates remained relatively consistent.

The three year AAA municipal securities yield increased to 2.85% at May 31, 2005, from 2.50% at May 31, 2004.

These trends resulted in the decrease in the fair value of the Company's investment portfolios from a net unrealized loss position of 4.2 million at May 31, 2004 to the 9.9 million net unrealized loss position at May 31, 2005.

Our net property and equipment balance activity during the 12 months of fiscal 2005 reflected capital expenditures of approximately 70.7 million.

Depreciation expense and amortization of approximately 62.0 million, and the net book value of disposals of capital assets was approximately 4.4 million.

In fiscal 2006, we expect capital expenditures to be in the 75 to 80 million range, accompanied by depreciation and amortization of 64 to 70 million.

The Company has $406 million of goodwill on the balance sheet, resulting from the acquisitions of Advantage and InterPay in 2003, and to a much lesser extent, Stromberg in fiscal 2004.

Goodwill balances are not amortized, but are tested for impairment on an ongoing basis.

No impairment issues were identified based on testing performed during fiscal 2005.

Intangible assets primarily represent customer lists and relationships, are amortized over periods ranging from 5 to 12 years, using either accelerated or straightline methods.

Total stockholders equity increased to 1.4 billion at May 31, 2005, with 193.0 million in dividends paid during the 12 months of fiscal 2005.

A payout of 52% of net income.

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

Investment rates of return.

Our investment portfolios and the earnings from the portfolios have been impacted by the increasing interest rate environment.

The Federal Funds rate, which was at 1% at the beginning of fiscal 2005, has increased to a current level of 3.00%.

The increasing interest rate environment is a positively affected net income growth.

Fiscal 2006 guidance.

Our guidance for fiscal 2006 is summarized as follows -- Payroll service revenue growth is projected to be in the range of 7 to 9%.

Human Resource and Benefits service revenue growth is expected to be in the range of 24 to 26%.

Total service revenue growth is projected to be in the range of 11 to 12%.

Interest on funds held for clients is expected to grow in the range of 25 to 30%.

Total revenue growth is expected to be in the range of 11 to 12%.

Corporate investment income is anticipated to increase approximately 55 to 60%.

Operating income growth, exclusive of float and unusual items, is expected to approximate 15%.

Net income growth is expected to be in the range of 18 to 20%.

These projections are based on current economic and interest rate conditions continuing with no significant changes.

We estimate that the earnings effect of a 25 basis point change in interest rates at the beginning of fiscal 2006 would be in the range of 3.7 million to 4.2 million for fiscal 2006.

The total investment portfolio, funds held for clients and corporate investments is expected to average approximately 3.8 billion in fiscal 2006.

We expect to take no losses on our investment portfolios from fiscal 2006 as we mentioned earlier.

Legal contingencies.

Paychex is subject to various claims and legal matters that arise in the normal course of business.

During the third and fourth quarter of fiscal 2004, we recorded 9.2 million and 26.6 million in expense to increase reserves for estimated costs associated with pending legal matters.

Legal reserves totalled 25.3 million at May 31, 2005 and are included in current liabilities on our consolidated balance sheet.

The Rapid Pay litigation continues and we have received several very favorable rulings over the past six months.

The reserves for pending legal matters may change in the future due to new developments or change in the Company's strategies or assumptions related to any particular matter.

In light of the reserves recorded, we currently believe that resolution of these matters will not have a material adverse effect on our financial position or results of operations.

However, they are subject to inherent uncertainties and there exists the possibility that the ultimate resolution of these matters could have a material adverse impact on our financial position and results of operations in the period in which any such effect is recorded.

We refer you to our Form 8-K for a more detailed explanation of pending litigation.

Sarbanes-Oxley.

I would like to take a few moments to express my appreciation and congratulations to the many Paychex employees who enabled us to meet the strenuous requirements of everything related to Sarbanes-Oxley legislation.

We anticipate receiving a clean attestation report from our independent accountants, which will be included in our Form 10-K.

This accomplishment went far beyond the finance organization, as people throughout the entire organization participated in documenting, testing, and improving virtually every process of our Company.

Equity based compensation.

Under the new accounting rules for equity-based compensation FAS 123, all stock-based compensation arrangements are treated for accounting purposes as other forms of compensation.

The cost of the award must be recognized in the income statement.

The Company anticipates adopting FAS 123 in the first quarter of fiscal 2007.

Based upon our current review of the new rules, and existing in anticipated equity awards, we expect adoption of FAS 123 will reduce net income by 3 to 5% in fiscal 2007.

Safe Harbor.

You should be aware that certain written and oral statements made by the Company's management constitute forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995.

These statements should be evaluated in light of certain risk factors which could cause actual results to differ materially from anticipated results.

Please review our Safe Harbor statement on Page 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 Jonathan Judge who will provide his comments on the fourth quarter before we open the meeting for questions.

Thanks, John.

Great job as always.

I just wanted to add a few comments to John's play by play of what happened for us in the fourth quarter and the full year if I might.

And I would like to start by publicly thanking the 10,000 Paychex employees who have a great deal to be proud of.

They committed themselves to outstanding performance and they executed across the board and allowed us to have the great results.

As John said, the fourth quarter was outstanding and it capped off an outstanding full year.

He took you through the great numbers in fourth quarter so I won't repeat those, but I did want to talk a little bit about some of the highlights.

The base business, obviously, was very strong with 9% growth.

Perhaps more importantly, though, our ancillary businesses were also quite strong with, in most cases, two to three times the growth rates of our base business.

MMS had a terrific year.

It is now almost a $200 million business and going strong.

We passed 25,000 clients this career in our MMS business.

Our HR and Benefits services revenue grew 28 and 25% respectively.

Terrific growth in 401(k), PEO, PAS, and our Time and Attendance products from the acquisition that we did a year or so ago with Stromberg.

All of those businesses up very strongly, in the case of Time and Attendance up more than 300% in its first year of operation inside the Paychex family.

And as John said, interest rates finally turned around.

The first significant increase we have seen since 2001, and he mentioned the fact that interest on funds held for clients was up 73% for the quarter and that drove an 11% increase for the year.

So we finally got the interest rates turned in our favor and we expect that wind to be at our backs until 2007 at least.

And the additional interest income, by the way, when derived from tax free instruments help lower our tax rates to 31%, down a point and half from last year.

Total expenses were also held in check and we continued to leverage our revenue growth into even greater income growth.

Total expenses, excluding the legal reserves, were up 9% on the quarter and 10% on the year, versus revenue increases of 15% and 12%.

And nearly all the expense increases that we saw through this year were volume-related, that is, they drove revenue.

Some other highlights.

Every one of our sales forces met or exceeded their plan.

We had our best client retention and customer sat year ever.

We passed 520,000 clients, we completed the integration of two large acquisitions, InterPay and Advantage, adding over 80,000 new clients to the Paychex family.

And we did those integrations faster, cheaper and with less client attrition than expected.

We turned client growth positive for the first time in a while, up 3.5% versus 3% last year, and we will continue to improve on that.

We had a very successful first year with our operation in Germany.

We finished ahead of plan and ahead of the growth rates that we saw in most cities in the United States.

I'm also proud to announce that we've made the decision to open our second city in Germany this month and the city that we've selected to go to is Berlin.

We have already begun hiring for that effort.

Some other highlights in the fourth quarter, we made some early investments for fiscal year '06.

We released new hires for sales early in the fiscal year '05 so that we could get these people on board and try and minimize any open territories that we might see as we go into the new year.

We also got all of our planning done early.

Quotas were done, got them out to the field, and we committed to an aggressive '06 operating budget and got that out early as well.

So we got a great jump on '06 and feel very well positioned for both our success in '05 and what we hope to have in '06.

So while we are excited about our prospects, just as a summary, the base business our Core Payroll services to small and medium businesses is very healthy.

Our ancillaries are doing extremely well in all cases, growing faster than our base business.

Our client retention and customer satisfaction are at all-time highs.

Our sales forces are hitting on all cylinders.

Interest rates are in our favor for the first time since '01 and should be that way for several years.

The economy is stabilized.

Certainly the downward spiral has stopped, and in many cases, we have seen improvements in the economy that should help us.

Job growth, for example, has turned slightly positive.

The small business market is healthy.

We have terrific products that are fairly priced and valued by our clients, and we've got a business model that is Advantage.

So you add that all together and you end up with a terrific fourth quarter and a terrific full year '05, and some very positive positions on guidance for '06.

At this point, John and I would be happy to entertain your questions.

Thank you.

We will now begin the question-and-answer session. [OPERATOR INSTRUCTIONS] Thank you.

Our first question comes from Adam Frisch with UBS.

Sir, your line is open.

Good morning, guys.

The forecasted payroll growth for next year is decelerating a little from bit from this year, but the HR and B revs are projected to be a little bit higher than we were expecting.

Two part question for you.

One, is your confidence level in the better '06 margins driven by the growth of these higher margin services?

And then two, where in the 7 to 9% range do you think we will wind up and what could make this range higher or lower?

Basically, the payroll range is the range we gave.

I don't think we will get any more specific than that.

As Taxpay and employee pay mature a bit the payroll growth can slow a little bit.

It doesn't concern us at all because our real focus on revenue growth, while payroll remains strong, is more towards the Human Resource side where revenue growth is exceptional.

So we don't see this as any issue and this is one of the things that happens when we break down the revenues in so many categories, there will always be some that are going to be better than others.

As far as margin improvements, that just continues off our continued expansion of services and taking various services and adding them on to the client base that already uses the basic services.

But the HR and B services are generally higher margin than the Core Payroll; correct?

Yes.

And then the 7 to 9 range, is that something that we should think about being the range for the next few years or is it something that could bounce around in future years?

What's your view on that?

We gave the guidance.

We have a long tradition of continually doing better and better, and that's our tradition and we'll continue to do that.

But the numbers we look at in the end is, where are we on the total numbers.

Okay.

On the total.

Quick question on pricing.

Can you talk about the changes you've made so far for the new year?

Have you had any push backs from clients?

The pricing that we've done this year is very similar to the pricing changes that we've made in year's past.

It has been certainly more than ten years in a row that we have been able to increase prices.

By the way, we do that because we increase the value in the products that we deliver to the marketplace.

We had no push back on the pricing this year.

We saw nothing different this year than we have seen in years past.

And again, I think this is more a question about what value are you delivering versus anything else, and our clients seem to still feel they are great getting great value from the products that we bring to them.

Thanks, guys.

Nice quarter.

Thank you.

Cindy Shaw with you may ask your question.

Thank you.

Congratulations on a very nice quarter and great outlook.

A couple of questions for you.

We heard a year ago that going into fiscal '05 the billing days, a couple of seasonal anomalies, and also just because of the way the calendar fell, less billing days in fiscal '05 than in fiscal '04.

If you could give us an update on any impact in fiscal '06 versus fiscal '05.

And also on SG&A, you had said a few quarters ago that you expected it to be in the mid to high single digits, wound up spending a little more.

If you could give us a sense for your current outlook on SG&A?

Basically, the calendar had a little bit of difference in '05.

I don't believe there is any in '06.

If there is, we will let you know about it, but I don't think there is any.

As far as the spending, we invested in the sales forces at the end of the year, and let them bring on the new hires so we could get off to a great start in '06.

So SG&A, how should we think about growth in fiscal '06?

We gave you guidance on a lot of numbers and our goal is to look at the 15% operating income and, obviously, we got to continue to leverage.

And for John Morphy, on the portfolio, if you could update us on the duration, any changes you might be planning for the portfolio over the coming year in terms of cash mix, duration, anything like that?

I would refer you back into the 8-K that we filed today and then eventually the 10-K for more data on that for exactly where we are.

I don't anticipate any major changes, but if this interest rate environment changes, our determination, we are not going to take losses, could change what we would do on duration.

But I don't expect it to be significant, because I don't expect there to be any significant changes in long-term rates.

They have been pretty resilient to stay where they were.

So I don't think I see many changes, most of the opportunity here relates to the short-term rates which effect -- which happen pretty fast, but as long as the Fed continues to raise rates, and last year we didn't get there all at one time, we're going to get what John talked about as positive results clearly through 2007 and probably at least neutral in 2008.

Great, thanks very much.

Thank you.

David Togut with Morgan Stanley, you may ask your question.

Thank you for taking my question.

For fiscal '06, what do you expect in terms of net client growth?

Our goal is 5% and we keep working very hard to get there.

I think sometimes people get too focused on client growth.

We are working our sales force very hard to do both.

We have had more emphasis on revenue growth and that is why we have had some great revenue years in the past here and can expect more in the future.

We would like to get to 5%.

Exactly how much improvement between 3.5 and 5, I don't know, is the effect of the advantage in the InterPay acquisition has lasted a little longer than we anticipated.

I think the more important number is, we are over 5% when you look at it without those two organizations.

I see.

And what specific -- what specific impact has the CPA to business program have?

We have been getting some pretty positive data points from that.

It has been -- this is John Judge.

It has been a very good program for us.

Good enough so that we decided to continue it into '06.

We haven't released any specific data on that and I'm not going to do that today.

I think the easiest way to explain how we feel about that program is to tell you that we decided to continue it into '06.

I see.

On the last call, John, you talked about reducing attrition for sales people and payroll specialists.

Do you have specific targets for fiscal '06?

I don't have specific targets.

I view that more as a journey than I do an event.

It was -- and part what I was doing was trying to change the mindset inside the Company in terms of focusing on those, because I think they will have great payback for us, both with our clients and with our financial performance.

And so there is nothing specific that we are talking about publicly, but you read my comments correctly and it is something I'm pushing pretty hard inside the Company.

Just finally, you saw a big pickup in workers' comp clients in the fourth quarter.

Were there any specific factors that drove this?

Well, the workers' comp environment is always very cyclical.

And the two things workers' comp environments don't like are real low interest rates and recessions where there is a lot of unemployment.

The reason they don't like low interest rates is, most people are probably not aware of it, workers' comp carriers actually pay more out in claims than they receive in proceeds or service, premiums and that is because of the losses.

They make the money off investing the money they receive far ahead of time, so I think that is the result of favorable interest rate environment and the economy, which is causing more carriers to want to be more aggressive in writing business.

Thank you very much.

Thank you.

Kartik Mahta with FTN Midwest Research, you may ask your question.

John, I was wondering if you could provide some numbers on the new hires that you have done in the past?

Well, the new hires have been pretty steady for our Company in the 6 to 7% range in the sales force and close to that overall.

The hires that were released for the next year are in the same -- the same range.

So we stay pretty consistent on that.

On the sales side, just as some background for you, we've had years where we increased the sales force greater than that, and what we've discovered is that the optimum number for us is in that 6 to 7% range.

Once we get much more -- much beyond that, we start to get diminishing returns and it becomes not worth our while to go and put those types of investments in place.

So we will continue as long as the environment is right, and it looks to us like it is going to be right for the foreseeable future, we will continue to keep investing in our payroll -- excuse me, in our sales forces, and in roughly that area that I talked about, 6 to 7%.

Great.

And I was also wondering, I knew in the past or now you don't provide pace per control number, but you've also provided some type of employment growth number for your clients.

I was wondering if you could maybe talk about that, if those numbers are available.

Are you talking about new hires for them?

Yes, John.

The numbers that I just had them run for the fiscal -- excuse me, for the calendar year instead of the fiscal year, since everyone is not obviously going to be on our fiscal year, so the numbers last year improved about 0.5%.

So if you look at calendar year '04, the new hires were up 0.5%.

That is the first time in several years that those numbers have been positive.

The prior two, three, four years had all been negative and middle to high single-digit negative for the year, so that was positive.

Through the first quarter of this year through March, the numbers were up 1.5%.

Now again, I'll remind you that while these numbers, it is a very good sample size because they come out of the 522,000 clients we have, and we do the compliance reporting, new hire reporting to the Federal Government for most of our clients, the numbers are great numbers for our clients.

Whether or not they are great numbers for the whole economy is a different question that you will have to answer.

I can only show you what we see from ours.

So those are the two pieces that we see.

We also are starting to see a little bit more churn in the employees inside of our customers, and our experience has told us that once we see some of that churn, it is usually an indication that the economy is loosening up a little bit.

In tough economic times, people tend to stick with their jobs and not move, and then when the economy starts to loosen up a little bit, then you'll start to see more movement and people going from one company to the next, which we've just started to notice.

And one final question.

Your thoughts on the ADP Microsoft alliance.

If it's had an impact or you anticipate having an impact?

And also, would you consider a similar type of alliance or any other type of alliance that would potentially get a new distribution channel for your product?

On the alliance itself, I mean it obviously had at least a media impact because we get asked this question almost every time we get together with the analysts.

From what we have seen in the marketplace, I can tell you that to my knowledge, we haven't had a single client situation where the alliance was brought up or presented an issue for us.

So it's certainly not something that's impacting us, at least at this point.

How successful it has been or hasn't been, I really don't know, you would to ask Microsoft or ADP that question.

From our vantage point, it is something that we are aware of.

My guess is that it is probably more important to companies like Intuit than it would be to us.

Whether it is going to end up having any serious impact in the marketplace or not, I just can't tell you.

We certainly have not seen it impacting our business.

Thank you very much.

Sure.

Thank you.

Bryan Keane with Prudential, you may ask your question.

Good morning.

Is there other tuck-in acquisitions like Stromberg since that was so successful that are out there that maybe you can add to the Paychex portfolio?

As soon as we find one that works for us, we will do it and we will let you know that we did it.

The tenor or the tone that we have set in the past remains the same today.

We are open to acquisitions.

It is not something we are chasing.

We believe strongly about sticking to our knitting, if you will, to stay close to our Core business.

We clearly are interested in buying smaller payroll companies, we have been doing that for years and we'll continue to do that.

When acquisitions like Time and Attendance come along that are new product offerings that meld very well to our strategy and to our existing infrastructure, that is that our sales forces can sell it, our operating teams can support it and so on, you can be sure that we would be interested in them.

If they fit our strategy and they fit us financially and they fit us culturally.

We are wary, as most companies are, to go and get into the M&A game for the sake of getting into the M&A game.

We are aware of the issues associated with integrating companies one to the next.

So, obviously, any analysis that we do on these things will include all of those factors.

But I don't want you think that we are on a mission to go do acquisitions.

We are not.

But we clearly look at a lot of different opportunities, and should one come along that makes sense, we very are interested in pursuing that.

Is there certain products that you don't have or don't have enough of that maybe would be more interest than others?

There's nothing on the horizon now that we would be willing to talk about.

And what about -- there is a lot of noise on HR BPO-type services.

Is that an angle that you guys are looking at at all?

I think we already have that angle.

When you look at PAS and PEO, we are perfectly positioned probably the best of anybody, ADP could close the gap some, which would help us actually in educating the marketplace, but we don't think anybody is better situated than we are right now with what we have.

We think we are in a great spot for that market that is below where those giants are going to compete.

And just wanted to the make sure I understood the Payroll service revenue line, the key components there I assume are employee pay, Taxpay and probably client growth and pricing.

Is there anything else that drives that business?

Basically, it's all the Payroll processing.

So what you've got, everything related to basic Payroll.

MMS is in that number.

And that is what it is.

But remember our focus right now, when you talk about the HR BPO, we know Payroll is a great engine, it's going to stay a great engine, and it's still got a lot of under-penetrated market, but the opportunities that we have in the PAS, PEO, 401(k), workers' comp, those are phenomenal and that's where we are chasing them.

I think also you realize that that's where we really differentiate ourselves from other payroll providers in the fact that we can do all those things, which most medium-sized payroll providers cannot do.

Then just finally, John, I think you mentioned possible acquisitions of maybe small Core Payroll companies.

Did you make many of those in fiscal year '05?

We keep doing that, but they are not significant enough to worry about.

It's just a matter of, we buy them, we buy them in about -- after the paperwork gets to me, it takes about 15 minutes, but they are not significant.

So no material sized ones?

No.

Okay.

Thanks.

Thank you.

Rod Bourgeois with Sanford Bernstein, you may ask your question.

Yes, thanks, guys.

Your guidance for '06 is very clear, and I would say it is pretty exemplary in terms of its clarity in the sector, but I did want to inquire more about the revenue growth outlook.

I assumed the slight down-tick in revenue growth guidance is related to the Core client additions.

If that assumption is accurate, can you comment on whether the 3.4% base client growth, is that an issue of maturation?

I know the acquisitions are having an effect there, but can you comment on what else might be having an impact?

And how do you get that 3.4% growth number up to the 5% range?

First off, again, I think you are reading something in here.

Our guidance on revenue is almost identical to what the revenue was this past year.

So don't look and see that you think there is any weakening, because there isn't any weakening.

There might be a little weakening in element, whereas another element is stronger.

So I think as we look at this, you are breaking the baby into too many pieces, when you got to leave it kind of together.

As far as client growth, it is something we have been pushing at.

Client growth really hasn't changed all that much in the last few years since we got by the 2001, the recession.

It is pretty consistent at 6 or 7 organically.

So it's a matter of working through this Advantage InterPay thing, and it's a good example where the numbers don't always tell the true story.

So we think we are making some good progress on client growth, at the same time, we've had a sales force that's been very dedicated towards revenue growth.

And a very good thing happened this year, every single geographic area of our sales forces made the revenue quotas this year.

So we had a great sales year.

Walter's people did an outstanding job, the HR people did.

So we feel real good about those things.

So whereas you look at some of them and you want to see if there's a little bit of weakness there, we don't feel that way.

All right.

Understood.

And then on the float earnings assumption for fiscal '06, it is my sense that that guidance assumption is somewhat conservative.

It appears your guidance for next year, for fiscal '06 appears to assume the float earnings run rate would actually decline versus the level that was achieved in Q4.

So is that accurate?

And if it is, does that imply that your -- your float earnings assumption for '06 is somewhat conservative?

I would say it is somewhat conservative.

It's pretty much the calculation, and we hedged a little bit because we don't know where long-term rates are going, so probably the guidance of 25 to 30 are probably going to -- probably be towards more the upper end.

But you have to remember when we did this assumption, we left ourselves rate at 3.0% and the reason we did that is we think it is better for us to tell you what we see from a constant view point and let you decide what you think rates are going to do, versus us kind of spinning the -- kind of the optimistic ball and saying, okay, we will put this in, and then you say, well I don't like that so I will change it to this.

The other thing I don't want to do is have the Fed change what they do and then we got to make an adjustment.

Because right now we think it as little cloudy as to what exactly the Fed is going to do than it was just about six or seven weeks ago.

If you had to ask me what do I think will happen.

I think float income will be greater than the guidance, but that is going to take the environment giving it to us as we have been pretty accurate at estimating what is going to happen otherwise.

Now, we looked at the funds held for clients and we gave you some guidance on that going up, and we feel pretty confident that is going be around 10%.

So maybe a little conservative, but might not be as much as you would think, but the rate increases will make it conservative if they happen.

And your guidance, though, for overall sort of income does not need the float earnings assumption to be conservative, you can hit that overall guidance level without the float being on the conservative side?

We gave guidance based on where all of those things were, so I don't quite understand that question.

I think the way you should think about it is, the guidance includes the float as it was -- as it was posted.

We spent a lot of time thinking about this, by the way, and if there are people that have a different opinion on this we would love to hear it.

But the conclusion was, particularly when you have a volatile interest rate environment, that we'll peg it at what the interest rate was at the close of the year and let you decide what you think it is, and we ran our models on it at 3%, as John said.

Yes.

It's all very clear.

Thanks for that.

And then just one final thing.

When you look at the Core margin expansion that appears to be projected for fiscal '06, can you talk a little more about the drivers of that Core margin expansion?

I mean, is it anything beyond just the normal leverage that you get from the cross-selling et cetera in the model?

No, we have got a great business model, and part of our success is because we stick to it.

We are careful what we stick into it.

We have more opportunities to get revenue, but if they are not going lead to good profitable growth, we are not interested.

It really comes back to pretty much the same.

It's a reasonable client growth, grow those ancillaries, some price increases, and just leverage this wonderful infrastructure we have.

And the fact, and John talked about it earlier, I can't say enough about our 10,000 employees who do their jobs great every day and just know how to take added business and make it worth more to us and our shareholders.

Thanks, guys.

Appreciate it.

Thank you.

Jeremy Davis with CSFB, you may ask your question.

Hi, guys.

On the client growth side, in addition to just improving sales person productivity and then doing the hiring that you have laid out in your 8-K, is there any initiative that you are focusing on on the client attrition side?

Clearly, there is work on both sides of that.

If you step back and look at how that number gets comprised in our model, in the average year we will lose about 20% of our clients largely to businesses going out of business.

And then we will go and capture 25% new clients.

And so they net out at 5.

Clearly, there is two sides to the equation.

You drive the productivity of your sales force on the one hand, and on the other hand, you do everything in your power to retain the clients that you have, those that you have an ability to impact.

Obviously, we can't impact companies going out of business, but the ones that we lose for reasons other than that, we clearly can impact.

And so we have got initiatives going on both sides of that, and I think one of the comments that I made earlier, one of the great results that we had in this fiscal year was the best client retention year we ever had as a business, and that is thanks to Marty Mucci who is the Senior Vice President of Operations for our Company and all the work that his people are doing to drive client satisfaction to the highest level possible, and perhaps more importantly, to have a whole infrastructure set up so that if there is an issue with any of our clients, it is attacked immediately and they do everything in their power to return them to a level of satisfaction so that we don't lose those clients.

Every one of our branches throughout the United States carries as one of its primary measurements, client retention.

So was the -- were the portfolio acquisitions, well, not portfolio acquisitions, but your InterPay and Advantage acquisitions, did those portfolio clients experience generally higher attrition, which might have been higher than normal over the last two years, or was that not so much a factor?

It is not the attrition.

The piece that I think you're trying to get at is that, we have a business model that is highly dependent on referrals, both from CPAs and existing clients.

In fact, if there is a part of the secret sauce that is known, that is a big part of it.

We can't deal with clients, small businesses that will pay you on average $2,200 or $2,300 a year if you have a direct sales model where you are going out and trying to capture all these clients at $300 or $400 a sales call.

So the referral network is really important to us.

Part and parcel of that referral network is a client who feels very comfortable about our Company and the platform that they are running on and the service that we provide them.

When you bring on 80,000 new clients and you migrate them onto a new platform, they are not going refer for a year or two until they get migrated onto your platform and they feel comfortable enough about it to refer you to another client.

So it is a very natural course of events, and it's really nothing more than when you bring on, in this case that many clients, 80,000 clients, it takes some time to get them fully integrated and then it takes some time for the client to feel so comfortable with the service we're providing to then go and refer it to their colleagues.

Okay, great.

And then just lastly, back on the workers' compensation commentary that you guys gave earlier.

For the guidance, the growth guidance that you gave for '06, is there anything unusual, any noise or adjustments that might be in that number that we should be aware of?

No.

Okay.

Thank you, guys.

Thank you.

Brandt Sakakeeny with Deutsche Bank, you may ask your question.

Thanks, good morning.

Just a couple of quick housekeeping items.

John, what is the largest client size right now that you are servicing in the major market segment?

And also, can you just give us a little view as to what your expectations are for growth in that segment in '06?

The largest right now is about couple thousand employees.

Just shy of that.

That would clearly be more of an outlier than an average.

We still -- the majority of the clients that we service in our business in general are still 50 and under, and in the major market businesses, they tend to be in the neighborhood of 50 to 500.

So we do have some larger ones.

We are extraordinarily careful about the clients that we bring on board that we can do an exceptional job in servicing them, and if there are any questions about our ability to do that, then obviously then we would pass on that.

You don't get 89 to 90% client sat on a regular basis without being very careful about your ability to deliver to these clients.

I'd say the average is around 200 to 300, and we have a couple of clients -- not a couple, we have more than a couple, but we have a small percentage of clients that are in the -- between 1,000 and 2,000.

I think we have around 100 clients that have more than 1,000 employees, give or take a little bit.

And the mix of the additions into that segment, is it still sort of a third from from your traditional business moving up, a third new, stuff like that?

About a third, actually a little bit -- slightly less now as we offer MMS throughout the U.S., we're not opening new markets in cities where we had Core, so that will tend to drift down a little bit, which is actually something that's favorable.

And expectations for fiscal year '06 in the segment?

For MMS?

Yes.

If we didn't give specific guidance on it, then we didn't.

Okay.

Let's see.

Operating cash flow for '05.

Can you give us some sort of what that was and also CapEx -- and final CapEx in '06 and '05?

Sorry, we didn't hear your question.

Sure.

Operating cash flow in '05.

John Morphy, do you have that?

I disclosed it.

It is in the 8-K, you can find it.

Nothing unusual.

It is still pretty close to what net income is, except for dividends.

The capital I can find in a second.

Capital expenditures were approximately 70.7 million.

Depreciation expense was approximately $62 million, that's expense and amortization on the intangibles.

Next year we are looking at 75 to 80 million, and total depreciation and amortization of about 64 to 70 million.

No significant changes.

Now, you will see some of that up a little bit.

The accounting people decided that when you get incentives when you lease facilities that you have got to capitalize that, so basically, you capitalize and then you reduce the rent you pay, so.

Okay.

Great.

That's all I had.

Congratulations on a good quarter and good year.

Thank you.

Greg Smith with Merrill Lynch, you may ask your question.

Good morning.

With regards to the lower tax rate, given more tax exempt investments in your portfolio, does this signal a structural shift in the way you are managing that portfolio?

No, it is as simple as more investment income.

Now, to put that in perspective, let's assume that we got 4 million more of float income next year, okay.

The taxes on that 4 million would simply be -- normally we are in tax exempts about 85% of the time, so you would take 4 million times 15%, which I think is 600,000, and you put about a 40% rate on that, because that's the incremental rate, 40% rate on that and that is all the taxes that would be on that $4 million of income, and you could see that that would effectively lower the effective rate as you got more and more of that.

Got it.

Makes sense.

On then just lastly, on the integration of Advantage and InterPay, it sounds like you are pretty well along, but is there sort of any latent operating leverage there that we are going to see kick in at some certain point?

No, I will let John answer after me, but no, there's nothing.

We are very pleased with where it came in.

The InterPay is completely integrated.

It is running on our platforms.

The Advantage is completely integrated in our Company.

We are still running that work on the Advantage platform because the clients on that were quite satisfied with where they were, and we are off to the next set of challenges that we are working on.

So that one was completed in November of last year, and we feel pretty great about where we are and where we are headed.

Basically, when we integrated these, they presented significant challenges and significant opportunities, and the operations people, the sales people did a good job of integrating the front end.

It was a little bit easier and they had to do it quicker because the sales forces have got to really start flying, which we did.

On the operations, though, when you talk about taking on all those branches and all those clients and getting them into our kind of family, that was a big effort that took quite awhile.

Now, there isn't many of those opportunities left, but the opportunity the Ops people have now is to focus on the whole business just as it is, not having to worry about this big integration.

I know there was some people way back when we did these acquisitions, they didn't say we couldn't, but they raised the question, can Paychex prove it can swallow something of that size, and I think we clearly proved we can swallow them.

Okay.

Thank you.

Thank you.

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

Thanks.

I just wanted to drill down a little bit more on the float income growth.

Was it -- the float income average balance is up 23%, new clients were up 3.5.

John, can you give us a little more detail as to how much did employee pay help versus wage growth or other factors.

Employee pay is a big factor, in we're successful with our Readychex program.

And the Readychex program, we get the float because the checks are drawn on our bank account, and they will tend to be more than the one day the direct deposit normally gives you, plus you've got wage inflation, and that's actually -- you can see the impact on that in our portfolio, Greg, because you've been with us a long time, you know the long-term, short-term piece used to be 50/50.

It is now 60/40 short-term and it's all related to employee pay.

Now, employee pay, while you see 65% utilization and we are selling it over 75%, the opportunity there is a little bigger than you might see because still in America the people that are paid on direct pay, or I mean, direct deposit still is low, so we believe there is more opportunity in the 65% as kind of an overstated number slightly, whereas when I look at a Taxpay at 90, that number is right dead on.

That is pretty much what is happening.

Also I would be interested in what you -- what kinds of investments or initiatives are planned in fiscal '06 to further boost sales force productivity and client growth, aside from just adding new sales people?

John Judge, maybe you can give us some perspective on how you are taking the experience at IBM and applying it to Paychex?

It's more -- it's really -- it is not all that sophisticated.

We have a very good sales operation here.

In some cases, more sophisticated than a lot of the companies that I have been with or I have seen, particularly as it relates to the whole systemized approach to selling.

It is very much by the numbers.

It's how much business do the sales people want to close?

What level of recognition do they want to get?

How much money to do they want to earn?

That, because of our history and the high transaction nature of our business can almost -- they can just reverse engineer how many leads they have to have, how many sales calls they have to make, how many demos they have to make and so on all the way through.

So it is a very well-engineered, selling methodology that was here before I got here.

The thing that we are pushing on hard is, we are pushing clearly on adding more sales people, particularly where we can get the sales people on board and do it in a way that is optimum to us.

That is, don't bring on too many so that we have diminishing returns, but just the right number.

We push very hard on the training.

We are working clearly with the first-line managers to make sure that they are doing their best effort to develop our people, and not, by the way, just the superstars, but also to do a better job of developing the average sales people, those that are struggling a little bit.

You know that we have been working on trying to get the attrition levels down and so on.

It is a whole bunch of different efforts, but I don't want you to think that there is sort of a student body left going on here.

Our sales team is very well run.

The sales methodologies that we use are tested and true, and it is really more of about incremental improvement and incremental change.

Okay.

And finally, MMS, do you think that this is a business that can sustain 20% plus growth for the next couple of years?

Sort of new Intuit, it is one of those businesses that -- every once in awhile it is nice to be the guy that is kind of crawling in under somebody else's umbrella, whether that is their market umbrella or their pricing umbrella or what you.

So we started and made our mark as a Company that serviced largely clients 50 and under, and to go up into the higher end, it is a brand new market for us.

It is relatively unpenetrated for us and we think we have still got several years of open selling there at pretty good rates of return for us, provided we execute properly.

Great.

Thank you very much.

Glenn Greene with ThinkEquity Partners, you may ask your question.

Thank you.

Just a couple of quick ones.

I was wondering if you could just update us on your client bankruptcy trends and the impact that had on your retention metric for '05?

We actually haven't seen much change in bankruptcies through the whole recession.

At the low end it was more constant than you think and a lot of them go bankrupt, and they just open up another one the next day.

But we have not seen any significant changes and it really has not affected anything.

So the improvement in your retention is more just execution then?

Absolutely.

We think we are at the highest service levels we've ever been at.

The surveys show that.

Our people are doing a great job of servicing clients right now.

And then just a clarification, the 5% client growth goal for '06, I assume that is inclusive of InterPay and Advantage?

Yes.

Inclusive of -- exactly, of our entire opening install base.

Great.

Thank you.

Thank you.

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

Thanks.

John, looking at the ancillary business, that continues to gain scale, but the growth rate continues to remain relatively robust.

Can you give us some insight, is it structural issues in the industry?

I'm sure it's a combination of factors, but if you could give us a sense for what is driving the growth, whether it's the structural issues, investments that you are making, or cyclical issues that are driving the growth?

I think it is simpler than that.

We are just driven to get the results we know we need to produce.

And we obviously sit down and look at the opportunities that are in front of us and the best ways to do that.

And, obviously, the ones you go and you push the hardest are the ones that have the best opportunity at the time.

A good example of that is, Taxpay and direct deposit were moving reasonably good paces, but nothing super-accelerated until the government came out and changed a few laws on how you transferred money electronically, and we jumped right on that opportunity and saw a chance to really accelerate the growth.

So now, that was back then, so we took advantage of it.

Well, right now we are doing some things on 401(k).

We are trying to offer what we call the 401(k) light to try to get some more people.

We are working real hard on being significantly able to expand the number of money managers we can use, which you hope they will have by next fiscal year, that will allow us to go into our client base a little more aggressively.

So I think it's a matter -- we kind of know as a Company what we need to do, and we know we got to go find ways to do it, and while things kind of appear to be right in front of us, it is our appetite for success that drives us to do them.

So there is nothing on the workers' comp side that is particularly driving that in terms of opening up new states or is that kind of something that happened a couple of years ago?

No, workers' comp, the thing that changes there is, I think last year for most of the year we could sell in California.

There is times we can't sell in California and other states.

So right now that environment is positive, because right now I think we can go in pretty much any state that we are really trying to service.

Now that could change and it can change quickly, but that is what that environment is.

But that is kind of something that, we don't control it, but we take advantage of it, and we have a good group of licensed people that are centralized in Rochester to make those calls.

One other piece that is sort of a structural advantage for us that I would add to that is, the nature of the clients that we serve and the strength of the distribution capability that we have.

A lot of these areas are areas where we are serving clients or we're providing access to clients, the products perhaps are made available through other people, and most businesses, they are great at going business to business with large clients, but they're not that good at going business to business with small clients, again, mostly because the cost of market access is so high and so difficult to achieve.

And the fact that we have it gives us an advantage.

So in a lot of these cases, we are actually bringing the products of other people down to the level of clients that we service, an advantage for them because they can't do it efficiently and it is an advantage to us.

So you will continue to see that I think as time goes on where we will be taking advantage of the business structure that we have, the distribution network that we have and our ability to get to small clients profitably.

Thanks.

Just one other thing on the -- getting back to the growth rate in clients, and I think, John Judge, you just mentioned that the 5% next year includes the acquisition.

So should we assume that going from the 3% range over the last two years to 5%, we are starting to reflect kind of the maturation of that base and the referral kind of network starting to kick in, or are there some other factors driving that?

Part of it is clearly that we are getting by the integration of those -- of those -- of InterPay and Advantage and we are getting those clients to the point where they are ready to refer to other clients, so there is a part of that that is clearly there.

There is a part that John mentioned earlier, which was in the last couple of years, we had almost a singular focus on revenue and so we were driving revenue.

There was a -- there was some debate as -- and there is always going to be this debate as to clients when you are dealing with units or new clients, they are really a surrogate for revenue.

And so there was a great push on revenue and we've just put more balance into it to ensure that we get the client growth and we get the revenue job done at the same time.

So a part of it is that.

And clearly, we are investing behind your plans.

So when we tell you that we're driving for 5% growth, we are putting the sales force investments in place to get that 5% growth, as well as any changes that we need to make to our infrastructure to allow that type of growth to happen.

Okay.

I'm going to throw in a perspective here.

We have a lot of goals for '06, and we would like to see client growth get to 5.

But it is not the most important goal we have.

The most important goal we have is to deliver the revenue we need and to deliver enough revenue so we can get there in '07 also.

So we put that out as an aggressive goal, but it -- there is other goals that affect the income statement that we are much more conscious on.

I guess what I'm getting at is I'm just trying to understand if there is a point at which we start to kind of see those acquisitions starting to contribute to client growth rather than being a drag, and perhaps that is not the right way to look at it, but just looking for kind of signs of that starting to take hold and then we start having some more positive comparisons.

Well, 3.1 went to 3.5.

And I hope 3.5 goes higher next year.

It should.

So I think that is the beginning.

InterPay now is fully integrated.

Those people are on the Paychex platform.

So that should help the referral business and we'll see what happens.

You are reading it right, David.

That is a piece of the equation.

Great.

Thank you.

Thank you.

Gary Bisbee with Lehman Brothers, you may ask your question.

Hi, guys.

My congratulations on the quarter.

I guess, given the continued strong outlook for growth in the HR services part of the business, can you give us the sense as to how much of this growth has been coming and if you expect that to be any different in the future from upselling to existing payroll customers, versus selling all new clients on other HR or Payroll and HR?

I don't think a lot has changed.

We sell new clients.

We upsell.

We have a great sales force and payroll specialists that are looking for opportunities all the time.

There is one change that's happened, is the sales force is used to operating fairly independently.

Today with the array of products we have, we have many, many, many more calls where the client will be approached, even on the first call, with probably more than one sales person trying to make sure that we're going to provide the best solution.

Now that could be as much as having an MMS sales person, a Core one, and a 401(k) one and then a past sales person at some point, so I think the big difference is the team selling has improved greatly and helped us really emphasize and take advantage of these opportunities.

The business model, though, still is valid.

So when we talk about 12% growth in our business model and we talk about roughly 5% of it coming from client growth, 3.5% of it coming from price increases, 3.5% of it coming from ancillary services, that business model is still in force.

It may end up being plus or minus 1 or 2% in any one of those categories.

But there is nothing that we see in our current environment and in the environment in the future that we're looking that would tell us that that business model is no longer valid.

It is very valid and it is very relevant to what we are doing.

I guess digging into that a little more.

Is there any way for you to give a sense as to people who are the using the ancillary services or the HR services, how penetrated they are on average versus the product portfolio lineup that you have got?

Do you have people who are taking just one service or are you seeing a lot of success with people doing the benefits, the retirement, the -- and all the other products or is there still a huge opportunity within the existing client base?

I'll give you a general answer to that and then maybe John will want to add something more specific, but in general, and as part of the basic business strategy, we believe that we have clients that the run the gamut from clients that just need simple payroll services all the way to clients who need a fully outsourced HR model, if you will, and everything in between, and we believe that it is to our advantage and to our clients advantage to continue to allow them to both select individually, as well as go and buy bundles of services, and there is nothing in the near term that would tell us we are going to discontinue that strategy.

So we will always have clients that will run that gamut, and certainly for the foreseeable future, we will always have clients that may start small and upgrade, and we'll always have clients that will start in a fully outsourced model depending on what their business needs are.

So we expect that we will see contributions from all of those across the board.

In terms of saturation points, we do have rough ideas about where we are.

For example, we published the fact that we are at 91% penetrated on our Taxpay product.

I think we've also published it -- if not, I guess we are about to, that in the new clients that we brought in in fiscal '05, 97% of those clients were taking Taxpay, so even in the ones that appear to be fairly heavily saturated, we continue to drive levels of saturation in new clients that even defy the odds as we see them.

So each of our different products, we do have different saturation levels depending on how new the product is and how long it has been around.

But even in cases like ones that have been around for awhile and we have done a terrific job with them, they continue to get stronger and Taxpay would be the example of the numbers I just quoted.

If you want to look at some of the penetration, then one thing you remember, you take even a Taxpay as mature as it is, we are still going to get two-thirds or little bit more than that, of our revenue goal on a mature product, because we're going to get the price increases, and we're going to get the client growth.

Taxpay is about 90%.

It is higher than we ever thought it would get to be and that is because our people in the HR group services run by Diane Rambo have found a way to really minimize loss risk and ere able to take clients that in the past we couldn't take.

So they have done a good job of helping us with that.

Direct deposit is at 65%. 75% of new sales take it.

I think over time, that will depend, if the U.S. got stronger on enforcing direct deposit, there's no reason that wouldn't be equal to Taxpay.

In Europe, 98% of the people are paid on direct deposit.

Workers' comp is at about 10% penetration.

We simply have a better way to do that work.

You would love the state governments to say, hey, if you got a payroll provider, buy it there, it is better.

The system works better.

What can 10% get to?

I don't know.

It's too early to tell. 25 to 30 likely.

Much higher than that just can't tell.

401(k), that market is reasonably well penetrated in many respects, but at the same time, we have over 100,000 of our 500,000 clients at 401(k) plans, we just don't have a fair share, we've only got about 35% of those.

So that is 65,000, 70,000 clients we are going to be able to more aggressively go after when we change this funding arrangement or the people that manage the money.

So a great opportunity there.

And then PAS and PEO, and that is in its infancy, I can't even measure the penetration there it's so low.

So we think we have a full array of products.

We have a lot of good opportunities in front of us, and we continue to say that we got to be choosey about what we do to make sure the profit quality remains there.

Great.

Thanks a lot for the color.

Thank you.

Thatcher Thompson with CIBC World Markets, you may ask your question.

Just a couple of quickies.

That client retention that is at an all-time high, that includes the impact of InterPay and Advantage, which I would assume had higher turnover?

Actually, they had slightly lower turnover because the client base isn't taking on the additions, so it did include them.

Okay.

And then, John, you mentioned 65% penetration of direct deposit.

How much of that is this Readychex product that helps boost your float.

I'm going say about 25% of that is Readychex, but I could be way off, too.

I'll follow up on that later.

Great quarter, thanks.

Thank you.

Thank you.

Mark Marcon with R.W.

Baird, you may ask your question.

Let me add my congratulations.

With regards to the maturation, can you -- can you talk a little bit about where you think we are with regards to just the Core Payroll business in terms of penetration rates among your target clients?

I believe the growth in Payroll that we have now is sustainable for quite awhile.

I think the market's got enough underpenetration in it, there is enough new business formation, there's enough education to get there.

I don't see that changing, I don't see it -- I don't -- when you talk about it, I don't think it is a matter of saturations causing any difference.

Would you say it is around 30%, John, or?

I think the whole market is around -- the whole market is 17% penetrated, but the ten and under market is where most of the opportunity lies.

I think if they go to the ten and over markets, I would say about 30% is penetrated.

Now you have to realize that we don't participate in the way, way upper end, which has the highest penetration.

Sure.

And the market between the 50 and 500 we have got this friendly competitor who has a lot more of it than we have, so in that marketplace it is much easier to get somebody to switch than it is to get them to start doing it -- or outsourcing it versus doing it themselves.

So we feel good.

Great.

And then with regards to -- with regards to the guidance that you gave, it sounds like what you are saying is, don't get hung up on the 5% new client growth, the guidance isn't dependent on that?

Absolutely.

Okay.

Great.

And then with regards to the interest income on the float and the guidance that you are giving, it looks like you are basically implying a combined effective yield of about 2.6% on the total portfolio including the corporate investments, which is equal to the effective yield that you had, roughly speaking, during the fourth quarter.

Shouldn't just because of the maturation of the longer, the 40% that's invested in longer-term securities, shouldn't we see some sort of natural increase in the overall effective yield even if interest rates don't change?

You won't see much, because we had the three points for almost the whole fourth quarter.

Right.

The long-term portfolio right now, the rates aren't changing.

So you'd say that's going to basically stay flat?

[inaudible], but right now I don't see those changes.

They came down a little, if anything.

The focus here on rates right now until the long-term starts changing, is just watch the short-term.

The reason we got a little more bounce than some of you might of anticipated is the fact that we have 60% in short-term.

All right.

And then one little question just in terms of the -- in terms of the release.

There was some discussion about net incremental PEO revenue of 6.7 million and $3.2 million expense charges.

How should we relate that to the HRB growth that you saw in the fourth quarter?

I look at them combined.

I don't really look at the PEO separately.

I really have a tough time responding to that.

I guess was the 6.7, was that similar to what you experienced last year in terms of the --

Oh, you're talking about that.

Yes.

We are about the same now because we were in the new -- not new, we were into self-insuring workers' comp.

Right.

And we have gotten good at it so the comparisons now are consistent.

That comparison issue only really goes back to '03 from '04. '05 and '04 are pretty comparable.

Right, but that 6.7, that all fell in the fourth quarter; right or not?

A good part of it did.

Or it was in the third.

I can't remember.

I wouldn't worry about it.

I know for the year it is -- it is accurate.

I was just trying to figure out if it boosted fourth quarter numbers at all?

This year?

Right.

No.

Okay.

Great.

And then lastly, if we take a look at your sales force growth, you're looking at 9% for this year relative to 12% for last year.

Given the slower rate of increase in terms of sales reps, should we see a slower increase in terms of SG&A expenses on a year-over-year basis?

I keep going back to the formula.

We kind of know what 12% produces.

Right.

We kind of know we got to give you 15, that kind of tells us how much money we've got to spend, okay?

And our people are very good at controlling expenses.

We have investments in Europe, we've got some investments in Stromberg, so the sales forces I'm sure if we have the opportunity, we will invest in them again early.

So it isn't like -- we are not going to probably ever make numbers because we just underspent.

It isn't going to happen.

We invest.

We are very predictable and those things are going to happen.

We know we got to keep investing in the future, but at the same time we know we got to keep giving you -- giving our shareholders results that what they expect.

Lastly, workers' comp, you are boosting up the sales force there pretty materially.

Sounds like you are pretty excited about that business.

Can you talk about the economics of that business for you?

It is -- it has got margins similar between what I would say Payroll has and then a good Human Resource product, so they're fine, they're not the highest ones we have, but that doesn't matter.

The reason that is being boosted is because the workers' comp carriers are more bullish and we can sell in more places.

Great.

Thank you.

Thank you.

Ten Sen Wong with J.P.

Morgan, you may ask your question.

Thanks.

A quick follow-up question to the prior question.

Noticed that you are slow in the rate of growth in your PAS, PEO sales headcount a bit in fiscal '06.

Anything to read into there?

No, you will find that when we have new products we grow the sales forces you can grow them percentage-wise more aggressively in the beginning, but as the sales force gets bigger and bigger the organization structure to manage it starts to slow you down.

We have had great experience of growing sales forces too fast and we know what it causes, so we are careful and we make sure we can properly deal with all the business we're getting.

But is there a bias toward the PAS side there for the PEO?

Yes, bias towards PAS.

Lastly, what would be a reasonable growth target for number of PAS or PEO work site employees for fiscal '06?

We didn't establish one.

Okay.

Thank you.

It sounds at this time we don't have any more questions and we have been on here about an hour and a half.

I really appreciate all your interest in Paychex.

We were thrilled to have another great year and we enjoyed sharing those with you.

And if you are interested in replaying the webcast of this call, it will be archived until July 27th, 2005.

Again, I want to thank you for taking the time to participate with us and we wish all of you and your families an enjoyable and safe summer.