沛齊 (PAYX) 2006 Q1 法說會逐字稿

[OPERATOR INSTRUCTIONS] Now I will turn the meeting over to Mr. John Morphy.

Sir, you may begin.

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

With me today is John Judge, our President and CEO.

The teleconference call will be comprised of three sections.

A review of first quarter fiscal 2006 financial results, including comments and revised guidance for full year fiscal 2006, an overview and comments from John Judge and lastly the Q&A session.

Yesterday afternoon after the market closed we released our financial results for the first fiscal quarter ended August 31, 2005.

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

We have filed our Forms 10Q and 8K with with the SEC, which provides additional discussion and analysis of the results for the quarter.

These filings are 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 October 28, 2005.

Please refer to our Website for all access to all recent news releases, current financial information, SEC filings and Investor Relations presentation.

The last one which will be updated in the next week or so.

First quarter highlights.

We achieved record net income of 115 million or $0.30 diluted earnings per share.

Net income increased 31% and diluted earnings per share increased 30%.

Fiscal 2006 is off to an exceptional start as a stronger-than-anticipated economy caused our revenues and net income to exceed our expectations and accordingly, we have increased revenue and net income guidance for fiscal 2006.

Service revenue growth of 15%.

Interest on funds held for clients increased 79%.

Total revenue was up 17%.

Operating income growth, excluding float, was 22% for the first quarter.

Cash flow from operations was strong at 162 million.

We now refer to the consolidated income statement.

Payroll service revenue increased 10% for the first quarter to 308.6 million.

This growth was driven primarily by higher check volume and positive trends in new hire activity, accompanied by client base growth.

First quarter check growth was the strongest we have seen in recent years.

Ancillary services, special reports, and other payroll services also reflected good growth levels.

As of August 31, 2005, 91% of all clients utilized our tax filing and payment services and 66% utilized the employee payment services.

Major market services revenues increased 28% to 52.4 million for the first quarter.

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

Human resource services revenue increased 39% for the first quarter to 75.8 million.

The growth in human resource services revenue was 28%, excluding the impact of PEO workers compensation.

The timing of PEO workers varies differed significantly due to actuarial period claims and revisions to prior year claims.

The 28% increase is more indicative of actual results for human resource services revenue growth as we expect that PEO worker compensation growth will be lower for the last three quarters of the last fiscal year.

The increase in Human Resource revenue reflects growth in clients for retirement services, growth in client employees served by our Paychex Premier Human Resource, previously referred to as Paychex Administrative Services or PAS, and Professional Employer Organization, PEO, services and growth and revenue from our time and attendance solutions.

Retirement services revenue increased 17% to 24.6 million for the first quarter at August 31, 2005.

We serviced more than 34,000 Retirement Services clients.

Sales of Paychex's Premiere and PEO products have been strong with administrative fee revenue from these projects increasing 35% to 21.5 million for the first quarter of fiscal 2006.

As of August 31, 2005, our PAS and PEO products serviced over 237,000 client employees as compared with over 168,000 client employees at August 31, 2004.

Interest on funds held for clients increased 79% for the first quarter to 19.3 million.

The increase in interest on funds held for clients is primarily due to a higher interest rates earned and higher average portfolio balances.

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

The Federal Funds rate, which was 1.00% June 1, 2004, steadily increased to 3.50% through August 2005 and is currently at 3.75%.

The increase in interest rate environment has positively affected net income growth.

The average interest rate earned on funds held for clients increased to 2.7% from 1.7% a year ago.

The higher portfolio balances resulted from client based growth, higher check volume within our client base, and increased utilization of ancillary services.

The average investment balance for funds held for clients increased 11% over a year ago.

We refer to you our management's discussion and analysis of financial condition and results of operations in the section "Market Risk Factors" for a more detailed explanation of the affects of fluctuation and interest rates and related risks.

Our explanations and guidance in the area includes the most recent increase in the Federal Funds rate to 3.75% on September 20, 2005.

Consolidated operating, selling, general and administrative expenses increased 11%.

Compensation related expenses increased 14%, compared to 11% last year, due primarily to earlier hiring of our planned sales force growth in fiscal 2006.

Facilities and depreciation increased 11%.

Other expense growth was favorable compared to the prior year as fiscal 2005 included legal expenses related to the Rapid Pay litigation.

There were approximately 10,300 employee August 31, 2005, compared with approximately 9,600 at August 31, 2004.

We have reclassified operating, selling, general and administrative expenses to more appropriately reflect the Company's most current way of conducting business.

Over the years the role of the branch and its relationship to consolidated support operations, information technology and corporate has evolved to the point where our old method of classification needed to be updated.

The new classification provides better year-over-year comparisons for operating expenses in selling, general and administrative expenses.

Restatements of prior information on a quarterly and annual basis, not included in the most recent press release and Form 10-Q, can be found on our Website under "Investment Relations" during the week - - first week of October 2005.

Investment income net increased to 4.9 million for the first quarter due to higher average interest rates earned and growth in average invested balances, which resulted from investment of cash generated from ongoing operations.

Our effective income tax rate was 31.4% for first quarter ended August 31, 2005 compared with 33.0% in the prior year period.

The decrease in our effective tax rate is attributable to higher levels of tax exempt income derived from municipal debt securities held in our funds held for clients and corporate investment portfolio, and a lower effective state income tax rate.

Moving on to the balance sheet, the August 31, 2005 balance sheet reflects our growth during the latest fiscal quarter.

Cash and corporate investments were approximately 800 million August 31, 2005.

Our cash flows from operations were again strong at 162 million for the first quarter of fiscal 2006, an increase of over 36 million 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 11.9 million August 31, 2005, compared with net unrealized losses of 9.9 million at May 31, 2005 and net unrealized gains of 9.1 million at August 31, 2004.

The change in the unrealized loss position is due to increasing yields that decreased the fair value off the Company's investment portfolio.

The three-year AAA municipal securities yield increased to 3.03% at August 31, 2005, from 2.85% at May 31, 2005.

Our net property and equipment balance activity during the first three months of fiscal 2006 reflected capital expenditures of approximately 20.6 million and depreciation expense of approximately 12 million.

Client fund deposits as of the end of the quarter declined to 2.4 billion from 2.7 billion, due to the calendar timing of the end of the quarter.

As previously discussed, the average during the quarter averaged 2.7 billion or an 11% increase.

Total stockholders equity increased to 1.5 billion at August 31, 2005 with 49.3 million in dividends paid in the first quarter of fiscal 2006.

Our return on equity for the past 12 months was 29%.

Fiscal 2006 guidance.

The economy strength in our first quarter is evidenced by the highest check volume growth we have seen in recent years.

While we hope that this will continue, we can not predict the impact of the recent hurricanes and rising gas prices.

We have increased our fiscal 2006 guidance as follows.

Payroll service revenue growth is projected to be in the range of 9% to 11%.

This compares to our previous estimate of 7% to 9%.

Human Resource services revenue growth is expected to be in the range of 25% to 28%.

Total service revenue growth is projected to be in the range of 12% to 14%.

Interest on funds held for clients is expected to grow in the range of 40% to 45%.

This compares to our previous estimate of 25% to 30% and reflects the most recent increase in the Federal Funds rate to 3.75% on September 20, 2005.

When we gave guidance last June, the rate an the guidance that was based upon the Federal Funds rate being at 3.0%, which is where it was back then.

Total revenue growth is estimated to be in the range of 13% to 15%.

This compares to our previous estimate of 11% to 12%.

Corporate investment income is anticipated to increase approximately 65% to 70%.

We expect the full-year fiscal 2006 effective income tax rate to approximate 31.5%.

Net income growth is expected to be in the range of 22% to 24%, compared to our previous estimate of 18% to 20%.

In fiscal 2006, we expect capital expenditures to be in the $75 to $80 million range.

Accompanied by total depreciation of property and equipment and amortization of intangible assets of 64 million to 70 million unchanged from our previous guidance.

These projections are based on current economic and interest rate conditions, including the Federal Funds rate increase announced on September 20, 2005, continuing with no significant changes.

Equity-based compensation.

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

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

We anticipate adopting FAS123-R in the first quarter of fiscal 2007.

We continue to evaluate the new standards and the models that may be used to calculate the expense for share-based payment transaction.

Safe Harbor.

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

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

Please refer to our Safe Harbor statement on page two of the press release for our discussion of forward-looking statements and related risk factors.

I will now turn the meeting over to Jonathan Judge who will provide his comments on the first quarter before we open the meeting for questions.

Thanks, John.

Nice job.

Good morning, everyone.

We appreciate you spending time with us this morning talking about our Company.

I would like to add a few comments on the quarter, and then open it up to your comments and questions.

I'll start by saying that we are obviously very pleased with our first quarter results.

In fact, if we were to write a script on what we would like to see in an opening quarter, it would be very close to results that John just described.

We had excellent revenue growth across the board.

I was particularly pleased with core payroll growth.

It is our biggest business segment, roughly 80% of our revenue stream and the basis for selling all of our other products.

So it is an incredibly important area of growth for us.

It would make it extremely difficult for us to accelerate our growth rates without strong performance from core payroll.

So, we are pretty proud of the quarter they had.

And on top of that MMS and HRS also had a terrific quarter.

And you saw the results.

Total service revenue growth of 15%.

The help of interest rates and a very large average daily balance of funds held for clients, total revenue growth of 17%.

I am sure you also noticed that we kept kept the reins on expense, growing at only 11%.

Producing an operating income before flow of 22% and net income growth 31%.

That is a great performance that we - - that came from our operations team on client retention and customer satisfaction.

And also payroll specialist attrition, which was significantly better than last year at this time.

So, a great opening quarter.

But frankly, we needed a great opening quarter, because we booked a very aggressive plan for ourselves for the year and we very much wanted a fast start.

It is why we pushed up our operational planning earlier in the calendar.

It is why we committed to ourselves to have budgets done and quotas out by June 1.

The first day of our new fiscal year.

It is why we released early hires for the sales team.

So we could have as many trained and ready-to-go salespeople on the street on the first day of the first month of the new year.

And, yes, it is why we said those extra prayers for a strong economy, which we have sure gotten the first quarter.

The reason I go through all this is because it is really about the year, not the quarter.

This quarter is what we need to do, and I am extremely proud of the 10,000 Paychex people that put these great numbers up.

But it is really about the year.

And secondly, because we wanted you to know that while we got help from a healthy economy, this performance came mostly from aggressive planning, a strong commitment process, and very good execution.

Let me elaborate on that for just a moment.

Many of you have heard me say many times before that we are focused really on three things.

We are focused on execution of our current business plan.

We're focused on a formal strategic planning process that ensures we are clear on our strategy and investing now to ensure a better future.

And we are working very hard every day to create a world-class work environment for our employees.

Now, as you would have guessed, these three things are really three big clusters of lots of activities around these three themes.

So, for example, when we say "execution of our business plan" we mean a lot of different activities but all focused towards one goal; support of execution.

Over the past year, we've examined our management systems, our measurement systems, our key business metrics, our hiring practices, our our training, and so on.

We have looked at nearly every facet of our business so that going into the budgeting process, we have very good idea of where we were strong and where we were weak and needed to improve.

And then we booked very aggressive plans that stretched ourselves, that demanded higher levels of performance.

And then we committed to them across the board, all of the management team.

And finally, we made sure that we put the expense investments in place to ensure that these aggressive plans had a very good chance of happening.

The net, it I wanted to tell that you our team is committed.

And as you have seen they are delivering.

Sales committed to higher growth and approved productivity and lower attrition rates.

Operations did the same.

Less client losses, higher client satisfaction, and lower payroll attrition just to name a few.

And again I am really proud of our team.

And I am really proud of how they are executing.

So in summary, we did have a terrific quarter.

It was a fast start and part of a very aggressive plan for a good year.

The economy is helping.

But our performance is due to our people's commitment to aggressive goals and them executing against those goals.

We are working on three key areas that I just mentioned, and they are paying dividends for us.

As a result of our fast start, our current level of execution, our forecast of continued execution and the benefit of a strong economy, we are improving on guidance today.

So, obviously we're bullish on the year.

We're obviously bullish on our ability to execute.

But our outlooks remain balanced real and our guidance reflects that.

We'll now open it up to your questions and comments.

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from Cindy Shaw of Moors & Cabot.

Great, a couple of questions and congratulations on a very nice quarter.

One is you mentioned stock option expense, you're still figuring out the numbers.

But it's pretty consistently been a low number for Paychex, about 3% of your EPS.

Is there any reason to expect that number to change radically?

No, Cindy, we still expect it to net 3% to 4% range.

And obviously we see no reason to adopt until it fits the requirement.

I don't believe it will be delayed but you never know.

Okay.

And then on Katrina and Rita, the hurricane impact it is said in your 10Q last night, less than 1% of your client base.

It strikes me near term, you could have a little less revenue, maybe a little more expense and then have it come back in a quarter or two.

If you could just give us any sense for that?

This is John Judge.

We've spent a lot of time on that.

And I guess I'd start off by saying that we, and I am sure all of you, were very saddened by the events down there.

We have a little over 100 people in - - this is specifically Katrina.

Rita has had minimal if any effect on us.

So it is mostly Katrina.

The effects have hit the New Orleans, Baton Rouge area.

We have a little over 100 employees down there, about 5,000 clients.

Our employees obviously were affected, some more so than others.

Our business continuity plan, though, was switched immediately when we knew there was a problem.

We moved all of the workload out of that area.

We had no business interruption.

The only interruption really that has occurred as a result of that storm was with our clients and their ability to call in to us.

So, we were pretty pleased with the way the business continuity plan was executed.

Our business down there still is a bit unknown.

We've done some preliminary forecast as to what we think the effect will be.

We think it will be nominal.

Certainly less than a $0.005 EPS in the worst-case basis.

There is a possibility by the way that the clients that we lose may end up getting replaced by new businesses that start in terms of the recovery process down there.

And that still remains to be seen whether those will end up being large companies or smaller companies, which is our target market.

But the actual effect to down there, we believe on the year, will be relatively nominal.

Great.

And then one housekeeping question on the portfolio, for John Morphy.

The duration?

The duration is, we're still right around two.

We haven't decided to move it out yet because we still think rates have got a little bit to go.

Especially on the long term, which hasn't fully reflected the Fed rate changes yet.

Great.

Thank you very much.

Greg Gould of Goldman Sachs.

You may ask your question.

Thanks.

John, I know you didn't disclose the number of new clients, but it was it in line with your internal projections?

Yes.

And to get a little more sense of the upside, is it coming from the addition of new clients?

Or is it from the - - better growth in the add-on services?

And I know you mentioned better - - or higher check levels helped.

But between new clients and add-ons, which was more - - drove more of the upside?

We won't go into the specifics on one versus the others but it is more than what you are talking about.

When you look at the quarter, we had a lot of factors that were coming together to make it a great quarter.

We had good client growth.

We had very good performance on discounting.

That is, the discounting was less in the quarter than we have seen in the past.

We had a very good performance on client attrition.

You remember last year we broke records on client attrition.

We are on the same track that we were last year in terms of breaking records on on client retention.

So it was series of factors that came together to help make it a good quarter.

Great.

And just one other question.

Traditionally you guys have raised the dividend in the second quarter - - the second fiscal quarter.

Is - - can you talk about plans to continue to increase the dividend?

That's a Board issue obviously.

That's not an issue for us.

So, you will find that out when it comes.

But what I would tell you is; if you looked at our performance, we are creating a lot of cash.

Until we tell you we are going to do something different, which we are not telling you which is stock repurchase or so on, we will continue to push for fairly substantial amount of our - - of the cash generated and the income generated into dividends.

Great, thanks.

Terrific job.

Pat Burton of Citigroup.

You may ask your question.

Hi, congratulations on the quarter as well.

My question relates to your decision to increase the sales force hiring at an earlier time the year.

Is that indicative of the end market demand that you are currently seeing?

It's a combination of a couple of things.

It's clearly the end market demand.

Although, the Company has for a very long time - - Tom has always been very on the notion of the direct relationship between the number of salespeople that we put on board and the amount of revenue and profit we are able to get out of it.

Because we are still in an underpenetrated market.

There's still lots of growth to be had.

In fact we actually are doing our hiring - - in general we do our hiring based on our ability to integrate and absorb those people in the Company.

And we actually look at optimal points, which you can actually hire more people than you can integrate and then you end up getting diminishing returns.

So, in general it's that.

But what we were doing this year on the early hires was specifically related to making sure that we got off to a fast start.

That we didn't have open territories.

We had quite a few open territories last year when we opened the year.

And we were fortunate as we came to the end of the prior fiscal year that our performance was good enough that we could afford to do some early investing in the sales force.

So we decided to make that decision.

We got the people hired up and trained.

Now, this was a few months prior to the end of the year so you can get them on board and trained so they are ready to go.

But the intent clearly was to try and open the year with no open territories and we achieved that goal.

As a follow-up for John Morphy.

John, you mentioned your comments on the PEO and workers comp revenue likely will slow a little bit.

Could you elaborate a little more how that will slow in each of the next three quarters?

Thanks.

When actually is - - when I look at the human resource revenue, for me I learned I should almost ignore the workers comp.

The actuaries changed the valuation, we can get a couple million dollars swing in a quarter.

We have a quarter because of what they do - - we have nothing in one particular category.

Next quarter 3 million or 4 million.

It's a small part of our business.

And I think the best way is for us to continue to let you know where we are without it, and you can model accordingly.

So it is not any big deal.

And I think this year some of those valuations went up now or the lowering of some of the estimates where last year they were further in the follow-up in the last part of the year.

Thank you.

Thanks, Greg.

Adam Frisch of UBS, you may ask your question.

Hi, guys, this is Steve Stout for Adam.

I wanted to see have you gotten any sense of changes in dry - - in hiring demand over the past three months since you last gave guidance?

What does that mean?

New employment.

Has the labor market really improved that much?

Yes, it has improved a little bit.

When we look at the core - - are you talking about hiring by our clients?

Yes, hiring trends.

Hiring by our clients is up.

It's up less than 2%.

It's a little over 1% in the quarter.

The nice part about it for us was that if we looked at the quarter before, it was actually down, so the spread is more than the hiring was.

So hiring is up a little bit.

Have you seen any changes in the pricing environment at all?

If anything, it is slightly improving because our - - we've really worked hard on both new clients and retaining clients on pricing.

We put the price increase in in May and the branches did a wonderful job of continuing our service to those clients at what we believe is a reasonable price.

John, can you describe in just a little bit more detail how you continue to generate better leverage from the prior investments you have made in SG&A and IT infrastructure?

Sort of kind of get a little color of what specifically you are investing in and where you may be cutting costs?

I wish I could be that specific, except that we have a long tradition here at Paychex that started with this person I used to work for.

It's called revenue must go up faster than expenses.

We don't really - -

It will vary.

What John said is right, it is a basic philosophy that says we must get leverage out of our revenue growth on the operating income line.

If we even tries to book a plan without it, you just - - there is nobody around here that would allow that to happen.

So, the actual elements that will change obviously will change based on what our needs are.

We may have a year where we have to do greater investments in IT.

Or we might have a year where we have to do greater investments in physical plant.

So the different items can change through the course of time but it's the philosophy that says - - given a certain revenue forecast, we are only going to allow a certain amount of expense, and that's it.

And then it's just a matter of prioritizing given those dollars we prioritize on them.

So, we actually start with a financial formula and work backwards.

Not the other way around.

Does this new guidance incorporate the latest Fed increase to 3.75?

Yes.

And you are not factoring any more rate increases?

No.

We continued our experience that we forecast rate to where we are.

We don't anticipate, because there is no way for us to be right.

And I think we start anticipating and you anticipate something different, and we - - it is too easy to get to the wrong place.

Okay, thanks.

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

Thank you very much.

John, could you talk about some of your progress in reducing payroll specialist turnover?

You've highlighted this as a major goal over the last couple of quarters.

Can you give us a sense of where it is and where you would like it to go over the next couple of years?

It's - - payroll specialists, it's also sales specialist, salespeople, so it's not located in the one area.

It's - - you start with the general philosophy.

My general philosophy is that when you have high turnover like that costing us a lot of money to recruit people, to onboard them, to train them to put them into their territory.

In the case of payroll specialist, they are the relationship reps that we have with our clients by and large.

And so you have that sort of turnover which clients don't like.

And so it's really - - it has to do with the way we operate our business.

It has to do with the financial impact it has on our business both from an expense basis as well as a revenue basis because of the impact it will have on clients.

So, it is the right thing to do.

What we - - all did I was just call out that our turnover was too high and needed to improve.

And then we started working on it.

Because when you have problems of this nature, it turns out that it is very rare that it is one thing that drives it.

It is usually a multiple of things.

Are we hiring the right people for the jobs?

Do they have the right personality profiles and experience and education profiles to be able to be successful in the job?

Are we doing the right job of onboarding them, making them feel welcome into the Company?

Are we getting them the amount of experience necessary so that they can be successful?

Are we coaching them properly?

And so on.

So, it's a whole series of things that I don't want to go into each one by the next.

But it really - - it permeates, when it is all said and done to an attitude of management to ensure that we are hiring the right people.

That we are making them feel welcomed.

That we are creating an environment for them where they feel valued and where they want to stay and continue to contribute year in and year out.

And I would say the progress that we are making on that is quite good.

Thanks.

And could you update us on your PEO strategy in California?

We have recently heard from ADP that they are starting to expand aggressively in California just given the change in the regulatory environment under Schwarzenegger.

What are your thoughts with respect to California?

First off, our strongest area for Paychex Premier, which is our PAS nonPEO product is - - California is one of the excellent areas because of the fact they have a lot of regulations and rules out there.

It is also one of our strongest client areas in the country, so we are doing quite well.

With respect to ADP, they basically announced not only the PEO thing, they've also announced that they're going to have a product that's very similar to our Paychex Premier, which means the employee - - the client's employee does not always going to be in their federal ID.

We see that as a passing event.

We went down a path nobody else went.

We are the first to do it.

Usually in payroll we are not quite always the first, so this is new for us.

So, we see they are moving in our direction.

And it is a sign of them accepting and realizing our success is very good.

And you would say does that help us in the marketplace?

It does, because we will have another person out there helping educate people on the benefits of full outsourcing.

And the market penetration is so low, you can't even calculate it.

I see.

And just a quick final question.

Given the strength and demand you are seeing on the payroll side and some of your progress in lowering payroll specialist attrition and sales attrition.

Any thoughts on changing pricing strategy beyond just less discounting?

Would you be able to go, let's say more than a 3% to 4% average price increase?

No, our pricing strategy is where it is today.

We review it all the time.

But there's nothing in the set of parameters that you describe that would cause us to change our pricing strategy.

Okay.

Thank you.

Jeremy Davis of Credit Suisse, you may ask your question.

Hi, guys it's Jeremy and Josh at Credit Suisse.

Just want to touch again on the PAS product.

Any rationale specifically behind the rebranding changes to Premiere Human Resources?

And then, I guess, coupled with your previous comments, anything you are seeing new going on in the marketplace aside from your comments on ADP that you might be seeing right now?

The rebranding was really more - - it was actually driven by the - - by Tony Tortorella who runs that division for us, the sales part of the division for us.

And it was put in place mostly to more accurately reflect what the offering bundle was.

And we obviously supported the desire to do that and rebranded it and relaunched it.

Clearly we are heading - - that is our premiere offering.

That is the packaging of all that we do in both the payroll and the HR services sides of the equation for our clients.

The full outsourcing.

It's not something that's going to be right for everybody.

But for those clients that really are looking for a robust offering across both sides of the equation, it is a terrific offering.

We have got great response for it and from it.

And I think we are adding tremendous value to the clients that have made a decision to go forward.

So, it was really more about a more accurate description of the bundling and the philosophy of a fully bundled outsourced offering than anything else.

And in terms of the marketplace, we feel very good with where we are in the marketplace.

We compete very nicely against ADP and anyone else that's out there and I don't really have any comments beyond that.

We haven't seen anything that dramatically changes the landscape for us.

You have seen our growth rates.

They are accelerating, not decelerating.

So, we obviously feel pretty good where we are.

And we are not complacent .

We'll continue to keep pushing the envelope but we are certainly not nervous or afraid of anybody.

Okay, great.

And then just touching back just on the sales force.

Is there a way you can give us a sense for a breakdown between how much of the current growth or, I guess, the acceleration in growth that we are seeing is coming from the addition to the sales force versus productivity improvements for the average salesperson?

First you have got to remember that when we add salespeople and they sell, what is sold in the year is very little.

So this strength we saw in the quarter, what the salespeople are doing, that is going to be even more favorable toward years after now.

The quarter really came out the efforts of the operating people and the salespeople also had an outstanding quarter.

But because of the nature of our recurring revenues, what is sold in the quarter generally does not affect the quarter by very much.

Okay.

And then just a last housekeeping question.

Did you give a workers comp client count number for the quarter or did I miss that?

I I don't believe we did.

Okay.

And you don't care to.

I don't know it right off the top of my head.

We will consider that for putting in the next time.

Thanks, guys

Craig Peckham of Jefferies, you may ask your question.

Hi, John Morphy, I was wondered if you might be able to give us a little bit more color on what you are seeing in terms of check volumes?

I know we are not doing checks per client anymore.

But you had indicated that volume trends were better than you had seen in some time.

Can you put that maybe in historical perspective?

Where are we in terms of volume growth compared to quarters past?

One reason we don't give the exact number.

There are many ways to calculate it.

I am still a little unclear how ADP does do it.

But I think on a consistent basis.

So I think it is only off their largest clients and they take out the lost clients.

They really get an apples-to-apples comparison and because they have those heavy-end clients they can do that better than we can.

Basically I want to reaffirm John's comments.

The quarter was strong from almost everything we looked at.

The checks were a little bit of the frosting.

And probably is why we got a little further ahead.

We weren't - - guidance - - the Street was generally around $0.28.

Our plan was slightly better than that but not as good as what we achieved.

So, checks were good.

And I think a lot of it came from the fact that new hires were up reasonably but I think there was more retention.

Not as many employees left jobs.

And companies tended to have - - a few more - - a little more employment than they had in the past.

Okay.

That helps put a little more color around it.

It is obviously not impacting your very strong core payroll numbers.

But I was wondering if you could give us a little sense for how your salespeople and how you're potentially seeing market impact from the combined ADP/Microsoft offering this fall?

Well, two - - let's start with the first part which is the salespeople.

I want to make sure there is not a misunderstanding here.

While John is very accurate that the sales in a given quarter are going to be a relatively small portion of the actual revenues in that quarter, they are of incredible importance to us because they are very important to the second quarter, third quarter, fourth quarter and then the first quarter next year.

So, the sales engine is an incredibly important part for us and we will continue to drive that pretty hard.

On the ADP side, my comments - - or our comments don't change from the last time we spoke.

ADP and Microsoft made an announcement.

We are watching that announcement relatively closely.

We haven't seen any significant activity to speak of anywhere in our territories.

That is not to say that it is not going to come over time, but to this point, it's been a relatively nominal amount of activity to us.

So we are not - - again, we will watch it, but it is not something that we are terribly nervous about it.

Okay.

Thank you.

Kartik Mahta of FTN Midwest Securities, you may ask your question.

Good morning.

I wanted to ask a question.

John you said on the cad side of things, you are probably looking to increase dividends.

I guess my question was, are there any acquisitions out there that you can potentially do - - anything significant that would utilize your cash?

Or is most everything that you are looking at would be small and that would just be something that would be an add-on?

Well, we are certainly not prepared to talk to you about anything that we are looking at before its time.

So we haven't announced anything and so I don't have anything to announce to you right now.

I have told you that part of our strategic planning process does include acquisitions.

It includes acquisitions of smaller payroll companies, which we have been doing for a very long time.

We will continue to do that.

Perhaps even get more aggressive in that.

It also includes acquisitions of companies that could add capability to us.

Be that product capability or service capability and Stromberg would be a good example of that.

So it would be in our thought process.

But if you are thinking about acquisitions of something that would be relative to our own size, while I would never rule anything out, that would be very low down on the priority scale of - - in my mind and in John's mind and in our whole senior team's mind.

So there is nothing going on that would suit - - that I would want lead to you think that we are looking at a really sizable acquisition.

So - - that is just not the case.

As you listen to your sales force, other than gas prices, what do you think is the number one concern about - - for your customers at this point in time?

Our customers or our sales force?

Your customers.

As your sales force tells you what your customers are thinking, what do you think their number one concern is other than the rising fuel prices?

I am not - - I've heard about the rising fuel prices as a concern for our salespeople.

I haven't heard that from them as a concern for the companies that they are dealing with.

But I am not sure I have a good answer for you.

John, I don't know if something comes to your mind.

Kartik, I think it would be just the general stuff you get in the economy.

From the economy momentum keep-up.

And other than that I think things are pretty well in the U.S right now.

You have some issues floating around and what will happen.

But I don't think anybody is overwhelmingly concerned about anything.

Thank you very much.

Gary Bisbee of Lehman Brothers.

You may ask your question.

Hi.

Pass on my congratulations for a great quarter.

When we look at your income statement, the operating margin you put up this quarter is the best you have had in several years.

And I just wonder if I could - - appreciated the breakdown in the 10-Q but wonder if we can get some more color?

Are the any reasons that this level of profitability may not be sustainable in the near term, meaning the next two or three quarters?

And then also as you look out over the next couple of years?

Or do you feel real good about continuing to put out this type of year-over-year margin expansion?

We basically commit to expansion of margins all the time.

We have an infrastructure that allows us to do that.

We have a product portfolio that allows us to do that.

As we we add on ancillaries, they come on at very good profit levels because in some instances a lot of the work has already been done, like data entry, et cetera.

These margins got a little benefit in this first quarter from the fact that check volume went up.

As we talked about when check volume goes down, obviously the extra check you do or the check you lose is the most profitable check that you have.

It is also not the highest priced check.

So the revenue per check is smaller on those.

So, we got some benefit from the fact checks were better.

And so I think you saw a little more of a jump in the first quarter than we might expect.

I'm ready to say we're going to give anything back.

We expect margins to stay strong for the rest of the year.

But other than the economy moving that along a little bit, that could change.

But other than that we're going to continue our trends.

Now, you should also realize that our price increase goes in basically on May 1.

So the first quarter also has the benefit of the margin expansion that takes place and that's usual and some of it we would expect to continue.

Okay.

Can you give us a bit more color on what costs were reclassified?

I understand you feel like you have more sophisticated ability to attribute them to the various business.

But what exactly is it that was reclassified?

What basically happened, was when Paychex started a branch was pretty much self-sufficient.

And so in a branch would you have costs that you would call were general and administrative.

And you would through operating.

We have now evolved branches where branches are great distributed service providers but they are not what I would call totally self-sufficient.

It isn't because anything so much changed by what they do, but what our products - - all these ancillaries we provide, they are in Rochester New York, centralized.

That's why we are able to leverage the employee ratios that you talked about in direct deposit and tax pays so great.

IT has changed.

We used to have computers in every branch.

We don't have computers in every branch anymore.

So basically, we have gone to a categorization that calls a branch, all of a branch operating and some of the costs in Rochester operating, and we just think it is a better definition.

Now, we also in our goal - - and you talked about increasing margins.

We had an awful lot of general ledger accounts related to doing this combination and that's one of the other things we are trying to simplify in our business.

So, it really isn't that big a thing.

The business is over 30 years old and kind of kept on the same structure and it was just time to change it.

Okay.

And then I guess lastly, when I look back over the last few years in your transcripts and other comments and whatnot, it seemed like a lot of times you were pressing to keep your operating income growth X the float growing in the mid-teen levels.

And it feels like it's looking to grow a lot faster in that this year.

Is that because things are just so strong?

Or has there been some sort of a strategic shift maybe with John taking over where you are more willing to let upside fall to the bottom line as opposed to reinvesting so aggressively?

Thanks.

Our long-term goal remains 15% operating income without float.

But we do know there are going to be times when you're going to get some wind mind your back, it's going to be better.

There's going to be sometimes when the wind is in your face, which unfortunately behind us we got by some of those years.

But we continue to be aggressive.

John has come in here and done a great job on pushing the planning envelope a little bit stronger and trying to get the growth rates up.

But we have always felt that way and we will continue to invest.

We are doing some things internationally that will help longer term.

And we are looking into other products.

So, I don't think there is major changes.

But just as we got hurt a little bit when the recession happened, now we are benefiting today from the economy as well as all the outstanding efforts that are being put forth by both our sales and operating people.

Just to add a little bit of flavor to that because of one comment you made.

There is nothing that's going on different now versus when Tom was running the ship about driving more profit to the bottom line.

So there's not - - if what you meant was, are we being more aggressive now about flowing profit throughout P&L than we were in the past?

The answer to that is no.

We are being fairly aggressive about trying to drive the acceleration of our growth and profitability, no different than when Tom was here.

So that part is true.

We've got some good breaks that are coming our way right now and we are going to capitalize on them.

And we might have - - as John said we might have gotten a little bit more aggressive on the planning side, but there's really nothing funny going on here.

This is just a team that is highly committed to trying accelerating the growth and the profitability of the Company.

Okay.

Thank you.

Mark Marcon of Robert W. Baird, you may ask why your question.

Good morning and let me add my congratulations, great quarter.

I was wondering with regards to the reversal that occurred in the quarter, can you give us just a little bit more color there, John.

What do you mean the reversal?

In terms of the worker's comp.

It is not - - the only place it is material is it affects the human resources total revenues only because of the size of the numbers and the worker's comp with some costs it doesn't change much in profitability.

So, when you are looking at the profit impact of that, it wasn't very big.

We had that in revenue and we had some in expense.

Okay.

And so X that, it would have been 28% for HR?

Yes.

It you look at our guidance it is 25% to 30%.

And the reason I went through this, I didn't want to you look and see the 39%.

Right.

And think that was indicative.

What is indicative is the 28%.

Okay.

Can you split out for us - - if we were to strip out Paychex' premiere PEO and the 401K business, it seems like you are seeing very strong growth in all the other ancillary services.

Has there been a noticeable pickup or is it continuing along the same lines?

Pretty much along the same lines.

And I was a big skeptic in the old days on the Paychex Premier, I have to admit that, but I was.

But that product just continues to pick up momentum.

We just had a great sales conference in Palm Springs, where had all the salespeople of all the sales offices.

And it's always good time for me to get really back in tune with the salespeople and they are just so bullish on what this product can do.

It is just a great product for us.

Great.

And then taking that into account, given the lag in your effective yields, you know increasing relative to where rates have gone, the normal seasonality in the business.

It seems like while you did take your guidance up it is -- and I I am not trying to press you, but seems like your guidance is still somewhat conservative.

Are you concerned about the impact of Katrina?

Or is there any other reason for caution out there in terms of the remaining quarters of the year?

I expected this question, so I am - -

Somebody had to ask it.

So, I am going to give you a response.

Obviously we are guiding pretty close to the first three quarters all being about the same.

Yes.

Last year, the first three quarters were about the same.

Fiscal 2004, first three quarters were all about the same.

Fiscal 2003, first three quarters were all about the same.

That is our natural trend and we are not overly conservative here.

We are not overly aggressive.

I would say when we look at this forecast, we try to cut this about as close as we can.

We don't leave a lot of room for conservatism.

We think we increased the guidance because we realized that the year was going to be better than we thought it was and we realized that as we were going through the quarter.

But our usually - - the first three quarters usually, the EPS number is almost identical every quarter.

Now, whether that will happen exactly that way this again way, I don't know.

We even had one year where I think the third quarter was $0.01 less than the first two.

So I wouldn't look at this and say we are any different than we normally are.

To be fair, John, wasn't in terms of some of those years that you're citing isn't that partially as a reflection of the decline in the effective yield that you were experiencing at that point in time and then some changes with regards to your corporate income?

If I go back ten years, you are going to find this trend.

All right, that's fair.

Thank you.

Tien-Tsin Huang of J.P.

Morgan you may ask your question.

Thanks , a couple of quick questions.

What are you seeing in terms of wage inflation both among your Paychex employees and among your client base?

We haven't been seeing anything different than we have been seeing.

We have believed over the last few years there has been wage inflation.

But I think the wage inflation is offset by companies being very aggressive and becoming more productive.

But we think the worker in most situations is getting a raise.

And you can see that because our float balances go up.

Right.

So the float balance trend, we should still assume sort of double digits from here?

Whether that stays there.

But we definitely see - - we're going to get some ancillary growth.

And we usually factor in when we do our plan about 3% wage inflation.

This growth was probably a little bit better than what we anticipated but not significantly.

Okay.

You have got to keep looking at that.

I can't make a statement that I think it will be double digits for a long time because I just have no way of doing that.

Okay.

Any change in the level of bankruptcies overall among your clients?

No, but we haven't seen many changes in bankruptcies through the whole recession.

I think on the low end you have what you you have.

Very good, thanks

Dominic Vignola of Merrill Lynch, you may ask your question. [OPERATOR INSTRUCTIONS] We will move on to the next question.

Cynthia Houlton of RBC Capital Markets.

You may ask your question.

Hi, just on the expense structure.

I know you talked about that it is an ongoing target to expand margins and decrease the cost structure.

Is moving some of the costs not necessarily customer service and kind of direct client basing but more back-office costs.

Have you revisited moving any of those costs offshore?

It sounds like today a lot of the things are centrally done out of Rochester but something you are considering now more or less?

Just maybe an update on that.

We're not.

We have actually done some programming overseas.

Not a lot.

We have had mixed experience with it.

I have had a great deal of experience with it in prior lives, both with Crystal Decisions now Business Objects and then IBM.

But for our business, which is almost exclusively a United States based business, we'll quite satisfied with where we are right now.

And we are aware of what is happening in both India and China.

Our margin expansion comes more out of being able to add on these products with higher margins.

It's like, a good example, is this 401(k) most record keepers would have to do the data entering, we already have it.

So, that's why we can increase the margins.

It really doesn't come so much from how fast and how hard can we cut costs to the bone.

We want to make sure we offer the best customer service possible and we get fair prices for products and value added.

And then maybe just as a follow-up.

If you look at you customer mix on the - - in terms of what industries they serve, are you looking more or less at looking out to the next several quarters?

Obviously there's a lot of concerns of what potential impact rising fuel costs will have especially if you think of more consumer-driven markets.

Is that something you are looking at in terms of slicing and dicing who your customers are and where your potential risk may lie?

And could you give us any kind of sense of breakdown of what are the major segments of your customers?

We are far less industry-focused than large enterprise-type environments.

So when you are deal with small business, the whole industry orientation is much different than when you deal with large enterprise-based clients .

And with that said, there is nothing that we have seen to date that would suggest to us that rising interest costs are going to have a material effect on us.

Okay.

Great, thank you.

[Fanil Japtadar] of Romwell Capital Management.

You may ask your question.

You had in your Annual Report you had mentioned about expansion internationally.

I think you were establishing offices in Germany, I believe.

Is there any revenues recorded in this quarter from the international [offices] Or - -

Yes, but they are not significant.

Given the underpenetration in the U.S. market, do you think international strategy - - you want to do any international expansion?

Or do you just want to concentrate on the U.S. market currently?

Well our business is overwhelmingly predominant in the United States.

We just - - our first foray into the International front was Germany, which started about two years ago.

Our experience to date in Germany has been very positive.

Our first operating year in Germany we finished the year well above where we expected to finish.

It caused us to start further - - to approve further expansion.

We opened a second office in Berlin.

And quite frankly if Berlin happens the way we think it's going to happen, you can expect to see the third and fourth office open before too long.

So, we are pleased with where we are in Germany.

With that said, international expansion is something we are going to do on a very measured basis.

In the payroll business, it takes multiple years, five, six, seven years for operations to become profitable.

And so we will continue to invest in Germany.

And once we get Germany to a point we we are satisfied with it, we will move to the second target that we have.

And when it is appropriate to tell what you that target country is, we will let you know that.

But in general terms we see the international market as one that is very attractive to us.

We still have lots of great opportunity in the United States.

So it's not as though we are completely penetrated in the United States and need to go somewhere else.

It is just that the international market is at least the size of the U.S. market, if not larger.

It is clear to us that with the research that we have done that not all of those markets are going to be attractive to us but there are quite a few that will be.

And we will move into those markets at a pace that we believe is in good standing with what our financial goals are and the returns that we expect from those investments.

And the business model in those markets would be different from the U.S. model or it might be similar?

And the kind of margins you anticipate in that business?

Country by country will vary.

Obviously margins are important.

If we went into a country that had margins that were significantly less than what we were used to here we would probably pass and move on to a different investment.

But our experience in Germany has been terrific.

And, yes, there are things that are different.

Germany, as an example, does almost exclusively does monthly payrolls.

On the surface you would think that that would be not necessarily a good thing.

It turns out that the price that one is able to get in Germany for a job well-done is higher than the price that is capable in the United States.

And so while the frequency is less, the profitability is more than acceptable for us.

So we look at a whole variety of factors when we look at markets to enter.

We do that well in advance of making a decision to enter.

And quite frankly, if a market didn't offer the type of returns that we'd find attractive we wouldn't enter the market.

One last question on - - in terms of the operating margins.

Obviously gross of 40% this quarter.

How much leverage is left in that?

You mentioned about you go some benefits from the higher check volume.

Was there anything else that one of the benefits also gave from price increases that you had on [sources]?

Is there anything that added to that margin improvement?

And do you think that operating margins can reach 45% in the next few quarters?

We have a formula, it's 12% revenue growth will achieve 15% operating income without slope.

That is still the long-term formula.

Sometimes they will get a little better bounce.

We got that this time.

Except for some parts with checks, the rest of it was our people doing a good job and the ancillaries coming through and just the same old Paychex thing.

Now, how long can margins go up, I think we are nowhere near the end of it.

Obviously they can't reach 100%.

But they have also gotten to levels that I think even here we realized, we take this a year at a time we keep working at and we keep surprising ourselves on how profitable we can get.

Okay, thank you.

Robert Kong of Citigroup, you may ask your question.

Guys, congrats on the quarter.

In terms of what you expect major market revenues in '06, can you give us a sense for that?

I don't think we gave guidance on that, but if you took what they were last year, because we announced it, and you put the growth percentage on what it was around the first quarter you're going to be reasonably close.

So probably in the 220 million range is reasonable?

Yes.

But we really now look at this more and more with them together, because the major markets really represent the larger client.

He's not a soft we're using in the core.

But they have gotten more and more clients.

You've got to remember, a third of them come out of the core base.

So it's - - it shows how well we are doing in an area where we didn't do very well five to ten years ago.

That's why we stress it, but we really focus on the total revenue growth and payroll together.

Okay.

And just in terms of the advantage in InterPay.

Just kind of an update on your penetration of the - - of your selling into the CPA channel?

And any other kind of lingering integration issue in term of platform, sales force and like, price increase parity.

I didn't understand the first part of that.

I guess you guys had not really - - or Advantage and InterPay hadn't really been selling into the CPA channel, and that was an initiative that you guys had been talking about a couple of quarters ago.

Well they were more in the CPA channel, I think, you understand.

But basically our sales force has been consolidated and our focus on selling is the same as it was.

What you wind up with is, first off, InterPay no longer exists at all.

Every client has been converted.

There's nothing with Interpay's name on it.

And that integration is completely finished in an excellent faction.

A lot of people did a great job including the sales and the ops people.

The Advantage integration is finished but we have not moved people from one platform to another because we have private label branding with an associate group, which is like a franchisee.

And New England Business Systems, which had a private label product and they do a good job of selling it.

So, we can't eliminate the platform at the moment.

The cost loss of not eliminating it is not significant, so we still have the platform.

But I actually look at those two integrations and I consider them done.

They are kind of a nonevent right now.

We don't even talk about it here anymore.

And you guys in terms of bill pricing and price increases, I guess you guys usually do about 3% price increases.

I remember a couple of quarters ago you guys were talking about 7% to 9% increases for the Advantage and InterPay basis.

Are they pretty much on parity in terms of pricing now, the core Paychex and the acquired Advantage and InterPay clients?

Basically we have been raising the Advantage customers a little but faster than the Paychex people.

A guideline could be 8 versus 4.

That might not always be the case.

We'll continue to narrow the gap.

But the most important thing to us is to retain the clients.

Okay.

Thanks.

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

Hi, this is Richard Gray for Brandt.

Just one question.

We noticed that the legal reserve for Rapid Pay dropped a little bit and we were hoping you could give us an update on that situation.

Basically we established the reserve for Rapid Pay - - the The first time it got established I think was in the third quarter of the year we established it, which was over a year ago.

Then increased the reserve in the fourth quarter of '04.

And we charged some expenses to the income statement in the first quarter of basically '05.

Since then, we have charged any expenses we have had against the reserve, because we believe the reserve is adequate.

We have had some good court results on this over the last 12 months.

And right now we believe this is in a pretty good place.

And you also have got to remember that the reserve is also for all legals, not just Rapid Pay.

So, the charges were though, the expenses related to the Rapid Pay litigation right now are being charged the reserve.

Do you have an estimate as to how long that litigation will take?

No.

Right now we are working on resolving it.

But we got into this litigation because of some pretty significant differences of opinions on some contracts.

We have had some real good rulings lately from judges.

But we still have some differences of opinions and we are moving forward.

But right now again, this litigation other than paying some money has no impact on our business at no time.

Because the level of the franchisees that we had was not significant us to.

The highest revenue number was still far less than 5 million a year.

We haven't been booking that revenue for some time.

Some we're billing.

Most of them are now off the system.

There's very few left.

And a judge has allowed us to say basically that we can get them all off the system, I think it's in April of '06.

So, this really has become a much less significant item.

And hopefully we will get it resolved in the near future.

Okay, thanks, great job on the quarter.

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

A question for John Judge.

John, you were off on to pretty good start at the helm here.

I'm wondering what you're seeing as the next potential big opportunity for Paychex?

If there's anything you can point us to besides the strategy of just focusing on solid execution?

Do you have anything else in your plan or your strategy beyond - - those execution aspects are clearly important.

I'm just wondering if there is anything else?

It is pretty much what I told you and I have off to a good start because I came into an extremely healthy Company.

So, to be clear on that.

And it's a terrific Company.

It's been a terrific Company for a long time and it will be a terrific Company for a very long time to come.

But we are - - as I said we are working really on those three things that I mentioned earlier.

We are working on execution across the board, all elements of our business with extremely high buy-in.

I am blessed with an incredibly good management team who are all of a common mind, which is completely aligned with shareholders.

We are just trying to literally make this the best public Company that ever was in the United States.

And we are all about moving towards that goal.

And the second part of it, as we talked about, is just making sure that we're being appropriately mindful of the acquisition alternatives that we have out there for new products, new markets, and so on.

And as I said earlier, when the time is appropriate, when we find some targets that look like they're appropriate and will help grow our business and can be integrated in a timely fashion and are - - make sense for us from a financial strategy and as - - from a cultural fit, then we will make those announcements as we go.

But there is nothing on the horizon that I can tell that you we are about to do something major.

We are all about continuing with incremental improvements.

And as we see things in the marketplace that we could add to our family of offerings that will be good for us and good for our clients, then we will do so.

Okay.

And then a quick question for John Morphy here.

If I am reading it right, the biggest surprise in the quarter on the upside was the check volume activity.

And not to beat a dead horse here but is there a simple way just to quantify what the impact of the above expected check volume activity was?

What that did to you '06 plan or your August quarter earnings?

Some of what you would see and what the increased guidance was for the year that we anticipate.

I wouldn't say it was all from check volume though.

Because again I want to re-emphasize that we went into the year planning somewhat aggressively.

We were asking for an awful lot of things from our sales force and our operating people and they did them.

So, it's a little of everything.

But a little bit - - for me to be a little better than we thought it would be really because we anticipated in the plan came from checks.

So it is some of it.

You saw the guidance change.

And you also have to factor in that to a lesser extent but it is in there, there is some interest impact.

Sure, exactly.

Okay guys, thanks very much

[OPERATOR INSTRUCTIONS] At this time, I show no further questions.

Okay.

At this time, I would like to, again, thank everybody for joining us.

It was an exceptional quarter.

We felt great about it.

And we just want you to know that the whole team here is really committed to do the best we can to make this Company as good as possible.

And we are going to continue to do that.

So, I hope you all have a great day and enjoy the sunny day here in New York.

Not sure when winter will arrive but probably sooner than later so take care.