沛齊 (PAYX) 2006 Q3 法說會逐字稿

Good morning 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. I will now turn the call over to Mr. John Morphy. Sir, you may begin.

Thank you for joining Jon Judge, our President and CEO, and me today for our third-quarter earnings release. The teleconference call will be comprised of three sections, a review of third-quarter fiscal 2006 financial results including comments and guidance for full-year fiscal 2006; an overview from Jon; and lastly a Q&A session.

Yesterday afternoon after the market closed we released our financial results for the third fiscal quarter ended February 28, 2006. This press release can be obtained by accessing our website at the Investor Relations page, www.Paychex.com. We have also filed our Forms 10-Q and 8-K with the SEC which provide additional discussion and analysis of the results for the quarter. These filings are also available on our website and in addition this teleconference is being broadcast over the Internet and will be archived and available for access on our website until April 28, 2006. Please refer to our website for access to all recent news releases, current financial information, SEC filings in the Investor Relations presentation which will be updated in the next week or so.

The third quarter was another excellent quarter for Paychex, very good by all measurements and right in line with the expectations we established for fiscal 2006 performance at the end of the first quarter. Increase of 23% in net income to $114.5 million. Diluted earnings per share was $0.30, an increase of 25%; total revenues up 15%. Payroll service revenue up 10% to $320 million, human resource services revenue grew 24% to $81.9 million. Outstanding selling season for fiscal 2006. That is something that both Jon and I and the whole organization are very proud of.

We will now refer to the consolidated income statement. Payroll serve revenue increased 10% for the three months and nine months ended February 28, 2006 to $320 million and $932.5 million respectively. This growth was attributable to client based growth, increased utilization of ancillary services, price increases, checks volume growth, and new hire activity.

As of February 28, 2006, 91% of all clients utilized our tax filing and payment services and 68% utilized the employee payment services. Major Market Services revenue increased 26% and 27% for the three months and nine months ended February 28, 2006 to $59.5 million and $165.2 million respectively. Approximately one-third of our new Major Market Services clients are conversions from our core payroll service.

Human Resource Services revenue increased 24% and 31% for the three months and nine months ended February 28, 2006 to $81.9 million and $232.8 million respectively. The increases in Human Resource Services revenue are comprised of the following four key areas, retirement services revenue increased 15% and 16% during the three months and nine months ended February 28, 2006 to $27.6 million and $78.0 million. As of February 28, 2006, we serviced more than 37,000 retirement services accounts as compared with approximately 32,000 clients at February 28, 2005. Again we expect to sell more 401(k) accounts than anyone else in America.

Sales of the Paychex Premier products have also been strong as administrative fee revenues from this product increased 54% for the three months and 64% for the nine months ended February 28, 2006 to $13 million and $38.0 million respectively. The increase in administrative fee revenue is driven primarily by client growth and the implementation of initial enrollment fees, signup fees, effective May 1, 2005. As of February 28, 2006, our Paychex Premier product serviced approximately 212,000 client employees as compared with over 146,000 client employees at February 28, 2005.

Our PEO product provides essentially the same services as Paychex Premier except we serve as a coemployer of the client's employees, assume the risks and rewards of workers' compensation insurance, and provide more sophisticated healthcare offerings to PEO clients. The PEO product is available primarily for clients domiciled in Florida and Georgia, where the utilization of PEOs is much more prevalent than other areas of the United States. Revenues from the PEO product increased 9% in the three months and 36% for the nine months ended February 28, 2006 to $17.2 million and $49.7 million respectively. We expect the full fiscal year 2006 growth in revenue from our PEO products to be in the range of 15% to 20% over PEO revenues of $53.7 million in fiscal 2005. As of February 28, 2006, our PEO product serviced over 56,000 client employees as compared with over 52,000 client employees at February 28, 2005.

Revenue from other Human Resource Services including time and attendance solutions increased 35% for the three months and 34% for the nine months ended February 28, 2006 to $24.1 million and $67.1 million respectively. Interest on funds held for clients increased 71% and 72% during the three months and nine months ended February 28, 2006 to $28.7 million and $68.8 million respectively. The increases in interest on funds held for clients are primarily due to 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% at June 1, 2004 and 2.50% at February 28, 2005, steadily increased to 4.5% through February 2006. The increase in interest rate environment has positively affected net income growth. The average interest rate earned on funds held for clients increased to 3.3% and 3.1% for the three and nine months ended February 28, 2006 compared with 2.2% and 2.0% for the respective prior year periods. The higher average portfolio balances were driven by client based growth, wage inflation, check volume growth within our current client base, and increased utilization of our tax filing and payment services and employee payment services.

The average investment balances for funds held for clients for the nine months ended February 28, 2006 increased 12% over year ago compared to a 9% increase for the same period ended February 28, 2005.

This is a good time to provide some perspective on float income. We have frequently referred to being with the wind neutral and into the wind regarding the impact of changing interest rates. In the early 2000's, we were into strong headwinds and in fiscal 2006 the wind is now clearly at our back. We should be with the wind at least through fiscal 2007 with the periods after that dependent upon future changes in interest rates. From 1995 through 2000, the Federal Funds rate hovered around 5% for most of the time with a short duration low of [4.75]% and a short duration high of 6.5%. Since then the Federal Funds rate moved from a peak of 6% to a low of 1%.

We view the movement towards the 5% rate as a return to normal levels of float income versus extraordinary levels. The predictability of float income becomes much more certain when we're not in periods of rapidly changing rates in either direction. For most of the '90s we were neutral to rates and are hopefully headed towards that direction again. We refer you to our management's discussion analysis of financial condition and results of operations in the section market risk factors for a more detailed explanation of the affects of fluctuations in interest rates and related risks.

Combined operating and selling, general and administrative expenses increased 13% and 11% for the three months and nine months ended February 28, 2006 to $270 million and $752.1 million respectively. These expenses were impacted by a number of factors as follows. The third quarter includes our most important selling months, when approximately one-third of our new client additions occur. This selling season was outstanding and resulted in higher than normal selling costs related to higher commission and bonus expenses. These new clients will contribute to revenue on an annual basis beginning in fiscal 2007.

We are again in the midst of achieving another record year regarding client retention. Our success was due in part to higher retention of our payroll specialists and reducing the number of clients per payroll specialist. The majority of our W-2s were in the hands of our clients' employees on or before January 15, 2006. Another great client year-end which Jon will share some comments with you in a few minutes.

At February 28, 2006 we had approximately 10,700 employees, compared with approximately 9,900 at February 28, 2005. Year-over-year growth and operating income excluding interest on funds held for clients was 11% for the third quarter and 18% for the nine months ended February 28, 2006. We expect year-over-year growth for fiscal 2006 to be in the range of 16 to 17%, which exceeds our stated long-term goal of 15% year-over-year growth.

Operating income growth excluding interest on funds held for clients has been stronger in the first half of fiscal 2006 than the second half due to the timing of workers' compensation revenue on self-insured workers' compensation in our PEO; timing of information technology expense growth; higher than normal sales expense in the third quarter related to an exceptional selling season; and improving client service by reducing the number of clients per payroll specialist. Whereas the first two situations are not recurring, the last two are contributing to the strongest client growth we've experienced since the acquisitions of Advantage and InterPay in fiscal 2003. Client growth for the past 12 months has been 4.4%.

Investment income net increased 105% and 107% for the three months and nine months ended February 28, 2006 to $6.4 million and $16.8 million respectively. These increases are due to increases in average interest rates earned and increases in average portfolio balances which resulted from investment of cash generated from our ongoing operations.

Our effective income tax rate was 31.4% during the three months and nine months ended February 28, 2006, compared with 33.0% in each of the respective periods last year. The decrease in our effective tax rate is attributable to higher levels of tax-exempt income derived from municipal debt securities held on our funds held for clients in corporate investment portfolios and a lower effective state income tax rate.

We will now move onto the balance sheet, which reflects our growth during the first nine months of fiscal 2006. Cash and corporate investments were more than $900 million at February 28, 2006. Our cash flows from operations were again strong at $458 million for the nine months of fiscal 2006, an increase of over $91 million from the same period a year ago.

The Company has reclassified variable-rate demand notes, VRDNs, and auction rate securities from cash equivalents to available for sale securities. The classification change was based on the Company's review of the maturity dates associated with the underlying bonds and liquidity being provided by a party other than the original issuer. Reclassification had no impact on reported consolidated earnings. We refer you to our Form 10-Q for the quarter ended February 28, 2006 for further information.

Our total available for sale investments including corporate investments and funds held for clients reflected net unrealized losses of $18.6 million at February 28, 2006, compared with net unrealized losses of $9.9 million at May 31, 2005. The change in the unrealized loss position is due to increasing yields that decrease the fair market value of the Company's investment portfolio. The three-year AAA municipal securities yield increased to 3.42% at February 28, 2006 from 2.85% at May 31, 2005.

Our net property and equipment balance activity during the nine months of fiscal 2006 reflected capital expenditures of approximately $56 million and depreciation expense of approximately $38 million. Client fund deposits as of February 28, 2006 increased to $3.9 billion from $3.0 billion at May 31, 2005. Typically the third fiscal quarter is the highest for client fund balances.

Total stockholders equity increased to $1.6 billion at February 28, 2006, with more than 170 million in dividends paid during the first nine months of fiscal 2006. Our return on equity for the past 12 months, 30%.

Fiscal 2006 guidance. Our guidance for the full fiscal year ended May 31, 2006 includes the effect of the Federal Funds rate increase on January 31, 2006. Therefore it does not include the effect of the most recent change yesterday, which I will discuss in a few seconds. The Federal Funds rate increases directly affect interest on funds held for clients and corporate investment income. Our guidance is summarized as follows.

Payroll service revenue growth is projected to be in the range of 9% to 11%. Human Resource Services growth is expected to be in the range of 26% 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 60% to 65%. Total revenue growth is estimated to be in the range of 14% to 16%. Corporate investment income is anticipated to increase approximately 95% to 100%. 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 24% to 26%.

These projections are based on current economic and interest rate conditions continuing with no significant changes. Yesterday the Federal Funds rate was changed to the 4.75%, which would increase our fourth quarter expectations for pretax income by slightly less than $1 million.

Equity based compensation. In the first quarter of fiscal 2007, we anticipate adopting the revised accounting standard related to stock based compensation. Upon adoption, we will be required to record compensation expense in our income statement equal to the estimated fair value of any stock based compensation awards including stock options. The prior standard for stock based compensation which we are still following in fiscal 2006, allowed us to just disclose the pro forma impact on the affect on net earnings and EPS as if we had applied fair value accounting to existing stock based awards. This disclosure is contained in Note A to the financial statements in our Form 10-Q.

However there are some differences in the calculation of fair value and expense under the revised standard. We continue to evaluate the new rules and based on our current review of these rules and anticipated equity awards in fiscal 2007, we expect that adoption of the revised standard will negatively impact net income for fiscal 2007 by approximately 5%.

You should be aware that certain written and oral statements made by 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 statements on page 3 of the press release for a discussion of forward-looking statements and the related risk factors.

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

Thanks, John. Nice job. Good morning, all, and thanks once again for the great interest that you show in our company. We appreciate your time and interest and all the helpful questions and comments you always provide us so sincerely. Thanks for joining our call this morning and for following our Company.

I wanted to add just a few comments to the excellent discussion that John just took you through and to give you some additional perspective on the third quarter results as well as how the year is shaping up and what we see going forward.

Let's start with the third quarter and the importance the third quarter is to our year. The third quarter is historically our toughest quarter financially and at the same time always our most important quarter from a sales and operation standpoint. In fact, it is a very important indicator for the year that we are in and for the next few years to come.

So why is that? Well, it's the toughest quarter financially because we have all the extra work and expense that comes with calendar year end. It's the year-end close for our clients. It's the W-2 season. It's the time of the year, January specifically, when we do the most significant number of new client loads for the year. And in many cases the expense for all these activities is concentrated in the quarter, while the revenue is spread over the year hence the toughest of the quarters financially. And we plan for that.

Then there is the flip side of the quarter and it is the importance to us from a sales and operation standpoint. We call the third quarter our selling season because we typically do over 20% of our sales for the year in the month of December alone and then load all these new clients onto our systems in January. We have to do it in a way that is so trouble-free that client satisfaction is high so that the prospect for a lifetime client is also high. You can see that we view the third quarter as much more important than just another quarter, so with that as a backdrop, let me add a little more color to the third quarter results. John just took you through the financials and we are obviously very please with both the quarter and where we are for the full nine months year-to-date.

Revenue growth across all of our lines of business was very strong from both a quality and a quantity standpoint. Our sales performance in the third quarter was outstanding, boding well for this year but more importantly for future years. And our operations team also had an outstanding quarter. Year-end processing was one of the best that we have been through ever. W-2 processing, over 11 million W-2s, again was the most successful in our history. 100% of our core W-2s were sent to clients by the 10th of January, significantly earlier than is required.

401(k) plan startups were huge. Over 40% increase this January versus last January. Core payroll client satisfaction at record level highs. Same for our [LNS] client satisfaction. Payroll specialist turnover is down almost four points versus a year ago at this time and with all this our operational expenses as a percent of service revenue continues to decline year-over-year by a full margin point. You can tell I'm sure that we are very pleased with the quarter and the terrific results achieved by our people.

So what does that all mean for the year? Well, it means that we are in very good shape. We started the year booking an aggressive plan and knowing that we had two critical quarters, the first quarter and the third quarter. The first was critical because that was the quarter that we had to get off to a fast start so that we would not be chasing deficits all year. The third quarter was critical for all the reasons I just elaborated on.

Now you know we got off to a great start in the first quarter and you now know that we had a terrific third quarter. So you've put it all together and we feel very good about the year and very confident about how we will finish relevant to guidance. So good in fact that we are raising guidance for the second time this year and we told you in the first quarter when we raised guidance it was the first time we had done that in some 10 years and now here we find ourselves in the third quarter raising guidance once again in the same year.

We have moved our guidance on net income growth from a range of 22% to 24% to a new range of 24% to 26% which results if you do the math in a positive EPS move of roughly $0.02 a share. We have a fourth quarter yet to do and clearly I don't discount the effort in front of us in any way. But given our execution to date, the positive nature of the economy, both interest rates and employment growth, and the commitment of our Paychex employees, we remain very bullish about our prospects for the year and beyond.

I will conclude my comments on that note and ask the operator to open the conference call for questions or comments.

(OPERATOR INSTRUCTIONS) Karthik Mehta, Midwest Research.

Good morning, John and Jon. A question on the increase in commission and bonus expenses. How much of it do you think is related to just pure outperformance and compared to just an increase in pay you would anticipate year-over-year?

Basically we had a little bit of both, but when we factor in the extra expenses, we probably lost about a half (technical difficulty) around (multiple speakers) if we hadn't had this performance.

Just a comment on that, though, maybe at a slightly different perspective. There are lots of different types of expenses that you'll see in a company. High money -- anytime you have expense that you get only because you're going to get revenue, that is a good expense.

I think in the past you have said that if I remember right maybe new sales contribute about 10% of revenue in the year. If you're going to look at what you did this selling season, which was excellent, is that changed at all the amount of revenue that you would expect from new sales going into a new year?

No, basically we look for about 10%. That's about what it is now. The key to remember is we are a heavy recurring revenue model. I think the good news here is the client growth has improved and that gets us back on our formula a little bit. We still stick to the formula in the 12 and 15 and it's far too early to say whether that's going to be better. But we feel real good about what happened. We have been working very hard to getting the sales force to be more productive and pick it up and in the third quarter they did it when it counted the most. That's when one-third of the business comes in.

One last question. What were the checks per clients? Can you just give maybe a directional feeling for how that number is shaking out?

We don't really talk about that anymore because calculating is so difficult and we've got competitors that do it but I don't think any of us calculate the same way. But we still see the economy as being relatively strong.

Thank you very much, gentleman.

Rod Bourgeois, Bernstein.

I was hoping you could share with us kind of an update on new services and products that you might be looking at to be able to cross-sell into your existing client base and maybe the initial traction you might be getting along those lines?

I'll give you a general feel and we've talked about some of this at some of the analyst conferences but when it's time to introduce the new services, we will do it at that time. What I've talked about so far is obviously you take all of the services that we have and we are constantly working on improving those services either from the functionality of the service that we provide or from the features and we talk about some new ones. We've talked to you in the past about the fact that we introduced a new 401(k) light product, which was geared at the one to four or one to five employee client that was interested in some type of a retirement service product but really did not fell like they could afford or wanted the complexity of a full-blown 401(k) product and that has done pretty well.

We've talked about the fact that in another couple of months we're going to be introducing a multi-fund product that will literally allow us to take over the record-keeping aspects of all 401(k) offerings from all 401(k) money managers. In the past we have been constrained to just the five money managers that we've had relationships with and a handful of offerings to each one of those five. So that literally will open up the opportunity for us to do the 401(k) record-keeping for all of our clients over time.

So that part is pretty exciting and the way to think about this, if you go across all of our different target markets, we have work in under way in all of them to improve the existing offerings that we have in the marketplace but then also try and find new ones.

The last thing that I will talk about because we've talked about it publicly before is the whole area of health insurance. We think that this is an opportunity that could be very significant for our business over time mainly because the market looks very similar to what the payroll market looked like when we entered it for the first time. It's a very underserved community. The existing method by which health insurance has moved to clients is largely through independent agents. If an independent agent had to make a decision in a day whether he's going to call on a small client or a medium and large client he will call on the medium and large client every time. So our view is that this is once again an area where the market is underserved.

We have an existing distribution method to all of these clients, both current clients and obviously the new clients that we bring in. And so we think it is a natural for us and we started with a pilot last year. We put about a dozen sales reps in on the phones here in Rochester and we put eight reps into the field. The results obviously were quite strong, strong enough to cause us to change our model and make a fairly significant investment into the insurance side of the business. So that is a flavor of a couple things we're doing and I will leave it at that as a flavor.

I will tell you though that we have got work going on in every one of the markets that we serve and in all of the product areas and when we find products or potential offerings that make sense for our clients and that can leverage off of our existing infrastructure, then obviously those are the things that we want to invest in. So we feel pretty good about where we are with what we have today and we feel very good about the things that we're working on for the future.

It sounds very good and just a point of clarification. If we take something like health insurance, is that a market that is similar to the international expansion efforts in that great long-term idea but in the next five years there is investments and other things needed to get to critical mass? Is it one of those deals where the payoff is really year five or is the near-term payoff on healthcare in health insurance potentially better than what you see in some of the other market segments?

It's a great question because it gives me a chance to talk a little bit about what we're trying to do strategically. We have a series of efforts and therefore investments that are in what I would call the near-term buckets, the things we're working on to make the next one to three years better, the intermediate buckets which would be three to five or three to seven years and then the longer-term buckets.

When I think about what we're doing in international, that's more in the longer-term bucket and it's going to take awhile for that to get up to a point where it is materially relevant. But more importantly because the whole international market is available to us so we're just starting into it, in all cases when you expand internationally -- it is not just us by the way it is anybody who is in the international market -- you're always going to have revenue lagging your expense. So as long as you have aggressive growth plans you're always going to be putting investment in that exceeds your revenue until you get to a point where if you did it on the averages, until you are halfway through your penetration of those markets and your revenue now exceeds the expense you're putting in. That is going to take some time for that to happen. So that is what is what puts international more in the long-term bucket.

We clearly think that the insurance piece -- while there will be some lag between revenue and expense, we see that much more in the end of the shorter term to the intermediate term.

Health care is going to follow the profile much more closely of what 401(k) did and workers' comp, and workers' comp now is really picking up some great sales momentum. So basically what you're in the year -- if you have a year you would do what we just did, it doesn't have much effect. Then you have the year where you step up the salesforce, that's your biggest investment, year, year two you will get close to breakeven and year three you start making money and it starts moving at good margins in the whole thing.

Nice plan. It sounds very good. And John, Mr. Morphy, let me ask you one other here. I guess it's clear that the third quarter is critical for signings and therefore there is some pressure on the margin, but that is something that happens every year. And you do have a year-over-year comparison that looks somewhat weak this quarter, so I guess I'm wondering was it just an anomaly of a quarter where your signings were so strong that there was sort of an unnatural affect on margins?

Basically when we get into this analysis and we've talked about this before, we get down to numbers that are so small that one million here, one million there makes those percentages change rather dramatically when we look at this third-quarter as a great third-quarter, right in line with what we would like it to be. I think some people looked at our margin expansion the first half and thought it would continue right through. We said that it wouldn't and that's what we believe.

The other thing that happened is last year's third-quarter actually we've had abnormally high-end margin so we had a tougher year-over-year comparison. Some of that is workers' comp. Some of that is some other things. So basically what happened to us we probably lost half a penny because of these expenses but the rest of quarter was right in line with what we expected because it's not just the selling season. What we also have going on in this quarter is what we call client year-end that Jon talked about and that's basically we've got all these expenses in it. And you've got service things and we're really pushing hard. Our service levels are the best they've ever been. We think we're doing some things a lot better than we've ever done.

So we feel good about what was it was and I think when you look at this margin thing, you're looking too closely inside of a quarter and you've really got to look at the year because we are committed to leverage. We will leverage and this year like it or not a little more of the leveraging was in the first half for various reasons and last year some was in the second half. But we feel great where we are.

That's helpful. Thanks guys.

Adam Frisch, UBS.

It's Steve Stout for Adam. I wanted to ask you a little about the growth drivers. You mentioned client growth price increases, hiring activity, increased ancillary sales. Can you give us a little bit of a breakout of how much each of those contributed to growth?

Actually those don't vary too much. There are all there. Obviously we're getting a little bit better at client growth, so that's helping a little bit.

That was the 4.4%?

For the last twelve months. The economy is pretty good right now. A new hire reporting was the best in this quarter of all the quarters all year. So we're getting a little bit of wind there and some of it gets us back to -- but obviously we are investing like crazy in the things we want to invest in, whether that's time and attendance, some of that is international. And what tends to happen with us is if we find a little extra money we chase it back into investment and one thing we're in the process of doing is we're going to turn loose some of the sales hires ahead of time again in the fourth quarter to help make the following year better and get another good sales year like we are in. So a lot of this money – you are always talking sometime about 1 million or 2 million of variance here which when you start talking revenues over $1.5 billion we definitely are pretty exact in what we're talking about.

I wanted to drill down a little bit more into that. Hiring went up about 8.1% this quarter.

No, new hires are up about 3.

Oh really? I thought you said -- I'm sorry, employees -- that was total employee headcount went up. How do you see salesforce hiring increasing? Is it going to accelerate? Is it something kind of similar to what ADP has done?

We only basically -- we run a salesforce that has assigned open positions and we start those at the beginning of the fiscal year to maintain a quota, integrity, people integrity, all those things. We do not change the salesforce during the year. What will happen now is we will bring the salesforce in four to eight weeks, sometimes 12 weeks early to get them properly trained so when we put them in these positions at June 1, they are ready to go. In some of the prior years we did not always do that and we suffered because the salesforce did not get off to as good a start as we would have liked them to.

Can you tell us what the price increases were that contributed to growth?

Our price increase generally is between 3.5 and 4% and it goes in May 1. And obviously we are in the process of getting ready to implement another one this May 1.

And that will be about the same rate?

Yes.

All right. Thanks a lot, guys.

Greg Cappelli, Credit Suisse.

It's Greg and Jeremy. Just following up on that salesforce question, your goal I know was 7 to 8% growth in '06. Is it looking like it will remain the same in '07 at this point?

We haven't defined that yet. We're heading into our crucial budget season. I don't think you will see much change in payroll but the real question is going to be what do we do on the healthcare side, which we're going to try and be as aggressive as we can reasonably afford. How does Paychex Premier look like when we get the actual numbers of where we are positioned? How do we look at 401(k) with the new product expansion? So those decisions haven't been fully made. I wouldn't expect it is going to be unbelievably different but it hasn't been decided yet.

Okay. John, not to beat a dead horse on the cost issue you explained progression of the margin but do the comments you made then, should we assume that we would expect that level to maybe fall some the quarter we are in and perhaps even the first quarter as well?

First quarter of next year, no. We will get margin expansion next year in the first quarter. I can't say how much but I can't comprehend that we wouldn't get that. We are committed to 12% revenue growth and 15% operating income growth without float. And that says you've got to leverage. Now when you get down to the quarter-by-quarter you can get some minor gyrations. Now what is also causing us a little more gyration is I don't think I can remember us ever being in a period where we were investing in quite so many things. We have got lots of good things going on whether it's healthcare -- and our people are charged up to find new ideas. We've got the international thing which you know is long, long, long-term but it is there. What we are doing in time and attendance, the new 401(k). We are pretty aggressive at trying to make sure we maintain these growth rates.

One thing I would like to add is if you're looking for some inside or some recommendations from us on what you should infer, I've got a couple for you. One, you should infer that we have a pretty good handle on our business and how we think our business is going to unfold in the course of the year and we tell you that in guidance. Two, we don't really manage the business quarter-by-quarter. We manage the business year-by-year. So the points that I made to you earlier, we knew where the third quarter was going to play out. We knew how important it was going to be to us and we knew where it was going to play out.

The part that's interesting to me as I listen to some of the comments, we are very happy about the quarter. It is actually beyond where we set it to be in the plan when we first set the plan. We can't always dictate where you all are going to decide that you think -- the quarter is going to be or the number is going to be but we are in a year where we're not only on guidance, we are exceeding guidance. We are in a quarter where we had a quarter that we feel like was extremely strong relative to the job that we had to get done in the year.

So I guess if there is one scenario I would paint for you in terms of recommendations it's that when we give you the annual guidance you ought to listen to that and -- because we run models as you run models and we have a pretty good handle on where we think we're going to be. As I mentioned earlier, we're right in the middle of a year where we're actually going to do a little bit better than we thought we were going to do on guidance, but we are pretty close to what we called.

Okay, I got it. One last point just -- I'm curious the extent of the growth of your PAS or now Premiere Product that might be coming from existing PEO clients switching over versus new users altogether?

The Paychex Premier gets very little benefit from the PEO converting over and actually it's minimal. Now what is happening in Florida is the PEO growth is slowing down a little bit because we are a little more aggressive in trying to get customers to choose the premiere offering versus the PEO offering.

The PEO offering right now in Florida -- if they really want it, we offer it. We're probably going to use it throughout the U.S. a little more in a defensive sell. Because what happens is sometimes a CPA will call us in and say, look, my client really needs a PEO solution. They don't understand that Premiere is almost the same thing and they just get hung up on the PEO thing.

So we would tell them we will probably offer you that and in the sales call, it becomes evident that they really can use the Premiere and it works out. So the PEO is something we continue to do. I wouldn't say it's got unbelievable emphasis on it because we still believe the Premiere model is the better place to be but we aren't seeing very much of any switching from the PEO towards Premiere.

Great. Thanks a lot, guys.

Bryan Keane, Prudential.

Good morning. If we just map out the margins if we just freeze most of the onetime events, it seems like the first quarter is the strongest margin and then the third quarter will be the lowest margin. Is that how it seasonally looks? Maybe you can comment on the second and fourth.

That is how it seasonally looks and the reason is we run a tight ship here on expense. We got a culture here that is a certain way. You don't spend what you weren't given. So what generally happens is the price increase goes in on May 1. That goes in boom, so you get the margin jump on that. People tend to not spend all their budget money in the first quarter because they are optimistic but they don't spend it. So that makes that one where the jump takes and in sequential quarters, it doesn't mean much in our business.

Now the third quarter though winds up with a lot -- it winds up with kind of the selling season in it and I have to expense all those commissions all up front. So I have long said the more I sell any year, I actually lose more money in the year but it helps the next year. We had that phenomenon.

Then on top of that you've got all the client year-end W-2s, and all those things going and sometimes you get a fair amount of revenue on special reports. You never know how that's quite going to be. So what you're saying is true and what I would say is the first quarter kind of jumps. Second quarter usually stays about the same and might trail slightly, not too much. The third quarter you're going to get hurt a little. And in the fourth, it can change around based on how much we want to invest.

Right. Then I was looking at the stated goal is 15% off income growth ex-float. This year you're guiding to 16 to 17%. What exactly -- what are the key factors that is boosting that this year to be a little bit ahead? Then what are the swing factors that get you up above that 15 or below that?

That's the economy. In other words the economy was a little better than we anticipated. We have chosen to invest some of it and some of it is falling right to the bottom line in the 16.5.

So in a normal growth economy, 15 op income ex-float is the right number?

That is our stated target and that is not a slam dunk goal but it's a very achievable goal. It's something that is where we want to be, 12 and 15. So when you look out three to five years and you said what would make Jon I happy and the Board happy, it's 12 and 15.

Okay. Just finally is there anything that is underperforming that seems to be dragging down growth that is kind of a project to be fixed or does it seem like most things are going to plan?

No, we don't have anything that is underperforming and what has really been optimistic to me is the product we started off with and I think this is what you go through sometimes -- it didn't quite get going as good as we would have liked as workers' comp and actually the one product -- it's not major but the product that is outperforming the most right now is workers' comp.

Okay, great. Thanks, guys.

Greg Gould, Goldman Sachs.

It's Liz Grausam sitting in for Greg. I just wanted to get a sense on how -- at lease with the new client growth for the past twelve months has been 4.4%. I assume that has been accelerating over the past few quarters. If you could also give us a sense of how the average revenue per new client is tracking? If you've seen acceleration in that? And also the average profitability per new client as you're selling more ancillary services.

That's a lot of questions. The client growth has been -- it has been accelerating. Now whether that continues to accelerate I don't know. We have a stated goal of wanting to get back to five. The good news when I see the 4.5 or 4.4 number I feel a lot better about getting back to five than I did and I think I said early on this year that while we had a goal of five, anything above four would be wonderful.

Now what has happened is our average revenue per client is probably a little higher than what we anticipated because we're selling more ancillaries. And some of those other things you're asking about we just don't track into that level of detail. I don't really look at profit by client. I've found I really can't. We are at high margins. I'm sure some of them are more profitable than others except that the margins change because the smaller client where you think you would be making less is where the pricing is the best because of the way the ancillaries work. So we really look at the whole thing.

That and the fact that we do very little customizing for clients if any at all so we're very much a leverage model.

Okay. Then you mentioned that you had about a 4% improvement in your specialist retention due to some of the programs you've put in over the last year. It sounds like from your comments in the third quarter that you are continuing to invest in some of those programs. What do you expect going forward in further improvements in your specialist retention, if any?

That's an area for my money that will be an area that will be a continuous improvement area, so I am very happy with where we are. The payroll specialist is at the heart of the service delivery model for our business. They are the people that are responsible for long-term client retention, for long-term client relationship management. So in many respects, they are Paychex to the outside world, so it is an incredibly important job for us.

I'm thrilled with where we are right now and the improvement we have made in retention. When you have a high turnover of payroll specialists, lots of bad things happen. Our recruiting costs go up, our onloading costs go up, our training costs go up. Our client satisfaction goes down. So we are pretty happy with where things are, but there probably won't come a day when I'll say I'm satisfied and let's stop. So I'm sure I'll continue to put pressure on that until the numbers get down into an area that is essentially the difference between your ability to be perfect in hiring and the normal human frailties that we all have and how we do hiring. And that number is probably somewhere in the high single digits or low double digits.

Great, thank you.

Glenn Greene, ThinkEquity Partners.

The first question for Jon Judge, just drilling down on the strong client growth you had in the quarter, I was wondering if you'd just give us some more color on what drove it. Was it better execution; the fact that you had changed incentive plans; you hired salespeople earlier in the year; share gains? Just some color on what sort of drove it.

I think it starts with just focus. It really does just sort of start with focus. One of the things that was obvious as we looked at our business model, when we've got something in the high 70% of our revenue being in core payroll clients, it was vital for us that we get that group or that part of our company growing closer to the model. So if we say we want to grow at 12, we can't have that group growing at 7 or 8%. It's got to grow closer to the 12, and we've got that group now growing somewhere in the 10% range.

It's the best growth we've seen in that group for some period time, and it comes from a lot of things. It's the management team taking on responsibility to try and -- our productivity and our performance harder. It has to do with the early hires that we did in getting people on board. There's been some terrific movement in that group as well, in terms of salesforce attrition. I have been around sales and marketing all my career, and I'm a huge believer that tenured professional salespeople will outperform new hire young salespeople 100% of the time.

So getting ourselves to the point where we've got a more stable salesforce and we keep our high-performing salespeople longer and so on are all positive things in that regard. We're not -- we haven't changed significantly if at all the compensation for our sales teams. The way that Walter had set up the whole compensation system for our team, it's very line of sight. They know from the day that they start selling exactly what they're going to get when they sell a client or what commission they're going to get on the revenue they bring into the Company. And as they get further, as they get closer to 100% and then they go above their targets, they can see the accelerators that they get.

It's very important for a salesperson that they have line of sight, that they can see exactly what they're going to get at the conclusion, successful conclusion of the sale, and we have got a team that is very well-managed. We've got a set of measurement management systems in place that are quite helpful to us. And again, it starts with the focus, and I think a big part that has helped us is the early hires and holding our tenured salespeople in place.

Thanks for the color; that's very helpful. The second question just would be use of cash and priorities for cash flow. I think previously you've alluded to you're more inclined to let the cash build than to contemplate a share repurchase. Just sort of an update on your thinking there.

We're pretty much in the same place we've been. We keep looking at it, keep looking at the dividend rather aggressively, because we think that's the best way to return the cash. But as we earn more, we will have to keep an open eye to what we will do, and we will keep looking at that.

Just real quickly, John Morphy, it looked like the PEO revenue actually came in somewhat higher than you contemplated coming out of the 2Q. And just sort of an update on the workers' comp issue.

About the same and the workers' comp issue hasn't changed. We gave a lot of detail on that last time to kind of get off that subject. But it hasn't changed much. It is what it is.

Okay, thanks.

Gregory Smith, Merrill Lynch.

Just hoping you could comment on Intuit. They seem to be staying in the payroll business. We thought they looked like they might get out but are staying the course. Are they a credible threat or anybody you are really worried about or see often in the marketplace?

Anybody who is in the business is a credible threat. Intuit is a very good company, no question about that. The reality is though that we rarely see them in the marketplace. So in terms of the clients that we deal with it is rare that our sales teams will bump into their sales teams. We are in a very different model than they are and I think there is a part of their business that is in sort of in the fully outsourced model which is I believe where they have publicly stated they have had some difficulties, which isn't a surprise to us. Where they are in terms of assisted or do-it-yourself, they're not models that we compete with. So that is the main reason why we don't see them. So they really have not been a factor. That's not to say they won't be a factor some time in the future, but they haven't been a factor so far.

Is there any desire, increased desire on your part to partner with any of the software vendors at this part?

The easiest way for me to answer that is to say that we are always open to suggestions along those lines. But if you looked in our history, each time that we have done a due diligence on partnering, we tend to come to the conclusion that we are probably better off continuing to go it on our own verses partnering with other people. But that's not to say that we won't bump into a scenario or a player sometime in the future that where it makes great sense for our shareholders and for our clients for us to partner with them.

Okay, and then I just wanted to be sure. The 401(k) light product that has been rolled out? You are selling that at this point?

Yes.

Okay, thank you.

Tien-Tsin Huang, JPMorgan.

Just a question on the operating expense side. It looked like compensation expense grew at a healthy -- it looked like 17%. Can you help build that 17 up for us?

Yes, the increase above norm was the salesforce. We also had some of the payroll specialists to a much lesser expense but we paid a lot more in bonuses and we were successful. And when you are successful, when the salesforce is successful they usually expect you are going to pay them and we did that. So that's what that is.

This is the point that I alluded to earlier where if there's a good kind of expense, it's where you get the expense only because you get the revenue and the additional expense that we saw in the quarter was completely for good reasons. Is was the fact that our sales teams were far more successful than we had planned them to be and therefore these additional clients will definitely help us next year in terms of revenue.

Agreed. So it sounds like there's no other factor. So just trying to understand what I think I heard earlier, trying to understand what sales are creating targets and triggering higher bonuses and it sounds like some investments of higher client service. Can we assume above-average services growth next year because of that?

We do everything we can to get client growth but again I am going to go back to we have the model 12 and 15, revenue growth is hopefully based on about 5% client growth, 3.5% price and 3.5% ancillary. It varies. We might get one year that client growth is not quite there, which it has been through the last three years. So we are getting a little bit more out of ancillary so we're trying to get back to the formula.

So I don't think you should assume because one little piece of the revenue formula gets better that some other little piece isn't going to get to be a little less, so we are pushing all these elements. We have stated goals. We think doing what we're trying to do is not easy and at the same time we have to balance today verses three years from now and 15 years from now. This is a model that works. If you really maximize all the income you could in one year, you'll get a nice one-year but you won't get You'll get a nice one year result but you won't get a good two, three, four result.

Understand. Congrats on the sales performance.

Cindy Shaw of Moore's.

Thanks. A couple questions. One, in the HR and benefits revenue growth, the guidance in the 10-Q that showed up last night changed just slightly, bumping the lower end of the range down by one point. I'm wondering if you can comment on what was behind that, if it was the workers' comp changes. Then I have a couple more questions after that.

All it was and maybe we had something in the wrong place. The guidance was 25 to 28. We just took up the low-end because we don't think the low end is going to happen.

Okay, then nice growth of 24% in HR and benefits revenue this quarter. Obviously slowing due to the workers' comp changes. Is that 24% pay sustainable? Because it's a pretty good number and you've alluded to the fact that things do move around.

I believe that HR growth is going to be somewhere between 20 and 25% and as we get bigger and bigger it is probably going to trend more towards the 20. The reason for that is one of the big growth drivers is Paychex Premier and if you look at any of our other growth factors, these products start at these raging growth number 60% plus. They can't stay at that level as they get bigger and that's one reason why you saw Premier start to slow down a little bit. But then you got to also take into consideration that while HR revenue growth is very, very important, it's still only about 20% of the total revenue base so that where the payroll revenue really goes drives it. But when we factor all those things in and again, sometimes you got better in Premier at the front end, but then you've got some other expenses. So revenue growth in HR will tend to come down some, Cindy, only because of maturing. But then I could go out two years and it will bump up again hopefully with healthcare.

Okay, and then this year you saw a reduction in your tax rate due to basically mix shift of your income to interest-free UNI securities. It looks like that shift is going to continue next year. Do you think your tax rate will go down again?

I believe it will go down and we will provide guidance on that in June.

One last question. The cash mix in the portfolio at the end of the quarter has been well below the roughly 50% target. Is that just a quarter end thing or is that also much below 50% in terms of the average cash balance during the quarter?

You mean the amount invested in long-term versus short-term?

Yes, exactly.

That's model change. We've talked about that. It's not a lot lately but because of the success with Readychex and Direct Deposit, that's growing faster than taxpay because of tax pay being near maturity. Our model is not 50-50 anymore. It 60% short-term, 40% long-term.

Okay, and that is the over the average of the quarter?

Yes. You can't look at the end of the quarter on any of that money. You can't believe how much the numbers bounce. One of the things I inherited was great. Our treasurer group is great at expecting cash balances. I mean I think our number went up by billions when we had bonus times. So it bounces all over. The end day of the quarter doesn't mean anything.

Okay, great. Thank you very much.

David Grossman, Thomas Weisel partners.

Thank you. I think the question just came out a little bit about growth and I guess I am just isolating the payroll business itself. It sounds like you feel pretty comfortable with getting your annual price increase in in May. And it sounds like your new client growth is improving and your retention is as strong as it has ever been. So I guess with all those elements combined together with your great visibility entering a year, is there any reason to think that payroll growth projectory shouldn't be anything other than that flat to up next year?

Yes. You've got the economy moving on checks. You've got new hires moving and then we have this other thing which we need to do some of those things, a thing called employee pay and taxpay. They are big revenue producers and the growth in them is slowing. We know that. So I think there is a lot of factors that go around here, David, and I know we all want to pick the one or two good ones that can give me a plus when I know I've got other things to neutralize.

My believe is payroll growth between 8.5 and about 9.25 is normal. And I go above 9.25 it's sensational and we are getting that right now but I think some of that is a little bit of wind that has got up to 10 is coming out of the economy. Maybe the economy is going to steady but I don't know because the economy continues to be strong for us. We don't see anything slowing down. So that could happen next year but that would be the end we probably wouldn't quite plan for because in this business, if we miss our revenue goals, it is very hard to make our profit goals.

And one thing David, and I completely have to counsel John gave you with the things that could tamp it down versus the things that could put it forward but the one thing I will tell you these are all things that might could happen. We don't really know what is going to happen next year. I will tell you this, we will not take the pressure off of increasing sales in the payroll group one iota.

So if there is anything that is humanly possible that can be done to keep that growth at the level it's at or accelerating it, we will do it.

Right. And I guess just a quick follow-up to that comment about employee pay and what was the other one? How much of a factor are those in terms of a composition of the overall revenue balance?

They are there, but we forecast to do long-term strat planning and it is just something I'm dealing with. I didn't quantify how much it was. I still believe that the formula is still very good. I just know some pieces move around.

Just one other question really on getting back to some of the questions about the investments that you have been making. Can you just give us any high-level look at perhaps as a percentage of revenue what investments will be this year perhaps compared to what they were in fiscal '05?

We have multiple investments. I don't think we have any investments that I would say is more than $5 million. The international one we don't give you an exact number. But it's not five and it's not one. We tend to start things. They tend to be in those low single digit means. But you have to realize that is $6 million is $0.01 and we're not talking about much range here. So the things we're investing right now we started the healthcare thing. It wasn't a major investment this year. We had some money there. We've got international. We've got investments in time and attendance and we obviously had some stuff in the 401(k). So we've got a bunch of them and they are all right in line with what we think we need to do. We are just going to continue to aggressively find new things to do to better ensure we get the revenue growth we want.

I don't mean to pressure you on this but can you give us any idea as a percentage of revenue what those investments in the aggregate total verses maybe where they have been historically?

The best way to look at that is to step back and say that we have a business model that we've talk about. We have a P&L that we manage pretty carefully and you're pretty familiar with those aspects. And the investments that we make we essentially self fund inside the P&L and the business model that we talk to you about. So as opposed to going to one here and one there and one the other place, it's all part of the financial formula that we're using to run the business.

Very good. Thank you.

Brandt Sakakeeny, Deutsche Bank.

John Morphy, quick question on the float balance. I think they were up about mid single digits last year and this year it looks like they are up sort of 13, 14%. What is a sustainable sort of level of growth to model going forward here for sort of '07 and beyond?

I wish I knew. I'm kind of as amazed how strong they are as you are. I wouldn't put them in at the levels they are at. I wouldn't take them all the down to the other level either. I think we have long believed there has been wage inflation in the U.S. that's higher than most people think it is. It could be it's more on the low end and I think what it is is the productivity gains in this economy in America, the people are doing better in some respects in certain areas and a lot of it is forced on material prices and other things to keep costs down. But people are getting raises and bonuses are better and it's hard for to me to tell where that goes. I think we're in a good, strong economy and we are getting a little wind out of that.

The other that's happening is helping float is my Readychex process because that is sticking in here where I get a little more float off the person's Paychex so instead of getting one day I might get two or three. So that's probably impacting it also. Hard for me to estimate but that in itself could be what a good share of what the higher than normal is and that product keeps becoming more and more taken because clients don't want to reconcile their bank account.

Great, thank you.

Gary Bisbee, Lehman Brothers.

For the healthcare health insurance business, are you using an existing sales force to sell that or are you building out a separate salesforce?

No, that is actually a licensed salesforce, so we are using people that have experience in the area or have great promise in that area and we put them through the licensing practice. But the piece where it becomes what we think is an exceptional business opportunity for us comes from the fact that our whole business model is one of referral. The 70 or 75% of our clients or more come to us referred either through existing clients or CPAs or bank affiliations that we have and so on.

This model while we will have a specialized salesforce because we are required by the state authorities to have a licensed salesforce, this model will also become a referral model. In the average year we bring in about 120,000 clients. Of that if you took again on average it's about half of that, about 60,000 of those are new business. We are talking to all of these clients with our regular payroll sales teams. It is a very natural discussion to also have a talk with them about whether or not they are interested in health benefits. And if they are, then the referral goes from our sales team to our health benefits salesforce.

So it is going to be a separate salesforce. We believe that it is going to be like our existing salesforce and incredibly productive salesforce because the majority of the leads that they have that they will get will be prequalified.

Is there any thought now that you have a lot more products than you had, say, five years ago, any thought of changing the comp plan for the salespeople to incent more cross-selling or are you comfortable that the way it's set up now you're going to continue to get real strong performance?

The answer to that is both. We are comfortable with the way that it is set up now for our current business environment. We have cross-selling. I think we've got a very good balance on the way the salesforce is constructed, the way that it is hired, trained and motivated. The work that has been done -- and this was before I ever got here -- it was all built up by the Head of Sales here, Walter Turek and a terrific set of Vice Presidents that work for him, it is one of the best managed salesforces I have ever seen and I have been in sales most of my life, 25 of which was at IBM. The whole sales methodology that we use, the information system that drives the whole sales process is really quite extraordinary.

So I feel like we are in a pretty good position right now in that we have the right emphasis that we want on cross-selling and as our product mixes change or as other things happen either environmentally or inside of our business, then we will adjust accordingly.

Okay. Can you give us any sense as to how penetrated you think the Paychex Premier product is? I know you've said recently that you're selling that in all 50 states, but is there a percentage of the potential sales routes or something like that that you've got still? Is there any way you can help us understand how long you can keep this growth going?

It's too small to calculate at the moment. Paychex Premier is in so few clients and we've got this big client base out there and it is hard to even estimate. We don't know what's possible.

Definitely it's not penetrated at all. We're early stages of its growth.

Okay. Just last question, the PEO revenue is up 9% is certainly better than I think you might have indicated you thought it would be a quarter ago. The guidance for the year seems to imply it would actually fall 10 to 15% in the fourth quarter. Is there some reason there would be such a dramatic change or maybe is that just conservatism?

It's the year-over-year workers' comp adjustment that took place last year in the last six months. This year they wound up in the first six. The best way if you really want to look at how we are doing and we gave you the numbers when you look at it, you should take Paychex Premier and the PEO and add them together. That really is the true measurement of how we're doing. Now the other thing you have to realize about the PEO while we said penetration is not measurable in the Premier, penetration in Florida I would have to give you a different answer. I don't know what's possible. PEO has been around a long time but that is only one state and it’s not that big a deal but the rest of country is very underpenetrated.

Great, thanks.

Mark Marcon, Baird.

Congratulations. I was wondering with regards to the payroll specialist increasing relative to the clients, can you talk a little bit about that in terms of what the level of increase is and what the associated benefit that you would expect in terms of retention both from the specialist as well as the client perspective would go?

Tell me what you mean when you say increasing?

In the Q it sounded like you're increasing or decreasing the number of clients per specialist service.

The thing that -- the main thing that happened in the quarter was the payroll specialists were underplanned and they caught up to their plan. When we run under plan with the payroll specialists, so if we end up running significantly underplanned, that work has to get done, right? I mean one of the things that's different about our business versus other businesses is that if the payroll is due on Tuesday, it's going to be done on Tuesday come hell or high water. If it happens to be that the branch that's doing the payroll is under three or four payroll specialists, that work gets spread to the ones that are there because it has to get done.

To the extent that you run under the payroll specialists headcount for an extended period of time, you put incredible pressure on the existing people that are working and that is one of the contributors to why we were dealing with higher attrition rates with our payroll specialists. So the reference that was made there is that we got ourselves to a point where we started to get caught up on the planned headcount for the payroll specialists. When that happens, the actual load that is being carried by those gets disseminated over a larger number, therefore it comes down a little bit. So that's basically what was happening.

Long-term, there is no question that this is going to pay great dividends for us. As you take -- as I've mentioned earlier as you take the payroll specialists attrition down, you spend less money on recruiting. You spend less money on onboarding. You spend less money in training. You do a much better job of taking care of your clients. You get stronger retention of those clients. And in the final analysis you actually save yourself money by doing this right in the first place.

Great. So it sounds like there's no change in the actual formula. The formula is essentially the same. You were just a little bit under before and now you're going back to normal plan.

That's correct.

In terms of the workers' comp insurance, is that now the predominant portion of HR excluding retirement and PEO/Premier?

No, other HR is time and attendance, handbooks, and stuff like that. I don't believe there's --

Is that half of that or is it -- how big is workers' comp insurance sales within that other bucket?

Workers' comp benefit is not the PEO part.

Right. No, I understand that. I just meant the workers' comp --

Somewhere between 25% and half. I don't know the exact number.

Great. Then in terms of the 12 to 15 normal formula, obviously you are ramping up your investments and there's some other components of compensation that will change next year. That 15% still applies. Is that correct?

That's what we keep talking about.

Great. Thanks.

Tim Willi, AG Edwards.

Two questions. The first one revolving around the sales force and productivity. I'm just curious if over the years or even in the time that you've been with the company, Jon Judge, if you looked at how the sales force is trained and taken to market and look at the successes over the prior years at the Company, are there things in your training program and once people are on the sales force and out in the field that you're doing differently in tracking that show demonstrable improvements in a salesperson's productivity in the current timeframe versus maybe where they would have been 2, 3, 4 years ago when they got out in the field and started selling?

It is hard to get that specific particularly when you're looking at a full sales force. But in general terms and admittedly this will be somewhat anecdotal, clearly when we looked at it, one of the things that we knew we had to do differently was we had to get the open territory staffed and so we got that done. That takes some pressure obviously off and it obviously is better for us.

Some of the productivity gains that we saw in this year though were really I think the result of in our budgeting process we just asked the sales force as we asked all parts of the business and the operation side and the elements of G&A, we asked them to step up and to get themselves into a position where they understood that going forward every year we were going to expect every part of the business to get more productive. So it starts with assigning in the case of sales it starts with assigning quota to the sales teams that expects that they are going to do better, but then turning around and making sure that we're making the investments that will allow them to succeed that way. Some of that is the early hires that we talked about and getting people in the territories. Some of that is understanding what some of the issues are in the field that are causing attrition and addressing those issues and so on.

So from a straight having the sales people sell better on an individual basis there's really nothing that I can think of that I can tell you that we're doing differently. I said earlier I was very impressed with the way the sales force was managed when I got here and so it's really more a tweaking thing that we've been talking about than anything else.

Thank you. The second question thinking about longer-term operating leverage opportunities that you all obviously have said you're committed to and can see, if we sort of think about the core payroll business and then the HR, any way to just give us some color on the relative impact of leveraging those two businesses from this point? Is there equal opportunity on the core payroll business versus HR in your mind? Or will one more than the other be the bigger driver over time?

Our leveraging in improved profits does not come from taking costs out. It comes from continually adding ancillary products into the revenue stream that have a higher margin than the base. It's basically we start off with a payroll product; we've got to do all the data entry; we have it. And then we add products to it, we get leveraging off of that. So it's hard to say which one is which.

Okay, thank you.

Michael Baker, Raymond James.

I was wondering if you could give us feel for the blue-collar/white-collar mix within the PEO? Then I have one follow-up.

No clue and we probably have a PEO that's more towards the white-collar because we are very risk averse in Florida.

Okay. Then in terms of the health insurance offering, which carriers are you having the most success with?

Too early. We have over 80 already.

Thanks.

Just a point though on that because it is a great question. One of the things that we have discovered as we got into this business is that different carriers are successful in different geographies. So when you go into a city you may find that the overwhelming majority of that city has actually been captured by two or three. So for our formula to be successful, we had to develop a program that would allow us to deal with multiple carriers and make sure that we always carry the offerings that were important in a city so the way that the business plan was put together assumes that we are going to have lots of carriers. And that the success rate on those carriers will probably -- particularly if they are unhappy with the penetration that they have had in small clients, when they look at us and they look at the distribution capability that we have not just the existing clients we have but the fact that we meet so many new clients every year, they get pretty excited about the prospect of teaming up with us. Now we are obviously going to have to do our part and deliver, but we feel pretty comfortable that we will be able to do that.

Thank you.

Craig Peckham, Jefferies.

The 4.4% client growth, that is a gross number, right?

What do you mean by gross?

As opposed to net, before any attrition.

No, net.

That's a net number, okay, great. I guess the other question is if we put Premier and the PEO together, how much of that combined revenue would you say comes out of California?

Oh, I don't know. It would not be -- I would guess maybe 10%? It might not even be that high.

Okay, thank you.

[Neil Detarter], Sentinel Asset Management.

Most of the question were answered but one of the things when you're talking to the clients do you get a sense from the clients that they are worried about the economy six to nine months down the road?

No, again remember who our clients are. Our clients, our average client, has about 14 employees. So they certainly don't have a corporate economist on their staff. I don't really get -- from what we can see, we don't get a feel that our clients are that nervous about the economy. Absent the number of employees that they might carry, our business model has proved to be somewhat resilient to the moves in the economy. We do get benefits when the economy as hot, but we have been relatively resilient to downturns in the economy.

The net of it is I don't think that our clients really spend that much time thinking about the economy 9, 10 months out.

Okay. Last you mentioned about the price increase that may go into effect on May 1. Now last year there was a price increase. Do you expect to have a price increase every year or is it a timeframe that you tend to have a price increase?

We have had price increases every year for almost as long back as our people can go or can see. It comes from the fact that we are continually improving the offering that we put into the marketplace and putting obviously more expense into place to make those improvements. It also comes from the fact -- it also is something that turns out to be not very much of an issue because of something we talked about as relative versus absolute. When you talk about a 3% or 4% price increase, that's a relative number. And if you think about that over long periods of time you might say well, can you really sustain 3% to 4% every year? The absolute is the interesting part because the absolute piece is $60 or $70 a year spread over 12 months.

So it's really never been an issue for our clients mostly because the value proposition that we still put forward is so extraordinary. For client we're going to try to do what we do for them on their own and charge them on the average about $2200 a year. They would be looking at who knows what they would have to spend to get that done, but it would be a multiple of that. So I think that is largely the reason that we rarely see much resistance to a price increase is because the value proposition is so strong to the client in the offering that we provide.

At this time I think we would like to take one or two more questions and we will -- we do appreciate your interest, though, so we will take one or two more.

[Robert Hsun], Citigroup.

It's Rob Hsun for Pat Burton. My question is simply a kind of a follow-up or -- to the question that was asked before about how new sales basically contribute something like 10% of the next year's revenues.

The easiest way to think about that is in the calendar year, because of the way clients come in in the year, they are spread over the 12 months and because of the very high nature of recurring revenue we have in our model, sales in the current year in our model rarely represent more than 10 or 15% of our current year revenue. They become more meaningful to us in the out years because they have the full year impact, the full year revenue impact versus in the current year. And because we have such a very large number amount of recurring revenue.

Okay, so given kind of the fact that your sales activity and the commission expense have picked up in the past two quarters, can we kind of expect that maybe that -- that in 2007 new sales in fiscal '07 we can have more than a 10% contribution to revenues from new sales?

It will depend more on the economy than it will on that.

It would be unlikely. Again, this is really more an issue of numerator and denominator than anything else. The size of the recurring revenue is so high that it is unlikely just based on history it is unlikely that the sales efforts in the current year would jump above 15%. It would be terrific if it did. But it is unlikely not because of a negative. It is unlikely because of a positive and that positive is the enormity of the recurring revenue that we have.

Great. Thanks, guys.

Okay. I want to thank you very much for your interest in Paychex. A lot of good questions and hopefully we gave you a lot of good answers. Again we think we are a great Company. We think we've had a great quarter and we think we've got some stuff in front of us. As always we really greatly appreciate all your interest in us. So thank you and I hope spring is coming your way. It is sunny here in Rochester, so that looks good too. Take care. Thank you.