沛齊 (PAYX) 2007 Q2 法說會逐字稿

Welcome and thank you for standing by.

At this time, all participants are in a listen-only mode. (OPERATOR INSTRUCTIONS) Today's conference is being recorded.

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

Now I would like to introduce John Morphy, Senior Vice President and Chief Financial Officer of Paychex.

Thank you, sir; you may begin.

Thank you for joining us for our second-quarter earnings release.

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

The teleconference call will be comprised of three sections, a review of second-quarter 2007 financial results including comments and guidance for full-year fiscal 2007, an overview from Jon, and lastly a Q&A session.

Yesterday afternoon after the market closed, we released our financial results for the second quarter ended November 30, 2006.

This press release can be obtained by accessing our website at the Investor Relations page, www.Paychex.com.

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

This filing is also available on our website.

In addition, this teleconference is being broadcast over the Internet and will be archived and available for access on our website until January 22, 2007.

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

Second-quarter highlights.

Another excellent record-producing quarter for Paychex.

Net income increased 18% to $133 million.

Diluted earnings per share increased 17% to $0.35.

Payroll Services revenue grew 9%.

Human Resource Services revenue increased 24%.

Total revenue was up 14%.

We increased our regular quarterly dividend by 31% to $0.21 per share.

We were pleased to see growth in the service revenue of slightly over 12%, which is primarily driven by a continued stable economy and growth in our Human Resources Services revenue.

We continue to leverage our revenue growth with operating income growing faster than revenues.

Operating income, excluding interest on funds held for clients and stock-based compensation cost, increased 15% to $158 million and 14% to $321 million for the three and six months ended November 30, 2006, respectively.

Operating income excluding interest on funds held for clients and stock-based compensation cost as a percentage of service revenue was 37% and 38% for the three and six months ended November 30, 2006, respectively.

For both periods that was about 1% better than the prior year.

Before moving on to comments on the income statement, I would like to thank those people who issue reports between yesterday's release and our call this morning.

An unexpected advantage of our filing the 10-Q before the call is that your releases provides us with a good idea of the areas you'll ask questions about.

Hopefully the following comments will provide color in our key areas.

We will now refer to the income statement.

Payroll Service revenue increased 9% for both the three months and six months ended November 30, 2006, to $332 million and $667 million.

This growth was again driven primarily by higher check volume, price increases, client growth, and growth in the utilization of our ancillary services.

All of our key indicators on the payroll growth continue to be positive, and we have seen no signs of a weakening economy.

The next few weeks will provide another good measurement of the strength of the economy as the year-end bonus season works its way through the Paychex system.

As of November 30, 2006, 92% of all clients utilized our payroll tax administration services and 70% utilized the employee payment services.

Approximately 85% of new clients utilize our employee payment services including direct deposit, Access cards, and Readychex.

Human Resource Services revenue increased 24% for both the three months and six months ended November 30, 2006, to $93 million and $187 million.

The growth was generated from the following.

Retirement services client base increased 14% to 41,000 clients.

Client employees for our comprehensive human resource outsourcing services increased 31% to 328,000 client employees.

Workers compensation services client base increased 18% to 56,000 clients.

Additionally the asset value of retirement services, client employees funds, benefited from the stock market and increased 25% to $7.2 billion.

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

The federal funds rate, which was at 1% at June 1, 2004, has steadily increased to 5.25% through June 29, 2006.

The average interest rate on funds held for clients has increased to 4% from 2.9% a year ago.

Interest on funds held for clients increased 43% and 49% during the three months and six months ended November 30, 2006, to $30 million and $60 million respectively.

The increases in interest on funds held for clients were due to higher average interest rates earned and higher average investment balances.

The current effect of higher average interest rates is expected to diminish as the federal funds rate has remained unchanged since June 29, 2006.

Interest on funds held for clients is expected to increase 20% to 25% during the last six months of fiscal 2007.

Consolidated operating and selling, general, and administrative expenses increased 13% for both the three months and six months ended November 30, 2006.

The increases were due to our continued investment in personnel and other costs related to retaining clients, promoting new services, and creating more efficient systems for selling and servicing through new and enhanced technology.

Total expense growth would have been 11% excluding stock-based compensation costs.

As of November 30, 2006, our employees increased 8.5% from 10,600 employees a year ago to 11,500 employees at the end of the quarter.

Our stock-based compensation costs and the adoption of FAS 123(R) included in compensation-related expenses were $5.8 million and $12.3 million for the three and six months ended November 30, 2006.

Stock-based compensation expense was slightly lower than normal in the second quarter, due to a slightly higher than normal forfeiture rate that we do not expect to reoccur.

Please refer to form 10-Q for additional information regarding stock-based compensation costs.

Investment income net increased 79% and 86% for the three months and six months ended November 30, 2006.

This was due to higher average interest rates earned and growth on the average portfolio balances resultant from investment of cash generated from our ongoing operations.

Our effective income tax rate was 31.0% for both the three and six months ended November 30, 2006, compared with 31.4% for the same periods a year ago.

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 portfolios, and a lower effective state income tax rate, partially offset by the nondeductible compensation related to incentive stock option grants.

I will now move to a discussion of the balance sheet.

Cash, corporate investments, and long-term corporate investment were $1.1 billion as of November 30, 2006.

Our cash flows from operations were again strong at $279 million for the six months ended November 30, 2006, an increase of 19% or approximately $45 million from the same period a year ago.

During the second quarter we raised our dividend 31% and expect dividend payments of approximately $300 million in fiscal 2007.

Our total available for sale investments, including corporate investments and funds held for clients, reflected net unrealized losses of $2.8 million at November 30, 2006, compared with a net unrealized loss position of $22 million at May 31, 2006, and net unrealized losses of $19.9 million at November 30, 2005.

The change in the unrealized loss position is due to decreasing yields that increased the fair value of the Company's investment portfolio.

The three-year AAA municipal securities yield decreased to 3.50% at November 30, 2006, from 3.65% at May 31, 2006.

Our net property and equipment balance activity during the first six months of fiscal 2007 reflected capital expenditures of approximately $40 million and depreciation expense of approximately $28 million.

Client fund deposits as of November 30, 2006, increased to $3.8 billion from $3.6 billion as of the end of last fiscal year.

Client fund deposits vary widely on a day-to-day basis, and the average balance increased 5.9% and 7.1% for the three months and six months ended November 30, 2006.

The growth in client fund deposits was adversely affected by more tax pay clients falling under the next day tax withholding payment requirement and the continued growth of direct deposit products, which does not retain client fund deposits for as long as tax (inaudible).

Total stockholders equity increased to $1.8 billion at November 30, 2006, with $141 million in dividends paid in the first six months of fiscal 2007.

Our return on equity was a strong 30%.

Looking at guidance for fiscal 2007, our current outlook for fiscal 2007 remains unchanged from the guidance provided at the end of our first quarter; and except for the change in the federal funds rate on June 29, 2006, this guidance is virtually unchanged from the guidance we provided at the start of the current fiscal year.

Payroll Service revenue growth is expected to be in the range of 9% to 11%.

Human Resource Services revenue growth is expected to be in the range of 20% to 23%.

Total service revenue growth is projected to be in the range of 11% to 13%.

Interest on funds held for clients is expected to increase approximately 30% to 35%.

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

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

Stock-based compensation costs will be primarily included in selling, general, and administrative expenses and are expected to be in the range of $25 million to $30 million.

Effective income tax rate is expected to approximate 31.0%.

Net income growth is expected to be in the range of 13% to 15%.

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

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 statement on page 3 of the press release for our discussion of forward-looking statements and the related risk factors.

I will now turn the meeting over to Jon Judge.

Thanks, John.

I just want to add few comments behind John's, and then we will open it up to questions.

First and foremost I would like to say Merry Christmas almost and happy holidays to all of you on the call; and thank you again for taking the time to talk with us about our Company and its performance.

John did a really good job I think of taking you through the financial results for our fiscal second quarter.

As you saw, it was a very good, very solid quarter for us, which -- when coupled with the strong performance of the first quarter -- leaves us very pleased with where we are at the halfway mark.

In all key performance measurement areas we are very much on track to producing another record-breaking year and well within the range required to give us the confidence to reaffirm our full-year guidance.

Our employees around the Company are proud of what they've accomplished this quarter, the financial results John conveyed and more.

Client satisfaction survey scores are at an all-time high, resulting in record levels of client retention.

All this while also driving some of the highest levels of operating efficiency ever.

All in all, a very strong quarter.

In addition, our teams are getting ready for one of the busiest times of the year, December and January.

The sales teams have been driving for a strong January since October.

January is always our biggest sales month.

There is terrific energy and activities getting ready for it.

Our ops teams have a huge amount of work in front of them over the next two months, both in the year-end close activities for our clients and the enormous new client loads that occur each January thanks to the excellent sales performance from our sales teams.

Last year the year-end close was almost flawless.

In fact, most W-2s were in our clients' hands between one and two weeks early.

We've done all the prep work and are hoping and expecting the same great this year as we close the books for our clients at the end of December.

The economy has also been favorable to us, particularly those aspects of the economy that affect our business area.

New hire reporting inside our clients was up 3.2% this quarter versus 1.9% a year ago.

The 3.2% was helped by a very strong November of 5% job growth.

That coupled with the relative stability of existing employee counts at our clients led to a very nice performance in check volume.

Of course you know the Fed fund rates of 5.25% were up versus 4% last year, so it helped us, given the large average daily balance of funds held for clients that we have.

So all in all, the economy was also very helpful to us.

So given all that, our reflections at the halfway mark are pretty positive.

We feel really good about where we are and what we see in front of us.

In all areas of the guidance we provided earlier in the year, we are performing well and are on very firm ground as we reaffirm that guidance.

We have very good plans in place for the second half and a terrific team in place to execute them.

We look forward to the rest of this year and finishing at the record levels that we plan for.

At this time, John and I would be happy to take any questions that you might have for us.

(OPERATOR INSTRUCTIONS) Rod Bourgeois, Bernstein.

A couple of questions.

First on the health insurance brokerage business that you guys are kind of in the lead in the industry on pursuing at this point.

Can you update us on your progress in the health insurance sales business?

What is the progress since the last time we spoke there?

I guess first I would correct you by saying that we are not in the lead, since this is a business that we are entering, although we would agree with you that that would be our objective.

I guess I was mentioning versus other payroll processing companies that are thinking about going in that direction.

It is clear that you are ahead in that regard.

Sure.

Things are going well.

We have talked quite openly about what our plans are in this area.

We are very excited about the marketplace, the prospects of the marketplace, and quite frankly about our positioning.

This has become the number one investment activity that we have in front of us.

We have staffed the sales teams about 100 salespeople at this point.

The rollout of the insurance area both in the way that we have staffed it as well as the work that we're doing in the back office to be prepared for this being hopefully a significant business for us someday, it is all going well.

So everything that we see in that area is positive and the reaction we're getting in the marketplace is pretty much in line with what we expected to get.

So we feel pretty good about it.

Any specific numbers on number of new clients signed up or plans to add to your licensed sales force, or any specific numbers you can provide?

Too early to do that.

We've got to wait and see the results.

We will know more and I'm sure at year-end we will be giving out some numbers when we know more.

The sales force is all in place.

Everything is pretty much where we want it to be, but it is still early in the game.

Got it.

You mentioned the client hiring activity with growth of 3.2%, which is solid.

I was wondering if you could give us any other specific metrics to allow us to gauge the health of the economic environment within your small-business client base.

Can you talk about new business formation happening in your target client segment; or the specific check volume growth number that you experienced this year versus last year?

You know that we don't publish the check volume numbers, so I can't give you that.

Probably the piece that is in front of us that will be helpful to us and to you, which is yet to come, is the bonuses that occur at year end.

The next time that we get together and talk we will give you any information that we have on the bonuses.

The bonuses paid by our clients to their employees are a very good indication of their view of the health of their business; and so we will share that with you.

But the main numbers that we watch are the ones that we shared with you.

There is no way to get an early read on the bonuses?

That is something you don't know about until it happens?

It is incomplete at this point.

It hasn't happened in most cases and until the numbers are complete they really wouldn't mean anything to you.

(multiple speakers) days are next week; and since companies will process this bonus activity literally the day or two days before we see it, the game is alive when we see it and I think that will be a good measurement factor.

Because everything right now in the economy, as Jon stated, is positive.

I won't say anything is emerging a lot, but it is very positive, no signs of weakness.

But the next few weeks will give us a little bit of a view on what's going on.

Has churn dropped further again in the quarter?

It has been showing a nice trend over the last year.

Is it continuing to come down, client churn?

Churn inside the client?

Yes.

That was the point that I made to you about relative stability in their client base, so there's not a lot of churn going on as we see it.

But your client churn dropped below 20% a couple of quarters ago.

Is that --?

You're talking about client retention?

Is that what you are talking about?

Yes, well, the client retention has been going up; and the inverse of that is client churn, which has been coming down.

That is a term that you use that we don't use.

But yes -- no, that is what I mentioned earlier about in the quarter the level of the success that we had with client retention was at record levels, so you know that we publish numbers in the 20% range, and we are beating those right now.

Okay, great.

Thanks.

Brandt Sakakeeny, Deutsche Bank.

I have two quick questions.

First, John Morphy, should we assume that the forfeiture rates are going to [sit] going forward and that it will be close to $0.01 on stock option cost?

Stock option cost will probably be pretty close to what it was in the first quarter.

There is some volatility, not much.

We had just an unusual situation in the second quarter that we know is not going to repeat.

Okay, that's helpful.

Thanks.

I guess for Jon Judge, can you just update us on the payroll platforms?

Maybe give us an update on the InterPay Advantage integrations and sort of what platforms they are using for their core payroll?

Also to that end, what is happening in the major market segments?

Thanks.

You're talking about the payroll platforms we use inside of our Company?

No, for InterPay and Advantage.

For their clients.

Have you transitioned their clients onto a different platform?

Or are they still using the core Advantage platform for Advantage customers and the InterPay platform for InterPay customers?

There is really been no change in that in the last year or two.

In the case of InterPay and Advantage, InterPay we migrated onto our platform almost immediately; so they have been fully integrated onto our platform for some period of time now and no change there.

In the case of Advantage, most of the Advantage clients we left on the Advantage platform.

It is a stable platform.

It is producing very high client retention levels.

So we have left them on that platform and they will stay on that platform for the foreseeable future.

So again, no change there either.

The Advantage platform, we also have the associates that we support.

This is a group of people that were involved when we purchased Advantage, and we are very committed to servicing them and giving them the same level of service that our other Advantage customers are getting.

So that will be on that platform for a while.

As Jon said, retention is absolutely the best retention we have in the Company.

Some of that is because we're not adding a lot of new customers, but the platform is very stable and not expensive to maintain.

Great.

With respect to the major market segments, can you just give us an update on growth there and also what type of platform is being deployed for those clients?

Is at all different than the core platform, or the core Paychex platform that you have traditionally used?

The MMS platform is the one we purchased from Olsen back in '95.

That platform is absolutely the differentiator in being able to compete in the 50-plus marketplace.

We have improved the platform greatly over the last three or four years to where we don't believe we have any disadvantages when we compete with ADP in this marketplace -- and actually have some things that are actually better than what they have.

In the old days, a client would look at us and tell us what they needed; and we would say, I guess have you got to use ADP.

We don't have to say that anymore.

Now the individual growth rates in MMS to me no longer are that meaningful, because MMS has been here quite a while.

It is in all the branches.

One-third of the clients come from core, and sales that used to go into core now go into MMS because core can handle obviously clients above 50.

So the product continues to be excellent.

We have only stopped giving the revenue number because you really want to look at payroll with the two combined.

That is how we look at it here at Paychex today.

But the product is great and the sales forces are -- is has got our strongest people in it.

That sales force also has the least turnover in it.

So it is going well.

Perfect, great.

Thank you.

Bryan Keane, Prudential.

The Human Resources division popped up a little bit.

I guess inside there you got couple different divisions -- retirement, comprehensive resource outsourcing.

I guess I was just trying to figure out -- is any of those groups outperforming your expectations or anything that is underperforming that needs to improve there?

I would say, Bryan, it is pretty much about on target.

When you say it popped up a little bit, about $1.5 million pops it up on 100, so it is pretty close to what we would see.

We know this one is a little more volatile than what our other stuff is.

So 24 this quarter could be 20 or 21 the next quarter, and that would not alarm us at all.

401(k) continues to go real well.

We are finding, though, the multifund takes a little bit longer to get the client converted.

A little more complicated.

This is nothing unusual when we add a new product.

Over time we will get that so it goes as streamlined as the other one.

But at the moment it is taking a little bit longer; but everything else is pretty much right on target.

Okay.

The other question I get often is on acquisitions.

Anything in the pipeline that you guys are targeting, kind of areas that you will be tackling, or things that could be imminent?

We're looking all the time.

But it's hard to find things.

When we find them, we will buy them.

But our ideal acquisition, though, is something that is relatively small that we can leverage the hell out of.

But there's probably not very many core payment platforms of any size.

Obviously we know most of them.

But it doesn't look like there's that many of those out there.

Or do you just sort of try to buy out a lot of little ones to make up for that?

We would not be looking for platforms.

When we buy, we buy lots of small payroll companies each year.

We will continue to do that.

Typically when we buy them, because of the nature of our business, which is a very highly a referral business, we will buy those companies; we will take the clients; convert them over to our platform; and then throw everything else away.

Again, because we need them on our platform to be able to get them to refer to future customers.

So there is nothing in the payroll side on a platform basis we would be looking for.

What we typically look for in the nonpayroll companies are people that have experience or systems in areas that we're not in today that might be a good fit for our Company and for our clients.

We have -- because of the nature of our business, with having 550,000 clients in the small-business arena, anybody who makes something that they want to sell to that marketplace normally will contact us.

So we have a pretty good view of the different companies that are out there.

As John said, we don't have appetite for large acquisitions.

That is not to say it would never happen, but it would start out with a pretty negative view from the management team.

We tend to look at smaller acquisitions that we can snap into our infrastructure and then leverage the existing business models that we have, whether that is our distribution channel or whether that is our client base or what have you.

So -- and as soon as we get to a point --.

We are always looking.

We have a function inside of our business that that is what it does for a living is look at potential acquisition alternatives for us.

As soon as we get one to the point where we think it is appropriate to talk about it, we will clearly talk to you about it.

Okay.

Remind me, how many clients do you typically acquire each year on an average basis?

1,000 to 1,500, but that might be -- that could be 50 acquisitions.

We do them literally -- once the branch manager and the salesperson looked at it, they process through here in about 30 minutes.

Okay, great.

Congratulations on a solid quarter.

Pat Burton, Citigroup.

Congratulations.

I think the results speak for themselves.

My question I guess will be with the dividend increase, a very substantial 31% hike.

Where do you see the payout ratio going over time, to either one of you Johns on that, please?

We're not limited to any specific number.

I will let Jon give his coverage.

But we believe the dividend at the moment is the best way to pass the money back.

We look at the payout factor.

It is our ability to continue to product cash that is a bigger indicator.

We have this conversation at every one of our Board meetings, and it is inevitable that we will have it again at the next Board meeting.

At least once a year, sometimes more, we look at the different alternatives for the use of the cash that we have, both [$1 billion] plus or minus that is on the balance sheet as well as the cash flow that we generate from our operations.

We have looked at stock repurchase every year.

We look at one-time dividends and so on.

The general feeling that the Board has had in the past, and I suspect will have going forward, is the best use of that cash, after we get to a certain level that we believe we need on the balance sheet, is to just distribute it right back into the shareholders.

That is why you saw the increase in the dividend.

The thing that we do to get ready for that, when we talk with the Board, is we give them a flavor for how we feel about our ability to sustain any increase to our dividends.

We don't want to put it on this year and take it off next year.

So we give them a feeling about our confidence in being able to sustain the dividend.

Once again to that point we increase it.

Unless somebody comes up with a better idea for us about what to do with the cash that we have on our balance sheet and what we generate, we are going to continue -- I think is reasonable to assume; obviously it's decision that has to made by the Board -- but we believe that we are going to continue to keep pushing that money out the form of dividends.

So it would be reasonable to assume that we will continue to increase the dividend over time.

Thank you.

Yes, it is a tremendous yield for a company of your quality and growth prospects.

Thanks.

Keep it up.

David Grossman, Thomas Weisel partners.

John Morphy, you made some comments about what impacted float or (indiscernible) balances year-over-year.

I am looking; could you just review that again?

Is that something that is a moment in time?

Or is that something that we should expect to continue to impact the growth in those balances over the next several quarters?

You know, over the last about 18 months the float balance increase has actually been surprising me on the positive side.

This time we're probably slightly surprised on the downside, nothing real significant.

We continue to look at our data, because to look at this data you have got to go through mounds of data to see it.

But we do have the trend that we know is happening, where more and more of the money that is in client funds is direct deposit money.

Direct deposit money we only hold for one day, whereas the tax pay money on average you hold it for something more than one.

The other thing that happened is we are seeing an increase in the number of tax pay accounts that have to remit within one day, once you over the $100,000 limit.

So we have got a couple trends that started to move the other way in the quarter.

Whether they're going to be continual or not, I don't know the answer to that.

Some of this will be continual, but I will know a little more after we look at this deeper and deeper and take a harder look at it.

In terms of the rates, it sounds like from your commentary that based on the structure of the portfolio that, without any change in the rates, we should expect flattish sequential overall yields for both corporate and client funds.

Is that a correct conclusion (multiple speakers)?

I think the yields are going to stay constant.

The long-term yield has actually going down slightly when you look at the AAA munis.

So I think yields are going to say about the same.

So when you take this floating comment, it is going to change off the acceleration down to something that is going to be less than it was.

That is why we changed the -- we focused on the guidance for the last six months.

So the year-over-year anniversary is out at the end of June then?

Most of it is going to be out at the end of May, because the last increase was June 29.

But that is only 25 basis points. 25 basis points on a run that was 1 to 5.25, there's not much left.

Right.

Just one last question on the insurance.

I know you mentioned there is not a lot to tell.

Could you just remind us what your sales headcount is now and what your objective is going into next year?

The sales headcount, and I will be close, it is something right around 100.

What was the second part?

What your objective is going into next year in terms of the headcount.

I don't think I want to necessarily say that.

But what we have decided to do on this, when we put the pro forma together on the business and we put the model together on getting into the business, one of the gates that was tamping down the growth was the ability for us to deploy the sales force at a rate that we felt was reasonable, given the fact that we have to train them and get them integrated.

So the thing that will slow it down at least in the first couple years will actually be the ability for us to integrate it.

So we're not going to try and put 500 or 1,000 salespeople out there.

So we will grow it as fast as we can, and do it under control, and build the business up as quick as we can, but do it under control.

Okay, great.

Thanks very much.

Liz Grausam, Goldman Sachs.

Just on the portfolio and the duration, I think we talked last quarter about potentially extending the duration of that, given the interest rate environment and the outlook into '07.

Can you just discuss any measures you're taking there, John?

We're moving the duration out some; but because of the rules we can't sell off the portfolio.

You can't move it very fast.

But we think things are going to stay pretty stable here.

Okay, great.

Just your enthusiasm for the insurance business, you have clearly beaten now two quarters in your new fiscal year and have the ability to spend more if you so chose.

What is your enthusiasm level for that insurance business?

Are you going to continue to heavily invest in that and really drive the top line for that business going into '08 and '09?

Is one of the areas that we are investing in; and yes, we will clearly continue to invest in that unless something clearly unforeseen happens.

That, as I said earlier, is the number-one investment area that we have going on right now; and there will be others.

But going back to the discipline that we use in running the Company, we set the guidance.

When the set the guidance, included in that guidance is the assumption that we're going to invest some relatively modest amount of our income, but some of our income, into projects that will help us in the out-years.

But first and foremost is once we set the guidance and we set our plans, we're going to make those plans.

So we drive as hard as we can at the top line, which helps all things.

But if we don't get the growth at the top line that we want, we will manage the expense part of the Company to make sure that we hit the bottom line.

So we do all of this in sort of a holistic way.

We're not driving these things independent of one another.

So the investments that we make are very much done with the light on the entire portfolio of businesses that we have and we will continue to run it that way.

What are some of the other areas outside of insurance that you really see as large opportunities for the Company going forward, of new investments?

We invest in our sales force every year.

We grow our sales force every year that goes after the existing business in the U.S.

We are constantly looking at adding products into the portfolio.

John spoke recently about the investments or the addition that we made of something that we have called internally multifund.

But it is the ability in the 401(k) environment for us to do the recordkeeping for any client that we bring into the Paychex family.

In the past, the only 401(k) products that we could handle were the portfolio of products that came from five money managers that we had a partnership with.

So if you were not willing to use one of those five money managers, or those specific programs inside the money managers, then we didn't have the chance to do the 401(k) recordkeeping for those clients.

With the investments that we made on our systems to be able to open those funds up, we can now literally take any equity based 401(k) plan and run it, the recordkeeping, from a Paychex standpoint.

That was a year-long investment that we made.

We think that is going to have great results for us.

If you look at any of the areas that we have, we are constantly trying to find ways to improve the existing offerings we have and other ones; and we just keep investing in those.

Besides that you know that we have an investment that is going on in Germany.

That again, for it to be material is going to take a long period of time, but we continue to invest there.

We have investment in time and attendance software, and we continue our investments there.

So there is a whole variety of different areas that we are investing money and luckily so far they've been paying off pretty well.

Great, thank you.

Happy holidays.

Tim Willi, AG Edwards.

A couple quick questions.

First on the topic of the health insurance, could you just offer up any comments that you might have on sort of how your customer base is thinking about -- for those that have health insurance or you're talking to -- about the consumer directed health plans, the HSA accounts, and sort of -- is that an additional opportunity for you at some point down the road?

Then I have a couple follow-ups.

We will continue to look at all those things.

HSAs are very small, not anything really active at the moment.

I think we offer them; but we're not selling a whole lot of those.

But the health insurance thing, the thing we have to do -- and it happens at all these businesses -- this opportunity is I think one of the best I have seen since I've got here.

But I also know at the same time it's going to be very similar to 401(k); it is going to take a little while till we get fully recognized as somebody that provides this, so the referral bases get to know it.

It's just going to take a little bit of time.

But everything we see is very positive.

If HSAs start to pick up, we are right here.

We can adjust to whatever happens, but so far we haven't seen too much there.

Okay.

Then on 401(k) if I remember correctly, one of the things I thought you guys might have done over the last year, year and a half, is I thought you had mentioned sort of a 401(k), quote unquote, lite program that would be much more simple and easier for maybe the smaller end of your customer base to utilize.

How has that been received?

We have those in place and they're going quite well.

Okay.

The last question is in terms of new products and services, do you hear or see from your clients a need for help in terms of recruiting, or making sure that they are interviewing and hiring the right people in an effort to try to increase the stability of their workforce and deal with tight labor markets?

The answer is yes.

What we do for them mostly is we're focused on the applicant tracking side of it, not to do that as a service.

So we have no interest in getting into the recruiting business per se.

But in terms of helping them manage the recruiting process, we are absolutely interested in that.

Okay, great.

Thank you.

Adam Frisch, UBS.

Steve Stout for Adam.

First of all, congrats on the quarter.

It was definitely impressive results again, and a nice holiday treat.

Same here.

I wanted to see if we could just talk a little bit about kind of the back half of the year.

We've talked about you're going to have a little bit more difficult comps.

Can you talk a little bit about your SG&A and kind of what factors might impact that in the second half, in terms of maybe the advanced hiring that you did last year?

Basically -- and that is why I made comment, that our guidance really, except for the interest rate change, is unchanged from what we gave last June.

We start off the year; we have a pretty good idea where revenue will go.

The economy has stayed stable, so I don't think we have any surprises on revenue.

Not as much plus side as we had a year ago when the thing kind of went to a place we didn't see coming.

So it is predictable.

Our results, we give the guidance as for the fully year.

One thing we have been able to do is we thought the year was going to be back-ended a little bit more.

By watching expenses plus a real commitment from the management team to get back to 12 and 15 as soon as possible, which we achieved in this quarter, we probably moved some expenses, maybe some expenses out, watching.

Now the thing you have to realize when you go through this whole thing you're not talking about a lot of money moving. $3 million or $4 million moving from one quarter to another affects these percentages higher than what you might expect.

So we went into the year with a plan.

We are pretty much still on the plan.

Our operating people and the salespeople did a real good job watching expenses; and we asked them to, to take out the kind of what I call the choose-able expenses.

Not the ones you have got to have.

They were able to do that; and we're looking forward to good back end on the year, but right in line with what we had planned to do at the beginning.

The only other thing I might add to that, I mentioned it in the last call that we were on -- one of the things that we do as part of the normal management here is we look at all expenses in the future and sort of prioritize those from a must-have to a nice-to-have in the event that we have to make any adjustments in the second half of the year.

So as John said we don't see anything that would tell us that we have got a revenue problem.

But were one to crop up we would immediately clamp down on the expenses.

The discipline in the business is such that there won't be any surprise expenses, certainly none that we can control in the second half of the year, just because we won't allow it.

Right, I was just wondering if you could give me some color as to what are the factors that could potentially make that SG&A line different in the second half and the numbers we've seen in the first half of the year; you know, the [1.24], the [1.21].

(multiple speakers) The main thing that could change it that I could see -- because if you look at what comprises it, it is largely driven by people and commissions; and we control the people.

So the piece that could drive it would be if we had extraordinary success in selling, we could have additional commission expenses.

But those are the kinds of things that we actually look forward to.

I love getting expense when I only get it because I got the revenue.

Any thoughts to doing anything different in terms of the hiring or the timing of your hires in the back half of the year?

We will do the same thing that we did last year.

When we get into the fourth quarter, in our budgets today we have some prehiring already planned in the budgets to make sure that we are at full staff, full strength when we get to the beginning of the next fiscal year.

So that part is pretty standard.

If it turns out that we have more money and there's some things that makes sense for us to use that money for, in terms of expenses in the year, and we can afford it inside of our guidance and our budgets, then we will consider it.

But right now I don't see any of that happening.

Okay, thanks a lot, guys.

Craig Peckham, Jefferies & Co.

As you look at the 543,000 payroll clients you have today, can you give us a sense for how many of those or what percentage of those roughly are sort of the optimal targets for the health insurance offering?

About 25% have some form of healthcare that we can see, because we can see copay, which most of them have.

Obviously the larger clients, I think this is going to be -- this product, the more it just goes along, it shapes up just like what happened in 401(k).

With what we learned on that we might able to accelerate this a little bit, but not too much.

What you'll find is the best client choice is going to the new one that doesn't have any healthcare.

Then the next one is going to be if you can get somebody to switch.

We just don't know how successful that is going to be, because we think healthcare is something people want to hang on to.

But we will see what happens over time.

I think we're going to be successful, but it will keep changing.

But you've got to remember our client base churns enough naturally with basically selling so-called 24% and losing 20% that the existing base over four or five years changes pretty quickly.

I think the timing, by the way, is right for us.

It is not something that we count on, and it is not in our pro forma.

But I think timing is right as well.

I think healthcare is one of those social issues that the political process will drive pretty hard.

Are we still running at about 100 different carriers?

Where do we see that going?

We are, and we see it going to a few hundred.

It will be whatever it takes for us to have the right players in place for the markets that we are going in.

The research that we have done suggests to us that each city has two or three people, two or three carriers that dominate that city.

If you're not able to represent those carriers, then obviously you are limiting your ability to have success.

So we'll have a number of carriers that we need to have the offerings that we need for the geographies that we're going after.

The obvious balance there is to make sure that we are being careful about carrying enough carriers to be successful; but not so much that the administrative cost of doing so offsets our success.

We believe a high percentage of this, probably greater than 75%, at the end the day will be in less than 25 carriers.

One more HR question for you.

Can you give us a little bit of a sense for -- of the 25% increase in retirement services assets, how much of that is coming from, say, new customers coming on as opposed to organic asset growth?

No, that lump was the market movement.

Market moved, and those assets moved.

Just like when they go down, they go down.

So the 25% you are saying is all --?

Don't try to judge what that does by what the client base is doing, because there is no parallel.

There is some, but it is not very much.

Okay, thanks.

Gary Bisbee, Lehman Brothers.

Adding my congratulations on the quarter.

Can you give us a sense at all of what percent of the HR growth is coming from upselling of extra services to existing payroll customers, versus brand-new customers to the Company that presumably would be doing payroll in addition to signing up for HR?

I think it is about 50-50.

Has that been changing much?

No.

About the same.

On the 401(k) program, you mentioned it is taking a little more time.

But it wasn't clear to me.

Were you talking about you have signed up clients and it's taking time to get them on to the system?

Or the sales cycle is longer, such that it's taking longer to actually sign up the new clients?

It is more the sign-up period.

The sales cycle might be slightly longer, but not much.

It is more the sign-up period.

You have got to interface with all the new fund managers.

As we get deeper into this, we will have more interfaces.

You know, in the old days you only interfaced with four of them; so it was pretty simple.

But we are getting it.

They're working on the process.

It is just like anything else we do.

We are a little too aggressive sometimes on what we thing we can do in the next two weeks; but eventually we fix it all and it works real well.

They are in the middle of doing that.

All right, so you don't have any reason to believe that the customer interest or uptake of this is going to be different than you initially thought?

It is just a matter of getting to the point where you are executing it right?

Right, and also getting them all to be aware of it.

The other thing is we would not want everybody to ask for this tomorrow.

Okay.

When we look the interest rate you're earning on the float and then on your corporate balances, it looks at least in recent history like you are being more conservative investing the corporate balance.

Is it safe to assume that it is probably going to continue to be this 30 to 40 basis point discount versus the rate you're earning on client float?

Or could that -- as interest rates sort of stabilize here, is the corporate wanting you to move up towards what you're earning on the client float?

Actually I would come to the same conclusion you just gave me if I was just looking at the data and you didn't have the knowledge I have.

Basically what is, is the corporate funds, which are more predictable and less volatile, are invested more in long-term.

The client funds are invested more in the short-term.

So what you have got is you have got a portfolio; and what we do is we invest long-term all the money we know we will always have.

That number keeps increasing, but the volatility is all in the other one.

So it just turns out that one has more of the long-term portfolio than the other one.

That is why the rate differences are there.

Okay, so if we were see the yield curve sort of normalize at some point, then the rate you were earning on the corporate funds would actually potentially go up?

Give you an example.

When rates drop, the corporate fund is going to earn more than the other one.

All right, great.

Then just to clarify, I'm sorry -- actually last question.

The job market has continued to be pretty strong.

Obviously your clients are hiring.

Have you seen any change in terms of your internal hiring for the sales force or for service people?

Has that gotten any more difficult, or is that still pretty easy for you to grow your employee headcount?

You mean in finding qualified candidates?

Yes, exactly.

That's not a problem.

Okay.

All right.

Thanks a lot.

Mark Marcon, Baird.

Let me add my congratulations.

With regards to the core payroll, can you talk a little bit about the new client adds during the quarter?

Were you up running around 4%?

We only comment on client growth once a year. (multiple speakers) time to look at it any way because the moment of truth is the next eight weeks.

That was going to be my next question.

If we take a look at the core payroll revenue growth relative to the acceleration in terms of the sales force adds, would you expect that the real kick from the increase in the new salespeople and the acceleration of that process will really be visible when we report the next quarter?

No.

I'm not sure that would ever be very visible.

Because when you talk about a client base of 540,000, a sales force of 2,000 people, the number of early adds -- it makes sure we get the territories full.

And I think what it does, it guarantees better that we're going to make our goal.

I don't think it accelerated anything above and beyond that.

It is not enough of a change to influence it.

Okay, but in terms of getting towards the goals, you're feeling better about that?

We keep moving towards the goals, but as I said the moment of truth is coming.

So I feel good, but January has almost 25% of the clients that are added for the whole year.

Okay.

In terms of the health insurance initiative, did it add anything to HRS this quarter?

Not materially.

Not materially?

Are the results that you're seeing currently in the markets that you initially rolled out right after the test markets, are those results consistent with your test markets?

Yes, we are selling pretty much what we expected to sell.

But as I said it is real early and the numbers are not that big.

We are getting people educated.

But we are happy with where it is going, but we're going to keep telling you that this is a great opportunity.

But it's like everything else in our world.

Nothing happens real quick.

Sure.

With regards to one of your key initiatives in terms of decreasing sales force turnover, can you give us a sense for how that's going?

We had a good year last year, as I think reported the last time or two times ago that we talked.

We continue to do well both in the sales side and in the payroll specialist side.

So it continues to improve?

Continues to improve and that will help show some results in terms of the performance of people in their jobs.

I have been here obviously longer than Jon has.

I would say the improvement over the last 18 months is one of the longest sustained periods we have had improvement.

Terrific.

Then from your perspective, are you seeing any change at all in the competitive environment?

Not really.

Everybody talks about this stuff with ADP; but no, the environment is pretty much the same.

Since we bought Advantage and InterPay it is us and ADP doing our thing.

They are aggressive, we are aggressive.

We're both pushing to provide the maximum shareholder value we can both produce.

We're both outstanding companies.

They were a great role model.

Then you got all the little guys running around, and that hasn't changed very much, except there aren't as many big ones.

Okay.

As we look out towards the next quarter we should see our normal sort of sequential increase in terms of the commission jump, right?

I mean there's no change there?

January, all the things that you will see in a third-quarter release, which is sometimes the revenues are higher because of year-end; but you have got all the expense.

There is nothing that is going to change dramatically that I can think of.

We will just see what happens.

But that all is in place.

Okay, great.

Thanks a lot.

Kartik Mehta, FTN Midwest.

I had a question on your new sales cycle, at least for January, since it is such a big one.

Are you going to make any changes compared to last year?

Or are things fairly well in place and there's really no need to make a change?

Is pretty much business as usual.

Because as John said when the January -- the average January represents somewhere in the neighborhood of 25% of the new adds; that also by the way would represent 25% of the sales quota or the sales success.

So it is a big time of the year.

And it's not anything new, by the way.

This has been going on since Tom formed the Company.

So there's a lot of work that gets done.

There is a lot of activity.

There is a lot of energy around making sure that January is successful, as you would imagine.

Because if January is not successful, then you've got one hell of a digging out to do in the next five months to make the year.

So.

But it is really -- it is not a whole lot different.

It is a natural time, by the way, for clients to change.

So it is not just a sales push obviously; it is the natural time for clients to make a change if they're going to make a change because of all the tax data.

But there's nothing new going on there.

I think we feel like we're in pretty good shape for it.

We keep hearing more about financial institutions wanting to get into the business, maybe offering free payroll.

Have you seen that have any impact on the business or customer choices?

The only one -- I mean, you're talking about Banc of America, I'm sure, which is the main one that has started.

Whenever those things get announced, obviously we watch them and we learn as much about them as we can.

At this time of year we will see all kinds of different things happen.

People will be offering free this or forgiving payment for a few months on that.

But there's nothing really going on in that marketplace that is dramatically different, certainly, than what has been happening for the couple of years plus that I have been here.

John has been here longer.

But there's nothing going on in that marketplace that has got us nervous.

We are obviously -- we watch all those developments carefully.

But as John said earlier the biggest competitor that we have is ADP; and the second-biggest competitor we have are regional payroll companies.

A last question.

Up to this point the Company's been fairly positive and you obviously have seen positive results.

But if the economy were to turn, where would you see the first signs of it?

Would it be new sales or would be the number of checks you're writing for a customer?

Checks.

Checks, okay.

Thanks, John.

I appreciate it.

Have a great holiday.

T.C.

Robillard, Banc of America Securities.

Just two quick questions.

First, last quarter you had mentioned that on the insurance product that the expense side was probably going to peak in the second quarter and then kind of even out or stabilize through the second half of the year.

Is that still the outlook in terms of the investment side for that product?

Yes.

Okay, then just lastly on the stock comp -- and John, forgive me, because my numbers may be -- my calculations may have been wrong, which is why I am having a disconnect here.

But I was under the impression that the year was looking to kind of closer to $35 million or $40 million; and now it is looking 25 to $30 million.

Has 25 to $30 million been -- because I know you did it more in terms of a percentage when you talked about it going (multiple speakers) year.

I want to go back first.

What was the first comment you had?

I wanted to add something I forgot to add.

The first question was --?

The one you asked before that one.

In terms of the insurance product, expenses, (multiple speakers) peaking in fiscal second quarter.

The expenses in the second quarter that we expected for insurance all happened.

Where we were better on margins was really people in the other parts of the business just being very careful in what they spent, knowing we wanted -- especially the senior management people -- knowing we wanted to get back to the 15% goal as quickly as possible.

Now the stock-based comp, what happened was we gave you the guidance at the beginning of the year.

You would have gotten to a number like you expected.

That was because we did not know exactly what we were going to do with an option program in July.

That is in there, approved by the Board.

At the same time we did not know exactly what we were going to do with our broad-based option plan to employees.

Now our option practices I think are just like everything else -- are world-class.

We basically issue our options in July.

We are not in a blackout period.

It is generally within two or three weeks after we have given the guidance for the coming year.

The Board approves them all; there is no consents.

The Board approves every one of them.

They have got the list right there at the meeting.

We generally then -- the only other option grants that are approved during the year relate to broad-based plans that are employees, and we only do those about every 30 to 36 months.

We did do one in October.

When we originally looked at stock-based comp we knew we were going to do one, but we didn't know exactly what we approved.

So we went conservative on that first number.

We now have a much better idea what the number is going to be, because we are probably done issuing stock options for the year; unless we had some key employee got hired or something unusual.

So we have a pretty good idea what it is going to be.

So the focus you would look at is the one we just gave you.

That is really a better tuning from what we knew at the beginning.

Okay, perfect.

Thanks for the clarification.

Charles Murphy, Morgan Stanley.

My questions have been answered.

Thanks very much.

Franco Turrinelli, William Blair & Co.

I will try to keep this short, but I do have a little bit of a follow-up question.

One of the main things that you have been investing in and that you have talked about is your investment in the sales force, and more especially in the payroll specialists.

I was wondering if you could just as an update of your assessment of the return on that investment, particularly on the payroll specialists' side.

We have talked about this a lot.

The genesis of it was just fairly high churn.

We were worried about, I was worried about the impact that churn has on clients.

We are a referral business.

So if you think about it, it all comes back to how happy are your clients?

Do you believe that more tenured, more senior people can deliver better service than junior people?

It seemed fairly obvious to me, both in the client satisfaction side of it as well as reducing the expenses associated with hiring people, training them, and deploying them, and so on.

So I feel pretty good about where we are.

I think it has helped our business.

I think it has clearly helped our client sat numbers and our client retention numbers.

So we feel pretty positive about it.

So again, I am not trying to -- but you are in fact seeing improvements in client sat and client retention that you think can be attributed to those efforts?

I clearly see improvements in both of those.

I believe they are coming from that.

So, yes.

Excellent.

Thank you.

Happy holidays.

Sanil Daptardar, Sentinel Asset Management.

In terms of your client growth, the client growth was in line with your expectations of 4%?

We don't comment on client growth.

We said that before.

First off, right now, to comment on it doesn't make much difference, because the period which really controls what's coming.

But in terms of your health insurance initiative, you are recording any kind of revenues?

In what category it might be falling into?

Is it possible to disclose that number, how much you recorded in the quarter?

Not enough yet to matter; and the revenue is in HRS.

Okay.

You said in the commentary that you see no signs of weakening economy.

Now, in terms of your clients, what are they comfortable about the economy, in that they see the demand continuing [as it is] for the quarters that they see going forward?

Or what is that gives them the comfort level to say that the economy is not kind of in a soft mode?

We have lots of things we look at.

You just kind of get a feel for it.

We have got lots of things going across the whole business.

We obviously track checks per client all the time.

We're looking at checks.

When we do a financial plan we actually go branch by branch and build up the estimates with checks.

We spend a lot of time on that, so we get a good picture of what's going on, what we expected, by looking at that.

You see new hires.

We knew how new sales are going.

We have got three or four things we look at.

We don't give the specific numbers out because sometimes the numbers vary little bit.

Just like ADP when they gave the data out on new hires, they thought they had a statistic and right away they were at odds with what the government put out.

Who knows what was right?

So we just look at those things; and they continue to stay pretty stable.

We have learned not to try to react to anything in too short of a period of time, because calendar timing and just where paydays fall can vary from year-to-year.

Okay.

Just going back on to your client growth, if you had to continue growing at the same rate, what you are growing currently at, do you need to continuously invest in your salespeople or hire more salespeople to do that?

Or the existing sales force can generate the same amount of growth what has been happening?

Client growth last year was 4%.

We know to get additional client growth we have to increase the sales force.

We have the highest productivity in the business; and we will continue to have the highest productivity.

It is not even close.

But for us to increase agrees the clients we have to hire more salespeople.

Okay, thanks.

Michael Baker, Raymond James.

In terms of the health insurance initiative, I was wondering what you are seeing in terms of seasonality.

I know the large group is typically 1/1.

I know that is not your focus.

You are more in the small group.

Basically I agree with you on the 1/1.

The 1/1 is going to be affected more by -- on the conversion marketplace, which we're not as active in yet.

New clients, though, the 1/1 won't be that big a deal, because new clients -- if they want to add healthcare they will be adding it.

It won't be tied to a year or so.

There will probably be some seasonality and we will probably see that as we go along.

But right now we are not big enough so that is really a factor.

Okay, then in terms of kind of commission rates, are you seeing any hike so to speak, given the trend of some of the larger insurers to kind of shift more focus into the small group market?

Not yet.

Okay.

Then obviously you have kind of an initial placement.

How does it work on a renewal in terms of your fee?

We still get the same thing.

Okay, thanks.

That's all.

Thank you.

A will go ahead and turn today's conference back over to John Morphy for closing remarks.

Thank you very much.

Again we enjoyed producing good results and we are committed to continue that.

I hope all of you and your families and your loved ones all have a great and safe holiday season.

So thanks again.