沛齊 (PAYX) 2007 Q4 法說會逐字稿

Welcome, and thank you for standing by.

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

After the presentation, we will conduct a question and answer session.

(OPERATOR INSTRUCTIONS) Today's conference call is being recorded, so if you have any objections, you may disconnect at this time.

I'd now like to turn the meeting over to your host, the Senior Vice President and Chief Financial Officer of Paychex, Mr.

John Morphy.

Sir, you may begin.

Thank you for joining us today for our fiscal year-end earnings release.

Also here is Jon Judge, our President and CEO.

The teleconference call will be comprised of three sections: a review of our fiscal 2007 financial results including comments and guidance for fiscal year 2008, an overview from Jon, and lastly a Q&A session.

Yesterday afternoon, after the market closed, we released our financial results for the fiscal year ended May 31, 2007.

The press release can be obtained by accessing our investor relations page at www.paychex.com.

We have also filed our form 8K with the SEC which provides additional discussion and analysis of the results of the year.

This is filing is also available on our website.

In addition, this teleconference is being broadcast over the internet and will be archived and available on our website until July 27th, 2007.

This morning, we released the year-end investor relations presentation.

You may also find it on our website along with all the recent news releases, current financial information, and SEC filings on that same website.

Fiscal 2007 was another excellent year.

And our 17th consecutive year of record revenues and earnings.

And we look forward to continuing our streak well into the future.

We continued our history of successfully selling, retaining, and servicing clients, with our comprehensive portfolio of payroll and human resource service offerings providing opportunities and value to our clients.

In fiscal 2007, we made investments to broaden our portfolio of services, enhancing our 401K record-keeping service, expanding health insurance nationwide, and introducing Paychex premiere and HR online to our MMS clients.

During fiscal 2007, we experienced record levels of client retention and satisfaction with client retention exceeding 80% of our beginning client base for the first time ever.

Our customer survey results are also at an all-time high and our client base grew 3.4% to approximately 561,000 clients.

Year-end and fourth quarter highlights.

Total revenue growth was 13% for the fiscal year and 11% for the fourth quarter.

Total revenues for fiscal 2007 were nearly $1.9 billion.

Payroll service revenues increased 9% for both the year and for the fourth quarter.

Human resource services revenue increased 22% for the year and 16% for the fourth quarter.

The fourth quarter of fiscal 2007 and the first quarter of fiscal 2008 will be adversely affected by changes in workers' compensation revenue from our PEO located in Florida.

I'll discuss that in a little more detail later in the call.

Operating income excluding interest on funds held for clients, stock-based compensation costs, and an increase to our litigation reserve increased 15% to $631.1 million for fiscal 2007.

Net income increased 14% to $531.6 million for the fiscal year.

For the fourth quarter, net income increased 12% to $137.2 million and diluted earnings per share were $1.39 for the fiscal year versus $1.22 a year ago, up 14% on an unrounded basis, and $0.30 -- $0.36 for the fourth quarter versus $0.32 for the prior year fourth quarter.

We'll now refer to the consolidated income statement.

Payroll service revenue growth was 9%.

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

As of May 31, 2007, 93% of all clients utilized our payroll tax administration services and nearly all our new clients purchased these services.

Employee payment service utilization was 71% and more than 80% of new clients select these services, which include direct deposit, access cards, and Readychex.

Human resource services revenue increased 22% for the fiscal year to $396.2 million.

This growth was generated from the following: retirement services client base increased 16% to 44,000 clients, comprehensive human resource outsourcing services increased 26% to 373,000 client employees served, and our workers' compensation services client base increased 19% to 62,000 clients.

Additionally, the asset value of retirement services client employees funds increased 34% to $8.5 billion.

As we have discussed previously, workers' compensation revenue is more volatile between accounting periods than our other revenue streams.

This occurred again in the fourth quarter of fiscal 2007, as lower than normal HRS revenue growth in the fourth quarter of fiscal 2007 was the result of lower workers' compensation revenue from our PEO operations in Florida.

The reduction in PEO workers' compensation revenue is a result of Florida tort reform that was enacted in October 2003, that was subsequently accompanied by reductions in workers' compensation insurance rates initiated during January of 2006 and more price decreases were initiated in January of 2007.

The tort reform initially increased our profit margins on workers' compensation where the subsequent rate reductions reduced them.

Human resource services revenue growth for the fourth quarter of fiscal 2007 would have been 20% excluding the PEO services revenue.

To a lesser extent, the same phenomenon will occur in the first quarter of 2008 with little or no affect anticipated in subsequent quarters in fiscal 2008.

Interest on funds held for clients increased 33% for fiscal 2007 to $134.1 million.

The increased on interest on funds held for clients was due to higher average interest rates earned in higher average investment balances.

The higher average portfolio balances for fiscal 2007 were driven by client-base growth, wage inflation, check finding growth within our current client base, and an increased utilization of our payroll tax administration services and employee payment services.

The average interest rate earned on funds held for clients is increased to 4.0% from 3.2% a year ago.

The effective increase in the average interest rates is expected to end in the first quarter of fiscal 2008, as a federal funds rate has remained unchanged since June 29th, 2006.

Please refer to our form 8K for further information on the effect of interest rates on interest on funds held for clients.

Consolidated operating and selling, general and administrative expenses increased 13% for fiscal 2007.

Our stock-based compensation costs included in compensated related expenses were $25.7 million.

Excluding stock-based compensation costs and a $13 million expense charge in the third quarter to increase the litigation reserve, total expense growth would have been 9% for fiscal 2007, compared with 12% for fiscal 2006.

This increase was a result of 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.

In addition, for fiscal 2006, total expenses were affected by a strong sales year as our sales force exceeded its targets resulting in higher than normal levels of sales expense in fiscal 2006.

As of May 31, 2007, our employees increased 7% from 10,900 employees a year ago to 11,700 employees today.

Investment income net increased 60% for the fiscal year to $41.7 million.

This was due to higher average interest rates earned in higher average portfolio balances, resulting from investment of cash generated from ongoing operations.

Our effective income tax rate was 30.8% for fiscal 2007, compared with 31.1% in fiscal 2006.

The decrease in our effective income tax rate was primarily the result of higher levels of tax exempt income, which is derived primarily from municipal debt securities and the funds held for clients and corporate investment portfolios and a lower effective state income tax rate.

For fiscal 2007, the effective tax rate was also unfavorably impacted by nondeductible compensation related to incentive stock option grants.

Moving on to the balance sheet.

Cash and total corporate investments were $1.2 billion as of May 31, 2007.

Our cash flows from operations were again strong at $631 million for fiscal 2007, an increase of 11%, or approximately $62 million from the same period a year ago.

Last October, we raised our dividend by 31% and we will continue to evaluate the best means for Paychex and its shareholders to benefit from our superior ability to generate cash.

For fiscal 2007, 57% of net income was returned to shareholders in the form of dividends.

Our total available for sale investments, including corporate investments and funds held for clients reflected a net unrealized loss position of $15 million as of May 31, 2007, compared with a net unrealized position as of $22 million for May 31, 2006.

The three-year AAA municipal securities yield increased to 3.71% at May 31, 2007, from 3.65% at May 31, 2006.

The net unrealized loss position was $22 million as of June 22, 2007.

So it's changed not too much.

Client fund deposits as of May 31, 2007, were $4 billion as compared to $3.6 billion as of May 31, 2006.

Client fund deposits vary widely on a day-to-day basis, with the average balance increasing approximately 6% for fiscal 2007.

The growth in client fund deposit of 6% is less than the 12% we experienced a year ago due to several factors which were also mentioned in our last teleconference call.

Continued wage inflation accompanied by no index changes in the federal deposit rules since 1993 means more and more clients are required to pay their taxes weekly versus monthly.

The fund balances benefit from Readychex was not as great as in prior years as the growth of this product is now much closer to that of direct deposit.

Readychex is a service where we pay client employees with checks drawn on Paychex bank accounts.

Total stockholder's equity increased to $2 billion as of May 31, 2007, with $301 million in dividends paid.

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

Rapid payroll litigation.

During the third quarter of fiscal 2007, we recognized $13 million of additional expense related to the Rapid Payroll litigation that commenced in August of 2001, and has been previously disclosed.

At the present time, we have fully resolved our licensing responsibility and settled all disputes with 74 of the 76 licensees who provided services by Rapid Payroll.

A verdict favorable to Paychex Inc.

was issued with respect to our dispute with one of the remaining two licensees.

And that licensee is currently appealing the verdict.

A verdict was issued yesterday, but in respect to the litigation brought by the other remaining licensee.

In that case, a jury awarded $15 million to the plaintiffs in compensatory damages and allowed for an additional finding of punitive damages.

On Monday, July 2nd, 2007, the jury will begin to determine what amount, if any, to award for punitive damages.

Fiscal 2008 guidance.

Our current outlook for the fiscal year ending May 31, 2008, is based on current economic and interest rate conditions continuing with no significant changes and summarized as follows: payroll service revenue growth is projected to be in the range of 9% to 10%, human resource services revenue growth is projected 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 projected to increase approximately 6% to 9%, total revenue growth is projected to be in the range of 11% to 13%, corporate investment income is projected to increase approximately 20% to 25%, effective in tax -- income tax rate is projected to approximate 31.5%, and net income growth is projected to be in the range of 14% to 16%.

Purchase of property and equipment in fiscal 2008 are expected to be in the range of $80 million to $85 million.

Fiscal 2008 depreciation expense is projected to be approximately $65 million.

And we project amortization of intangible assets for fiscal 2008 to be approximately $17 million.

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 refer our Safe Harbor statement on page three 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.

Good morning, everyone.

And thank you, again, for taking the time to discuss our company, our 2007 results and our 2008 outlooks.

I just have a few comments and we'll get to your questions.

As John mentioned, fiscal 2007, another record-breaking year is now in the books.

And we're very proud of the solid results that were accomplished by our employees and business partners, especially given the tough year-to-year comparison that we faced.

John covered the key financial results, all of which fell comfortably within our guidance and which produced our 17th year in a row of record revenue and profit.

Some quarters were stronger than others on a year-to-year comparison as predicted.

And the year came together very nicely, though, very close to how we planned it.

Beyond the impressive financial results, we had very good execution in several of our key business initiatives and investments.

I wanted to give you a sense of some of them.

We focused on growing our client base both through organic means and acquisition.

We did this through investing and more salespeople.

We worked on lower employee attrition rate and better rev productivity through the introduction of some new tools and management systems.

We continued the acquisition of clients at a reasonable price that allowed the acquisitions to not only produce revenue but to produce profit growth.

And while we finished slightly below last year, we had a very good finish and we entered the year with a good sense of momentum for growing our client base.

We focused on growing our ancillary product penetration, as well, both in the install base and with new clients and succeeded in both areas as evidenced by higher revenue growth than unit growth.

We focused on growing our portfolio of offerings.

We added enhanced retirement service offerings like the open-architected 401K solution.

We added significant investments in the health benefits area, both in sales and operations manpower, as well as back office systems and processes.

We continue to add health providers and strengthen our relationship with these important business partners.

We expended -- expanded our HR online product and introduced Paychex premiere offering to our MMS clients.

We focused on client satisfaction and client retention, and as already mentioned by John had an incredible set of results in both, including a new client retention record that broke through 80% for the first time ever, and the highest customer sat ratings we've ever achieved, both in core and in MMS.

These are just some of the examples of the initiatives that is we undertook and the investments that we made to ensure that we kept the business model producing the top line and bottom line growth, as well as impressive margins.

And then just as the year was winding down, we went into the budget planning for fiscal '08, which we've concluded and successfully committed to new initiatives and investments that will get us to the results that you saw outlined in our '08 guidance.

We're proud of the year we just concluded and the terrific dedication, hard work, and results achieved by our employees.

And looking out to fiscal '08, we'll continue to focus on the key strategies that go us here, namely: aggressive, but achievable planning followed by a commitment process by our senior management team, superb business execution from our sales, operations, organizational development and training and finance and planning teams, ongoing product enhancements and new product development, business development, especially in the areas of client acquisition and future products and service offerings, and continued focus on expense management and margin expansion.

We'll follow this road map in '08, and we fully intend to deliver another record year, our 18th in a year, hopefully, of excellent financial returns.

Again, we're very proud of the results that we put up this year.

And John and I would now be happy to take any of your questions.

Alright, then.

We'll now begin the question and answer session.

(OPERATOR INSTRUCTIONS) Our first question comes from Rob Beaujois of Bernstein.

Go ahead, please.

Hi.

Great.

I'll start with a question with John Morphy first.

John, I just wanted to confirm the basis for your fiscal '08 growth guidance.

Are you guiding off the pro forma fiscal '07 earnings number or the GAAP number?

We're guiding the guidance after the actual number that's shown on the bottom of the income statement of the financial segments.

So you're guiding off of GAAP?

Yes.

Okay, alright, and then the other question is, the core payroll business had decelerated in the February quarter.

It looked like it reaccelerated here in the May quarter.

And the guidance for next year signals further acceleration in that core payroll business.

Can you talk about what's happening there and what's giving you the conviction that business will sort of reaccelerate here.

You use the word acceleration, I wouldn't use that word.

I'd use it again as continued very good.

We talked on the last call about the lower than anticipated payroll number.

I wouldn't have called that the acceleration.

It was again the result of some tough comparisons year-over-year that really didn't matter so much to what I call the ongoing momentum of the daily business.

So we, again, are really in the same place, continued unstuck in a good place.

And we believe the payroll revenue will be right in line with what we expect.

And we did not see as much aberration as you did.

And I understand why you all felt that way.

Because you saw a number in the third quarter that was less than you anticipated.

So that's where we are.

So there's no real change there.

You kind of had a tough comparison and some issues last quarter and things are just kind of normal at this point in your guidance?

This part of the business, this is Jon Judge.

This part of our business is really sort of the spade and shovel, hard work business.

It's all the basic blocking and tackling.

It's keeping the territories filled, it's keeping the reps in the territory longer.

We have measurements on this part of our business that are pretty finite that actually get down to the number of reps that are in a territory per week which looks at where we are on vacation schedules and open territories and so on.

And it's really just continuing a hard focus on the day-to-day operation of that business.

Because that is the part of our business that actually is sort of the hardest by the numbers business.

And we had a slight hiccup in the course of the year that -- we told you before, we don't really watch the quarter to quarter as closely as you guys do.

We watch the full year.

We felt pretty comfortable to go through it.

We came out of the fourth quarter with pretty good momentum in that business and we feel pretty good about where we are.

And we feel pretty strongly about the fact that our guidance is going to be extremely close as it has been for the last, what, 10 or 12 years?

Right, and then the final question on the returning cash to shareholders.

Is dividend still the priority over share buybacks?

And if so, can you help us get an idea of what the magnitude of the dividend increase might be when the board meets later this year?

We made a commitment that we will come up with some statement on what we think about our cash position.

And the time period I asked for was through the end of October, because there's two board meetings before then.

We're going to talk to the board about it.

And dividend is generally our preferred method.

But we're looking at all the alternatives and I wouldn't rule anything out.

Thank you, guys.

Next question comes from Adam Frisch of UBS.

Thanks, guys, good morning.

I didn't get too bent out of shape about third quarter.

I just viewed it, kind of like you did, Jon Judge, as a -- kind of like a little bit of a hiccup.

But the business is obviously going great.

Guidance for '08, steady as she goes in terms of revenue growth.

Is there anything there that can materially change your current guidance one way or the other?

You talked about economic changes and so forth.

But outside of like crazy events like 9/11 or something like that, is there anything out there that you're tracking that could materially change what your outlook is today?

Nothing off the top of my -- nothing on the top of mind can I think about.

I -- the business model that we have and the type of business that we have is so different from others.

So much of our business is by the numbers.

We literally sit down with our sales reps every year and go through how much they want to make and what level of recognition they want to achieve.

And that tells us the rep exactly how much booked revenue they need.

And we back -- we have a model in the way that we run sales that we can back off of that exactly how many presentations they have to make and how many calls they have to make on existing clients to harvest referrals, and how many calls they have to make on CPAs to harvest referrals.

And we trapped the closed rates by territory.

It's a fairly scientific but very work-intensive product.

And as long as we continue with the basics, as I mentioned earlier, it's very difficult for me to see something that would materially change us.

Certainly for the negative, we don't see a lot of positive -- it's pretty much the same.

I don't really see anything that would materially change.

If something happened that would cause a significant uptip -- uptick in the acceptance rate by clients in the territory, obviously that could help.

I think it's going to be pretty steady as it goes.

Okay.

Two checks on revenue growth.

May pricing increases, were they around the same 4% that you got historically?

Yes, boring, but the same.

I'll take 4%.

That's not too boring.

And then an update on the health care and 401K initiatives.

I know there's been a lot out there.

Some expectations have been way off base.

We're still looking at that as good growth, good opportunities, not something that's going to affect necessarily fiscal '08, but something that's still proving -- moving along enough to enforce your views on 12% kind of growth on the top line?

Well, I guess the first thing I would say is that we do fairly significant modeling as you do.

We somewhat have an advantage over you and that we know what all the numbers are and we only share some of them with you.

But when we release our guidance, it's very detailed planning that goes in behind the guidance.

So all of the things that you would mention are in our models.

And on the insurance and on the 401K, both of those areas are extremely important areas for us.

We're making significant investments in both.

The baseline model of our business will grow the payroll side of our business in 8%, 9%, or 10% range, and then we'll get ourselves to the 12% by growing our HRS revenue far more aggressively than we grow the baseline revenue, and that's where the 401K plays, that's where the insurance plays and the other product offerings that we have in 40 -- in the HRS world.

The 401K, you know that we introduced a new product, it's an open-architected product, it's really first year of early implementation this year.

While we don't give you the specific numbers.

What I have said at a couple of the analyst conferences, is that in this past year we were somewhat surprised with the take-up rate of the new offering.

It came in at almost three times what we had planned.

So it's caused us to do some fairly aggressive planning on the -- both the back office systems to be able to take the enhanced volume, as well as what we're going to do with the reps -- adding reps into that world.

But that's something that we think long-term is going to be one of the smartest moves that we've made in terms of continuing to own the 401K businesses as you know we have.

We write more 401K products in a year than probably the next three combined.

On the health side of it, we talk quite a bit about that in the course of the last year.

We're going to probably double our reps again in the next year.

We're putting a lot of investment into the back office systems and processes, as I mentioned earlier.

That business to us, all of the work that we've done on that business says that that field is wide open for a player like us.

And we believe that we are extremely advantaged in that world because of the existing distribution channel that we have, the familiarity that we have with insurance products, the contact that we have with literally hundreds of thousands of potential buyers every year.

We think that we're extremely advantaged in that area.

And we're moving out of it aggressively as we can to drive the growth of it.

And we've told you what we think that growth is going to be over the next four to five years.

If we get lucky and we are able to grow faster and get a better uptick than is in our pro forma, then the minute that happens we see that we'll tell you.

But all of those -- both of those are extremely areas to our HRS world and they are definitely inside our model.

Okay.

Great.

Thanks for all that color.

That's awesome.

One last thing that I had for you is on the OBO speculation that's out there.

Obviously, there's -- that's been a cold glass of water thrown on it this week or in the past few days.

But there is still a lot of speculation out there in processor land.

And what I wanted to ask you is do you guys need to be a public company at this point?

Or are there any issues be it operational or regulatory or something with the rating agencies, considering the fact that you're a payroll company preventing you from taking the [flood] of leverage to go private?

I think that the decisions that were made in our company going almost back to the time that we went public in '83, things about how open and transparent we were going to be with the markets and the work that done in the last 9 or 10 years to get all of our filings done at the same time that we do our press releases and so on.

That when things started to occur in the Sarbanes world and others had caused angst and consternation in some other public companies, those things didn't really affect us as much as they'd affect others.

So the first thing I'd tell you is we don't feel the issues.

I know there's a lot of talk right now about companies that'd rather be private than public, from either Sarbanes standpoint or the ability to do long-term investments and not worry about quarterly or annual returns to shareholders and so on.

In our particular case, we talked about this quite a bit internally.

There are very few things that we would modify if we were private versus public.

The one thing you might consider doing differently is maybe the way you invested your money, in terms of short-term risks versus long-term returns.

But even in that, it wouldn't be a lot different.

And quite frankly we think a lot of the discipline we have in the way that we make our decisions on investments and manage our P&L are healthy ways to manage our business regardless of whether it's public or private.

On the LBO side, the two things that typically would drive an LBO, we don't believe present in our company, and that's underpar performance -- sustained underpar performance, and a business that's easily divisible, so that you can sell parts of the assets off.

The part that's made it more interesting, I think, or has caused some of the discussion, is the fact that there's so much money out there right now looking for interesting places to go.

And there appears, at least in the discussions that some of you all have had with us, there appears to be a belief that the LBO world is going to start to be more attracted to investments that could be in a 12% to 15% return range versus the 25% to 30%.

And that -- when you get down into that range, companies like ours look pretty good, more from a hold standpoint than from a improve the performance and trying to resell them.

The long and short of it is, we have not -- have had no activity to report on.

So we have not made any reports.

We sort of find this to be more curious than anything else and don't necessarily think it's all that applicable to us.

Okay.

Last question here, do you think the dividend, could it get 90% to 100% kind of payout?

We're going to answer those questions over the next six months.

It depends what you do in all of the areas and I think for us it would be conjecture.

And the board has obviously a big say in that.

But we don't really feel confined by any percent.

But that doesn't mean that we would go that high.

Great.

Alright, guys.

Thanks a bunch.

Next question comes from Charlie Murphy of Morgan Stanley.

Thanks, I was wondering if I -- we could get a little bit more on detail on the drivers behind the human resources forecast for FY '08.

And in particular, maybe if we could get what PEO revenue was for FY '07 and FY '06.

We haven't disclosed the PEO revenue and so we won't disclose it here.

Basically the same drivers we've always had.

The biggest driver right now in terms of growth is Paychex premiere.

And work site employees we take the PEO and premiere combined.

We are almost equal to ADP, [Jevene], and Administaff combined.

401K is going to pick up some more momentum with the new fund offerings, which is going to enable us to continue to maintain, I believe, our number one position selling 401K.

Workers' comp remains strong.

So it's pretty much the same things with the filler of health care coming along to pick up some of the slack when a few of those slow down a bit.

So we feel pretty good.

Okay.

And on investment income, what are the key drivers behind the 20% to 25% --

-- for the growth in our cash balances.

And obviously whatever we do on the dividend or any other strategies could affect that number.

But it would be the results of the cash going somewhere.

So I don't see that as a problem.

Basically, the reason that one grows faster than funds held for clients is we have better growth on the balances in investments, our cash, than we do on funds held for clients.

Great.

Thanks.

Next question comes from Pat Burton of Citi.

Hi, congratulations on the year.

Another outstanding year.

Two-part question.

First would be regarding the balance sheet and the follow up on the earlier question.

Do you guys have an aversion to putting any data on the balance sheet?

Or optimally as some small amount of debt may be good for your shareholders?

That's the first question.

We don't have an aversion against it.

As we've said in the past, we have very little sort of religious convictions around here relative to the balance sheet.

We don't have an aversion against stock repurchase if the numbers work out for us and it's something that we'd be interested in doing.

I guess the only thing I would say that there has been a demonstrated aversion to is a one-time dividend.

But as John said earlier, we are aware of the fact that we've got a capital accumulation that's occurred on the balance sheet and the fact that we are a cash flow engine.

We have started having more serious discussions with our board and consulted with some outside parties as to what the appropriate capital structure for the company should be going forward.

And as John said, those are scheduled to be talked about with the board in the next couple of board meetings, and hopefully we'll have a resolution on that by the end of October at the latest.

Okay.

And the follow up is just what are you earning on a pretax and after tax basis for John Morphy on your cash balances right now?

Well, it's what we disclosed.

I think the cash balance on the long-term portfolio was around $3.7 million with the exact specific numbers is in the 8K.

So I could trade that off against an equity buyback and do the analysis myself.

Thanks, and congratulations again.

I don't think the stock price is reflecting the results you guys have delivered the last few years.

But we'll wait on the dividend and the capital allocation strategy.

Thanks.

Thanks, Pat.

And, Pat, to answer it, so you put a few words back in there.

I would use 3.5% as the tax-free rate when you did that analysis.

Next question comes from Jim Kissane of Bear, Stearns.

Thanks.

Jon, what's your target for net new client growth in fiscal '08?

We don't talk about that, Jim, other than the general discussion that we have with you about what our model is.

And the model is 5%.

Okay.

Because I'm just trying to get a sense of the sales force productivity in terms of adding just new clients.

Because you had the record retention over 80%.

But your net new client growth slowed to 3.4%.

Yes, but that -- the way that I look at that is -- and first of all, I look at both.

We actually -- when you think about new client growth, or you think about we call them units inside the business, that's one measurement.

But in some respects that's a surrogate measurement to get you the revenue.

The key thing that we drive obviously is the revenue.

So the part of the new client that's important to us is to give us a place to not only retain but to grow over time with new offerings.

So that's the reason that we push that pretty hard.

And as we've said in the past, if we stay in the 3.5% range, we'll be okay as long as we continue to drive the penetration rates of ancillaries into the existing base and a richer configuration of new clients that we bring in, which is exactly what happened in '07.

Ideally what we would like to do is get that number up close to the 5% and that's what we're going to continue to push for.

Okay, great, and hate to bring it up, but will you be appealing the rapid payroll ruling in California?

That thing is so new, the verdict literally came out about two hours before we went to the press -- we issued our press release yesterday.

There's another leg that's to happen, as Jon mentioned, yet on Monday and Tuesday, probably perhaps even Wednesday.

So what I would suggest is just let us get the thing rolled out first.

Let us have a chance to analyze it, which we really haven't had a chance to do because it's ongoing and we'll -- we'd be happy to comment on it.

Great.

Thanks, Jon.

Next question comes from Liz Grausam of Goldman Sachs.

Thank you.

In terms of your HRS product strategy, can you help us understand if you have kind of anything in the hopper in terms of innovative new products you're expected to launch in 2008, and kind of where you stand in that product launch?

I think the best thing I can do to tell you about what we're up to, Liz, is that -- I think we made it very clear that is one of the growth drivers of our business.

It's the area where we've done the majority of the expansion from a product standpoint in our total portfolio.

If you think about payroll as our base business and then the expansion is coming to all of the other offerings, either payroll related or HR related has come into the HRS world.

And we're committed to continue that.

We typically, though, do not talk about things that we're working on until we're ready to introduce them.

And so you have what we've talked about so far is what we're prepared to talk about.

But I would tell you that we are constantly looking and working on new offerings, both developed internally as well as potentially purchased in the marketplace.

And in terms of the addressable market within your customer base of these new products, you think of direct deposit obviously being very well adopted.

When you think about the health care insurance products, what do you see as the addressable penetration within your customer base?

It varies by the product.

And I'd start with the thing that we continually to be amazed or amazed by is the fact that the ones that everyone knows about and have been viewed as that saturation for some time now, and that would be tax pay and employee pay.

Those two continue to defy gravity.

We're now at a situation where taxpayers coming in at almost 99% or 99% plus of the new clients that we bring in.

Employee pay is up in the 80% range now.

Sarbanes is obviously less than that.

So we'll still continue to get lift out of those two offerings.

When you go -- and you go to the other ones.

You have to go one by the next and 401K is going to be different than insurance.

But in general, we tend to think of that as somewhere in the 25% or 30% range would probably be a fair general statement about what the addressable market is.

And of course, that will change from one to the next.

So, for example, a large part of our market is in the 1 to 4.

It's probably not reasonable to assume that you're going to have a 30% penetration rate of 401K or health benefits in the 1 to 4.

But the latter health benefits perhaps could change some legislation that way.

But as you get into the larger clients, the MMS clients, as an example the penetration rates would be north of what I talked talked to you about, so -- or the addressable market would be north of what I talked to you about, but -- In general I would say if you were thinking in terms of the 20% to 25% range, you'd probably be close.

Great.

Thank you.

Next question comes from Glenn Greene of CIBC.

Thank you, and good morning, guys.

The first question I just wanted to -- for Jon Judge, talk about sales force turnover trends.

I know that was sort of a focus of yours since you sort of came on board.

Can you sort of update us where we are there and how we exited the year?

It's not just sales force.

It's the two key ones for me were sales force and payroll specialists.

And it -- for fairly simple reasons, which I've talked about it, it has a lot to do with the productivity of the individuals in the field.

More experience, more tenured people, particularly in the referral base business as the sale side is, tend to be more productive.

And on the payroll specialists, since we are service-providing company and that is the point of service delivery.

The reason why that is important is pretty evident.

In both cases in both sides over the past couple of years, we've made steady progress.

We're not actually calling the numbers out.

But we have had progress in both areas, in the 1% to 2% range improvement.

And our intent is to keep this on until we get -- when we started sales, when I first looked at the sales, the numbers were in the high 30% and low 40%.

They're in the 20% now.

And when we looked at the payroll specialist numbers, when we -- when I first started looking at them they were in the mid to high 20% and they're in the very low 20% now.

In the case of both of them, I often get asked the question where do you think bottom is.

And I don't know, but it's a long place from where we are now.

I think we can continue to improve those numbers.

And when we improve those numbers, the results should be pretty evident.

That's helpful.

And just quickly on your sort of view of the macro employment environment.

Obviously, you have great data and sort of a good view into that.

But what are you sort of seeing in looking at your client data and talking to your clients in terms of the overall employment environment?

Well, I'll make a couple comments and invite John to do the same.

But anecdotally, the current economy, and I'll step outside of our frame for a second and go into the specifics of our framework.

But anecdotally the economy looks little schizophrenic to me.

It's -- when you look at housing [starts], when you look the subprime loans that market looks to be a little of a mess at the moment.

But when you look beyond that -- And I talked to some of our clients and obviously other business leaders that I work with.

The spending outside of those two areas tends -- appears to be relatively normal.

Even despite the fact that you've got gas prices rising where they are.

When we look at the specifics of the things that we have of visibility to -- And the main number that we look at is the new hired transactions per client.

And the change in that from a growth year-to-year basis of 2007 ended up at 4.2% for the full year and 5.1% for the fourth quarter.

So those are two very healthy numbers.

Last year as an example was 3.1% on the full year.

So John has often talked about as being the economy stuck in a good place.

And the stuff that we -- the elements of the equation that we see, specifically new hire transactions because we do the compliance reporting, bonuses paid is another one that we look at at the year end, the bonuses paid by our clients to the employees were also up.

We look at checks per client.

That was also up on a year-to-year basis, although modestly.

So the things that we look at suggest to us that the economy, at least the one that we're addressing, seems to be okay and it doesn't seem to be moving dramatically one way or the other.

John.

I would say the same.

The last time we saw what I would say was meaningful change was in the August 2005 quarter.

Since then, we've seen tremendous stability.

You might see a little down tick, a little uptick.

But nothing that indicates much is changing.

So we think it's, again, stuck in a good place and doing well.

Alright.

That's great.

Thanks.

Alright.

Thank you.

Next question comes from Dave Grossman of Thomas Weisel.

Thanks.

I know this has come up a few times in other questions.

But it just seems there's a lot of moving pieces impacting growth whether it be quarter-to-quarter or quarter-over-quarter.

And on the other hand, and it sounds like better sales performance and a very positive fiscal '08 outlook.

And then on the other hand, it looks like client adds are tracking a little bit below your target.

And just based on the trend in payroll, I know it's within range, but still down a little bit from I think where you thought you came out in the fourth quarter.

If I remember right you were hoping for 9% or better.

I'm not sure if the 20% on the nonPEO HRS is consistent with the prior quarters, but it looks like that might be a little lower than what you've seen in the other quarters of the year.

So can you just help us maybe understand the different dynamics that may be affecting those numbers and how we should think about this going forward?

I guess the first thing I would say, and I'll give you my thoughts and then John can give you his, the first thing I would say is that I completely agree with the first part of your statement, which is this is a model that has lots of moving pieces.

And the interesting thing about our business is that it tends to be extremely predictable on an annual basis, not necessarily as predictable on a quarterly basis.

And so what we've talked in the past about is the fact that while the quarter-to-quarter moves, either up or down may be interesting and may want to give you reason to either celebrate or frown.

The reality is that if you look at what our performance has been relative to our guidance over the past 10 or 12 years, I think what you'll find is that we've been plus or minus 1% through all that period with the exception of when we've changed guidance.

And there's evidence even recently that whenever we see the model changing from what we've given guidance on, we change our guidance.

So it's not going to be -- our quarter-to-quarter movement is not going to be even, it's not going to be as predictable as you'd like.

The annual movement is very predictable.

And I think we've got a pretty strong track record of calling it pretty closely.

So that's why we tend to tell you that we don't pay as much attention to the quarter-to-quarter moves as I think some of you guys do.

We pay a lot of attention to the annual budgeting process and the annual commitment delivery process and that's sort of where we are.

John.

And we look at payroll revenue to me, anything between 8.5% to 9.25% is what I would call a good norm.

And would take the economy or something [genuine] to kick us out of that.

The HRS revenue, although it's getting up there, it's about $400 million for the year.

It just doesn't take many millions to move that thing.

And HRS revenue because it has more up front sign-up fees and some other things just isn't going to be as predictable and as consistent as payroll revenue.

It's just something that is going to happen.

But again, I think we're very good at predicting for the year.

Once in a while you're going to get a quarterly blip.

The other thing, when you look at the blip -- you look at the revenue blip, the thing we watch very hard is we don't want the profit blip.

And the revenues in this business pretty much are going to be what they're going to be.

They can move a little bit and then we just know how much we've got to spend.

So we put -- while we put a lot of focus on revenue.

There's a lot of focus, even more focus on making sure we make the bottom line.

So as I look at new client growth, as given normalized retention and your 4% price increases, is that adequate to grow as the payroll business about 8% or 9%?

I think 3.5% is.

Again we get caught up in this thing where client growth versus revenue growth.

We were very happy with the revenue growth gets to be a difficult chore.

And we keep pushing the units, but we know the units are not always the best measurement of what's going on.

Let me give you a very specific example so to help you with this.

When -- a lot of times when people look at our unit growth they're assuming that all units are the same.

Here's a very practical example.

If we moved our measurement system exclusively to units, I would predict that we would be signing up nannies at a record rate.

And likewise, if -- which means you get one unit, but you get almost no revenue for it.

When we moved to a very heavy emphasis on revenue, what we ended up getting was fewer units, but much more rich revenue with the units.

So what we want is a balance.

We want to be able to get the rich revenue mix, but we want to get the units so that we have sort of the envelopes if you will to sell additional products into the future.

That's why we push both of them.

My strong encouragement to you is don't get too hung up on the unit number specifically.

Because typically what happens, and it happened in this past year, when the unit was down a little bit, we still got our revenue growth and we did it by doing a little bit better job on client retention and doing a much better job on moving the penetration -- the ancillary penetration of our existing customers and our new customers.

I see.

That's very helpful, thanks.

And let me ask you one other thing, Jon.

Maybe you could -- just looking at the sales numbers, the head count, is there any segment that you're in that's maybe not mature, but maturing, that provides a benchmark on sales productivity that would be a useful benchmark for the insurance business -- the health insurance business?

Well, we're already in several health businesses today.

So I'm not sure I understand exactly what your question is.

Well, if I'm looking at, for example, the number of salespeople and the number of clients, for example in the retirement services area.

Is that a -- is there any relationship that's useful in helping to estimate the sales productivity that we would see in the health insurance business if that business develops and grows?

I think the health insurance productivity is going to be close to a 401K rep.

It's too early to tell.

Okay.

Great.

Thank you.

Next question comes from Gary Bisbee of Lehman Brothers.

Hi, guys.

I guess looking at the 8K last night, one thing I noticed was you're projecting slower sales force head count growth, retirement, Paychex premiere PEO and workers' comp area.

I guess, can you give us any sense as to why you're thinking about that?

And maybe how you're confident in the same general revenue growth from HR services despite lower head count?

It's really nothing more than sort of the ebbs and flows or some years we hire more in some areas, some years we hire less.

Part of it, obviously, has to do with the way we do financial planning in general, which is where we think the market opportunity is for us, what we feel is affordable given the revenue we are confident we can capture.

On the sales piece itself, though, it really has more to do with what we think we can absorb or conversely where we are at the time.

We finished this past year slightly above where the head count was pegged for on the sales side.

And so the requirements that we had going into the next year tended to be less in some of our areas.

And that's probably what you're seeing.

Our model is one that has been pretty consistent, which is we put as many salespeople in as we believe that we can get continued returns and not diminishing returns, which has happened to us in the past where we put too many people with the exception of some of the investment areas.

In the case of insurance, an example, we're doing pretty significant adds.

Last year we did a significant add.

This year we're going to do another significant.

And that's an entirely different subject.

That's growing a new business.

What's the average, and does it change by product in terms of the timing it takes new salespeople to get up to productivity?

So is it safe to say you had really rapid growth in several of those product areas last year in the sales force and so that you're still in fiscal '08 going to get the benefit of these guys continuing to become more productive?

The second part of the question is yes.

And the way that we do it we take a look at the territory structure we have, the reps that we have in the territory, the -- what we're experiencing from an attrition level which tells us what the ideal scenario would be in terms of people in the pipeline that are getting ready to get into a territory .

It takes, I would say it does vary a little bit by product and obviously by the experience of the person that you hired.

But it probably takes somewhere in the neighborhood of three months to get them trained up in the territory and probably another three to six months to get them running at acceptable levels of productivity.

So we do have a -- sort of a lag time between identifying a hire and getting them hired and getting them in place and productive.

The more important part that we've been focusing on is not so much that, it's the keeping them in territory for three, four, five years.

And when we look at our most productive reps, and again this is sort of obvious because we're in a referral business.

But our most productive reps are the reps that have been in the field for a significant amount of time and in the same territory for a significant amount of time and have very deep relationships both with the existing client base as well as the CPA community.

So it's really the model on how we deal with sales is around where are we on territory structure, where are we on the strength of people we have in territory, where are we on open territories, or projected territories, if there's going to be any reorganization of territories.

And then we hire accordingly.

We're pretty comfortable, by the way, with where we are with our plans on the new hires versus -- or in support of our plans for the financial results.

So we have no questions about

Okay.

And can you give us a quick update just on the status in Germany and whether you're -- as you look over the next 12 to 18 months think that you'll be at the point to enter another country?

Or if it's still expanding in that market?

My guess, and I don't have a specific answer for the 18 months out, but my guess is that 18 months from now we will still be growing Germany.

And it's for the reason that I mentioned on prior calls.

When we look at the incremental investment of a dollar in an international territory, given the fact that we are not the dominant player in Germany at this point is far more profitable for us to make that investment in Germany versus start the development of a new country.

So we will stay on the path with Germany.

And it would be reasonable for you to assume that the incremental investments that we make over the next 12 to 18 months would be in Germany.

The only thing I think could change that is if we came across an acquisition opportunity in one of the other countries that is we have an interest in that was a favorable one for us.

But to be honest, we have not found one that fits that profile yet.

So our focus right now is on Germany.

Okay.

And then, will the normalizing of the yield curve over the last month or so or the long end rates moving back up, is that likely to have any impact on the yield you're earning?

Or is it just too small?

Minimal.

Some positive, but not very big.

Yes, and just lastly, is it safe to assume you're still around 17 to 18 clients in terms of the average client/employee side?

About 17 employees.

17.

Okay.

Thank you.

Next question comes from Mark Marcon of R.W.

Baird.

Just wondering if you were going to potentially tweak the sales force compensation package in order to maybe get the -- that growth rate in terms of the units closer to the 5%.

I've heard everything you've said so far.

It all makes a ton of sense.

But I was just wondering if you would like it to be a little higher and therefore would tweak things around a little bit.

We tweak the -- both the measurement system and the compensation system every year, based on where we are and where we're trying to get things, either to do a course correction in places where we'd like more focus and more achievement, quite frankly, as well as to incent new areas that we're trying to get into.

So we constantly look at that each year.

And we are definitely making more aggressive moves, both in the management system and the compensation system to try and drive unit productivity.

Okay.

So getting back up to kind of a 4% range or maybe even higher would be a reasonable assumption on our part for this coming year.

The trick is to -- is really to listen to what I said earlier.

I could get the unit growth up to probably 6%.

I understand that.

Nannies.

That's not what we want.

Yes.

We want a balance between the units and the revenue.

Okay.

Great.

And then with regards to -- one thing you're going to have as a positive this year, this last year you absorbed $25.7 million in options expense.

Is there going to be any incremental increase in terms of the options expense, John, in this year relative to last year?

Basically where we are in option expense is in the fir year, obviously, it's a year-over-year thing.

Sure.

Okay, now, we were a little bit fortunate in the fact that the higher than normal growth and float income was pretty close to offsetting the negativity of stock-based compensation.

Now when you go forward, we don't really -- we won't exclude stock-based compensation anymore, it's just an expense.

Sure.

And we would rate that with other things.

No when you talk about stock-based compensation, you've got to look at how many options you can grant, etc., but you also got to look at your other employee benefit programs and balance them.

So I don't think while we will have disclosure on stock base, we look at managing the whole business completely together.

And if we were to do a little more on stock-based compensation costs, we're going to take something out of something else and vice versa, so I wouldn't look at it individually anymore.

But if you want to see the impact of options, it'll be disclosed.

And as I think as you're aware, our option dilution is lower than most.

Sure.

I just meant simply from the standpoint that we had a tough comp this year because we obviously weren't reflecting it the prior year.

And now it seems like if we put together your price increase, the anniversarying of the options expense, a slower growth in the overall sales force, all those factors together that should lead to a nice resumption in the overall operating margin or the fee operating margin on a year-over-year basis that would be in line with your historical trends.

I just wanted to make sure that that's a correct assumption.

Correct.

We're still living with the assumption that we've got to do 12% and 15%.

And the stock-based compensation would have been excluded, but it'll be back in.

And the 12% and 15% to remember, I can go to the board meeting and I can be at 11.5% and be at 15% and I'm probably done.

I walk in the board meeting and I'm at 12.5% and I'm at 14%, I'm not done.

So the number we really focus is on is the bottom line number.

We do as much as we can on the revenue number and we try to keep driving it to as close as 12% as possible.

But we're going to keep going forward.

But, no, you'll see margin improvement.

Okay.

Great.

And this is a really small line item.

But just curious about it.

On the time and attendance solutions, the growth rate, was that impacted this year by kind of switching over to kind of a software service model?

No, we had a big push in that group, which you get from small groups time to time.

And they pushed hard at the end of last fiscal year.

And the growth last year was probably higher than normal and then they really depleted their backlog.

And they struggle a little bit in the beginning of the year to get going.

But they had a good end and they did well and we're pretty happy with where they are.

Great.

Thank you.

The next question comes from T.C.

Robillard of Banc of America.

Thanks.

I think you guys certainly have overly addressed all of the key issues.

Just one question, I know it's not overly material, but more out of curiosity.

With respect to the litigation on the Rapid Payroll side.

I know it's still -- the ink's still drying on the recent licensee.

But does your insurance cover any of the compensatory or punitive damages that may get awarded to the plaintiffs?

No.

Okay.

And I'm assuming any other -- I'm assuming the reserves that you guys took last quarter already flew through your cash flow statement?

Cash flow statement -- book to reserves that really isn't cash.

When you go pay the expenses the cash goes.

Okay.

Yes.

That's where I was going.

That's certainly something that's ahead of you guys, but obviously not material.

You got to wait and see what happens on the facts.

Okay.

Great.

Thank you.

Next question comes from Tien-tsin Huang of JPMorgan.

Go ahead.

Thanks.

Can you comment, how much cash do you need to run the business?

$1.

Very basic one, right?

Obviously you guys --

Why don't you ask your real question.

The -- let me ask a separate question then I guess on the sales force side.

Premiere and PEO, I think you commented on sales force in general.

But it looked like you're cutting your growth there in half.

How much of that is a function of the emphasizing growth in PEO (inaudible) or just having ample sales coverage in all of the territories there?

We look at that from year-to-year.

If you look at the growth last year, we accelerated it.

We were very successful with it.

And this year we decided we can't strain the whole thing as much as we did again.

We need to get experienced reps.

And you've got to remember, we take all of these sales people out of our various sales forces.

And it's a balancing act.

So we looked at it and this year we decided to go with what we had.

And we feel very -- we feel just as good about the sales force growth this year as we did a year ago, it's a little bit in a different place.

Okay, and then on -- can you just comment broadly on pricing for Paychex premiere and if there's any notable change in the competitive landscape?

And also if you can also just give us the average number of employees for a typical premiere client, that'd be helpful for our modeling.

I don't actually know the typical -- the average number of employees for premiere.

It's probably north of 20.

I'm going to guess between north of -- between 20 and 40.

But basically on pricing, no change in the environment.

We continue to be the price leader.

So if there's a change, we're the ones that will be changing it.

And we kind of like it the way it is.

Us and ADP, we compete very favorably on price.

And they can discount, we can discount.

But we believe the pricing environment is still pretty much the same as it has been.

Are you seeing interest in premiere from companies that are not already Paychex clients?

Yes.

About half of those sales are nonPaychex clients.

Got it.

Thanks.

Next question comes from Sanil Daptardar of Sentinel Assets.

Yes.

Question's been answered.

Thanks.

Next question comes from Michael Baker of Raymond James.

Yes, I had a question from the perspective of your health offering.

I was wondering given the health insurer's perspective -- from their perspective the segment of the market in which you reside is a key growth area collectively for them and it has increasingly been so -- being so.

And I was wondering if you are seeing that reflected in rising commission levels or replacement fees?

The first part of your statement is accurate as we see the world.

The discussions that we've had with the providers are that they see this as essentially a hole in their coverage because the normal way that their products get to market is through the independent agents, and independent agents are not that interested in spending time with smaller clients.

So the first part of your statement is definitely accurate.

There is some consternation on the part of the providers about that the market itself.

They worry that -- or they tell us that they worry that they have a greater exposure to adverse claims out of the smaller companies and the larger companies.

When they talk with us because they know the with which we operate in this business, they feel pretty comfortable that we'll be a good enforcement agent to make sure that adverse clients don't happen.

So all of that has been good.

On the commission side -- the commission structure of the industry is such that they're going to pay us the same as they pay anyone else.

From time to time there may be some arrangements that are made where they'll pay higher commission rates to try and influence us to go into certain markets or to sell certain lines.

And we'll evaluate those as they come.

But our model does not expect that we will get higher commission rates than anybody else.

I appreciate the commentary.

Thanks.

You're welcome.

Alright, then.

We show no further questions.

Now, sir, we will now turn the meeting back over to you for further comments.

Okay, well, thank you very much.

Again, we felt very good about the year.

We really appreciate your interest, and we look forward to more great results in the months to come.

So take care.

This concludes today's conference call.

We thank you for your participation.

You may disconnect at this time.