沛齊 (PAYX) 2008 Q1 法說會逐字稿

Good morning and thank you for standing by.

All parties will be able to listen only until the Q&A portion of today's conference.

(OPERATOR INSTRUCTIONS).

Today's conference call is being recorded.

If anyone has any objections, you may disconnect at this time.

I would like to turn the call over to Mr.

John Morphy, Senior Vice President and Chief Financial Officer of Paychex.

Sir, you may begin.

Thank you.

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

Also joining us is Jonathan Judge our President and CEO.

The teleconference call will be comprised of three sections, a review of first quarter 2008 financial results including comments and updated guidance for the full fiscal year 2008, and overview from John and lastly a Q&A session.

Yesterday afternoon after the market closed we released our financial results for the first quarter ended August 31, 2007.

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

We have also filed our form 10-Q with the SEC with provides additional discussion and analysis for 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 on our website until October 29, 2007.

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

Fiscal 2008 is off to a very good start.

We are on track to achieving our 18th consecutive year of record revenue and earnings.

We achieved record net income of $151.1 million or $0.40 diluted earnings per share in the first quarter and look forward to continuing this streak well into the future.

Total revenue increased 10% generated by payroll service revenue growth of 8%, human resource services revenue growth of 20%, and interest on funds held for clients growth of 8%.

Service revenue growth of 11% was right in line with our fiscal 2008 first quarter expectations.

At this point in time we have not seen anything definitive with respect to new business starts, bankruptcies, or checks per client that would indicate there has been any significant change in economic conditions inside the businesses that we serve.

Operating income excluding interest on funds held for clients increased 14%.

For some time we have been evaluating the best means to share our exceptional ability to generate cash returns with our shareholders.

Our cash balances well in excess of $1 billion on July 12, 2007, we announced two significant actions.

The first was to commence a $1 billion stock repurchase plan that would quickly reduce our hefty cash position.

To date we have repurchased $500 million with $400 million or 8.9 million shares accomplished during the quarter of fiscal 2008.

The stock repurchase plan will reduce net income while more importantly slightly increasing diluted earnings per share at the lower net income resulting from the repurchase program is more than offset by the decrease in average common shares outstanding.

The second was to reduce the future accumulation of cash by increasing our dividend to 43% to an annual rate of $1.20 providing a dividend yield in the 2.5% plus range.

This results in an anticipated dividend payout ratio in excess of 70% for fiscal 2008.

For those of who you like to ask how high can it go, we have no established maximum payout ratio and will continue to evaluate the best means to share our cash generation capability with shareholders.

We will now refer to the consolidated income statement.

Payroll service revenue increased 8% for the first quarter to $361.5 million.

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

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

Employee payment service utilization was 72%, and more than 80% of new clients select a form of employee payment services.

Human resource services revenue increased 20% for the first quarter to $113.3 million.

This growth was generated from the following: retirement services base increased 18% to 45,000 clients.

The year-over-year growth was enhanced by the acquisition of a small record keeper in fiscal 2007.

Comprehensive human resource out outsourcing clients employees increased 22% to 381,000 client employees served.

In our workers' compensation insurance client base increased 19% to 65,000 clients.

Additionally, the asset value of retirement services, client employees funds increased 30% to $8.5 billion.

Interest on funds held for clients increased 8% for the first quarter to $32.3 million.

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

The higher balances for the first quarter 2008 were driven by client-based growth, wage inflation, check volume growth within our current base and increased utilization of our payroll tax administration services and employee payment services.

The average interest rate earned on funds held for clients increased to 4.2% from 4.0% a year ago.

The recent federal funds rate reduction of 50 basis points on September 18, 2007 will negatively impact our interest on funds held for clients for the remainder of fiscal 2008.

We have estimated a 50 basis points reduction will reduce income or the revenue in this area by approximately $5 million but another approximately $1 to $1.5 million change on corporate investment income.

Please refer to our form 10-Q for further information on the effect of changing interest rates on interest on funds held for clients in corporate investment income.

Consolidated operating and selling, general and administrative expenses increased 9% during this quarter.

This increase was a result of our continued investment in personnel related to selling new clients, retaining clients, and promoting new services.

As of August 31, 2007, our number of employees increased 6% to 11,900 employees compared with approximately 11,200 employees as of August 31, 2006.

Operating income increased 13% for the first quarter to $210.6 million, operating income excluding interest on funds held for clients increased 14% to $178.3 million, and improved as a percent of service revenues to 38% from 36% for the same period last year.

Investment income net increased 30% for the first quarter.

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

Future investment income will also be adversely affected by our stock repurchase program and the recent federal funds rate reduction of 50 basis points which we have already talked about.

Our effective income tax rate was 32.2% for the first quarter ended August 31, 2007, compared with 31.0% in the prior year period.

The increase in our effective income tax rate was primarily the result of lower levels of tax exempt income derived primarily from municipal debt securities and corporate investment portfolios due to the funding of a stock repurchase program.

The rate was also increased slightly as a result of adopting new accounting guidance related to uncertain tax positions or namely FEN 48.

We'll now move to a discussion of the balance sheet.

Cash and total corporate investments were $959.7 million as of August 31, 2007.

Our cash flows from operations were again strong at $253.2 million or for the first quarter of fiscal 2008, an increase of 27% over $199.9 million from the same period a year ago.

Our total available for sale investments including corporate investments and funds held for clients reflected a net unrealized loss position of $6.3 million as of August 31, 2007, compared with a net unrealized loss position of $14.9 million as of May 31, 2007.

The three-year AAA municipal securities yield decreased to 3.64% at August 31, 2007, from 3.71% at May 31, 2007.

Our net property and equipment balance activity during the first quarter reflected capital expenditures of approximately $21 million and depreciation expense of approximately $15 million.

Client fund deposits as of the end of the quarter decreased to $3.5 billion from $4.0 billion due to the calendar timing of the end of the quarter.

Client fund deposits vary widely on a day to day basis and they averaged $3.1 billion during the first quarter representing a 4% increase over the prior year.

Client fund deposit balances are growing at a lower rate due to continued wage inflation accompanied by no index changes in the federal deposit rules since 1993 which 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 much closer to that of direct deposits.

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

Total stock holders equity decreased to $1.6 billion as of August 31, 2007, with $115 million in dividends paid during the quarter and $400 million in stock repurchases.

A return on equity for the past twelve months was a strong 28%.

Moving to guidance, as we have mentioned before, one of the benefits of our filing of our form 10-Q the night of the press release is that it provides you time to do a thorough review of our released information and then through your analyst reports you provide us with an early indicator of where your questions will be focused and/or areas that may need further explanation.

It was no surprise that many of you focused on lower than Wall Street expected payroll service revenue growth.

I say Wall Street because first quarter service revenues were right in line with our fiscal 2008 financial plan projections.

We like to reiterate our guidance answer is annual guidance, and quarter by quarter results may not always be in line with our annual guidance.

The guidance is based upon our best knowledge at the time and does not anticipate future ups or downs in the economy, and/or interest rate changes.

Without factual evidence these are much too difficult to predict with any accuracy.

We have a track record of being extremely close to our guidance numbers, and a track record of revising them when it becomes apparent we need to do so.

We believe our guidance ranges are extremely narrow.

For example, the revenue range on payroll is only $13 million or 1% of payroll revenue.

We believe our best estimate for fiscal 2008 payroll revenue is still within the guidance range.

We do not change the guidance until we believe otherwise.

The question was raised as to why we are not changed total revenue guidance to the recent 50 basis points reduction in the federal funds rate.

We have talked about the effect in many of the documents but to put this in perspective, the 50 basis points reduction affected projected total revenues by less than 3/10 of a percent.

Regarding diluted earnings per share, the effects of the stock repurchase program, 50 basis points reduction to the federal funds rate, and the adoption of FEN 48 related to effective income taxes has complicated things a bit.

The simplest way to look at these changes is the stock repurchase program is slightly accretive to diluted earnings per share as a reduction in net income related to funding this stock repurchase program is more than offset by the the benefit of fewer common shares outstanding.

The 50 basis points reduction in the Fed fund rate and our adoption of FEN 48 each reduced diluted earnings per share approximately .01 or $0.01 or approximately $0.02 in total from our guidance of July 2007.

Our guidance of July 2007 net income did not include any of the effects of the stock repurchase program because we had not yet implemented those.

Based on those comments, and the fact that our revised guidance estimates are based on current economic and interest rate conditions continuing with no significant changes, our guidance is as follows: payroll service revenue growth is projected to be in the range of 9-10%.

Human resource services revenue growth is projected to be in the range of 20-23%.

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

Interest on funds held for clients is expected to be relatively flat year-over-year.

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

Corporate investment income is projected to be decreasing by approximately 35-40%.

The effective income tax rate is projected to be approximately 32.5%, and net income growth is projected to be in the range of 12-14%.

Obviously the net income growth has been affected by the stock repurchase program, and that effect will sit there until we get out another year and the earnings per share remains relatively the same which is the more important statistic.

Purchase of property and equipment in fiscal 2008 are expected to be in the range of $80 million to $85 million, and fiscal 2008 depreciation expense is projected to be approximately $65 million we project amortization of intangible assets to be approximately $17 million.

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

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

Please review our Safe Harbor Statements on page 3 of the press release for a discussion of forward-looking statements and related risk factors.

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

Thanks, John, good morning, everyone.

You can tell from John's comments in our press release that we're pleased with the first quarter results and our solid start to the year.

As you know we were coming off an exceptional fiscal year that ended in May '07, a year that resulted in our 17th consecutive year of revenue and record revenue and profits as well as new all time highs for client retention and client satisfaction.

Obviously we immediately made plans to make fiscal '08 our 18th year in a row of record breaking revenue and profit, and as John mentioned at the close of the first quarter we're well on our way.

First quarter results were solid and very much in line with our expectations and our full year plans and guidance.

Total revenues increased 10% to $507 million, the first time in our history we surpassed the $500 million per quarter run rate and set up the fiscal '08 that the year that will break through the $2 billion mark for the first time.

Service revenue grew 11% consisting of 8% payroll revenue growth and 20% HRS revenue growth and right in line approximate our first quarter plan.

Operating income excluding float was also strong for first quarter at $178 million, a 14% increase and a 2% improvement margin improvement from 36% to 38% revenue.

Earnings per share hit 40%, also a 14% improvement and a full penny better than street consensus.

So the financials came in in line with our expectations, and we're obviously happy about that.

Operationally the quarter's results were also very solid, and I would like to share a few observations that.

Our sales units, core, MMS, HRS, Stromberg and Germany are all fully engaged with the territory staff and kick off meetings well behind us.

Our sales teams are off to a good start and turned in a very solid record performance.

Our operations teams, both field ops and HRS ops continues their excellent service delivery results chasing yet again new records and client retention and finally, our strategic investments are all on track and generating lots of excitement via our insurance offerings, the new 401(k) offerings, what we're doing in Germany, Stromberg or our latest acquisition Benetrak.

We put it together as we exit the first quarter feeling pretty good about our start and re-confirming our guidance with minor adjustments primarily relating to the 50 basis points reduction in the Fed funds rate.

I would like to touch on two areas very briefly and we'll open the line to questions.

The first has to do with the economy and what we're seeing.

There is lots of commentary in the news and trade press about the economy, and I think rightly so.

There is obvious concern over new job creation stats, Fed fund rate moves, the whole subprime debt debacle and the supply and demand imbalances in the real estate markets to name just a few.

How is this affecting our business?

We're watching our key indicators closely, and we'll continue to do so, but so far as John alluded to earlier in his comments, we don't see anything in our universe we classify as a definitve economic downturn other than the impact that the 50 basis points decrease has on our liquidity investments.

Our business and primarily because we're focus on the small and medium-sized clients tends to be reasonably resistant to the effects of economic down turns.

We were relatively unaffected when the oil prices rose precipitously, and so far we remain relatively unaffected by the current economic conditions.

The last thing I wanted to comment on was perhaps the best news that occurred in our first quarter for shareholders at least and that's the exciting news about our significant increase to our dividend and the announcement of a billion dollars stock repurchase.

I know you guys are all very familiar with both of these announcements, but that's not the point of my comments.

Bring it up again only to say thank you to a large number of people on this call that helped us think through our options concerns and capital structure and the best uses of our cash.

Your experience and your opinions are very valuable to us, and I see this as just one example where your engagement with our company has helped us manage Paychex to what we believe is the best possible outcomes for our shareholders, so sincerely I wanted to thank all of you that helped us think that through and do that publicly.

With that, John, and I would be now happy to take your questions and comments.

(OPERATOR INSTRUCTIONS).

Our first question is from James Kissane, Bear Stearns.

Thanks.

John, can you elaborate a little bit on why you expect core payroll revenue growth to accelerate over the balance of the year?

I know it is lumpy quarter to quarter.

You talk about acceleration.

We don't even think that way.

The payroll number you talk about being off which you guys had is $2 or $3 million on $150 million.

It is too close for me to call.

Obviously we would like to have been a little better.

But it still was within the guidance.

It was right on what we expected in our financial plan and only time will tell.

Now, you can sit here in the macro world and you can get all worried, but I have to say we spent obviously we knew people would be asking us about the economy.

We spent countless hours, and I drove a few of my people absolutely crazy with statistics looking at this economy from all angles, and at the end of the day we came to the conclusion we haven't seen anything definitive to say anything about anything that's worth saying, so we'll keep pushing on payroll revenue.

When you get down to a couple million, it is hard for me to sit there and say that's a trend or something.

I don't want to read into the term definitive which you used a few times.

We haven't seen anything.

Is there a change in tone of your customers or anything?

No.

Okay.

Just I guess, John Judge, comment on the progress towards the 5% net client growth target.

The 5% is in our model, right, when we talked about the makeup of the 12% revenue growth in the model, we say 5%, we're quite happy with if we get anywhere near 4%, and obviously we love to be 10%, but we feel like we're in pretty good shape.

As John said we looked at the core.

We read a lot of the comments that came outlast night after the announcement, and I guess my comment to your earlier question would be we're once again in one of those positions where our model and your model maybe a little out of sync, and if we felt like we had a problem, we would clearly tell you, but we don't think we have a problem.

There is lots of places to gain improvements in our revenue streams whether it is more new clients, larger new clients, better job on loss on our client loss world, better ancillary penetration, and there is plenty of things we're working on and plenty of things will get us where we want to be.

We feel pretty good where we are.

Great.

Thanks.

My pleasure.

Our next question comes from Rod Bourgeois, Bernstein.

I know you're going to keep harping on this economic question, but your guidance doesn't assume any change in the economy.

Can you give us an updated guideline on what are the main things you're watching and what type of a swing could occur if you were to start seeing certain of those factors turn to the downside?

We're basically watching our CPA business, we watch new business starts, checks her client, we look at pricing, how good the price increase went in, which it went in very well.

We look at all the statistics that is we have.

We don't look at too much by geographic part of the country, and most of the country seems to be pretty consistent, and we don't look at [Citgos].

If something happens and the first thing you see is checks.

If checks start to go down, you watch that.

The impact on us and checks is the last check you lose -- the first check you lose is the lowest revenue check but obviously it is a highest profit check.

In the recession back in the early 2000s, checks per client dropped precipitously over a three or four-month period of 4%, now, I want to be careful when we say this because Golisano was in the business a lot longer than I've been in it and he would say that's the most precipitous decline he ever saw and I think each one of these, whatever you want to call them, cycles is different, and there is always something a lit bit different in each one, and I don't think you just look at the last one as that's what's going to happen again.

That's what we start to see.

The things that normally show things starting to go south, we haven't seen it yet.

It doesn't mean it couldn't happen.

You look at the macro part and it kind of of is alarming.

But at the same token we don't seem them.

Now we we have another connection.

I'm not going to say what it is.

It is in a different business of ours, and they have verified the same thing we're seeing.

In other words, they think maybe it happened, but they haven't seen anything yet.

Okay.

And let's say something like checks per client started to taper off.

What levers in do you have in the business to offset that?

Is it just a net negative when that happens or do you pull the margin expansion lever harder in order to offset it?

You clearly had good margin expansion in the current quarter.

Could you pull that lever harder if you started to see a downturn in checks per client?

This is John.

There is an obvious answer which is checks per client is one piece, what's your average revenue per check, what happens with your frequency with the clients you have.

What's happening with the clients that you're losing.

Are you losing smaller clients, are you losing larger clients, so it is why we look at lots of different indicators, not just one, so in the spirit of your questions if we started to see checks decline, you obviously have to look at things like going after figuring out way to say get more clients in.

I am sure our sales guys would tell us they're looking at that every day trying to figure out how to get the maximum number in.

We have different levers we can pull relative to either price increases or different charges that we could do relative to W 2 processing and get a better different focus on our MMS business, if this was a core problem, and there is lots of different things we can do.

I think the main thing is what John was telling you, when we look at our indicators, and one of the them that's an interesting one is we look at what would you describe as?

You call it the new job creation inside of our existing clients, because we do all of the compliance reporting to the federal government on new hires.

When we look at those numbers on a year to year basis, they are absolutely flat out flat.

When you look at the labor statistics, they show you the first decline that they've seen in four years.

Those two answers are materially different.

The only thing I would tell you, and it is why some of the people on this call have called us out in the past why we tend to be relatively resilient to economic downturns, what happens in the small business environment is not the same that happens in the economy in general.

All right.

Just to pick up on something you mentioned, the ability to dig harder on sales if there were a slowdown in the economy, how is the sales force positioned here in the first quarter of the fiscal year?

Did you get off to a good start in terms of sales force growth and productivity trends?

We got off to a good start in all of those.

The thing that I sort of tend to watch the most is where are we on open territories.

There are two things I think one is more of a short-term issue, one is more of a medium to long-term issue, but the two things we tend to watch are how are we on staffing our territories and timing territories for the existing people and the second thing is how are we doing on attrition because it really has to do with the tenure of the people in the field and how well they're doing, and as I mentioned in my earlier comments our sales teams got off across the board by the way because we have multiple sales teams, got off to a solid start.

We're happy with where we are, we're obviously pushing harder, but we're happy with where we are, and it is in a large part what gives us confidence on the year.

Remember the sales piece in our world, once you're in flow in the current year really only after affects between probably 12 and 15% of our P&L.

The impact of sales team has is most largely noted in the following year.

Got it.

Thank you, guys.

Thank you.

Our next question comes from Kartik Mehta, FTN Midwest.

Thank you.

Good morning.

Good morning.

John, I had a question for you.

You talked a little bit about pricing, and I wanted to get your thoughts on maybe during the last recession was it hard to get your normal price increases or was this a business that you really didn't have a difficult time achieving those price increases?

Pricing is not a problem, wasn't a problem last time.

Now, one thing we're positioned better today on the pricing because we used to put the price increases in, and we didn't really train our payroll specialists as well to deal with making sure the client understood the value proposition.

We're much better at that.

We actually some discounting levels, discount levels on putting new, renewing businesses are actually better than they were, have ever been.

I think the pricing still stays okay.

And then you're going to be done with your share repurchase here in calendar 2007, is this something you consider doing, extending, because the business generates so much cash and it doesn't sound like there is large acquisition opportunities out there?

Let me say it a different way.

First off, all the board has discussed with it was the $1 billion and the dividend increase.

We do realize a balance is required, and we had a very good discussion at the board meeting, and the recommendation was implemented is exactly what management recommended, and we had good discussion on both sides of the case that was good discussion.

It doesn't mean anybody felt one-way or another.

It was just good discussion.

Looking forward, I think we will be looking and talking to them about what do we do about stock option dilution and how do we continue a balance of the dividend and repurchase.

Obviously we're not going to see us buy another billion.

I don't think you will see us take on debt to repurchase stock, but right now we're off to a great start.

We had two good announcements, and you will see us continue to evaluate capital structures.

What we do exactly depends on discussion with the Board and their feelings, and right now I can't predict them, but you can anticipate we made changes that will be ongoing.

Last question, John, considering the Fed funds rates are coming down, and that's going to have a negative impact on your clients fund interest income, would you consider using maybe a line of credit, having debt for a few days to help increase the amount of income you get out of the flow?

We're doing that already.

That's a new change that came out -- a capital structure change.

For example, when we are raising the billion, we decided we would not basically liquidate all our long-term positions, we put some of the long-term positions in different places, so we will take on debt periodically, not frequent, but we do know we can maximum maze returns by borrowing less than 20 days a year.

Thank you very much.

Our next question comes from Liz Grausam with Goldman Sachs.

Great.

Thanks.

Considering how much disruption we saw in August, certainly in the equity markets and the credit markets, was there anything you saw in your business as you moved month to month through the quarter and potentially any change from August to September moving into the current quarter and business conditions and potentially new business creation surrounding what was happening in the credit market science.

Absolutely none, and the thing that's interesting is it is the same thing happened when you saw the precipitous rise in the oil prices and lots of concern about the impact that was going to have on the economy, and there were lots of theories about how it was going to impact expense and gasoline charges for sales forces and blah blah blah, we watched it pretty closely, and we literally did not have a single blip on our radar screen, and as the whole subprime market unfolded and lots of talk it was going to bleed into the money center banks and so on, again, it is not an issue that appears to affect small business America in the least amount.

The only significant impact that we saw relative to subprime is that one of the large subprimes that went bankrupt was one of our clients, so we lost a client, but relative to the 570,000 install base we had, we saw absolutely nothing that would indicate to us that it was going to bleed into our business.

Great.

And I know you mentioned John Morphy that you don't really look at your client base maybe by industry sector, but just in general when you think about your business mix, by industry, and we certainly seen payroll growth most dramatically hit in-housing and construction markets and financial services, are those areas just by nature of the employment trends in those businesses that you're particularly under weight would you think?

Basically I think when you look at us and as we sit here in the fall and think small to medium-sized businesses, but you really have to get focused.

Our average client only has 17 employees and 40% of the clients have less than five, so I think some of those industries that get hit are in larger segments of employees, so we're not fully representative in them, but I do say when you take small business America measured as a just stated, we have a pretty uniform distribution.

The only thing that tends to be away from something is if the accounting is complicated and there is a lot of inventory accounting, we tend to not be in those areas because our supporting stuff isn't good enough to solve all of those issues, but for the most part we're in the simple part of America, and pretty representative across the board.

Great.

Thanks a lot, guys.

Our next question is from T.C.

Robillard, Banc of America Securities.

Great.

Thank you.

Just two questions.

On the client balance growth of 4%, if I remember correctly, I think the thought process was kind of a 6-7% growth for that.

Is this just a function of the seasonal pattern or how should we be thinking about the growth in client fund balances?

This is the third weakest quarter you get.

The next quarter is the weakest, the strongest is our third, and our fourth is the next best.

The 4% as we got this phenomenon going on hasn't been increasing as much as we thought it would.

Its where the balance averages are, but we have to look at the whole year.

We're open for 6-9%, probably closer to 6%.

We'll have to wait and see what happens.

Again this is an area we don't control.

I don't think this is a sign of anything, but remember what we charge people is all based on transactions, how much money people get.

We would like to charge on that basis, but we really can't.

We'll see.

The real period is going to be indicative on that is the bonus season which will be in our third quarter.

So at this stage fair to say that that's not necessarily a red flag from your standpoint.

No, wouldn't read anything into it this time.

I think there will be some indicators that come off this bonus season and what it looks like.

A year ago the bonus season stayed strong, so when you look at the bonus season, I will give you an idea how good people really did in calendar 2007.

Okay.

And then just separately obviously continued strength in improvement on your operating margins ex floats, about 37.5% in the quarter.

That continues to trend up.

Is this a situation as your mix continues to improve as you continue to get -- as you highlighted on past calls kind of higher revenue or higher quality kind of new customer adds, can that go to 40%?

Is that achievable or are we starting to kind of bump our heads up against where that number could go?

I wouldn't say we're bumping up against it.

Obviously I tell the joke when it gets to be we get 100% profit and so we get the money and don't do anything, obviously you can't go higher than that, but I think there is still room in this.

We talk about our formula to 12 and 15.

The 12 is very important.

The 15 is extremely important.

Our people are focused on knowing, we want to keep working towards the 15, and we look at what we have to invest, and we look at the balancing act, and you might get them all again on missing the revenue slightly because you can live without that, but you aren't going to get any mulligan on missing the 15.

So we knew in the quarter we wanted to watch expenses.

We had a budget.

We started off cautious, and people did a very good job across the whole Paychex universe of not spending money they didn't need to spend but spending the investments we need to do make so when we got to the end of the quarter we felt very good about what our people accomplished.

Okay.

Maybe just drill down a little bit more on that.

What's a bigger driver to the incremental margin there?

Is it simply just scale in terms of on the payroll side or are you getting more of a bump from increased ancillary services?

It has more to do really with the investments that we make.

If you wanted to just look at the business from one standpoint, if our business stayed static, then it is very conceivable that we could continue to drive that margin higher and higher.

You wouldn't as John said -- you wouldn't drive it past the point where your investments are zero because that's sort of a strategy that gets you to one last quarter before you turn the lights out because you stopped investing in your business, but the main thing that affects us or will affect that margin is where our investments, either in our infrastructure, investments in our people, if we go into new businesses, building new sales forces and so on, and we constantly make those trade offs watching the impact they'll have on on our P&L.

There was a comment made earlier by Kartik I think about the use of our cash and that there aren't a lot of big acquisitions out there.

The issue is not that there aren't a lot of big acquisitions out there.

We're very interested in acquisitions.

But we have such a high pre-tax profit and such a strong P&L it is unlikely that we're about to go jump into some business thats got half the profit margin and going to drag our profit margins down.

Part of it is we're pretty careful about what we look at in terms of bringing companies in, but we're clearly interested in continuing the M&A side.

The thing that I think drives it mostly is the mix that we have and the expense structure and investment of our business.

Thanks, John.

Our next question is from Adam Frisch, UBS.

Thanks.

Good morning, guys.

Hi, Adam.

Quick question for you, John Morphy, on the payroll stuff.

I don't want to get my head bitten off here, but since you were asked the first couple questions the stock has come down so maybe I am reading into it a little bit too much, but maybe the questions weren't answered as well as people wanted them to be.

The payroll growth the last three quarters now are a little bit below the 9% which is causing people to think why does it come back.

If you could just kind of go through the puts and takes in a given quarter of why it might be up and down a little bit, I totally agree with you, it is a $6 million difference between 7% and 9% growth.

It is really not that big of deal, but it is having an impact on your stock, and it will be the thing that people discuss going forward, so maybe you can address why you think the growth is going to be better in the next several quarters.

Is there things you're doing now like bringing more customers on board or sales accelerated or anything like that would suggest that?

We're pushing all the envelopes.

Again, I look at the year, first off you look at the revenue difference in the first quarter.

That was your revenue difference.

It wasn't mine.

Okay?

We hit the number I thought we would hit based on what the plan was, okay?

Right.

I know people can look at this, and I also know that we're in a world right now where everybody is looking for anything that kind of can signal bad, okay?

That's what they're looking for.

If I look at that number, I would look and say I wish it was a little bit better, I do, but I can't go get all alarmed over a couple million dollars on $150 million.

Okay?

Would I like it to have been better?

Yes.

I look forward to what we're doing.

I talked to Walter and the commitment the sales people are making, some of the adjustments we made to have a better sales year this year, and they're optimistic.

They keep pushing.

We haven't seen anything that says things have changed, and we're going to keep going on that basis until we reach the point where its got to be something different, and you got to believe, and we have a long track record of being very good about guidance.

We have a track record of changing it when we need to do change and we don't sit here and say we won't tell them because that doesn't do me any good.

I have got a lot of employees.

The whole thing needs to be in the right place, but at the same token we don't give up easily either, so we're optimistic.

We understand there this is a macro environment issue there is that somebody might say I don't know, but we're running our business the best we can, whether recession is coming, I don't know, and we're going to keep doing the best we can, and even if a recession does happen, we're going manage this the best way possible, and we think we'll be one of the better performing companies in that environment than somebody else.

We're going to keep plugging.

Okay.

That pretty much does it.

John Judge, one of the comments you made I thought was real interesting, that small businesses aren't an exact proxy for the economy, so if I take the bear case and look at Paychex or some of your peers, you're in employment and you're exposed to rates and so forth, not necessarily a great place to be right now, but that's completely overlooking the business model and the durability of it and everything you've done in the past, so maybe you can outline for us why you think this small business might not be a great proxy for the economy and why you think the business will perform better than maybe what the bears are thinking right now.

Purely history.

Just go take the time if you're interested in it and go watch what happened to our company and when there were different terms of the worm in the economy, and you'll see, now would be as good a time as any.

It is the bears sitting out there, and you hear the same thing after you've been saying it, and we hear the same thing and people talking about subprime and people talking about selected -- at least selected parts of the United States and housing starts and real estate sales, and you have retailers now that are apparently calling for a warning on their sales and a potential problem in the holiday season, and so on, and there is a lot of people now labor statistics down first time in four years, and so the bears are out with their claws, and I would I say look at our company, and I look at whats happening in our business and we're not having any of those issues, and I go back and look back to, I mentioned the oil crisis that was not too long ago, not a blip on the radar screen, lots of people forecasting it was going to cause all kinds of problems, and it just -- it appears to be a fact of life that in our business we tend to be much more resilient to these economic downturns than the rest of the economy.

Okay.

That's great.

Last question I wanted to ask you about was the -- I know you didn't mention any of the 401(k), health care and relief and still a little ways away from them becoming more material, but can you provide an update on their progress and when we might see them highlighted as a stand alone initiative.

First of all, I don't think I would be the one that would tell you they're not material, we just don't happen to break them out for you.

Last we checked I think they they were in the 5-$10 million range or so.

Health care.

Health care correct

401(k) is over $100 million.

Right.

So you're just threw health care out as an example and you specifically wanted to hear about health care?

Yeah health care and the 401(k), the expansion you're doing there with more plans and how that's ramping up.

Okay.

Start with healthcare.

Healthcare is going at least as as well as we expected and if we looked at the results that we got in the first quarter, then we would say it is going better than we expected because it is ahead of plan, but we remain very bullish on healthcare.

We spend a lot of time talking about it, why we think it is close to a perfect storm for our coverage model, our distribution model our experience in the agency business in the past.

We remain bullish on that and things are going quite well, and as I said in earlier calls we're sort of accelerating that as fast as we believe we can in terms of growth and staying under control, so it is all good news about health care.

401(k), we announced a whole new series of offerings last year.

I think we mentioned in prior calls we actually sold that significant -- we sold significantly more in the guided choice and the open architecture offerings than we expected to sell last year, we remain strong in those this year.

We're also having a good year with the original offerings that we had in the 401(k), more of the fixed fund offerings, so that in part what caused the HRS to rebound back into the 20% range.

In both of those areas we're feeling good about where we are.

Thanks, guys.

Just keep doing what you're doing we should be okay.

Alright.

Our next question is from [Tin Gin Wong] with JPMorgan

Thanks.

Most of my questions have been answered.

But just a few follow-ups.

The client fund balances, any way to isolate the question on slow balance growth due to the more weekly payments than before?

No, but we know it is got to be 3 or 4%.

Has this played out and could the timing of these payments continue to contract over time?

I am curious about the longer term dynamics of that.

Well we've said float income is going to grow slower than the rest of your business.

I don't know how fast it contracts, but obviously it is going to have some impact on us.

And then on the higher tax rate, heard the explanation there.

Any way to also quantify the impact from the lower expected mini-yields versus the FEN 48.

We talked about taking out $6.5 million.

Right.

A year.

I am rounding.

20% is taxable, and 80% is not, and you got a statutory tax rate of about federal and state for us is about 36, 37%.

You can run the numbers.

Got you.

And then on John Judge, just lastly sales force retention, hiring, relative expectations, any update there?

No.

Things are going fine there.

The main thing as I mentioned earlier was making sure we had the right number of sales people on board trained and in the field at the start of the year.

We did very well in that this year, and the efficient numbers are as I mentioned in the past, that is something I will never stop harping on.

So we made good progress, we got lots more to do.

Great.

Thanks for the details.

Okay.

Our next question is from David Grossman.

Thanks.

My questions have been answered.

Charlie Murphy with Morgan Stanley, you may ask your question.

Thanks.

I wanted to ask how much revenue came from BeneTrak in the quarter and how much you expect roughly '08.

Minimal, less than $10 million.

Excluding PEO, what would HRS revenue growth have been in the quarter?

Didn't calculate it, so I don't know.

Obviously better.

Okay.

Thanks.

Our next question comes from Mark Marcon, R.W.

Baird.

Can you remind us what the price increase was that went through.

Up 4%.

4%.

And then in terms of the core payroll growth, you know, you mentioned there are certain things you can do.

I am assuming that you would expect a pickup with regards to new clients added based on what you were saying about your sales force commitments, is that an accurate --

I hope so.

Because you got to go out and sell it, and you have to remember our selling season, while every quarter is important, the season is January -- is December, January, February.

When you talk about making the year or not making the year, that's pretty crucial.

And looking at that, would you say your sales force is probably because of improved retention is probably in better shape this year going into that December, January, February period that it has in the past.

Is that a correct assumption?

I think so.

Okay.

So part of what could potentially increase the growth rate from 8% to 9% or 10% on the core payroll would be improved sales?

Yes, but I don't want to get off the point John made earlier.

This problem is in your mind, not in ours.

We are exactly where we thought we were going to to be in the first quarter.

Your revenue was exactly in line with my estimates.

Not you, I meant in general.

Yeah.

We're not feeling a problem.

Yeah, I am not saying there is a problem.

I am just trying to clarify certain things.

The incremental margins on your fee businesses were 48% this last quarter.

Looks like what you're basically saying is you accelerated your operating -- your fee income growth to 14%, and if I go through the guidance, it seems to imply that we're going to get to 15% for the year, maybe even a little bit more than that.

We did 14% in the first quarter, so that would imply a little bit of acceleration.

Is that a correct assumption?

It is the way the timing of investments fall, and if I go back five or six years ago, we used to get very significant margin improvement in the first quarter and actually gave some of it away in the next three quarters and gotten to the point now we get pretty good margin improvement but don't give away much in the next three quarters.

We keep getting a little bit, but it is just the timing of expenses, and our investments have really changed and a little more in the sales forces.

You have the healthcare thing where the investments lined up more in the front end of the year than they did in the past when they were in software or something else, so we keep watching it, and the goal is to get to 15%.

I don't know that we get way above 15%, but the management team is highly motivated to get to 15%.

And then last question on the HRS side, you obviously had acceleration with regards to the growth there.

What was the area that you were most pleased with?

We're going to go right back to the same subject.

You guys talk about acceleration.

I don't look at anything quarter to quarter because this business has some things that are a little bit seasonal to it.

I look at what I am expecting, and so again just as my payroll number was close to what I expected, my HR number was better than your number, and it was better than your number, but it wasn't better than my number.

It was back to the end of the quarter and you take all of this money, we were within hundreds of thousands of dollars on both revenue categories, and I am sitting there, we rerun the base and expect to be that close.

I understand what you're looking for, and it is kind of frustrating for me on both of our sides, but I know you're trying to find anything to look at, and now we're looking at number that is are really miniscule.

I'm just asking what you were most pleased with, in terms of--

I know.

All I am saying is what did I walk away pleased from, and I walked away and I was right where I thought I would be.

So you were essentially equally pleased with all elements?

Yeah.

Okay.

Let's face it.

You know we would like payroll revenue growth to be better.

Right.

But it is kind of what it is, and we're okay with it, and we plan for it accordingly.

Okay.

Great.

Thanks.

Our next question is from Gary Bisbee, Lehman Brothers.

Hi, guys, good morning.

Just a couple of housekeeping questions.

It looked like in the 10-Q last night you may have adjusted slightly the mix or the targeted mix of your float balance more towards bonds and a little less towards short-term from what you said a couple months ago in the 10-Ks.

That's true, and it is the direct result of the stock repurchase program.

Okay.

All right.

We thought originally we were going to have to basically sell off all long-term, and we found a way by borrowing -- I don't think it is less than 20 days and maybe less than 5 by borrowing a few days a year not yet, primarily more in the -- our third third quarter, that we can shift more of that and keep it long-term with better rates.

So it is more due to the corporate portion than the client floated.

Absolutely.

Yeah.

And I also saw in there it looks look your liability per claim in the PEO business is actually moving up this year to a $1 million from $750,000.

I guess wondering I know it is not a big deal, but why given your risk aversion historically around this business.

Actually I am risk adverse but the way the insurance company works, it is in my favor to take that little bit of extra risk.

That wouldn't wind up being a very material number.

Okay.

And then on the recent BeneTrak deal, is this going to be something you just move into the business as an existing add-on, or are you going to aggressively try to sell it separately like you did a couple years ago like the Time and Attendance acquisition.

It will be both.

We will continue with the sales currently being done by BeneTraK, and we will integrate it into our products and drive it into our primarily our MMS business, but so it will be both.

Okay.

And then I also saw that Germany I think you said in the 10-Q was less than 1% at this point.

Is that -- I realize you have only been there for awhile.

Is it safe to assume that that is growing much faster than the U.S.

business and that if we look out a couple of years, at some point that will begin to be a more significant piece of the mix or is it -- is the growth similar to what you're doing here?

The growth is the faster than the what would be the average or even above average growth of a new city that we would open in the U.S., so that part has all been great, and clearly it is our hope it will become material in the future.

We wouldn't have made the investment in the first place.

Thanks for all the color.

Thank you.

Our next question is from Tim Willi with A.G.

Edwards.

Thank you.

Wanted to ask a question around the issue of capital structure and management.

I definitely appreciate that earnings growth is very important to the story and shareholder value, as is dividends, payouts and growth.

I was just curious if you could also discuss within the capital decision making process where returns on capital, sort of rank in those discussions with the board.

You clearly have an enviable level there, and just sort of are those -- is that an important part of the discussion that we don't really want the returns to come down so we very careful about making sure we're not retaining any more capital than we need and we'll make sure we're dispersing that one-way or the other?

Can you throw a little color on that topic?

It wasn't as sophisticated as that although there were some opinions amongst the analyst community that we should have spent time on that analysis that is that the cash on balance sheet is slower han any other part of our business and it is our strategy to reduce the cash or reduce all the cash and take on debt.

I think that was from a firm that was selling convergence but the way that the board really was what is the right amount of cash that we need on the balance sheet to responsibly run our business, have available acquisitions and so on, and once we got to that point, some general consensus, and that's an art, it is not a science but what do we want to do with the excess cash, and once we got ourselves to the point that we were north of a billion dollars, I would say it was largely John and myself who started the discussions about the fact that we now in a position where we had probably more cash on the balance sheet than we needed.

We started to do the modeling on the cash flow into the future, and it became obvious if we didn't do something we would soon have $2 billion on the balance sheet and continue on from there, and so that naturally started the discussions, and what we ended up doing is we ended upcoming to the conclusion that is we came to largely by eliminating the option that is were not attractive to us and modeling the ones that is were left and picking the ones that we felt were most attractive, and that's what you ended up seeing us rollout.

It wasn't really any more sophisticated than that.

Do you think that at some point in the future there might be more focus around that topic and in conjunction with earnings growth and dividend payouts that we want to try to make sure that the capital we still got in this business is generating returns of X amounts, and if we think those returns would be under pressure, then that falls into that discussion about give willing back more capital to keep those returns at an appropriate level?

I actually think that do what we do, that return on capital number kind of takes care of itself.

Fair enough.

Thank you.

Our next question comes from Brandt Sakakeeny with Deutsche Bank.

Thanks.

Hi, John and John.

I have a quick question to clarify what you said earlier.

John, did I hear you right when you said that you were getting no growth from your checks per client this quarter, and would you happen to have that number in the the year ago period?

I didn't say that.

Okay, I though you said it was flat.

We said we looked at the economy as flat and looked at checks and looked at lots of statistics, and we reached the point we think it is time to give checks or client data again we'll do it, and with don't think we reached that time.

The reason we stopped is the reaction.

The minor changes in checks was over reacted to.

The point where your reaction of the greater than what I would calculate to.

At the same time I say that, and we have not made a discussion of this or detailed decision, is I do believe we try to give you people the best information we can give you, and if it happened, haven't seen it yet, that discussing checks per client was relevant to you understanding our business, we will then seriously consider disclosing it again.

Again, I believe it would be for the period of time it was deemed necessary and not a permanent thing.

Okay.

Fine.

And just on the PEO side, there was and has been some volatility just around the insurance reserves.

Should that be more stable this year?

Are you getting sort of quarterly checks on that?

It already got more stable.

Some of the impact we were worried about in the first quarter was minimum minimized, wasn't as bad as I thought it would be, but Florida keeps lowering rates, it is going to keep affecting us which the tendency is they lower them for too long, and then they eventually put them whack up.

They have lots of stuff going on in Florida with real estate, et cetera, so lots of combating desires.

We'll see what happens and keep watching it and fortunately for us the PEO is not that significant to me, so this winds up being a more of a nuisance than a big headache.

Great.

Thank you.

Our next question comes from Glen Greene, CIBC World Markets.

Thank you.

Good morning, just a quick question for John Morphy.

On the expense side, the expense growth was 8.6% can which is kind of the slowest for at least a couple years or in a long time and obviously ties in with the margin ramp that you had from 4Q to 1Q which was really strong.

Was there any timing of investments that we should be aware of that picks up in the back half of the year or any just color on your sort of thinking on how the expenses came out relative to your expectations?

We didn't -- right now we don't have anything that I think is a significant ramp, and we just ,one thing we did, we made a change here to some of our incentive programs about two years ago, and the working extremely well and really motivating the whole team to do certain things, and we looked at the first quarter and said we have to look at the budget, and we have to watch expenses, and we probably have to watch them really hard all year.

We'll be realistic.

Three years ago the surprise up was revenue up.

If I, while I am very optimistic, I think you would think I was crazy if I told you I was looking for very optimistic surprise on revenue.

We're in the zone.

We're watching our stuff, and people have all got to identify expenses.

They can go, if we need to have them go.

People are watchful like you are in your businesses.

So we're doing what we need to do, and I wouldn't say it is anything unusual, and the good news is it is becoming a really part of Paychex culture to watch this.

Okay.

Thank you.

Our next question comes from Sanil Daptardar, Sentinal Management

Just a clarification.

On the human resources revenue for the first quarter, you reclassified a portion that revenue into HR services, its some honest reclassification.

I want to know what the reclassification and are we going to see for the reclassified revenues for the second quarter, third quarter, fourth quarter of last year.

No.

The numbers are what they are.

They change one modestly, but again the numbers pretty small.

Yeah.

I just -- the numbers are small, but why was the reclassification done now and what was the type of reclassification?

It was done a year ago.

It was done the second quarter.

We had HR revenue that was in payroll we thought was better in HR than payroll, minor amount of money.

I see.

Okay.

The companies have reclasses all the time, minor ones trying to make sure the reporting is as good as we can possibly make it.

Okay.

Had the reclassification not done the HR, the payroll services revenue growth would have just 7.1% versus 7.8% reported.

Actually go the other way.

The payroll revenue growth would have been slightly larger, and the HR growth would have been slightly lower.

Okay.

Down a tenth.

Our last question is from Rod Bourgeois, Bernstein.

John Morphy, just a quick follow-up.

Was there any payroll days issue in the quarter where there was a miss match in payroll days this quarter versus the year ago period.

Not that I know of.

My people would have brought that up.

I think the days were the same.

I think that we can have that issue, and trust me, if I knew that was the issue, no, we didn't have any day issue.

Thanks for addressing all the questions, guys.

No problem.

Thanks for asking.

We sit here and we're not always going to agree on everything, and that's okay, but I really do appreciate the openness, and we believe our 10-Q process is greatly enhanced our understanding, and I hope you see us as reacting to what your concerns are, and we actually changed some of our disclosure a little on this call because we knew there were a couple things a bit complicated namely the earnings per share, so we're trying to be as responsive as possible, and we really appreciate your interest in Paychex.

At this time there are no further questions.

That was a great place to end.

Thanks a lot.

We felt we had another great quarter, and we'll see what happens, and we look forward to talking to you guys again in three months.

Take care and enjoy.

Thank you for joining today's conference call.

All parties may disconnect at this time.