沛齊 (PAYX) 2009 Q3 法說會逐字稿

Welcome, and thank you for standing by.

(Operator Instructions)

I would now like to turn today's meeting over to John Morphy, Senior Vice President and Chief Financial Officer.

Thank you, sir, you may begin.

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

Also with us is Jon Judge, our President and CEO.

The teleconference call will be comprised of three sections -- a review of our third quarter 2009 financial results, including comments and revised guidance for the full fiscal year 2009, an overview from Jon, and lastly, a Q&A session.

Yesterday afternoon after the market closed, we released our financial results for the third quarter and nine-month period ended February 28, 2009 and we have filed our Form 10-Q with the SEC, which provides additional discussion and analysis of the results for the quarter.

These are available by accessing our Investor Relations page at www.Paychex.com.

In addition, this teleconference is being broadcast over the internet and will be archived and available on our website for approximately one month.

We continue to experience difficult economic conditions, and like the rest of the world, Paychex finds itself in unprecedented times.

During the third quarter, we saw economic conditions further deteriorate, but more about that later, as we would far prefer to start with a few of the areas we feel good about.

The selling season, while difficult, was good when measured against reasonable expectations in difficult times.

Reading the media, we sometimes get the feeling that everything is on stop.

Yes, we are experiencing less than desired activity and/or results, but our world is far from on stop.

Year to date, the total annualized revenue -- we refer to that as PAR -- that our total sales force as sold is about equal to last year and down only 4% in the third quarter.

Much of the 4% relates to higher discounting to meet prices offered by other competitors.

Year to date, our new unit sales from new business starts are down 16%.

Our sales forces have done an excellent job in working harder to find other sources of business to minimize the impact the credit crisis is having on new business starts.

One of our selling bright spots is Major Market Services, where we expect to achieve our aggressive fiscal 2009 financial plan for new PAR revenue.

This is due to our experienced MMS sales force taking full advantage of our product enhancements and being in a market that is not as affected by poor business starts.

Time and labor online is a good example of a product enhancement, as we can now better meet the time and labor reporting needs of both existing and new clients.

Overall, we added over 37,000 new payroll clients in the third quarter of fiscal 2009.

Our HRS business is experiencing some difficulty relating to the 401K environment, but healthcare continues to meet our expectations.

Operations -- we experienced another exceptional calendar year end from a service point of view.

Our customer survey scores remain at record levels.

In January, we processed over 11 million W-2's, all sent to clients by the 16th of the month and well over half by the 10th of the month.

There's been unprecedented volatility in the global financial markets resulting in many companies experiencing investments or credit losses.

We have maintained our conservative investment strategy and have not recognized any impairment losses for our investments.

We invest on average approximately $4 billion of our clients and our own cash with daily balance changes frequently in the $1 billion to $2 billion range.

In these turbulent markets, we have managed these sizable investments with no losses of principle and have met all of our clients' daily needs related to the payments of wages, taxes and other benefits to their employees.

We regularly monitor credit worthiness and are able to quickly react to any changes they may experience that would impact the flow of client funds or cash flows.

We are also extremely pleased with the performance of our risk controls in these difficult times.

We encounter client insufficient funds risk relating to the billing of revenues -- accounts receivable -- and also when we transfer client funds only to find out later the client did not have the funds to pay for the applicable transfer.

This risk arises because while we believe the money has been transferred into our bank accounts, the banks have two business days to reject an ACH transaction.

Our ability to minimize losses has been exceptional, as we incurred only $1.3 million of bad debt write-offs on $1.5 billion of service revenues during the first nine months of fiscal 2009, and only $3.2 million of write-offs on over $200 billion of client transfers during the first nine months of fiscal 2009.

We continue to divest in the business, just as we did during the last recession.

Examples include significant systems improvements, product enhancements, sales force growth in key areas and seeking acquisitions that will add value to our shareholders.

We continue to generate significant cash flow, even after paying dividends to our shareholders.

For the first nine months of fiscal 2009, our cash and total investments increased by more than $100 million.

During the same period, we generated $631 million of operating income, $420 million of net income, and paid out 80% of net income, or $336 million in dividends.

Our cash flows historically exceed net income, which allows us to be comfortable with and committed to maintaining our current dividend level, even though the payout is increasing as a percent of net income.

We will now share some of our key indicators and provide some insight into how the small to medium-sized economy has been acting during fiscal 2009.

Again, we have added some additional information that we believe will be beneficial to our shareholders, perspective shareholders, and the Wall Street community.

Hopefully this will enhance your understanding of Paychex.

Our checks per client decreased 4.3% for the third quarter and 2.4% for the nine-month period compared to a 1.5% decrease year-to-date through November 30th, 2008.

Our new client sales from new business starts decreased 23% for the third quarter, bringing the year-to-date decline to 16%.

Clients loss due to companies going out of business or no longer having any employees increased 21% for the third quarter and 16% for the nine-month period and the 2008-2009 bonus season was the weakest in recent memory.

Bonus dollars decreased 13%, whereas bonus checks decreased 25%.

In simple terms, the owners took less, but their employees felt the weaker economy more than the owners did.

On a positive note, while deterioration of these trends was very noticeable through January 2009, the trends appear to be stabilizing as we review our results for February and early March.

Again, that's a short period of time to say it's really stabilized, but at the same time, we're encouraged by the fact that the slope that was very steep in December and January appears to have abated.

Our service revenue grew 6% for the nine-month period, or $80 million.

We expect to complete fiscal 2009 with service revenue growth of 3% to 5%.

This is lower than the guidance we gave last quarter on service revenue growth of 5% to 7% and is a result of the key indicators deteriorating as we mentioned earlier.

We have continued to leverage our expenses.

Our operating income without float increased 8% for the nine-month period over the prior year and as a percent of service revenues improved to 37.4% from 36.6% for the same period a year ago.

We expect to generate a record for operating margin as a percent of service revenues for the full year in fiscal 2009.

Though our service revenue guidance is lower, we reaffirmed our guidance for net income, a decrease of 5% to 7% from last year and our operating income without float growth of 5% to 8%.

Contributing to our lower results of operations is a decrease in interest on funds held for clients which declined $40 million or 40% for the nine months ended February 28th, 2009.

Our guidance for checks per year to reflect a 40% to 45% year-over-year reduction of $52 million to $60 million, consistent with the guidance we provided with you in December.

On a positive note, our guidance for interest on funds held for clients is not subject to any significant downside rate risk, as we have reached the bottom on short-term investment rates and our long-term investment returns are very predictable.

Our long-term portfolio currently yields 3.3% and has an average duration of 2.3 years.

In each of the next two 12-month periods, slightly less than 20% of the portfolio will mature.

Our guidance policy has been in place for a long time and except for very few occasions, our actual performance has been exceptionally close to our guidance.

Our philosophy has been and continues to be to provide guidance based upon what we are experiencing in financial terms and quantifying our expectations for the current fiscal year.

While we do not change the steepness of trend lines, we do project current trends into future periods of time.

We believe it is extremely difficult, if not impossible, to accurately predict significant upturns, downturns in the economy, and even more difficult, to forecast increases, decreases to short-term interest rates.

Who could have predicted the rapid and significant changes to the economic environment that have taken place throughout fiscal 2008 and 2009?

We believe our guidance philosophy assists to many people developing in value and expectations for our future financial results.

They know it is based upon and they can, if they choose to do so, make their assumptions on what they believe are realistic assumptions of the future, whether it be changes to interest rates, employment levels, et cetera.

We will provide more information related to guidance throughout our discussion of our fiscal 2009 financial results.

I will now move to a discussion of our results as presented in our income statement.

Payroll service revenue increased 2% to $381 million, and 4% to $1.1 billion for the three and nine months ended February 28, 2009.

This growth was primarily driven by price increases and growth in the utilization of ancillary services.

The growth rates have been adversely impacted by the decline in checks per client.

The decline in checks per client for the third quarter was 4.3%, which is roughly the low point from the last recession.

In that recession, checks per client in 2001 declined 3.5% and in fiscal 2002, they declined approximately 4.0%.

As previously mentioned, our ability to attract new and retain existing clients continues to be challenged, as more companies go out of business or have no employees and new sales from new business starts continue to decline.

Additionally, monthly new hire transactions per client have decreased with some acceleration in the third quarter.

New hire transactions are volatile and some of the drop-off may relate to the fact fewer employees are also leaving their current jobs.

Looking forward, we expect payroll service revenues to grow between 1% and 3% for the full year fiscal 2009.

This is down from a range of 3% to 5% that was provided back in December.

Human resource services revenue increased 9% to $131 million and 12% to $391 million for the three and nine months ended February 28, 2009.

This growth was less than anticipated and based upon detailed analysis, a substantial portion of lower revenues were outside our control.

Factors contributing to 9% growth include comprehensive human resource outsourcing services -- client employees -- increased 6% from February 29, 2008 to 432,000 client employees as of the end of February 2009.

We continue to be the market leader for this offering, as the total number of our work site employees is more than equal to the next three competitors combined.

The 432,000 client employees served does represent a reduction from November of 445,000 due to lower levels of employees per client.

The client base during the same period grew 1%.

Workers compensation insurance client base increased 8% to 75,000 clients.

Retirement services client base increased 6% to 50,000 clients.

These client growth figures except for the comprehensive human resource outsourcing services client growth are based upon the comparable number at February 2008.

The client base for retirement services and workers compensation remain relatively flat compared to November 30th, 2008.

Our growth in health insurance revenues continued to be strong and grew 79% to nearly $15 million for the first nine months of fiscal 2009.

We are well on the way to our goal of $20 million for the year.

Factors adversely affecting growth include -- volatility in the financial markets caused the asset value of retirement services client employees funds to decline 23% from February 29, 2008 to $7.2 billion.

During the same period, the S&P 500 declined 45%.

The decline in asset value accompanied by client employees moving their portfolios to safer investments reduced retirement services revenue growth by $3.0 million for the quarter and $5.9 million for the nine-month period.

The lower level of employees per clients and our comprehensive human resource outsourcing services resulted in a reduction to revenue growth of approximately $3 million for the third quarter and $4.5 million for the nine-month period.

The estimated growth in human resource service revenue for the three and nine-month periods, if we excluded those two items, would have been 14% and 15%.

We continue to experience volatility in PEO service revenue due to the fluctuations in workers compensation claims and workers compensation rates, but those fluctuations were modest in the quarter we just had.

Looking forward, we expect human resource services revenue to grow between 10% and 13% in fiscal 2009.

Total service revenue increased 4% to $512 million and 6% to $1.5 billion for the three and nine months ended February 28, 2009.

Looking forward, we expect total service revenue to grow between 3% and 5% in fiscal 2009.

Interest on funds held for clients decreased 56% to $16 million and 40% to $60 million for the three and nine months ended February 28, 2009.

This is primarily the result of lower average interest rates earned on short-term investments.

The average interest rate earned on funds held for clients was 1.8% and 2.4% for the three and nine months ended February 28, 2009, a decrease from 3.6% and 3.9% for the same periods a year ago.

In addition, overall economic trends of companies going out of business and lower checks per client have adversely impacted the growth and average invested balances for the three to nine months of fiscal 2009.

Under normal financial conditions, the impact to our earnings from a 25-basis point increase or decrease and the short-term interest rates would be approximately $4 million after taxes for the 12-month period.

Such a basis point change may or may not be tied to the federal funds rate.

It is not possible to quantify the after-tax effect of a 25-basis point change in the current investment environment.

That will depend on whether the rates actually move.

On guidance, projects the year to reflect the 40% to 45% year-over-year reduction of $52 million to $60 million and interest on funds held for clients and is unchanged from the guidance provided last December.

Looking at expenses, consolidated operating, selling, general and administrative expenses increased 3% to $331 million and 4% to $956 million for the three and nine months ended February 28, 2009.

These increases were the result of increases in personnel and other costs related to selling and retaining clients and promoting new services.

As of February 28, 2009, we had approximately 12,600 employees compared with approximately 12,300 employees as of February 29, 2008.

Our philosophy on expense management is to continually look for more efficient ways to conduct our business while not impacting the level of service our clients expected when they added our services and to invest in the future.

In these turbulent times our employees are doing an excellent job of cost management ensuring we continue to provide our best service levels ever.

We are investing for the future with our continued investment in healthcare offerings that has been rewarded by 79% revenue growth in the first nine months of fiscal 2009 and we are managing our sales forces with the objective that all territories will be staffed with no reduction in territories.

Operating income decreased 6% to $197 million for the three months ended February 28, 2009, and was flat for the nine months ended February 28, 2009 at $631 million.

Operating income excluding interest on funds held for clients increased 5% to $181 million and 8% to $571 million for the three and nine months ended February 28, 2009.

Our guidance for operating income excluding interest on funds held for clients is unchanged from the second quarter and projected to increase 5% to 8% for the full year.

Net income for the third quarter decreased 8% to $131 million, or $0.36 diluted earnings per share.

Net income for the first nine months decreased 5% to $420 million, or $1.16 diluted earnings per share.

The majority of the decrease in net income was attributable to the decrease in interest rates.

To a lesser extent, earnings per share was positively impacted by the one billion stock repurchase program completed in December of 2007.

For the first nine months of fiscal 2009, the stock repurchase program increased diluted earnings per share by $0.05.

Looking forward, we expect net income to be 5% to 7% less than a year ago.

We will now move to the balance sheet.

Our liquidity position is strong with cash and total corporate investments of $572 million and no debt.

Our cash flow from operations were $563 million for the first nine months of fiscal 2009.

Our net property and equipment balances activity during the nine months ended February 28, 2009 reflected capital expenditures of approximately $53 million and depreciation expense of approximately $47 million.

Purchase of property and equipment in fiscal 2009 are expected to be in the range of $75 million to $80 million.

Fiscal 2009 depreciation expense is projected to be approximately $65 million and amortization of intangible assets for fiscal 2009 is expected to be approximately $20 million.

Client fund to obligations as of February 28, 2009 increased to $4.1 billion from $3.8 billion as of May 31, 2008.

Client funds held vary widely on a day to day basis and averaged $3.3 billion during the first nine months of February 28, 2009, which is relatively flat over the prior year.

The growth rate in average funds held for clients has been negatively impacted by current economic conditions as discussed previously.

Total stockholders equity was $1.3 billion as of the end of February, reflecting $336 million in dividends paid in the first nine months, or 80% of net income.

Our return on equity was a strong 44%.

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 to our Safe Harbor Statement in the press release for our discussion of forward-looking statements and related risk factors.

At this time, I am pleased to turn the meeting over to Jon Judge.

Thanks, John, and good morning.

That was a lot of information to digest and in many cases much more detail than we normally provide.

So I hope that was helpful.

I'll just take a few minutes to emphasize some points and then open it up for your comments and questions.

Our third quarter results, while certainly not at the normal Paychex levels of excellence, left me proud of how hard our team fought through the economic difficulties.

The third quarter was another tough quarter of macroeconomic headwinds that produced significant challenges for our clients and perspective clients and therefore us as well.

The same issues that have been affecting our normal business results were at play again in the quarter.

Increased losses due to business failures in nonpayment, decline in new business starts due to poor credit availability, very low interest rates on our float revenue, negative job growth and the highest unemployment in 10 years.

John took you through the details of how those issues affected our performance in such areas as sales from newly created businesses, client employee attrition and therefore lower check volumes, much higher client business failures and the lost revenue as a result.

But regardless of the tough economy, there are lots of very encouraging results as well.

The third quarter is our most important quarter from a sales standpoint.

It normally accounts for over a third of our total year sales.

We finished the three months down 4% over last year and flat for the nine-month period, well ahead of most, if not all of the participants in our market.

Our MMS division is having a very good year in new sales.

It's running essentially at a normal pace, despite the economy.

New products are being very well received.

Products such as time and labor online, HRL health benefits that John just mentioned.

We're gaining share versus our competition and maintaining extremely high customer satisfaction.

We remain very profitable and are actually expanding our margin and we have a terrific dividend.

We continue to leverage our growth through excellent expense management and obtaining leverage off of our infrastructure.

For the nine months ending February 9, we leveraged our 6% service revenue growth into 8% operating income growth [ex-float].

And while this is not at our business model of 12% top line growth and 15% bottom line growth, the leveraging of 6% top line to 8% bottom line is almost spot-on our model.

This is directly attributable to our margin expansion of almost a full point from 36.6% to 37.4% during the toughest economic headwinds of the past 80 years.

So in summary, the quarter once again presented some unusual economic headwinds, but the areas that we could control, we controlled very well, including excellent expense management and client satisfaction.

The $64,000 question is when will the economy turn to positive growth?

And while I don't have that answer any more than I suspect you do, I do know that when it does turn, Paychex will be in an excellent position to take advantage of the turn.

John and I would be happy to take any questions at this point.

Thank you.

(Operator Instructions) Our first question comes from Rod Bourgeois.

Please state your company name.

Rod Bourgeois here with Bernstein.

You guys, I just wanted to inquire a little more about the pricing environment -- you guys normally get an annual price increase of 3% to 4% and I'm wondering as you head into fiscal 2010, can you handicap your ability to push through a price increase next year, or is that not a good idea until the environment stabilizes more?

Rod, this is Jon Judge.

We -- I think we've talked about this in the last call as well.

We're very close to making that decision public.

We've had quite a few debates inside of our Company, as we do every year, by the way.

Both sides are very well represented.

The reality is that the environment that we're in right now is a very difficult environment.

The environment that we were in at this time last year was also a very difficult environment.

We're in about the 15th or 16th month of this recession and while we're not prepared to tell you what we're going to do at this call, I would say that it is reasonable for you to assume that we'll be in pretty much the same position we were in last year and that it's probably likely that we will do another price increase similar to what we've done in the past number of years, as far back as anybody can remember.

All right, guys.

And if you do put a normal price increase through, will that be offset by discounting and other price concessions that are happening in advance of that?

In other words, will you truly get a net 3% to 4% price increase as normal, even if you try to institute that, will you actually get it?

Well, time will tell.

We do have a lot of history on this and so we do have a pretty good understanding of what happens when we put a price increase in place relative to what we net.

And I would say that looking at this year versus last, looking at the activity that happened during the sales season versus last relative to competitive pressures on price, that it might be reasonable to assume that we might not net as much as we would normally net if we go ahead and do what I described, but it would be probably pretty close based on what we can see from this year so far and what we saw last year.

You mentioned that your bookings in the quarter were hurt by a price aggression from competitors.

Can you quantify the amount of price aggression or the amount of impairment to your business that is happening from the recent pricing pressures?

John, do you want to take a poke at that?

Well, first off, the year-over-year was only off 4%, so discounting wasn't all of that because we were down some on units.

I don't think it's significant.

There's no doubt, and you know the people that are doing more of it than others, and so it's there.

But we don't always see them head to head and when we have to match, we match.

But we're the price leader and we're going to continue to be the price leader and we think we offer better customer service and we don't have to win by always matching the price exactly.

So discounting is a little more difficult but not so much that it's going to change anything dramatically from what we see right now.

Great, and finally, can you tell us the plan on the dividend and if there's any entertainment at some point of doing share buybacks again, but mostly on the dividend, is that intact?

Well, two things on that and I'll go first and then Morph can put some in as well if he would like.

The dividends is a decision made by the board, not by the management team.

Obviously we have a position on it.

We discuss our dividend at every one of our board meetings, even though we change our dividend traditionally only once a year.

What I will tell you, and we've talked about this before, the dividend is a very large part of the culture of our Company.

It's something that we consider to be extremely important and I would be very surprised if there were any changes to the current dividend.

From the standpoint of ability to pay out the dividend -- from the income from operations -- we are not at risk this year and we don't believe we're at risk next year of needing to do anything other than to continue to produce profits to pay the dividend.

So on that score, I would tell you that I would be very surprised if there was any change to our dividend, but again, that is a decision that's made by the board, not by the senior management team.

I would add to that it has been discussed before, and paying 100% of earnings is not something that would bother us.

We're very fortunate.

Our cash flow is generally a little bit better than net income, so it's not like we can't pay out the full net income.

We're sitting on a nice cash balance of over $500 million.

It's not impossible we wouldn't use some of that if we didn't think the impairment was permanent.

So I would echo Jon's comments.

On the stock buyback, the issue there I think is -- right now cash is king for those who have it.

We're aggressively looking for acquisition opportunities and unfortunately haven't found anything that fits quite right yet.

I think to use the money to buy stock back would be short-term focused as we think we can do better in the long run, but that also doesn't mean that if things got a lot worse and shares or whatever got to prices it, doesn't mean we wouldn't consider it.

So I think we keep looking at this, but right now we feel very good about the dividend and stock buybacks, we're not even authorized to do any right now.

That's the best overview we can give you.

Very well said.

Thanks, guys.

Thank you, Rob.

Yes.

Our next question or comment comes from Kartik Mehta.

Your line is open and please state your company name.

FTN Equity Capital Market.

John, had a question, I know it's a very short period and you said you saw stabilization in February and March and obviously don't want to draw conclusion from a short time period, but I'm wondering if you can elaborate on what metrics you saw the stabilization for.

Checks.

The most important metric, checks.

It's the first time February and March look like the first month in quite a while since probably back to August where the forecast looks like it will be met.

It's been like we forecast -- we forecast the trends and they are worse than we thought they would be.

December and January, they were like rocks dropping.

Some of that is hung up in the bonus checks, but I actually think checks per client in March might be slightly better than they were in February, but that doesn't mean much because it's too short a period of time and you get the aberrations on how the calendar falls.

So it's too short a period to call.

I have had another person tell me that's in a different industry, it would be close to what they would see -- we would see and they would be a little ahead of us and they thought they were seeing some stabilization.

Now, we could see this and it could change again, so I'm very cautious about a short period of time, but same token, I'll take six weeks to what I thought stopped something over what I've had in the past.

Any good news is better than what we've had, right?

Right, and new hire report, that went off the cliff in December.

Now it dropped to a low point, but that's not gotten any worse either.

Maybe because it can't get much worse, but that's hung in there.

I think the new business people push to get to the end of the year and I hope they did what they needed to do and hopefully they have done most of it.

But only time will tell.

You also mentioned opportunity for acquisitions.

Is this just trying to buy some smaller payroll companies, or do you think there's an opportunity to maybe buy a product line or something else that would have an impact on revenue and earnings of the Company?

Without going into -- Kartik, this is Jon Judge.

Without going into any detail, because we would never talk to you about something we weren't prepared to talk about.

The answer in terms of what our interests are is all of the above.

We buy small payroll companies every year.

This year is no exception.

We've bought a bunch already.

We will continue to buy them as they become available at a price that makes sense to us from a lifetime profitability standpoint.

But the acquisition part that John refers to, or that I refer to and we talked about is more the latter of what you talked about -- which is finding companies that have solutions that would integrate well into our infrastructure, into our clients' needs, and with companies they don't have to be as profitable as we are.

The acquisition obviously would have to be accretive.

But they would have to -- they would have to be in a space where we believed that we could get them close to the profitability of our Company for long-term reason.

But that's what we're looking for.

We have a small group in our Company that does that.

We look at literally hundreds of companies each year, but from looking at us, one of the interesting issues that we have is when you're a 40% pretax Company, the types of things that you're interested in tend to be maybe not that profitable, but profitable -- and companies that are profitable aren't always interested in selling.

And a last question, John, are you seeing any small payroll companies having problems with their client funds?

I don't know if that was an opportunity to gain market share in this environment if those companies were having not only problems operating, but maybe even having problems with the client fund that they have.

I'll give you my opinion and then Morph can give you his.

The piece where I've been surprised to date is that there haven't been more companies who have had apparent financial difficulties in the environment that we're in.

Now, it is true that this space is generally a profitable space.

There's nobody that runs at our margins, but even if you run at half our margins, most people would think you had a pretty good Company.

So I for one have been surprised that there haven't been more companies that have found themselves in financial difficulties and therefore needing either a white knight or some other mechanism, other means to recapitalize.

So the answer I would tell you is no and I'm not aware of any companies that have had difficulty with client funds specifically, but you know as well as I do from following the space that from time to time we learn that there are some companies that get a little bit either more aggressive with how they are investing clients' money or in some cases actually using it inappropriately.

But I'm not aware of any in this current environment.

Morph?

I'm not aware of any, but I think the reason it's hard, first off, is as you said, companies are usually very profitable.

The other reason is when you take the float issue, the direct market in coverage -- you probably lose half of it.

Most of those people know that.

So they usually don't tamper too much.

The other thing that's interesting, we've bought some of them, you find float in unusual places.

Probably rarely would be too aggressively invested in the market -- a different flow than what you might expect.

Sometimes it's in a Jaguar or a Corvette, but usually I think they have known enough not to take too much risk, but only time will tell.

Because we have seen others where actually it isn't so much how they invested it, they actually stole it.

Right now, I don't know of any.

Thank you very much.

Thank you.

Our next question or comment comes from Jason Kupferberg.

Your line is open.

Please state your company name.

Thanks.

Jason Kupferberg, from UBS.

Good morning guys.

I wanted to ask a question on the operating income line.

It looks like as we head into Q4 that year-over-year growth in the operating income excluding the interest on client funds I guess could turn slightly negative.

Wondering based on what you see today, is it possible that this metric could be in negative territory for the full year fiscal '10?

Just recognizing that there might not be much revenue growth out there to get the typical natural leverage that you're accustomed to?

Basically what's going to happen, and we've talked about many times.

We can control costs exceptionally well for almost every circumstance.

The one that gets harder is when checks per client decreases, because the last check, while it's lowest revenue check, it's also the highest profit check.

Right.

So we will get some pressure on these margins.

Now, when I say that, I don't want you to go feel that the margins are going to go to hell, because that isn't going to happen either.

But the margins are going to see some pressure that's going start next quarter because of checks per client.

When you go into looking at fiscal 2010, in a world like this one, the change that can take place between now and when we give guidance at the end of June is too great for me to fully speculate on that.

Obviously we're looking hard at 2010, but we're not ready to say what we think it will be until we see what environment really actually happens, but we are aggressively cutting all expenses we can cut and we're also watching to make sure we stay supportive of our employees and we're doing everything we can, but we have to watch it.

You will see some pressure, but how deep, we don't know yet.

But if checks per client stays in negative territory over the next 12 months, the logic there would be that operating income would probably see some kind of absolute decline?

Not ready to say that yet, but the margin could.

Yes, the margin could.

Okay.

That's helpful.

Just wanted to talk a little bit more on the cost side as well.

Certainly seems like you guys have done a very nice job to date in that department.

What's left at your disposal when you think about the different levers that you can pull from an outright cost cutting perspective?

I mean is there still a fair amount in head count?

Is there anything facilities-wise or other back office types of operations, if you can help us think through any of those categories, that would be great.

Let me start with that, John, and then you can add in if you would like.

It starts, Jason, with a management philosophy that absolutely links revenue and expense.

So every one of our senior managers knows, as we go through our budgeting process -- and we're about to get into heavy duty budgeting process in the next couple three weeks -- when we go through the budgeting process, all of our senior management team knows that they get X amount of expense to generate Y amount of revenue.

And if the revenue line is coming down, then the expense line has to come down in the same ratio.

And so it starts with that.

It's not -- the way that we run our business, it's not as though we just -- when we get in trouble we go and try and find a couple of big line items and start hacking away at them.

It's a much more disciplined approach than that.

And all areas are up for grabs.

The thing that we do extremely well as a team is that we're very careful about the things that we cut to make sure that we're not cutting into things that will hurt our near-term and medium-term revenue growth potential.

So we're pretty careful to make sure that we're cutting the least impactful things first and the most impactful things last.

Now, we have done some things that will help us in the immediate year and next year.

You've probably read that we froze wage increases for all employees for one year, that we have discontinued the Company match on the 401K for one year.

Those two items alone generated savings that would be in the neighborhood of several hundred jobs as an example.

And as we go into the budget season, we'll be very careful to look at anything that we don't believe is necessary to maintain client satisfaction or generate revenue and profit growth and those things are all up for grabs.

Now, you probably know when you look at a Company like ours that's running at a 40% pretax, there's not a lot of fat running around.

So it has to be in most cases, it has to be pretty much disciplined across the board expense management.

John?

That was a great answer.

I don't have any more to add.

Just a quick clarification to wrap up here.

First, you mentioned that you added 37,000 new payroll clients in the quarter.

Was that a gross or net number?

That was gross.

I would have loved it to have been net.

We would shout it from the streets.

What was the net?

We don't disclose client growth except once a year.

We had mentioned on the last call that client growth could go negative for the year.

Right.

If you looked at ADP's numbers that were announced yesterday and the sectors we're in, they were negative.

Yes, and are you going to give this bookings metric going forward, the annualized revenue sold?

We will -- we talk about this data, my tendency is when times are difficult and harder to predict, we will tend to give more data.

When times get better, we'll tend to bring some of that data back, only because my experience shows when you give all this data, we get people that overreact, usually overreact to stuff.

But today I think we got to give you as much information as possible.

While it matters, we'll continue to give it to you.

And when it matters less, we'll probably draw it back.

But the time being, I don't think you'll see us drawing anything back immediately.

Fair enough.

Thank you, guys.

Thank you.

Our next question or comment comes from David Grossman.

Your line is open, and please state your company name.

Sure.

David Grossman from Thomas Weisel.

Just following up on a couple of those comments you just made -- in terms of the client growth, if you hold things and say they stabilize from the current levels, does that imply that client growth would in fact be negative for the year and can you give us a framework to think about client growth in fiscal '10 as well?

Well, I can't say what '10 will be yet, David, because I don't know.

But if you looked at what ADP disclosed, I'm better than they are.

So, that will give you a range that's pretty narrow.

We're not looking at something that's huge.

But you could get negative.

And again, similarly on the -- if you think about the revenue per client, sounds like bankruptcies are up a lot, but the checks per client are down.

How do we synthesize that into thinking about the revenue per check or the revenue per client type of metric?

Does that actually go up in this environment?

Does it stay flat?

The revenue per check will probably go up slightly.

And the reason it goes up slightly is that's assuming that we do a pricing increase, which we haven't totally decided yet, but that would have some assistance obviously.

The other thing is when you take out the checks at the bottom, those are lowest revenue checks.

So if you did revenue per check and it came out to a number -- I don't know that I'd increase it by more than a nickel, but it can definitely go up by a few pennies.

That's one of our tests.

When you look at our metrics in our business which are looked at every month.

When I see checks going down, I better see that revenue per check number going up and almost always we look and we go, yes, there are pops.

That's a reasonable expectation.

Okay.

Do you have any orders of magnitude in the last cycle how that metric trended in terms of revenue per check?

Revenue per check increased.

I'm going to say it increased -- that happened between $0.03 and $0.05 -- but going off memory.

Okay.

Not too far off on that.

Okay.

And just getting back to the question about expenses, if I just think about it in terms of absolute dollars again, just thinking things just stabilize from here on out, is it possible to do many of the things you've mentioned -- take the absolute spending levels down, but not really necessarily impact the investments that you're making to grow the business and retain employees, among other things?

I think expenses next year will be close to flat and depending how the budget process goes and the opportunities that are presented, they could go negative.

But I won't know that till I get there.

You're not -- negative isn't -- if somebody said to me could they be negative?

I wouldn't come back and say, no, that's impossible.

It will be definitely in the scheme of things that would be looked at.

Okay, and just generally, one last question, just on the EPS skew.

Again, assuming a more stable environment, just at current levels, would we have a different skew, I assume just logically you would be a little more back end loaded in terms of EPS for next year?

No, that's what I originally thought, but my first look at '10 doesn't seem to indicate that.

Again, it's too early to say.

I didn't see that.

Right now I think the skew's going to be normal but we'll know more about that when we get into it.

Okay, great.

I would have guessed what you said, but at my first look, it didn't happen.

I got a few people answering the questions, or at least doing the research, because wait, I didn't think that was going to happen.

Okay, great.

Thanks very much.

Thank you.

Our next question comes from Jim Kasane.

Your line is open.

Please state your company name.

Yes, [Uvay and Merrill].

Hi, Jon and John.

John, can you give us an update on the retention rate, and are you seeing more voluntary churn given what you've said about the competitors pricing more aggressively?

Well, couple things there.

One, most of the stuff that you'll hear about pricing being more competitive has to do with sales of new clients, not clients in the install base.

So you shouldn't necessarily translate one into the other.

So -- give me the rest of your question again, Jim.

It was basically that.

Where are you getting picked off?

You talked about the bankruptcies and going out of business or just employees going away, so the clients go away, impacting your retention rate.

I was just wondering, would it also be impacted by voluntary churn where clients go to another guy.

We'll have some of that every year.

When you look at what our losses are in an average calendar year we'll lose 10% to 12% of customers going out of business, another 1% to 2% of clients that lose the ability to pay and we take them off the service or they take themselves off the service, but they are still in business, they have just gone to no checks.

In a normal year there's somewhere in the 5% to 7% of the clients that we lose, we lose for other reasons and that would fall into that category that you were talking about.

So it happens each year.

We track pretty carefully the number of clients we lose to competition against the number of clients that we take from competition.

That number has been positive for the whole five years that I've been at Paychex.

It's still positive now.

You'll get little variations up and down.

The total number that are actually in this exercise relative to the total number of clients we have in the install base is pretty small.

Okay.

So that 5% to 7% number has not changed this year?

It has -- no.

The part that we can control is pretty much where it's been for as long as I've been here.

It gets -- we try to get it a little bit better every year because we dissect that 5% to 7% and try to figure out in that 5% to 7%, what are the things that we can control?

Obviously the generalized thought of our client satisfaction where you deal with clients is in that, but there's also specific things like different type of reporting capability, clients that want different feature functionality things and we work towards that.

A good example would be one of the reasons we're having such a great year in MMS this year is that one of the problems that we have with some of our MMS clients in prior years were things like we didn't have a robust enough set of applications, like time and labor online.

And so once we've built those applications and put them into play, we saved clients that we might otherwise have lost and quite frankly, we got new clients where we would have been excluded from bidding in the past.

Okay.

That's excellent.

And John Morphy, you talked in the queue about the float income, or investment income on client funds not going below $60 million.

Float plus investment income.

Okay, got it.

And the -- I guess that's basically based on the rates.

Yes.

That you're earning and what you can see over the next year.

What other factors could -- obviously float--

Balance could affect it.

That's right.

But based on what you're seeing right now, the $60 million is a good number to use?

Yes, and if it gets worse than that, we don't even want to talk about it because something else got real bad.

You did talk about the trend stabilizing, in answering someone else's question you said it was the checks per client primarily.

But, are you also seeing it also in new sales, bankruptcies, are trends improving there as well?

I would never look at such a short period of time on that.

Checks is the thing that really moves this thing and where the economy is going.

Actually the checks are a resulting fact of those other things, too.

We didn't look -- I didn't look at those in the same detail -- short period of time.

Checks -- when checks move you know it, and that's the best indicator of all of them.

That's great.

And thanks for the increased disclosure.

No problem.

That concludes your question?

Yes, thank you.

Thank you.

Your next question or comment comes from Julio Quinteros.

Please state your company name.

Thanks.

Goldman Sachs.

John Morphy, real quickly on the cost side quick, what was the benefit of the pay wage and the 401K matching changes that you guys had in the quarter and also related to that on the cost side, how much did you guys -- how much benefit did you guys get from sales commissions not being as strong as you would have thought in the quarter?

Basically those two items we got nothing -- because they weren't effective -- one wasn't effective until March 1 and one wasn't effective until April 1.

And the wage change isn't going to effect very much in this year because we don't have very many wage increases in the last three months of the year.

So the impact there will be more in the first quarter next year.

Got it.

Basically when you talk about incentive pay, there's no doubt, and we've talked about it before, one thing that's helping us on margins is incentive pay for both management and sales people, is less than what it might normally be.

So I went this morning and looked.

The impact on margins is less than 1% at the current time, so we're not talking about something that's a huge number, but is something we'll have to work against in next year's plan because you'll try to restore some of those things back to normalcy.

Got it, okay.

And then on the actual numbers, sounds like everything you've talked about as far as the improvements have been focused on checks.

But what -- at what level are they stabilizing at?

It was down 4% I guess through February.

About where the bad was.

I'm sorry?

Stabilized where the bad was.

Where the bad was?

What does that mean?

Stabilized there.

It didn't get better.

Got it, okay.

And then on the new sales and the client attrition or the clients lost because they are out of business, did those numbers also stabilize or was it just specific to the check number that you're talking about?

I just looked at the check number and the reason I do that is a lot of our season happens between December and February, actually December to the end of January.

So those aren't real indicative to start looking at those.

And we also get a lot of year end -- month end effects.

So March, I really don't have any numbers on those.

The thing, though, that will potentially affect those, those things should be directly affected by the things that are happening in both the monetary policy and the fiscal policy of the fed and of the president.

The thing, the area that's -- the thing that's hurting those things pretty significantly is the credit situation, which they are trying desperately to get under control and start to get credit flowing again and mostly that.

So if you start to see a much more of a loosening in the credit environment and credit dollars to start to flow again, you should start to see new business originations pick up as more normal than where they are right now and you should see clients going out of business less frequently than they are right now.

Yes, agreed.

And then just finally on just the pricing commentary, the two pieces to it, existing pricing increases versus new pricing increases, everything that we heard about yesterday at the analyst meeting for ADP suggested that there was definitely some pricing on new sales, et cetera.

So just -- can you just net those out, the comments that you had about the pricing that you're contemplating going forward?

Is that on your existing basis versus the new stuff?

Well, those are two different bases, because the pricing increase obviously goes in on the existing and you talked about that.

And then you got the price increases on the new.

That's going to be a function of what the market allows you to do.

We've got to be competitive.

Our sales force is allowed to discount on the spot if they need to be.

But again, we aren't going all the way to the bottom and we win business and we win off of our great service and we win off the ability that we've got a reputation.

We're not going to try to be the low price provider because we're the leader.

And we'll continue to fight in the marketplace and our sales people are doing a great job.

Got it, okay.

Great.

Thanks, guys.

Thank you.

Our next question comes from [Tinjeng Won].

You line is open and please state your company name.

It's Tinjeng Won from JP Morgan.

John Morphy, what are you looking for in the marketplace and I guess in order for you to move into higher yielding securities?

I think what -- right now the next indicator that we can move is the US dealer securities are still stuck at 5 to 15 basis points, which is better than they were.

Not much, but when that starts to move, to me that's the signal we'll move.

Okay.

And that's also will be the signal the banks are cooperating better.

The whole reason those rates are so low is because the banks don't trust each other.

They don't want to move anything between each other.

That's what the fed is trying to get fixed with this policy, but the banks are still sitting there and we just aren't back to normal.

I will say this -- we're not good enough yet by any means, but we're a lot better than we were in October.

We see this whole process working much better.

October was scary.

But I can't go to higher yields til I'm sure -- I -- my money is -- I can get it and as much as I would like to get to higher yields, us acting the way we are and making sure we're doing what we need for our customers is way more important than --

Agreed.

I was just curious what you were watching for.

That's useful.

It will be the move.

You see the move and you can say okay.

That will be a good move for everything.

Yes, agreed.

Two quick one and then I'll jump off -- what is the outlook for float balance growth because that's coming in a little bit weaker than what we were modeling.

I would say flat to you might make it slightly down.

Flat to slightly down, okay.

And I know Julio asked this as well.

Checks per client, so it's stabilizing at this down 4% level, is that the right number?

Unless they want to believe the world's getting worse or better or staying the same.

For me, we'll probably do a plan that's going to be right at that level holding.

Another thing that gives that some validity is that's where it stopped last time.

So unless I see some increases in it, I think that's a good number.

Do I think it's going to -- now you get into guessing when the economy's going to change.

I don't have any way of knowing that.

But I wouldn't leave -- I wouldn't take the number -- the number might be 3 for this year.

I think you got to work off closer to the 4.

But it could change.

Good to know.

Thank you.

Thank you.

Our next question or comment comes from Jim Macdonald.

Your line is open.

Please state your company name.

First Analysis.

Thanks for taking my question.

On HR services, could you talk a little bit about the sequential drop and was there any impact of end of year on that number?

No.

Most of the drop in HR is related to things we can't control.

It's the basis points, which over time are going wean off those anyway because the fund choices we have aren't going to have as much basis points, but then we charge more to the client.

So it's just on those things are happening.

The remarkable part is I think HR holds in there and 401K holds in there.

But we just got to keep watching it.

This is the first time we ever had this much revenue in that product line because if you go back to the early 2000s, that revenue line was like $100 million versus the $400 million plus it is today.

I was particularly talking about the client employees, which dropped.

The client employees on the work site is simple.

They are letting people go just like the other people are.

You have to understand that we've got, not a distinct side, but we have a little more geographic in Florida, which Florida is not -- Florida is probably worse than other places.

And do you see that improving as we go into the later calendar quarters here, your sales ability to offset the drop?

I don't know.

Okay.

Thanks very much.

Thank you.

Our next question or comment comes from Mark Marcon.

Your line is open.

Please state your company name.

RW Baird.

Good morning.

I was wondering, with regards to the potential price increase, how are you thinking about that in terms of magnitude?

ADP yesterday basically said well, probably not do our usual price increase, just given the current environment.

In prior discussions with you, it sounded like if we're going to do it, we're going to go all the way.

How are you thinking about that now?

Mark, I think the one thing when you ask that question is we've got a competitor doing what he's doing and I don't think we're going to answer that question.

Because we would rather -- we know what we're going to do or pretty close to it and we'll do it and it will go on the marketplace.

But they are competitive and they have been known to take advantage of what we say, so I think we would rather leave this where it is.

Okay, and certainly understandable.

Then with regards to sales force productivity, can you talk about that a little bit and how that may impact your plans in terms of how you think about increasing or changing the overall number of sales people and should we continue to expect strong growth in terms of the health insurance initiative?

You should definitely expect that we're going to continue to invest in health insurance.

It's going very well.

It's very early in its life and we have very high expectations for it.

So that would be a reasonable assumption for you to make.

On the other sales forces, in general, as I said earlier, we're just now entering in the detailed part of our budgeting process.

So we haven't, we haven't had these debates yet.

But in general, you should expect that we will move resources to the opportunities that present themselves as being the best opportunities for us to generate productivity and growth.

So for example MMS is having a great year so it would probably be wise to assume we're going to increase sales people in MMS.

In the other sales forces we have yet to have the debate.

So I'm less -- I'm more reluctant to give you an answer to that.

But you do know the history of our Company has been one where we increase the total number of sales people every year.

We did it this year.

We've done it every year that I've been here and for all the years before that.

So it's probably reasonable to assume that we'll make some increases in sales.

Whether it will be at a normal rate that you've seen in the past five years in a very robust economy?

My guess is no, but as I said, we haven't had a debate yet.

Okay.

It sounds like in areas like core and places where maybe quota levels aren't being reached just because of the economic environment, maybe no reason to increase those.

But in the areas where you're seeing growth, you would continue to increase.

That's a reasonable assumption.

But again, we haven't had the discussion yet.

Core is one of the areas because it's our largest business that we've always increased sales people.

But we'll see.

We haven't gone through it yet.

With regards to the 37,000 new clients that were signed, can you talk about that relative to the expectations or the quotas for that key quarter?

Well, basically we stated that we were about even to last year and down a little bit.

So you can assume I had a plan that would have increased, which the world hasn't given us that.

But the reason we gave the numbers, not so much to analyze the number.

The world has this feeling right now that everything's on stop and we added 37,000 new clients.

So the world isn't on stop.

Now you got clients you're losing.

But there's a belief that nothing is happening and that's a lot of clients in itself.

Yes, and it also sounds like you're saying MMS continues to do very well, so the mix of clients is actually probably better, right?

The mix is favorable.

Can you give us a sense for how big MMS is now?

Bigger than $250 million.

We haven't disclosed a number in a long time.

Yes.

Conservative number.

Great.

Thank you.

Sure, Mark.

(Operator Instructions) Our next question comes from Gary Bisbee.

Your line is open, and please state your company name.

Hi, Barclays Capital.

Just two quick ones.

Just so -- to get to the $60 million in float and interest income, it seems to me that the rates are -- what you're saying is the rates are unlikely to drop materially more from where they were this quarter.

Is that a reasonable assumption?

Well, for me, they can't drop because they got a long-term portfolio that's, I know what that's going to be.

And the short-term rates I'm getting 5 basis points.

So unless I'm going to pay somebody to hold the money, they can't get any lower.

I have to be careful.

I can't leave the money in the bank.

They want me to pay them to leave the money in the bank.

Right, okay, and just obviously you've had the issues in the HR services with the falling assets and those are the things that are really outside of your control.

But when you think about selling these products, have you been able to change the sales pitch for any of them to really focus on cost savings, or are there any of them that you think are providing really good cost savings to the customer, or is it much more about allowing them to have better service and offer their employees better service?

Are you talking about all of our products?

I understand -- the payroll is real clear.

I'm wondering more on the HR side.

Like is there anything that is doing really well today because you've been able to really focus the customers in on upselling existing customers because you have demonstrated cost savings?

I would say it this way.

I would say the majority, if not all of our customers, come to us on the payroll product mostly for ease of mind reasons and lack of desire or skill in doing payroll.

In most small businesses, the thing they all have in common is they are resource constrained.

So it's very critical that they keep the majority of their resources focused on generating revenue to keep their businesses alive as opposed to back office activities.

And particularly difficult ones like payroll and tax compliance and so on.

So it starts there.

In the more sophisticated offerings where you get into the payroll, there are definitely areas where clients not only are you getting increased capability, but where they have the potential to get reasonable savings, like time and labor management online gives a client the ability to look at things like how much overtime they are spending and are there ways to schedule differently to abate those costs and so on.

So -- but I would say in general terms when you look across the profile of all of the services that we provide -- products and services that we provide -- for the most part what the clients are doing is they are trying to figure out a way to keep their business running by outsourcing all of this BPO function, if you will, so that they can stay focused on growing their business.

It's more in that line than a case where somebody's trying to go to a client and say if you install this widget or if you do this other thing, I can save you 50% over what your spend is today.

Okay, great.

Thank you.

Thank you.

Our next question or comment comes from Sanil Daptardar.

Your line is open.

Please state your company name.

Yes, Sentinel Investments.

You talked about operating margin pressure coming from starting from the next quarter.

I just wanted to understand if the checks [book line dot stabilizing], can you help me understand where the operating margin pressure is going to come from?

Is it year-over-year comparison or it's going to be in absolute terms?

It's year-over-year.

Okay.

On your investment portfolio, last call I think you had mentioned that most of the investment was in triple-A securities.

Is it possible that 4 billion portfolio, can you break it down what kind of exposures do you have, is it the government securities or the corporate bonds or CMBS, is it possible to break it down where the exposure is?

We believe we have minimal, if any exposure and the best place to look is we filed our 10-Q last night and there is excruciating detail in there which I couldn't remember it all, I would have to read it all.

We believe we are in good shape.

We not had any issues and liquidity has not been an issue and we thing we've done an excellent job of seeing the dangers coming from auction rates to insured variable rate demand notes and we continue to be in that posture and I think the best place for you to look is the 10-Q with all the detail.

Okay.

One last question on the pricing side.

[Ofgors last night yesterday] talked about pricing pressures in all segments and you think of probably having a price increase again in the next year, 2010, at the beginning of the year probably in the same range last year that you had.

Seems like your business is doing better than any (inaudible) or appears that way.

You seem to be confident that you would be able to gain further share in the market that you participate in the low and the mid-market.

Is that a fair [exemption] to make, or you just believe that your client [versus more sticky] to your kind of your services that you offer?

All of the above.

We clearly would not be doing something that we felt would put us in a lost share position.

So we have -- our Company has been the price leader in these markets for a very long time.

So the value proposition that we put forward, the service that we give to our clients, and in some cases the fact that the absolute dollars that we're talking about are relatively small have all combined to put us in a position where we're gaining share and we're doing so with the highest margins in the industry and in many cases, the highest pricing in the industry, but it's pricing that obviously closes from a value proposition in the client's mind.

So we're not going to do anything crazy for certain.

But we feel having looked at what's happened last year and the prior year and knowing what's happened in prior recessionary periods, we feel reasonably comfortable that we're making the proper decisions about whether or not we should do this and as we said earlier, we haven't decided yet, but we've given you our leaning.

But if for hypothetically (inaudible) client retention becomes a little bit difficult, then you may rethink on your pricing policy in that case?

We are able to do that today on a situation by situation basis.

So there was a question earlier about pricing.

When we change our prices, the prices are changed for the products going to a new client as well as products for existing clients.

The difference is in a new client, our sales force has the ability to discount to meet competition if they do that, so they have got that ability.

And for our existing clients, if there are any issues with our existing clients, we have a very high touch model.

We talk to these clients every week or every other week or twice a month depending on what the frequency of their payroll is and if there's ever an issue, our branches are trained to deal with that issue and that's business as usual.

There's nothing new there.

Okay.

Thank you.

Yes.

Thank you.

And I'm currently showing no further questions at this time.

Okay.

Thank you very much.

We appreciate the time you spent.

I think we had almost 200 people on this call.

That might be close to an all-time record.

We look forward to talking to you again in June.

In the meantime, hope you all have a great day.

Thank you.

That concludes today's conference call.

Thank you for your participation.

You may disconnect at this time.