沛齊 (PAYX) 2009 Q4 法說會逐字稿

Welcome and thank you for standing by.

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

After the presentation we will have a question-and-answer session.

(Operator Instructions).

Today's conference is being recorded.

(Operator Instructions).

Now I would like to turn the meeting over to Mr.

John Morphy, Senior Vice President and Chief Financial Officer.

Sir, You may begin.

Thank you for joining us for our fiscal 2009 year end earnings release.

We will begin today with a review of our fiscal 2009 financial results, including guidance for fiscal 2010.

Then Jon Judge, our President and CEO, will provide you with an overview and we will end with a Q&A session.

Yesterday afternoon after the market closed, we released our financial results for the year ended May 31, 2009 and filed our Form 8-K, which provides additional discussion and analysis of the results for the year.

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

We expect to file our Form 10-K by the end of July.

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

Overview of fiscal 2009.

Fiscal 2009 was one of the most challenging years in Paychex's history.

We are faced with the weakest economic conditions we have ever experienced.

These included a severe credit crisis, which inhibited new business formation and made it more difficult for existing businesses to survive.

And extremely low interest rates on return on our funds held for clients.

Despite this, our team responded well to the challenge by delivering a record level of operating income, net of certain items.

Our operating income net of certain items was $730 million, an increase of 5% over the prior year.

We leveraged our resources, generating operating income, net of certain items, as a percentage of service revenue of 36.4%.

Our served payroll client base declined 3.1%, to just over 554,000 clients.

It was difficult to watch our client losses, due to companies going out of business, or having no employees, rise by 17% over the prior year.

At the same time, our new client sales from new business formation declined by 19%.

We believe both conditions were the worst in Paychex's history, which explains our experiencing negative client growth for the first time in our history.

While pricing conditions were more competitive, they did not have any significant impact on client share, as we believe we increased our market share in comparison to our significant competitors.

On the new sales front, we added over 111,000 clients during the worst business environment most of us can remember.

Our client base, CPA, and bank channels continue to be excellent sources of business.

On the bright side, we met our Major Market Services new sales targets which reflected year-over-year growth of 20%.

In total, we sold slightly less new annual business revenue than we did in fiscal 2008.

Operationally, again we received high client satisfaction results.

We find this to be encouraging, considering the economic pressures our clients are facing.

Our client retention was 77% of our beginning of the year client base.

Our range of client retention over the past ten years has been from 76% to 81% of our beginning of the year client base.

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

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

As of June 19, 2009, the total investment portfolio contained net unrealized gains of approximately $56.3 million.

We invest on average approximately $4 billion of our clients' money 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 principal and have met all of our clients' daily needs related to the payment of wages, taxes and other benefits to their employees.

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

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

For fiscal 2009, our cash and total investments increased by approximately $140 million, after paying $448 million in dividends.

This translates to a dividend payout to our shareholders of 84% of net income.

Our cash flows historically, slightly 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 strengthened our software as a service solution for MMS clients.

In fiscal 2009, we enhanced the Paychex time and labor online and internet based integrated Time and Attendance System.

We also introduced Paychex's expense manager and integrated payroll and expense management solution.

We continue to head down the path towards becoming a significant provider of health and benefits services.

Fiscal 2009 revenues were $20.9 million, up 70% over the prior year, and we expect significant growth from health and benefits services to continue in future years, as we look to pass the $30 million mark in fiscal 2010.

We continue to be the premier supplier of 401(k) record keeping services, as we sold 11,000 plans, total assets in the plans near $9 billion and our 50,000 clients means we are serving one in every ten 401(k) record keeping plans in the US.

We enhanced our 401(k) product through the addition of auto enrollment as an optional plan feature that allows employers to automatically enroll their employees in the Company 401(k) and increase overall plan participation.

We'll now take a few minutes and talk about economic conditions.

We will share some of the key indicators that should provide insight into how the small to medium sized economy has been behaving during fiscal 2009.

Again, we have added some additional information that we believe will be beneficial to our current shareholders, prospective shareholders and the Wall Street community, and also enhance your understanding of Paychex.

Our checks per client decreased throughout the year, with the largest sequential decline occurring as we moved from the second to the third quarter.

The calculation of checks per client for a quarter is based upon the number of payroll checks issued, divided by average client base for the quarter.

Checks per client declined 2.9% for the year, with a quarterly breakout and quarterly sequence of 1.2%, 2.1%, 4.3%, and 5.2%.

Looking forward, and assuming checks per client have bottomed out, we would expect the year-over-year comparisons to improve throughout the year, with a decline in fiscal 2010 approximating 3%.

Our new client sales from new business starts decreased 27% for the fourth quarter, and 19% for the fiscal year.

Clients lost due to companies going out of business or no longer having any employees increased 19% for the fourth quarter, and 17% for the fiscal year.

We earned an average rate of return on our combined investment portfolios of 2.1% for fiscal 2009, compared to 3.7% for fiscal 2008.

In short-term taxable average interest rate earned was 1.2% for fiscal 2009, compared to 4.2% for fiscal 2008.

Note that in fiscal 2009, our short-term portfolio became heavily invested in taxable securities as our current primary short-term investment vehicle is US agency discount notes.

Lower interest on funds held for clients contributes to lower results of operations, as it declined $56 million, or 43%, in 2009.

In addition to the lower interest rates previously discussed, average investment balances were down 3% in fiscal 2009, compared to fiscal 2008.

Overall economic factors which negatively impacted our client base were the main cause of this.

Average invested balances for the fourth quarter of fiscal 2009 decreased 9%.

The greater deterioration in the fourth quarter was due to weakening economic factors, fewer clients on tax pay and employee pay, and the 2009 economic stimulus package, generating lower tax withholdings for client employees.

Of the 9% deterioration, approximately half related to the stimulus package.

Although we've been operating in an unprecedented economic environment during fiscal 2009, we maintained stability in our employee base, no jobs lost, allowing us to continue to focus on providing excellent customer service and investing in our future.

We will now move to a discussion of our results on the income statement.

Payroll service revenue increased 1% to $1.5 billion.

The growth was driven primarily by our annual price increase and growth in the utilization of ancillary services.

The weakening economic conditions in fiscal 2009 negatively impacted payroll service revenue.

As of May 31, 2009, 93% of our clients utilized our payroll tax administration services.

Employee payment service utilization was 75%, with over 80% of our new clients selecting these services, which include direct deposit, access card and ready checks.

The Human Resource Services revenue increased 11% for the fiscal year to $524 million.

The following factors contributed to this growth.

Comprehensive human resource outsourcing services client employees, increased 3% to 453,000 client employees served as of the end of May.

Comprehensive human resource outsourcing client base increased 10% to 18,000 clients.

We continue to add clients at a higher rate than client employees, due to lower level of employees per client, especially in Florida.

Workers' Compensation insurance client base increased 6% to 77,000 clients.

Retirement services client base increased 2% to 50,000 clients.

Our growth in health and benefits services continues to be strong, and grew 70% to $20.9 million for fiscal 2009.

And we earned $12.4 million of retirement services billings for client plan restatements in fiscal 2009, that are required by law approximately every ten years.

The following factors adversely affected growth rates.

Volatility in the financial markets caused the asset value of retirement services, client employees funds to decline 12% from May 31, 2008 to $8.5 billion.

The decline in the asset value, accompanied by a shift in client employees retirement portfolio to investments earning lower fees from external money managers, reduced retirement services revenue growth by $8.9 million for fiscal 2009.

The lower levels of employees per client in our comprehensive human resource outsourcing services resulted in a reduction to revenue growth of $8.7 million for fiscal 2009.

Interest on funds held for clients decreased 43% for fiscal 2009, due to lower average interest rates earned, lower average investment balances and lower realized gains on sales of available for sale securities.

The average interest rate earned on funds held for clients has decreased to 2.2%, from 3.7% a year ago.

As previously discussed, our average invested balances were negatively impacted by the economic conditions and lower tax withholdings, as a result of the 2009 economic stimulus package.

Consolidated operating, selling, general and administrative expenses increased 3% for fiscal 2009.

Fiscal 2009 expense drove benefits from continued leveraging, in response to weakening economic conditions.

As of May 31, 2009, we had approximately 12,500 employees, compared with approximately 12,200 a year ago.

Our philosophy on expense management is to continue to look for more efficient ways to conduct our business, while not impacting the level of service our clients expect when they add 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.

Investment income net decreased 74% to $6.9 million for fiscal 2009.

The changes in investment income reflect lower average interest rates earned and lower average investment balances from the funding of the stock repurchase program completed in December of 2007.

Our effective income tax rate was 34.3% for fiscal 2009, compared with 32.6% in fiscal 2008.

The increase in the effective income tax rate was primarily the result of lower levels of tax exempt income, derived from municipal debt securities held in the investment portfolios.

We'll now take a look at the balance sheet.

Our liquidity position is strong, with cash and total corporate investments of $575 million, as of May 31, 2009, and no debt.

Our cash flows from operations were $689 million for fiscal 2009.

We continued to maintain in a conservative investment strategy, emphasizing maximum liquidity and principal protection first, and then investment yield.

See our preliminary MD&A filed with the SEC on June 24th, 2009, for detailed information related to our investment portfolios.

Our priority towards liquidity is to ensure we can meet all of our cash commitments to clients that take place as we transfer cash balances from their accounts.

Our funds held for clients routinely fluctuate daily by $1 billion to $2 billion, meaning we must be positive our investments can meet our daily liquidity needs without failure.

For additional liquidity, we currently have $400 million in a credit facility and $900 million in lines of credit available to us.

Our total available for sale investments, including corporate investments and funds held for clients, reflecting net realized unrealized gains of $66.7 million as of May 31, 2009, compared with net unrealized gains of $24.8 million a year ago.

Client fund deposit balances grew at a slower rate than historical in fiscal 2009, as expected with client fund deposits as of May 31, 2009 at $3.5 billion.

Total stockholders' equity was $1.3 billion as of May 31, 2009, reflecting $448 million in dividends paid during fiscal 2009.

Our return on equity for the past 12 months was an exceptional 41%.

We'll now talk about guidance.

Our guidance philosophy has been in place for a long time and that has been 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 the 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.

We believe our guidance philosophy assists the many people developing and evaluating expectations for our future financial results.

They know what 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, etc.

That said, our current outlook for fiscal year ending May 31, 2010, is based upon current economic and interest rate conditions continuing with no significant changes.

Consistent with our policy regarding guidance, our projections do not anticipate or speculate on future changes to interest rates.

Comparisons to the fiscal 2009 quarters are expected to improve as fiscal 2010 progresses.

That is primarily because the comparisons will become slightly easier, since some of the significant deterioration occurred subsequent to the first quarter a year ago.

Projected revenue and net income growth for fiscal 2010 are as follows.

Payroll service revenue growth, 3% to 5%.

Human Resource Services growth, 3% to 6%.

I'm sorry, the payroll service revenue is a decrease of 3% to 5%.

Total service revenue is projected to decrease in the range of 1% to 4%.

Interest on funds held for clients is expected to decrease by 25% to 30%.

Total revenue is projected to decrease in the range of 1% to 4%.

Investment income is projected to decrease by 30% to 35%.

And net income is projected to decrease in the range of 10% to 12%.

Operating income net of certain items, as a percentage of service revenue, is expected to range between 34% and 35% for fiscal 2010.

This will be the first time in some time that margins have not expanded on a year-over-year basis.

The primary reasons are the reductions in checks per client, as the last check issued to a client or by a client is the lowest revenue check, but at the same time is the higher margin check.

In addition, we have increased our selling expenditures to increase sales coverage in order to take advantage of opportunities when the economy improves.

We are also continuing our investments to aggressively grow our healthcare business.

When more normal conditions return, we expect to return to expanding margins on a year-over-year basis.

The effective income tax rate is expected to approximate 35% throughout fiscal 2010.

The higher rate for fiscal 2010 is driven by higher state income tax rates, resulting from state legislative changes.

Interest on funds held for clients and investment income are expected to be impacted by interest rate volatility.

Interest on funds held for clients will further be impacted by a projected 5% decline in average invested balances, with most of the effect in the first half of fiscal 2010.

Comparisons to fiscal 2009 are challenged by both the weak economic conditions and the 2009 economic stimulus package, generating lower tax withholdings for client employees.

As of May 31, 2009, the long-term investment portfolio had an average yield to maturity of 3.3%, and an average duration of 2.5 years.

In the next 12 months, slightly less than 20% of the portfolio will mature, and is currently anticipated that these proceeds will be reinvested at a lower average interest rate of approximately 1.4%.

Please refer to our press release filed yesterday afternoon for our fiscal 2010 projected changes by quarter, and interest on funds held for clients and investment income.

Under normal financial market conditions, the impact to earnings from a 25 basis point decline in short-term interest rates would be approximately $3.5 million after taxes for a 12 month period.

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

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

Purchase of property and equipment in fiscal 2010 are expected to be in the range of $55 million to $60 million.

Fiscal 2010 depreciation expense is projected to be in the range of $65 million to $70 million.

And amortization of intangible assets for fiscal 2010 is expected to be in the range of $20 million to $25 million.

At this time I'll turn the meeting over to Jon Judge, our CEO.

Thanks, John.

Good morning, all.

I want to add some comments on our fiscal 2009 performance and then reflect on 2010 and beyond.

Let's start with 2009.

There are very few companies I suspect that are satisfied with their financial results over the past year, and certainly true of us.

2009 was not a normal Paychex year.

Instead of setting yet again more records, we watched our streak of 18 consecutive record setting performances end due to the weakest economic conditions in the history of our Company.

John took you through the details of our financial performance.

We all agree those were not normal Paychex numbers.

We're clearly not satisfied with them.

But with that said, we are proud of how our team fought through the adversities of 2009's economic crisis and produced results that, while not up to Paychex standards, were better than most, if not all players in our industry, and most public companies in the United States.

We did increase our revenues.

We did expand our margins and achieve the highest expense to revenue ratio in our history.

We did create over $800 million of profit in the worst economy in 75 years.

We did create almost $700 million of cash flow and paid out almost $450 million in dividends to our shareholders.

There are also some important non-financial accomplishments that will benefit our future.

Despite very difficult selling conditions, we were able to sell almost the same new annualized revenue as last year.

Our major markets division had a very strong year, with a 20% increase in sales year-over-year.

In some respects, almost a normal year for our MMS team.

We continued to invest in our future, in areas such as sales reps and in our healthcare business, as well as new product enhancements.

And we implemented a price increase in May of between 3% and 4%.

We maintained industry-leading client satisfaction which is extremely important in this industry and in our business model.

When we look to the future, we remain very confident and very optimistic.

2009 was a tough year for everyone, but when we look back at our results, nearly all of our shortfall to a normal Paychex year was directly attributable to four things.

First was the fed funds rates at or near zero that caused our float income to decline by $56 million, or 43% year on year.

Second was increased losses due to business failures, or clients in such bad shape that they stopped processing payroll.

Third was the significant decrease in new business formation caused by the credit crisis.

This alone was responsible for 90% of our sales shortfall, versus a normal year, and fourth was the impact of unemployment on our check volume.

Those four areas were directly impacted by the economic crisis, and took us off the normal Paychex year, but more importantly, all four will improve with the return of a more normal economic environment.

That's why we're confident about the future.

If we were being disintermediated by a Company providing better products or services, we would be more concerned, but that's not the case.

In fact, everything we know says we're doing better than our competitors and taking share.

We can't predict when the turn for the better will occur for our economy, but we know that when it does, we'll be in a very good position.

In the meantime, we'll continue to invest in our business, while watching our non-essential spending and protecting our margins.

In 2010, for example, we'll add more sales reps, invest more in tele sales reps, continue to invest in healthcare and product enhancements, and tweak our comp plans to ensure that we get the best possible performance from all of our employees for our Company.

We don't expect 2010 will be an easy year, but the combination of our financial stability, our extraordinary business model, and our incredibly dedicated employees will make it as good a year as it possibly can be.

John and I would be happy now to take any questions or comments.

Thank you.

We will now begin the question-and-answer session.

(Operator Instructions).

One moment, please, for our first question.

Our first question comes from David Grossman of Thomas Weisel Partners.

You may ask your question.

Good morning.

Thanks very much.

You talked about the margin outlook being impacted by both cyclical factors, as well as the investments you're making in the sales force and healthcare.

Can you provide a little more color around the incremental investments that you're making, and maybe give us a sense of just how much you're actually spending on these initiatives?

I don't know that we'd give defined numbers, but obviously the checks per client affects the margins because in fact that last check is the most profitable check.

We've talked before about the fact that when checks per client get much over 4%, it really starts to inhibit our ability to increase margins.

The client decline affects it somewhat, too.

We've been able to offset most of that.

When you talk about the other investments, though, the healthcare thing, initiative we're processing, the sales force growth which you saw in the thing, we're increasing sales force in both the core and the MMS, and some of that is really to take advantage when hopefully this economy turns around, because the other thing is we don't want to cut our sales force because to do that would allow us to have a short-term earnings pickup, but in the long run it would hurt us in the future.

Okay.

And just in terms of the client growth, I know that it's a bad year to compare this, your guidance as well as kind of what's happened in the last 12 months, and I think client growth had been trending around a 3% to 4% range prior to the economic downturn.

Is that a number that we should think about going forward in terms of what's a realistic target?

Well, the thing I would tell you is, this is Jon Judge.

On the new client growth, the biggest single issue that we had in that was the lack of new business formation due to the credit crisis.

So to the extent that the credit crisis abates and new business formation returns to a normal rate, there is nothing that we see in any of our numbers that would tell us that anything other than going back to normal would happen.

In other words, we don't see any losses that are due to a better mouse trap or somebody providing better services.

Our issues on the new client growth really come from the new business formation, which as I mentioned in my comments was about 90% of the miss that we had to a normal sales year, even though we still had a pretty decent year, going flat versus most people down 10% to 20%.

And then the second thing would be losses.

An increase in client losses that have been directly caused by the economy, things like businesses going out of business or getting down to either so few clients or so troubled a business, economic scenario, that they stop processing.

Those two things were the ones that affected us.

And so when you think about when we go back to normal, there's nothing that we can see that will tell us we will not go completely back to normal, as soon as the economy changes.

To the extent that the credit crisis remains, to the extent that the economy stays bad and business failures continue at these unprecedented rates, it will be a slower return to normal.

To the extent the economy turns, we'll turn with it.

So does that 3% to 4% sound like a more normalized number to think about in normal economic times?

Yes.

And one last question, just on the skew of EPS.

I know you don't really talk about that in your guidance but given the current, where we are economically, does it make sense to think about the EPS skew kind of building momentum throughout the year, as opposed to your typical year which would see flattish sequential growth in EPS.

Normally you're right it would be almost, actually, the four quarters are almost identical.

There might be a penny difference.

There will be some skewing.

It won't be staggering.

The best way for you to calculate the skewing is really look at the investment income difference, which are disclosed in the press release and the filing with the SEC by quarter.

If you run that through, with also recognizing the checks per client will come back as comparisons get easier, you can pretty much figure out what the skewing would be and I think you would come up with a pretty good estimate of it.

One other thing in terms of your guidance.

I think if I heard you guys right, that you talked about checks per client being down 3% and that you got your price increase of 3% to 4% in for the new fiscal year.

Did I hear that right?

Yes.

Now, the checks per client for the year is down 2.9%.

And when you go next year and we're hoping it's going to stabilize right where it is, when you do that, you get 2.9% to 3% again, but it just happens in different places.

Meaning the decrease is toward the end of the year and the bigger hurt's in the beginning.

All right.

Got it.

Thanks very much and good luck.

Thanks.

Our next question comes from Chris [Lamond] of Deutsche Bank.

Your line is open.

Hi, thanks, guys.

Appreciate your comments about the guidance and the growth rates improving throughout the year in fiscal 2010.

Do you expect though on a quarterly basis that payroll growth will remain in negative territory for all four quarters, or is there a possibility it could return positive by the latter part of the year?

It's certainly going to start off negative in the beginning and I think where it will wind up in the end is going to depend what the economy does.

I can't remember if we were negative in the fourth quarter, but for it to get positive, where it would be meaningful, you would have to see some improvement.

Some improvement in the economy.

But, now, a lot of that, you get to a constant environment, I would not expect payroll revenue growth to be negative the following year.

If checks per client were to hang in there, and client growth stays around flat, we would get the positive revenue growth.

Okay.

And then could you give us any more granularity on the more recent trends in checks?

I know you did a good job in the last quarter of talking about the past six weeks.

Any color like that to I guess give us?

Basically I was hoping it wouldn't have gotten to five, but things aren't dropping off as significantly as they were.

We're seeing some stabilization.

We look at the June numbers which are really early to look at them, but we think we're going to make our revenue number for the first time in our forecast in quite a while, so that's hopeful.

But two or three weeks isn't enough to indicate what's really going to happen.

So right now we're hoping it's going to stay there.

Things were deteriorating in the fourth quarter, but at a much slower rate than they were.

My belief, it's a personal belief, is if we could get the world to be a little more optimistic.

Sometimes you can be so pessimistic you can create your own problem.

Not that we don't have a few.

But that could be just enough to get this thing maybe from slightly negative to slightly positive.

Only time will tell.

Okay.

Great.

I guess final question, as far as the sales force additions, if you were to, instead of a scenario where you're going to add 5% to the core payroll sales headcount, if you were to keep that sales force flat, would that change what your payroll revenue growth expectation would be for 2010.

It wouldn't affect 2010 too much but it would definitely affect 2011, because as we've talked before, in the year the sales force makes the sales, that's not the biggest impact on revenue, but the following year it sure is.

Great.

That's helpful.

All right, thanks, guys.

Our next question comes from Julio Quinteros from Goldman Sachs.

Great.

Thanks, guys.

Real quickly, John, if you were to go back to the comments I think you made one or two quarters ago about the drivers of the SMB segment in particular, credit card usage and things like mortgage equity withdrawals, just your sense on what your clients are doing to drive growth from here, assuming that those two sources of funding aren't there, what are the alternatives for some of your SMB clients at this point in terms of being able to drive both the growth and expansion, and obviously payrolls to feed their growth at this point.

Well, basically, we know we've got to guess how they're getting the money, they don't tell us how they're getting the money.

What you've got to realize is, how much difficulty is in the world, everything doesn't stop.

Right.

People are going to find ways to move forward.

And it isn't like everybody lost all of the money they have.

It might feel that way sometimes.

Sometimes I think the world lost more than it had, but that's not really what happened.

They've got to find ways.

There's pressure in America that big is moving towards small, so eventually these people know they've got to find a job.

They've got to do something.

And I think what happens, some of these jobs or some of this business formation doesn't require a lot of capital, so the thing that I feel good about, I don't maybe like the number exactly, but we did sell over 110,000 new clients.

That's a staggering number in an environment like this one.

So granted, you're down maybe 5% to 10%, but the other 90%, they find a way to do something and hopefully that will continue and hopefully it will more towards the 100% level.

Just on the tradeoffs between the investments to drive future growth versus continued pressure on the top line, at what point , and I know you guys are trying to balance longer term growth opportunities, et cetera, but at what point do you look at the plans to invest incrementally, et cetera and say we really shouldn't be doing this, or is this just something you guys are going to do no matter what because it's important for longer term growth

We aren't going to stop our investments in healthcare.

The ones that matter, we made two big things we've been doing over the last six months.

One, we continued our investment in our core platform, which has you now been put in service and we're in great shape on that and the other one is healthcare.

We believe that we have a great future in front us, and we believe to curtail those investments means we will have to accept lower results in the future.

Right now, everybody has got results they don't like.

We want to make sure when things are good we get ones we do like.

I guess what I would add is we have got , we're blessed with a financial stability that very few companies have.

We don't have any debt.

We don't use debt.

We've got a rock solid balance sheet and we clearly understand where we are in our business relative to the economy.

What part of our issues that we're dealing with are caused by competitive pressures versus what part are caused by the economy, and since the majority of our issues are caused by the economy, then the wise course to take is to make sure that you stay positioned for the future.

Relative to your question, I'm not sure exactly what you're trying to get at, but the point that I would hold up is the poster child of the conservative nature with which we manage this business.

As you look at 2009, one of the toughest economies in the history of the United States, and we expanded our margins, so we have a history in this company, we're going to make the investments but to a certain extent we're going to self-fund those investments by stopping noncritical or nonessential things to be able to fund the things we need to make our business stronger in the

Lastly, on the market share gains, is there any percentages or any ranges that you guys can think about in terms of sizing how much market share gains you guys have made in the marketplace?

And then on new sales, what's the pricing environment there?

I think the plus 3% was on existing clients or was that also on new clients.

Start with the first question you have on market share.

Market share is a difficult thing in this industry because there aren't a lot of numbers published, but the part that makes it a little easier is the fact that it's an industry dominated by two big players, and then it fragments down to a bunch of smaller players.

If you get a feel for what's happening with the two big players, and we know what's happening with the smaller, regional players, it makes it easier for us to see.

Things that we look at that give us a clue as to where we are relative to share gain, is the number of clients we take from our biggest competitor versus the number they take from us.

We've been positive on that for a very long time and we were positive again last year, and then we look at things like what kind of discounting is being done, particularly as it relates to newer clients, and we can see very clearly where they are and where we are and so, for example, you know that we just told you that on a year to year comparison that we sold roughly the same amount of annualized revenue in 2009 as we did in 2008.

I don't think there's anybody else in the industry that can say that.

Most of them as I mentioned were down 10% to 20% on a year to year basis.

Those are two pretty significant indicators that would tell you where the share thing is moving.

There are other things we look at but they're proprietary things that we don't talk about publicly.

Thanks, guys.

Our next question comes from Kartik Mehta of Northcoast Research.

John, you talked a little bit about your float income and I was wondering, what's the best thing to look as to when you think you might be able to invest in some short-term funds and other securities that get a little bit of a higher yield.

I know you've always wanted to stay conservative, but is there anything we could look at that says you feel comfortable moving a little bit up into other securities?

I think basically when the federal funds rate starts to move up, and this would happen inside a quarter and I think we would disclose it pretty quickly when it would happen because we do it in the next press release.

I don't think we would make a special press release for this factor, but when the federal funds rates start to move and the banks start to work a little bit better, we'll move back towards variable rate demand notes.

If you look at fiscal 2010, is checks per client the biggest impact to revenue up or down as we move through the year?

No, it's one factor.

The other factor is obviously negative client growth, so the biggest three things you've got going is pricing, negative client growth, in checks and then losses, losses in sales.

Those are factors.

One that's tough on revenue per check.

It's not that it has any bigger revenue impact, its just it's the one that wreaks the most havoc on what you're trying to do with your margins.

It's the most profitable check that peels off and you can't take much cost out because that check is handled pretty easily.

And then both of you gentlemen talked about dividends and safety and your desire to pay, or the Board's desire to continue to pay it.

Is there some kind of a stress where you say gosh, it might be time to look at the dividend again, or are you in a situation where the dividend at least for the foreseeable future is in pretty good shape?

I would say more the latter but we always tell you that this is a Board decision, not a management decision.

We obviously have an opinion on it.

We make recommendations to the Board, but the Board makes those decisions.

What I would tell you from the conversations that we've had over dividends and the Board, that we believe that it's one of hallmarks of our financial stability, and our financial model, and it's something that we definitely want to maintain.

So I'll start with that.

From the standpoint of stress, if we ever got ourselves into a position where our financial model was stressed and we needed to make the change to the dividend, I'm sure there would be a lot of discussion about that.

But if you think about our capital structure, the fact that we have no debt, that we have a fairly large amount of cash on our balance sheet, that we're cash flow positive and will remain cash flow positive, it's hard for me to see that a time, any time soon, where we would even be having that discussion.

So there's nothing in the near term that would tell me that we're going to be stressed to the point where we would have to start considering things such as decreasing our dividends.

So that's where we are.

But again, it's a decision that's always one that's held to the privy of the Board.

I think I've given you some insight in terms of where they are, how the feel about the dividend and certainly how the management team feels about it.

Last question was I think last quarter we talked a little bit about discounting and what was happening in terms of new sales.

Has the environment changed at all, or has it remained about the same for new sales?

Over what time period?

I guess in the last three or four months, have you seen a change in how your competitors are discounting their product?

Have they gotten more aggressive?

Has it been relatively the same or do you think it's gotten a little bit better?

It's gotten a little bit better but I mean part of that you have to be careful with because in our business, particularly as it relates to core, the majority, not the majority, but 25%, roughly, of a year is in a couple of months, November, December, or December, January.

And so during that period is when you tend, if you're going to see any kind of significant moves in discounting from competitors, you tend to see it in that period.

We did see it this year.

We talked about that already.

Whether that's in just hard discounts on a dollar basis, or whether it's in give-aways in terms of free service for three months in the front end and three months in the back end of the year, or commitments over long-term price freezes, or price movements that are restrictive, in all of that stuff we saw during the selling season.

There's still some of it that we'll see from time to time, but it's nowhere near as severe as it was during the selling season, but that would also be normal.

This year was not normal.

There was more of it than we've ever seen before and it was more national than we've ever seen it before, but that's when we typically could see it and so it's natural that it would taper down once you walk out of those important months.

Thank you very much.

Our next question comes from Jason Kupferberg of UBS.

Your line is open.

Thanks, guys.

Wanted to ask a little bit of a longer term question, I guess.

Do you think you get back to your traditional financial target model, 12%, 15% kind of thing, 15% being the operating income, excluding float.

Can you get back to that on any kind of sustainable basis?

I mean once the whole cyclical downturn is over, what are your thoughts there?

I'll give you mine and I'll let John give you his.

If you listen to what we told you about what drove us off of our normal environment, and our normal environment is a 12%, 15% environment, they were all issues that were around impacts from the economy.

So if the economy goes back to where it was, then there's nothing that I can see that would tell us that we wouldn't go back to where we were.

Now there's always, each year it gets a little bit harder, right?

We're not a baby Company.

We're a pretty large Company, so each year as you get more penetration it gets a little bit harder, but we've gone a lot longer than I think anybody thought was possible for a Company of our size, growing our top line at 12%, our bottom line at 15%.

The model that we have that gets us there is still a realistic model.

From my vantage point, if we were back in a normal economy, we wouldn't be having the tone of this conversation that we're having nor would you be having it with all the other companies in the United States.

It would be a much different environment.

Versus if there was a major shift in buying patterns in the United States, or if somebody created a better mouse trap and they were stealing share from us, then you would have a different scenario.

I would add, I don't think the economic conditions we're experiencing today are what puts that model in jeopardy.

The biggest issue on the model is as we get larger, it gets harder.

People have got to recognize, it really isn't the 12% to 15% that's the hard part.

The hard part is getting the 12%.

If you get the 12%, the 15% will happen.

The real question is going to be as we cross over this $2 billion mark, and you get a little better idea of what's going to happen in some of these other areas, as revenue grows somewhere between 10 and 12.

Right now we feel pretty good that it can be definitely double digits and how high you go, who knows?

The key really becomes to expand your whole set of ancillary offerings and things like insurance, et cetera?

Sounds like that's what you would need to do, because arguably in core payroll things are a lot more mature than they were years ago.

There's still some incremental growth with new business creation, but not a huge secular trend arguably, would you agree with that?

That's right.

But it's also been our model for a fairly long period of time now.

Core payroll has been growing in single digits for a fairly long time, and our model at the 12% and 15% assumes that a part of our business will grow at one level, and then we'll get other parts of our business that will grow at much greater levels than that, albeit they're smaller businesses and we'll continue to add things.

So for example, in the last two or three years, we've decided to get into the health insurance business and that business is now a $20 million business on its way to $100 million business.

What we have to do is keep finding those types of things that will help keep moving the needle, the combination of the different revenue mixes, to keep us at the double-digit level, and that's what we work on every day.

So you can call that ancillary, because I guess in some respects it is ancillary.

When you have a business as large and successful as our core payroll business, the only thing that keeps the whole Company from growing at that level is that we continue to push other services and put new products in place and continue to grab share and so on, and that's essentially our model.

And just two questions on fiscal 2010 assumptions.

One, what are you assuming in terms of new sales growth?

And two, are you assuming that the full 3% to 4% price increase, that all of that actually sticks throughout the year?

The price increase, most of it will stick.

Basically, you get some resistance in some areas, but once the price increase goes in and pretty much sticks on existing client base, and as the discounting that took place on new sales comes up, we recover a fair amount of discounting each year, so I don't see that as an issue.

The other assumption was on?

In terms of new sales growth you were down year-over-year.

New sales growth, we think will be slightly better but that's because we added sales reps.

We're not looking for anything dramatic to change.

Just last question, MMS, over time, how big could that get as a percent of your revenue?

Well, going to keep growing faster than core and that's simply because this is an opportunity that we've probably only been able to take full advantage of for five years.

We're growing well before that.

It's a part of the market that we weren't in until the late 1990s, and today we have products that compete very well, and we're aggressively pursuing making them better.

Most of the acquisitions we have made either relate to the human resource side or improving MMS, and we're seeing some really great results as a result of adding these full service elements, whether it's expense things or health things, et cetera.

So we're very viable, very good competitor and fortunately our share of the market, it's getting bigger but it's not that big.

Okay.

I'll leave it there.

Thanks, guys.

Our next question comes from Rod Bourgeois of Bernstein.

Your line's open.

Yes, Rod Bourgeois here.

I hope this is more than a semantic question or maybe it's a semantic question that should really matter.

But I think you noted that the deterioration in your key metrics in the May quarter was a slower amount of deterioration than what you were seeing earlier.

But when I look at the payroll revenue growth, it looks like it went from plus 1.9% in February, down to negative 4.8% in May, which is a pretty big turn in that core business.

So how do we think about the key metrics are declining at a less rapid rate, but the payroll revenue growth dropped off at an unprecedented pace.

Because the selling season is so big in the February quarter, so the real impact of that selling season and losses became full force in the fourth quarter.

Got it.

All right.

So that explains it.

That would imply is that there's no way you're going to see a similar amount of fallout in payroll revenue growth in the next couple of quarters, because you've already digested the impact of the weak selling season?

Yes, I don't think it gets significantly worse than it was.

I can't remember by quarter, but a lot of the quarterly impact relates to investment income and checks, with investment income being a good chunk.

Okay.

Great.

Looks like one of the metrics that's been troubling of late is client churn going up, and I assume that the increase in client churn is mostly because of bankruptcies, but can you quantify how much of the increase in churn is due to bankruptcies, and out of business activities, versus competitive factors that might also be playing a role?

Basically, 60 to 70% of our churn is in this bankruptcy out of business.

and that hasn't changed too much.

You'll see a little bit more on price but sometimes that's somebody not wanting to tell you they just can't afford it anymore.

The competitive factor is one that we think we're gaining share.

People want to look at this and think are we giving up share to hold price, that's not the circumstance and Jon can talk a little bit here about how we work with the salespeople and what they're doing.

But we know we're the price leader, but it isn't like we'll never bend.

We'll do what we need to do, but we think we're okay.

Are you in some cases giving up price to gain share or is that not necessary because your product set is sufficient to drive the share gain?

No, we don't lead with price.

If you look at core as an example, the core price position to market, we are comfortable selling normally somewhere in the 20% to 25% higher than competition, mainly because our offering is that much better than competition, and gaining share as we do that.

So we don't lead with price.

What we will do, though, is if we're confronted with price, then in most cases, unless it's just a crazy eddie kind of a thing, in most cases we'll meet competition, but we don't lead with trying to drive the price down.

So we won't allow share to be taken from us with price as the issue, but we won't use price to gain share or we haven't used price to gain share.

We use our service and our feature functionality and our people to be the thing that differentiates us in the market, and it's been pretty successful for a pretty long period of time.

All right.

That's helpful.

If you think about pricing with existing clients, just to ask a scenario here, if your client retention were to struggle further with your existing clients, would you consider more aggressive pricing as a way to counteract the impact of the weaker client retention?

First off, what's unique in this business is very few clients switch over price.

They usually switch because they're dissatisfied with the service.

A price differential on what this costs, doesn't drive that much switching.

When a client gets in a situation where they may talk to us about this, we are responsive.

It doesn't mean when an existing client calls up with a pricing concern, we ignore that.

We listen to them.

We do what we need to do.

We do what's right for us and them, and we work it out but it's not as conflictive as you might thing.

It makes sense because a lot of the clients aren't really (inaudible) price because it's not a big item.

And remember the numbers, the thing that people often forget when you're dealing with small and medium sized clients, and in our case the majority of our clients are small clients, is that if you look at percentages, it tells you one story.

If you look at the actual number itself, it tells you another.

For example, if we're selling a $2,500 and a competitor is selling at $2,000, you might say that's 20% difference, but $500 spread over 26 pay periods, spread over X, 14 employees per pay period, it becomes a very small number.

It's not typically the thing that will drive a client one way or another.

It's much more about the service they're receiving, the experience that they're getting and quite frankly the peace of mind and the guarantees that come from a Company like ours, which if there ever was a mistake made that generated any type of penalty, we pay it flat-out, no discussions.

So it's rarely, it doesn't get to be that big a deal.

All right.

That makes sense.

But that said, it's pretty clear that discounting activity with existing clients has increased in the last year.

Is there a way to quantify how much discounting has actually changed in the last year with existing clients?

I'll let John answer that if he chooses to, but before he does there's an important notion that I want to make sure you understand.

The increase in discounting was not originated in Rochester.

I understand that, too.

We react to it.

You also have to realize that the discounting pressure is like 95% on new business as opposed to existing.

Probably higher than 95.%

Okay.

In terms of the economic consequences or in terms of the percentage of the?

No, the activity.

Okay.

The activity is almost exclusively on the point of sale of new clients.

It's not existing clients.

Okay.

Give you a better perspective.

We've talked about this before.

Not saying we haven't talked about it.

We know who the other big guy is.

We know how many clients we lose to them a year.

We know how many we get from them.

And there isn't appreciable change in those numbers.

More importantly, the number that we take is larger than the number we lose.

Got it.

And that is also true in the mid-market segment?

The mid-market, we don't even, I think we tracked it.

I haven't looked at it.

We get more way from them than they get from us.

They have more.

Thank you for your help on that.

You're welcome.

Our next question comes from Jim MacDonald of First Analysis.

Your line is open.

Good morning, guys.

Can we talk about what seems to be more of a bright spot, the HR area, where it looks like your employee growth bounced back a bit this quarter, and could you talk about where that came from, that re-increase and maybe why there was a decrease last quarter?

Well, the last quarter was just small business really reacted in that January time frame.

Now you get back to where there's a little more seasonal employment as you head into the summer, so we'll see if it continues, but it was a bit of a bright spot, but we're cautious on bright spots right now but we'll take what we can get.

Since this could cover a lot of different areas, was this all in Florida?

Was it in ?

No, it probably was spread everywhere.

And was it in the comprehensive and PEO business or was it in other kind of ancillary services that are in the HR sector?

No, it would be pretty much in the Premier, I think.

Pretty much in the Premier.

And what about, if you talk about COBRA outsourcing impact in the quarter?

Too small to us to matter.

Okay.

Thanks very much.

Our next question is from Gary Bisbee of Barclays.

Your line is open.

Hi, guys.

Good morning.

I guess the first question, I just want to be clear on what's baked into your guidance in terms of the economy.

When you made a comment that checks per client seemed like it was maybe stabilizing or maybe bottomed, is the word you said.

Does the guidance assume that it stays at the current level, and thus the year-over-year comparison eases as you get through the rest of the year, or do you have some sense baked in there that we'll continue to see job losses on a monthly basis?

Basically what we bake in is we look at where we are, and we take the trends that are happening, we don't make trends get better and we probably don't make them get worse, so we take checks per client, a very good one.

We forecast the next year based upon the fact that checks per client are bottomed out around five.

Could we have made it slightly worse?

Maybe.

But wouldn't have made it much better either.

Now, continue to get further deterioration from this point, obviously it affects us.

If you get what we hope is improvement, it will affect us positively.

The reason we do that is we have no way of totaling forecasting what's going to happen.

So if I make a guess, then you've got to try to guess what my guess is before you put your guess down, because you are going to probably spin it somewhat, which is okay.

Basically we're trying to give you a basis of where we are so you can determine what you thing think is the right or wrong answer.

A slight change in this stuff doesn't affect us too much.

Basically we've got to plan and we work around our expense controls, and if we miss a little bit of revenue we'll find it.

Sometimes the water coming over the dam is just too much so you can't could much about it.

That's kind of what happened this year eventually.

We're hopeful next year that things will stay stable enough that we'll manage the business and we'll be right on the guidance we gave you.

The guidance seems to indicate that the interest rate you earn on the float is going to continue to ease somewhat sequentially as we move into the second half of the year.

Is that just ?

It only eases because my interest rates dropped like a rock after basically September.

And they kept dropping.

So all that's not any easing.

That improvement in interest on our interest thing is baked in.

It will happen unless rates go lower, and I don't know how they can go any lower.

Zero is zero.

So I know it's not a big deal in the grand scheme of the revenue guidance, but you mentioned a quarter ago that $60 million was likely to floor the float income.

Looks like the guidance is at least $5 million below that.

Is that ?

Rates got a little lower.

I didn't think they could go lower, but they did.

And then just two cleanup questions if I could.

The $20.9 million in health insurance revenue.

That was the full year number, right?

Full year.

A quarter ago.

You hear us in the streets.

Yes.

So a quarter ago when you said $14.8 million, that would have been the year to date through?

Yes.

Through nine months.

Okay.

And then the last one, the $12.4 million of revenue in HRS from the retirement plan restatements, is this more of a one time thing?

Is that why you pointed that out or was there some the prior year and there's going to be some of that this coming year, too?

Totally one time.

So that's a big reason why the guidance for revenue growth there would be much lower, you had a benefit the last couple quarters from that that's pretty much it?

Absolutely.

Okay.

Thanks a lot.

Our next question comes from Mark Marcon of Robert W.

Baird.

Your line is open.

Good morning.

I just wanted to follow up on the HRS side.

Can you talk a little bit more about the guidance in terms of the 3% to 6% growth and also what your plans are for the sales force there, and is there anything that's happening aside from the macro environment that might lead you to believe that things are going to slow down relative to the growth that you've experienced on the HRS side?

I'll take the guidance and Jon can talk about the sales force.

Basically, the guidance is our best estimate right now of what we think is going to happen.

We have not put out aggressive goals.

When we look at the sales targets, we've not made this belief that all of sudden this is all going to bounce back.

Obviously in the 401(k) market, where we are the leader, that market is under some duress now.

Because people aren't quite sure what is going on.

We do still sell 401(k) plans.

So the HRS revenue guidelines are what we think are reasonable and realistic in the environment we're in, and they're all toned down from what would be normal, and we probably toned them down a little bit more from what I would have said six months ago because the HRS revenues kind of lag what happens in payroll.

Right now we think we've been realistic, not too conservative, not too aggressive and we'll see what happens.

On the sales force, I'll let Jon talk about that.

The HRS is kind of a tough one to follow unless you're watching it over a multiple number of years.

We have made very aggressive investments in sales on the HRS side of the house, so it's normal that in some cases you take a pause.

If you look at all the different aspects of HRS, we are going to continue to increase, and in some cases significantly increase the sales people that we're putting against the significant growth areas, health being one of them.

So, that number will go up.

In retirement services, there will be a slight decrease there.

In HRS outsourcing, a slight decrease there.

In some cases its reflective of what's happening with our ability to bring on clients.

That sales force sells into the client base and sells into the new clients we bring on board.

So to the extent that we bring on less clients than would be in a normal case, then you would expect that you would have less opportunity to sell against those clients, since the overwhelming majority of the products that we sell go to Paychex payroll clients.

So that's really what's happening there.

There's nothing significant.

There's nothing that's gone on that tells us that the world is any less optimistic.

In fact, there's some things going on in healthcare that we think to be very good for us.

Depending on where this legislation comes out, the only thing that could happen on legislation that could be harmful to us would be if they decided that they were going to go to a national healthcare system that was basically piggybacking off of Medicare or Medicaid.

That would hurt us.

I don't think we need to worry about that too much because that would destroy the health insurance business, and you need another surplus program just to bail those guys out.

I think it's unlikely that that will happen.

Anything else that happens that causes more healthcare plans in the United States, given how we're positioned against healthcare, would be very good for our business.

Some of the things that they're looking at relative to retirement services and the importance of retirement services to Citizens, lifetime financial planning and any more pressure put on that obviously would be good for us.

In general what's happening in HRS is we've been adding lots of people to HRS over the years.

This year we're going to add more people into MMS because it's quite hot right now, and in the core and in parts of HRS, but not all of HRS.

Okay.

Just normally there's a bigger spread between the growth rate in HRS versus core, and if you come in at the lower end of the guidance, that would be a pretty significant narrowing, and I was just trying to understand is it more on the retirement services side because of the change in asset values that's driving that?

Is that the area that you would expect to be the slowest?

Yes, 401(k), you've got the decline in asset values, you've got declines in participants, you've got some declines in plans.

But we're still selling.

You're going to see several years ago we increased the HRS 401(k) sales force, after we were a pretty good size, by 25%.

We got a little bit ahead of ourselves and we're working it off.

This year we decided to finally set the level where it's at.

It's not about any lack of commitment or belief in the future of 401(k), it's just about being realistic about what our reasonable expectations to sell and putting the resources in the right place.

In terms of things like time and attendance and workers' comp, how is that selling through and how is that penetration?

Time and attendance is like very low penetration, doing quite well.

We've got two markets there.

We've got the upper end market, which really isn't where our client base is.

That's probably just doing okay.

It's not the highest priority.

The lower end, though, on time and attendance, we're definitely over $25 million.

I'll say we're below 50 in an area that we probably had very little sometime ago.

So we're feeling very good about that, and time and attendance along with some of those other products, is why we're doing so well in MMS, so we feel good about those things.

Workers' comp in this market place is not a big growth item, but not a negative growth item.

That's an area that we keep moving, but it's not again so material to revenues.

And then on Premiere, it sounds like you had a little bit of a bounce back this past quarter.

Shouldn't that continue to track on a positive manner, shouldn't it, or is it possible that you're going to have a decline in terms of the number of employees per client, and therefore a much lower than normal growth rate?

Well, think about Premier and what it is.

Premier in one respect should follow what happens with the economy.

That is essentially the packaging of all of our products at a bundled price.

So when the economy gets difficult and people start to baton down the hatches, then you would expect that the sales in Premier would get harder, and when the economy lightens up a little bit you would expect that they would get stronger because there's clearly great value in the offering.

So, it's probably more tied to the economy than anything else.

An average client for example that we bring on that was an average payroll client might be $2,500.

On Premier that could go as high as some where between $9,000 and $11,000.

Even during the last recession it did well so I'm just trying to.

You've got to be careful.

The last recession, we had just started this product.

Sure.

So it's in what I call the infancy stage.

My belief is the way to avoid recessions is you've got a product that's totally brand new, or one where the market share is so low, or you've got some new gizmo that just sells anyway.

That's kind of what we had back in the last recession with Premier.

There was lots of questions about pricing.

At the end of the day, what price increase did you pass through?

3% and 4%.

3% and 4%?

Yes.

And that's stock.

That's stock.

Was done in May and I would say that the reaction to it was very similar to the last five years that I've been here, which is very little reaction.

Okay.

And then with regards to, there's also discussion about new mouse traps and you're basically making the point that you're not seeing anything out there that's a better mouse trap or a substitute.

As you look at your, what gives you the confidence in terms of saying that, and when you look at your closing rates in terms of the number of new businesses that you approached, are those similar to what you've seen in the past and your sense is just because of the credit contraction, there's fewer new business formations.

It's pretty easy.

You look at your losses and why you lost and you look at your wins and why you won.

So when I look at why I'm losing businesses, or the companies that are existing clients, and we lose them,.

Right.

If we were losing them because somebody else had a better mouse trap, had better feature functionality, had a better way of doing it, had a dramatically cheaper way of achieving the same service levels, that would cause you to be concerned.

We don't see any of that.

When I look at when we win and when we lose on new sales, to what extent is that happening because people are going to a different type offering, not seeing that.

So that's why I say what I say.

When we look at our numbers and we look at how we performed this year relative to how we would perform in a normal economic environment, we look at the difference and then we go back and look at it, we know, when we bring on new clients as an example, we categorize every new client we bring on.

One of the ways we categorize them is prior method.

One of the prior methods is its a new business.

There was no prior method because there wasn't a business.

It was a business that was formed in that year.

Then we can take a look at what percentage of our sales come from businesses that were formed in that year, in this year versus all the prior years.

That's a point I made earlier.

That makes up something in the neighborhood of 90% of the difference between a normal year and the year that we just had, was the lack of new businesses.

We confirmed that also.

We do surveys of our CPAs and we confirmed it in one of our CPA surveys, by looking at what their new businesses were like and they had exactly the same issue that we had and that is they didn't have very many new clients either, or new business.

It was pretty clear to them that when they look at their differences in their world, they had fewer new clients come into the CPA firms and of the clients that did come in there was a dramatic difference in the numbers that were actually a new business formation.

So it's those types of things, those types of metrics that we look at that tell us that.

Very helpful.

Thank you.

Our next is from Kelly Flynn of Credit Suisse.

Your line is open.

Hi, this is (inaudible) for Kelly Flynn.

First, a question on the health and benefits product.

It's obviously seen good growth over the last couple years.

And I know in the past, you have talked about this as maybe being a $100 million opportunity or so.

What I'm wondering is outside of maybe enhancing the sales force, or increasing the sales force here, are there any things you feel you need to do to get there either in terms of enhancing the product or any change in strategy there at all?

We are an insurance agency as it relates to health and benefits, right?

So, we represent carriers and we carry their products to our employees.

So we are sales agents if you will or insurance agents if you will.

A big part of it is not necessarily creating new offerings, but it has a lot to do with the relationship you have with the carriers, the number of insurance agents that you have in the field, but more importantly, your ability to get to the end user and we have an extraordinary ability of being able to get to the end user because we have almost 600,000 installed clients, and we talk to in a normal year north of 300,000 prospective clients, so to the extent that they need health insurance and to the extent that we have relationships and carry products from a large number of insurers, not a large number of carriers, we're in an advantaged position.

So, it's more about that than anything else.

It's helped by the fact that small business is not an attractive target for independent agents.

If they can make five calls today, they're going to call on the five companies, prospects that they have that have the largest number of employees.

Their view is that it's just as much work to do a 500 person firm as a 50 person firm, or a five person firm.

They don't want to do a five person firm.

They want to use their time to do a 500 or a 100 person firm, so they tend to ignore the low end, which is not unusual for small businesses.

They largely get ignored by most players.

We have made our business out of taking care of those clients, and so it's almost a perfect storm for us.

It's a very natural situation for us.

Okay.

That was helpful.

And then is there any way to quantify and I don't know if this was covered before, what was the change in the number of clients that moved to non (inaudible) status.

We don't disclose that.

Okay.

Okay.

Yes, that was all.

Thank you.

Yes.

Our next is from Tien-Tsin Huang of JPMorgan, your line is open.

Just a few quick follow-ups.

Just on the $12.4 million on the retirement service billings, is that all profit?

Is it just isolated to the fourth quarter, John?

Those billings were all year.

I don't think any quarter's any bigger.

I would say if you said it was even all through the four quarters, you wouldn't be far off.

There's probably about an 80% margin.

80% margin.

Okay.

Helpful.

Then the health and benefit service revenues, how profitable is that now from a margin standpoint.

We haven't disclosed that.

Actually, I'll tell you, it's not a high priority of focus on that right now.

The focus is to grow the revenue, get the product to be as good as we can get it.

Understood.

Lastly, on management incentive compensation, I think in the past you guys have, I think it was pegged to the 15% operating income growth ex-float metric.

What metrics are you now benchmarking against for incentive comp given the economy?

Last year was not benched exactly to that, so it's something we keep looking at.

Are you talking about about the officers?

Yes, the executive management team.

The officers' comp plan has not yet been approved by the Board, that's going to be at the July Board meeting.

That might be a better question to ask the next time we talk.

Very good.

Thanks.

Our last question comes from James [Kasane] from Bank of America.

Your line is open.

What's the time frame for achieving the $100 million in the healthcare business, and what your margin objectives in the healthcare business are?

Let me take a shot at both of them and then John can talk as well.

When we first started out, I said that this was a business that I felt like we had a shot at maybe growing it to $100 million in five years.

It turns out with what's happened in the last year with the economy, that's probably not going to happen, but from all of the modeling that we've done and how the business has grown, we're still on the path to making that $100 million business and I feel very confident that we'll get there.

Won't happen in five years.

Maybe it will be six.

Maybe it will be seven, but we'll get there.

On the margin piece, I'm not going to tell you what the margin is.

John can if he'd like.

What I will tell you that's important to understand, is the way this business works and why it's so important to continue to invest in it the way we are, is that we're paid a margin, we're paid a percentage of the premium each year, and so we get it in the first year when we capture it, and then we get it every year thereafter as long as the client stays with us and stays with the carrier.

You know from our business that we have an extraordinary ability to retain clients, so we feel pretty comfortable with that.

All of our costs associated with that business are in the first year of capturing the client.

After that, all of the commission payments that we get from the carriers are pure profit.

So the way that this business works is you try and build up your sales force to get as many sales as you can in a year, and in the first year that you capture the sale you're not going to make much money on that.

Every year after that on each individual sale basis, you're making almost 100% profit from what the commission flows are.

So the trick in this business is to build up a book, if you will, to drive the out years and the numbers become amazing in the out years.

So we're in the early stages of this business.

As John said earlier, we don't really look at the profit at this point, because what we're looking at is building the book of business and building our capabilities, both with salespeople and back off processing capability.

I haven't see anything in this product that tells me margins are appreciably higher or lower than typical HRS products, which actually have margins a little higher than payroll.

It's got all the attributes of a 401(k).

Doesn't have the basis point fees, so we expect it will be profitable and I would be surprised if we were on the phone some day saying that margins went down because healthcare margins weren't the same.

I don't know of anything that would cause that at the moment.

One last question.

Just your appetite for acquisitions, especially in the bigger deals in adjacent markets.

Very strong and has been strong.

Our financial capability to do the acquisitions is extraordinary.

The trick is finding the right ones.

And how about just managing or balancing with the dividend.

Relative to the acquisition?

Yes.

None.

Remember, we have a very strong stock capability, and we have no debt.

So we have always done acquisitions using cash but in terms, if the right one came along and the right thing to do is to either use stock or use debt, we have an enormous capability from that vantage point, and we're sitting on just shy of $600 million on our balance sheet, so we're in pretty good shape from that standpoint and our dividend is less than what we make each year.

So, it's obviously would be a consideration.

If it was a mega deal.

But I don't personally think it would be an issue.

Okay.

Thanks, John.

We have no other questions at this time.

Well, again, we thank you for joining us today and your interest in Paychex, and we all look forward to when times are better, but in the meantime, we think we're doing as good as we can do and we'll keep moving forward, so thanks a lot.

This does conclude our conference for today.

You may disconnect at this time.