沛齊 (PAYX) 2010 Q3 法說會逐字稿

Welcome and thank you for standing by.

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

(Operator Instructions).

This call is being recorded.

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

Now, I will turn the meeting over to John Morphy, Senior Vice President and Chief Financial Officer.

Sir, you may begin.

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

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

The teleconference call will be comprised of three sections, a review of our third quarter 2010 financial results, including comments and guidance for full year fiscal year 2010, an overview from John, and lastly a Q & A session.

Yesterday afternoon, after the matter closed, we released our financial results for the third quarter ended February 28, 2010 and we have filed our form 10-Q with the SEC, which provides additional discussion analysis of results for the quarter.

These are available by accessing our investor relations page at 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.

Quarter highlights -- you have noted that in the third quarter we recognized $18.7 million of additional expense related to our rapid payroll litigation.

On March 9, the Court of Appeals in California upheld the jury verdict issued in June 2007.

While we are disappointed with the Court's decision, we intend to satisfy the judgment, including statutory interest, without further appeal.

Litigation results will not have any effect on future financial performance, as there have been no business transactions between Paychex and the plaintiffs since February 2007.

Excluding this expense charge to increase litigation reserve, our earnings were slightly better than expected.

Our guidance for the full year fiscal 2010 remains unchanged.

Achieving our revenue goals has proven a bit more difficult due to the adverse impact the economic headwinds have had on new client sales and client retention.

Our client basis declined 2.1% since May 31, 2009; the selling season was a difficult one as our new sales units for the nine months were down 6% from last year, primarily due to declines in new business formation and fewer companies moving to outsourcing.

On a positive note, exclusive of certain items, we have achieved our earnings goals in each of the first three quarters, our key indicators have shown stabilization for three consecutive quarters and our year-over-year comparisons continue to improve throughout fiscal 2010.

Some comments are follows.

Our checks per client decreased 2.2% for the third quarter compared to the same quarter last year.

This is an improvement of the declines of 3.7%, 5.0%, and 5.2% in the past three consecutive quarters.

Client retention, while less favorable than normal, began to show improvement as clients lost were down 5% year-to-date compared to last year.

A more meaningful statistic is we have seen a slight improvement in client losses as a percentage of the beginning of the year client base.

Throughout this challenging economic period, we have continued to focus on providing excellent customer services investing for our future, and maintaining a strong financial position.

Our investment efforts in health and benefits have been rewarded with greater than 50% growth in related service revenues.

We are generating positive cash flow from operations and maintain a balance sheet without debt.

We remain focused on investing in our products, people, and service capabilities, positioning us to capitalize opportunities for long-term growth.

Continued investment in our business including our technological infrastructure is critical to our success.

In the third quarter, we completed implementation of an enhanced platform for our core payroll process and capability.

We have successfully completed conversion of over 470,000 clients to this platform.

We invested over $60 million in this project and anticipate seeing return on our investments through efficiencies in our processes and building a products platform that will perform well into the future.

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

Payroll service revenues decreased 6% for both the third quarter and the nine months.

This is the result of economic impacts on our client base and check volume, which were discuss in my opening comments.

Human resource services revenue increased 3% to $135 million for the third quarter and 2% to $400 million for the nine months.

I will give you more on HRS service revenue in a few moments, where you will notice that our revenue growth was actually much stronger than those two numbers.

Combined interest on funds held for clients and investment income decreased 13% for the quarter and 33% year-to-date.

Yields available on high quality securities continue to remain low.

Three-year AAA muni yield was 84 basis points as of February 28, 2010, compared to 135 basis points as of May 31, 2009.

Operating income decreased 15% to $168 million for the third quarter, and 13% to $551 million for the nine months.

Operating income, net of certain items, which excludes interest on funds held for clients and the expense charge to increase litigation reserve, decreased 4% to $173 million for the third quarter and decreased 7% to $529 million for the nine months.

Operating income, net of certain items as a percentage of total service revenue, was better than expected in the third quarter at 35.0%.

Net income and diluted earnings per share decreased 14% to $112 million, and $0.31 per share for the third quarter.

For the nine months, net income was $361 million, and diluted earnings per share was $1 per share.

The expense charge related to litigation impacted our diluted earnings per share by $0.03.

HRS revenue growth was affected by a couple of nonrecurring items.

In October, we sold Stromberg Time and Attendance to Kronos.

While Stromberg operations were not material to our results, the sale did have a modest impact on our HRS revenue growth rates.

Also in fiscal 2009, we had non-recurring billings for statutory retirement plan restatements that are required about once every six years.

Excluding both Stromberg revenue and the non-recurring retirement revenue our HRS revenue growth would have been 7% versus 2% reported for the nine months and 10% versus 3% reported for the third quarter.

On the same basis, fiscal 2009 HRS revenue growth would have been 8% versus a reported 11%.

Highlighting contributions, HRS revenue growth were comprehensive.

Human resource outsourcing services, client employees served increased 9% to 472,000 employees as of February 28.

We have seen positive results from expanding our PEO offerings throughout the country this past year.

Our health and benefit services revenue increased 54% to $8 million for the third quarter and 49% to $22 million for the first nine months of fiscal 2010.

Human resource services products that primarily support our major market services client have experienced growth for the third quarter and nine months, compared to the same periods last year.

Our major market services area with our Software Service Solution continues to be a strong area of opportunity for us.

Dampening our revenue growth is the influence of weak economic conditions and client base growth, especially on retirement services; our retirement service client base is flat compared to a year ago.

As we mentioned, we are still earning low yields on our high quality investments.

In November 2009, we began to invest in select first tier variable rate demand notes for the first time since we had divested of these back in September 2008.

Variable rate demand notes are municipal issuers with liquidity or letter of credit enhancements provided by US government agencies, highly rated corporations, and higher education or highly rated banks.

Variable rate demand notes have either daily or weekly liquidity to investors.

In September 2008, we divested of our holdings in the securities is a result of the market turmoil and began to utilize US agency discount notes as our primary short-term investment vehicle.

We have gradually seen improvement in certain money market sectors and therefore have been investing in variable rate demand notes again, although considerably lower rates than in the past.

For the third quarter, we earned 18 basis points after tax for variable rate demand notes compared to approximately three basis points for US agency discount notes.

While a move in the right, meaningful improvement to yields is much more dependent on higher generates versus higher yield instruments.

We continue to remain conservative investment strategy ,emphasizing maximum liquidity and principal protection first and then investment yield.

Our priority toward liquidity is to ensure we meet all our cash and commitments to clients that take place as we transfer cash balance from their accounts.

Please we are to our most recent form 10-Q for additional information related to our investment of funds held for clients and corporate investments.

In spite of the economic environment and volatility in the financial markets, we have maintained a strong financial position with cash and total corporate investments of $689 million and no debt.

Cash flow from operations was $503 million, compared to $563 million a year ago.

Funds held for clients as of the end of the third quarter were $4.1 billion compared to $3.5 billion as of May 31, 2009.

Funds held for clients vary widely on a day to bay basis an average $3.5 billion for the third quarter and $3.1 billion for the nine months with year-over-year declines of 4% and 7% respectively.

In fiscal 2010, we have been experiencing lower average invested balances, primarily a result of the economic impacts on our clients.

Approximately 2% of the decrease related to lower withholdings for client employees with the American recovery and reinvestment act of 2009, or the so-called stimulus package.

The stimulus package went into effect last April, and the impact on year-over-year comparisons related to that should abate in the fourth quarter.

In the third quarter, we experienced a pickup in balances as a result of recent increases and various state unemployment rates that went into effect for the 2010 calendar year.

For the full fiscal year, average balances for client are expected to be down 5%, which is an improvement from our previous expectations because of the [SUEY] rate increases.

Our stockholders equity increased to $1.4 billion as of February 28, 2010.

A return in equity for the last 12 months was 34%.

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 trend lines, we do project current trends into future periods of time.

We believe it is extremely difficult if not possible to accurately predict significant up turns/down turns 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.

That being said, our current outlook for the full year fiscal 2010 is based upon current economic and interest rate conditions, and assumes these conditions will continue throughout the remainder of fiscal 2010.

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

Projected changes in revenue and net income for fiscal 2010 remain unchanged from last quarter and are as follows.

Payroll service revenue is projected to decrease in the range of 5% to 7%.

Human resource services revenue growth is projected to be in the range of 3% to 6%.

Total service revenue is projected to decrease in the range of 2% to 5%.

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

Total revenue is projected to decrease in the range of 2% to 5%.

Investment income net is projected to decrease by 30% to 35% and lastly, net income is projected to decrease in the range of 10% to 12%.

Anticipating some guidance questions in this call, we would like to in advance provide a little color on the above guidance.

The net income guidance reflects the RPI litigation charge of $18.7 million or $12.2 million net income effect.

Prior to this event, we expected to be slightly above the net income guidance.

In improving conditions, why would we experience a reduction in fourth quarter EPS, compared to the prior year and the first three quarters of fiscal 2010?

Excluding the RPI litigation, the rate of negative year-over-year EPS growth has been improving.

It was 17% negative in Q1; 10% negative in Q2; 6% negative in Q3; and we expect it to improve again in Q4, but probably not yet reflect an increase over the prior year.

As we have previously discussed, sequential earnings per share is not as applicable to our business as it may be for others.

While we do not experience significant seasonality, our quarters tend to match up better with the prior year quarter versus the sequential quarter.

The timing of price increases, expenses, selling new clients, sales commissions and funds held for client balances all contribute to differences in sequential revenue and earnings.

Essential decreases between the third and fourth quarters, however are expected to be less in fiscal 2010 than we experienced in fiscal 2009.

Refer to our outlook section in the MD&A in our 10-Q for more information on guidance for full year fiscal 2010.

Safe harbor.

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

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

Please review our safe harbor statement in the press release for our discussion of forward-looking statements and the related risk factors.

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

Thanks, John.

And good morning, everyone.

So with the exception of a one time litigation reserve increase, the quarter played out closely to what we predicted.

Revenue was slightly lower than planned, but certainly in the ballpark, and the key drivers for the softness continued to be less sales than normal due to lower levels on the business formation and more losses than normal, both directly tied to the economic headwinds.

Earnings were slightly higher than expected, driven mostly by excellent expense management and cost controls.

I remain very impressed and proud of our employees in their disciplined execution of expense containment in this difficult economic time.

EPS beat the street by $0.01, excluding a one time item.

Operating income was down slightly, but much improved over Q1 and Q2, but definitely moving in the right direction.

Same is true for checks.

Sales in the quarter were mixed.

Core payroll continued to be affected by less new business formation or origination, but MMS and HRS were pretty much right as planned.

Year end close for our clients went very smoothly.

We cut nearly 10 million W 2s, all on time or early.

Our operations team continues to do great work for our client, so all things considered, a pretty good quarter.

The important take-aways, I think, on this quarter, at least for me, were revenue close to estimates, excellent expense controls, profits slightly better than expected, beat EPS, and probably the big headline, I think, was the economic indicators continue to improve, suggesting that recovery is definitely underway.

Let me cover a few those indicators that are important us to.

New higher activity down 11% in the quarter, average monthly, down 11% in the quarter versus 31% a year ago; 26% in the first quarter, 21% in the quarter just before this.

So, 31% a year ago, 26% in the first quarter, 21% last quarter, 11% this quarter, excellent improvement.

Federal fund rates, steady at 0 to 25 bips.

The fed is saying they are going to hold it for some time.

Inflation, obviously, is not yet a concern for them.

There is some talk now amongst the heads of some the federal reserve banks about raising rates or certainly, not being tied to time frames, but rather to the key economic indicators, which at least for me, was nice to hear.

Checks per client, as John mentioned, down 2.2% versus 4% last year.

That was down 5% in the first quarter, down 3.7% in the second quarter, down 2.2% in this quarter.

Fourth quarter could be flat or just slightly below flat, so we're feeling like we're getting closer to the turn there.

Job creation, 57,000 jobs was the average monthly loss this past quarter versus 726,000 last year; 128,000 in the second quarter; 357,000 in the first quarter.

So 357,000; 128,000; 57,000, you can see we are making good progress there, and it would clearly look like we are getting close to turning positive.

Unemployment stayed flat for the last couple of months, down about 9.7%, averaging in the quarter about 9.8.

Payroll client growth down 3.6% versus 1.6% in the third quarter and 3% for the full year.

Sales from new business turned positive, 1.2% for the first time in seven quarters, so that would be 1.2% positive versus minus 12% last year in the third quarter, minus 4% in the second quarter, minus 8% in the first quarter, so again, pretty good trend there.

Losses due to business failures, actually improved 17 percent year-to-year, versus declining 21% in the third quarter of last year.

So it improved 9% in the second quarter, improved 1% in the first quarter, and 17% this past one.

So 1%, 9%, 17%, pretty good trend there.

Losses from price value also improved a little bit.

Business failures, by the way, are about where they were in 2008.

It really looks like that thing is starting to get under control.

Check volume, noticeably better for Q2 and Q1; obviously, still not where we want it, but mostly driven by the client base declines and check for payroll.

Ancillary, as John mentioned, still very strong with no issue there and penetration.

Employee pay is actually a little stronger than last year.

Payroll revenue growth minus 6% versus plus 1.9% last year.

Versus minus 6.4% in the first quarter, 6.7% in the second quarter.

That trending again continues to be good.

HRS revenue, John covered that, 3.4% positive would have been 9%, excluding (indiscernible) and Stromberg.

Good on performance given the economic headwinds and the small client base, so we felt reasonably good about what is going on in HRS.

Total service revenue down 3.6% versus down 4% in Q2, down 4.6% in Q1, definitely going in the right direction.

Interest on funds held for clients, minus 14% versus minus 56%, so it looks like we are almost through with the huge negatives.

I, for one, am certainly ready for the huge positives.

Those who have influence on the fed, talk it up.

Have them raise those rates for us.

Great job of managing expense, down 3.1% versus a year ago.

Margins essentially flat to last year, but extremely good discipline by a team, as I mentioned earlier.

Net, net, I felt like it was a pretty good quarter, good progress on recovery.

All key indicators of moving in the right direction, so as we said, given the economic headwinds that we are fighting, we felt pretty good about the way the quarter played out.

With that, why don't I open it up to your questions.

John and I would be happy to entertain them.

(Operator instructions).

Jason Kupferberg with UBS, your line is open.

Thanks, good morning, guys.

How are you doing?

I'm doing well, thanks.

I had a question about some language in the press release and in the 10-Q last night.

I don't think you guys elaborated on your prepared remarks.

There was some talk about fewer companies moving to outsourcing.

I don't necessarily recall in the past seeing that language from you guys.

I was hoping you can elaborate on that a little bit.

Is there something structural you see going on?

Is that observation causing you to do anything differently in terms of how you are running the business?

Just some additional flavor around that commentary would be great.

There is no big message there.

I guess what I would say, and this is Jon judge.

What I would say is, the way to think about it is what's happening, we believe, is probably what's happening in our own households.

When you get in an economy that tightens up like this what essentially happens is some decisions tend to get deferred.

When we look at our business coming in when we make new sales, we categorize every sale we bring in, by its source, whether it is coming from a competitor, whether it is coming from a business that started that year or a new business origination, whether it's a conversion from a client that's doing in-house and so on.

When we talk about a move to outsourcing, typically that is referring to a client doing it in some form or fashion, but not with an ADP or one of our other competitors.

They are doing it in-house in some form or fashion.

They move it on an outsource.

As we do the analysis on our source of new sales, one of the things that became obvious to us, is that that particular source of new sale was showing up as not as robust as it's been in the past.

So that's clearly an indication that people are just delaying decisions.

That is really all it was.

Another reason, Jason, it verifies it is probably not secular, is when you look at new business starts, we are still gaining the same percentage of new business starts to outsource as we were before this started.

It doesn't appear we believe any change in what people's preferences are.

Just a question on a company of metrics.

I think you guys indicated your total number of clients lost is down 5% year-over-year on a fiscal year-to-date basis.

Yes.

And I think the other statistic was that clients lost due to out of business is down about 8%, if I average the last three quarters of each quarter's year-over-year change.

Does that suggest that there is more clients being lost due to other reasons?

Basically to competitors?

Basically, we are swapping more clients with ADP.

We are still winning more clients from ADP than we are losing, but we are swapping more of them.

Okay, but you don't feel like your win rate is changing?

No.

We still, no, we track what we got from them, we track what we lose to them.

We are still winning more, it is just there is more of it.

On the OpEx, it was down 6% in the quarter and you guys talked about some of the cost control.

Can you get specific or more specific on the types of expenses you cut?

And how much of that do you feel will need to come back into the P&L when the top line starts to turn positive again?

The only two actions we have had, that we have that will come back is the first one, we had a wage freeze we put in on March 1, a year ago.

That's been put back in, now.

That was worth about $15 million.

We have a 401-K matched that was taken off last April.

That is about $15 million.

The decision has not been made in that one yet.

We are not sure what we are going to do

The rest of it the cost reductions are simply just continuing to manage our business better and better.

There is no one single thing.

Now, an area where we have not cut costs at all is in the sales area.

So basically, almost all the cost reduction has come out of G&A and operations through making more productive.

But the one thing, Jason, we have talked about in this prior calls, the one thing you can be sure of is, we have a mentality that expense is earned by revenue.

So it is reasonable to assume that as revenue improves, the gross expense will improve.

We are also pretty careful at watching what our margin percentages are.

There will be more expense that will come back into the system as more business comes back into the system.

We watch our margins pretty closely, so you shouldn't assume all of a sudden expense money is going to pop back in without revenue.

We just flat won't allow it to happen.

Makes sense.

Thanks.

Our next question comes from Kelly Flynn with Credit Suisse.

Your line is open.

Thanks, a couple of questions to actually somewhat follow-up to Jason's.

Also on your press release comments, I wanted to refer to what you said about the selling season.

It is difficult.

Could you go into more detail there on what you mean?

Specifically, was it disappointing or was it difficult?

If you could qualify those comments relative to what you said on the call, which is pretty much, pretty optimistic?

Most metrics seem to be actually improving.

Well, the optimistic part is about the economic indicators.

They are improving.

Those are facts and so that leaves us to feel pretty good about the fact that the recovery is underway.

As we have said in the past, the $64,000 question is how long is the dig out going to be.

Most people believe it is going to be long, not short.

It is going to be a bounce back.

It is going to be a -- we're going to come out of this recession, but we are going to come out of it not with a flash.

We're going to come out of it more liberally than that.

As it relates to the selling season, I don't know how to calibrate.

I'm not sure what the difference between disappointing and difficult.

The term difficult -- the reason we use that, and there wasn't a ton of thought given to it, it's not that we were trying to signal anything -- it flat out has to do with the number of sales that we make one year versus another.

What is happening is what we have been talking about.

The source of our sales over the years has been pretty constant.

We get the certain amount of our sales from companies that are formed that year; a certain number of our sales have come from people already outsourcing, but with a different outsourcer that are unhappy with them.

We get a certain number of our sales from clients that are doing it themselves either manually or using a software package in the house or using a QuickBooks type application.

They come over to a fully outsourced solution, which is what our business is.

So the comment was referring to the fact that the robustness of the amount of people that were in the market buying and therefore making decisions, was not as robust as we would have liked it to be.

So that is what we are referring to.

Anytime your sales are less, one year to the next or flat one year to the next, you are probably going to be disappointed.

We were more reflecting on the fact that it was still pretty tough sledding and mostly, as I mentioned, it's mostly in our core payroll business.

Our major markets business, which were the larger clients had a very good last year and it's in the midst of a very good year this year.

That is mostly taking clients, almost exclusively taking clients from other payroll providers.

Some of them are clients that are growing up from the core, excuse me, moving up from the core platform, but most of them are clients that were taken from other providers.

Then our HRS business is doing pretty well as well.

The HRS business is pretty dependent on what happens in core.

Our HRS business for the most part sells ancillaries and other products into existing clients of Paychex.

To the extent those client numbers are lower or flat then their opportunity to sell into that will be lower or flat.

But most of the comments referred to the largest part of our business, but it refers to the cover business.

Okay.

Yes, I guess what I was just trying to get at was, was it -- the selling season, was it worse than you expected?

Or was it kind of par for the course, given the overall disappointing economy.

That is a hard one to answer.

What do you expect?

We always whether we book plans, we book plans to get better, right?

We would never book a plan to get worse.

Okay.

So we booked a plan and it was -- I would say, it was a little bit less than what we have planned for.

I wouldn't say that I was disappointed in the performance of our people or in the results that they got, I just, it is like I'm not happy with the economy, right?

I wish that the economy is a little bit more robust.

We can see exactly where the sales are missing and that is why we have talked about this in the past; we are not losing the competition.

We're not having business taken away, we are not struggling with somebody who have invented a better mouse trap.

We are struggling, like most of the world, with the fact that the economy is moving more sluggishly than normal.

A follow-up question on the expenses.

I just want to clarify, John Morphy, on what you said about lifting the wage freeze.

Did you say there was a $15 million increase this quarter?

Due to that?

No.

Wage increase got lifted March 1, so it is outside the quarter.

Some impact on the fourth quarter, but in the four quarter, they won't all be the same.

The $15 million annual number is not quarterly.

Thank you very much.

Our next question comes from Julio Quinteros from Goldman Sachs.

Your line is open.

Hey, guys.

Real quickly, on the margin commentary for the full year, the 34% to 35% range.

The release says that it's a net of certain items.

I want to make sure that -- are you excluding litigation charges from that?

Or is that included?

Oh, we exclude it.

The 34% to 35% for fiscal 2010 excludes litigation charges?

So, if I look at that on an apples to apples basis, in the February quarter, excluding litigation charges, I'm getting an operating margin of around 35%, excluding (indiscernible) revenue.

(Indiscernible).

Now, go ahead and keep going.

I can anticipate where you are going.

I'm justify trying to figure out from there to get to 35% to 34% where you have been for the first three quarters of the month, what is the implications for the May quarter?

It sounded like you actually expected improvement in the May quarter.

We don't expect improvement in the margin; the lowest margin quarter for us is almost always the fourth.

There's a few reasons for that, one I talked about earlier, we have some seasonality.

I mean, basically the third quarter has a lot of unusual income and expense, so the revenues drop sequentially, although we don't think the sequential drop is going to be as great as a year ago when it was very big.

We also have the issue, our selling people are pushing it at the end of the year making quota.

They don't all miss, a lot of them do make it.

We have to pay higher commission figures based on all the quota numbers.

We also start to staff up some of the sales forces early because we want to build optimistically with what we need; we haven't exactly decided how much we are going to add.

In the areas like healthcare, major markets, we add them.

You have some things that happen.

The fourth quarter, typically, is the the lowest margin quarter of the year, and the highest margin quarter is the first.

Basically, an improvement year-over-year, but a little bit down on a quarter-over-quarter basis for seasonality.

It will be very close year-over-year.

Okay got it.

All these ramps getting folks on board -- as you guys start thinking about 2011, any sense on what types of improvements would you need to see on some of these key metrics to really get to the 8% to 10% or so revenue growth trajectory in fiscal '11?

How fast do things need to come about back or if we are in the state we are in now we are probably working our way through the improvements of fiscal '11?

Is there some way to weight some the metrics which ones need to come back first to really think about the improvements in revenue growth as we move into fiscal '11?

We won't give guidance on '11 until we get to June and had our operating plan completely finished.

You have to recognize, we don't get significant revenue ramp ups.

To get one, it is pretty simple.

The economy has got to ramp you up.

If the economy ramps up suddenly, then we'll get it.

If the economy doesn't ramp up suddenly, we are going to keep working on continued improvement.

We think things are happening, but you are not going to see something that big.

The reason is we are a business of small transactions.

Companies that have large transactions and quick things, they get ramp ups.

They also get bigger down decreases.

Unfortunately, we don't have much volatility; but it happens both ways.

Okay, understood.

Great.

Thanks, guys.

Julio, it is because of the size of the recurring revenue in our model.

Right.

The good news about this type of a company is you are not going to get dramatic downs.

And as a consequence, you are also the same thing that drives that to happen drives -- you're not going to get dramatic ups.

Understood.

Next question comes from David Grossman with Thomas Weisel Partners.

Your line is open.

Thank you.

Recognizing that you don't want to get too much into fiscal '11, and just to respect that, but just to follow-up Julio's questions, based on the current trends in the business that you have and the comparisons that you face, what would be the obstacles to getting to more normalized retention and some new client growth over the next several quarters?

Well, the retention piece we are getting pretty close to now; we are making good progress in the retention.

The thing that is driving the retention -- and it is pretty clear when we look at the data -- the thing that really is driving the retention the most is the increased number of clients going out of business because of the pressures that the economy has put on them and their inability to make their business work.

So when you get back to a more normal economy, we are going to be right back into the 19%, 20% client loss, 80%, 81% retention levels.

There is nothing that tells us that won't happen; we are pretty confident of that.

That piece is going to take care of itself.

The part of it that is driving it the most, we really can't do anything about.

I can't do anything about clients going out of business.

I can do things about clients that leave us for other reasons, whether they are leaving us because we are not providing a certain level of service or a certain type of functionality or they want a different price model.

Those are things we can do something about.

We're very geared up to do that.

We have been for quite sometime and we make conscious decisions on all of those.

So that one, I think, will take care of itself.

On the new business, there are things in this particular economy that we can control and things that we can't control.

On the things that we can control -- as you guys know, we have a new head of sales in our Company.

He is doing a phenomenal job.

He is very strong on board.

He has taken a very solid approach to understanding our business and our industry.

In a fairly short period of time, he is completely up to speed on our business and on our industry.

As it relates to sales, he has taken a very systematic and very data intensive approach to understanding all of the things that we do and particularly in core, by the way, but understanding all things we do.

He has run focus groups with external parties that are important to us, like the CPA community and banks and so on.

He's run focus groups with sales reps and managers.

He has looked at all the sales collateral, all the material we use, he has looked at all of the training, all the reasons why we lose sales reps that we want to retain, so regretted losses.

All of the different pieces of the sales puzzle.

He has done a very, very solid piece of work, come up with a lot of different conclusions on it and he is in the process of launching a whole new re-vamped approach to market that is very detailed, very pragmatic, very focused on doing the right things, doing the things that are important, stop doing the things that aren't important.

I'm very optimistic about how this is all going to play out.

He has had a national sales meeting for all of our first line managers across the country.

He laid out all of his findings, he's laid out the new approach that we are going to take going forward.

I feel very, very comfortable that the things that we can control, that we have a renewed, emphasis and reinvigorated approach to, I feel good about that.

On the things we can't control, like new business formations and so on, you just flat out can't control that.

To me the thing we have to be careful about doing is making sure we are weathering the storm, that we're being responsible about the way we spend our money and therefore, generate our profits, that we don't cut anything that is vital to us in the short-term or intermediate term, and that we just keep moving forward.

I feel like where we need to be, the things that we can improve, I feel like we have had good energy on those, and we're going to try hard to improve them.

The things we can't improve, we are not spending a lot of time or emotion on those things because they are outside of our control.

Let's just focus on the things we can control and do the very best we can.

I feel good about where we are.

Right.

Just to clarify Jon, a couple of things you said.

It sounds like the retention that is pretty close to back toward the 79% to 80% level right now, did I understand that right?

No, no.

Where we are on that is the decline has stopped.

It stopped getting worse and we are moving towards getting better.

We are not back to 20% yet but we'll get back to 20%, as soon as these losses get under control.

Okay and then just the mechanics of the new client growth, given that a lot of that comes from sales this year.

If the retention stabilizes over the next six months, and new sales do turn positive, is it reasonable to think that you could see new client growth in the next fiscal year or is that going to be challenging given the mechanics of the timing of new sales.

You can get new client growth.

How large it will be is another question.

I can say for a fact we haven't done it yet so I guess it isn't a fact, we will not have a plan for next year that has no clients.

Okay.

We're not going to say it is going to be a healthy number or a number we'd all like to have.

We will not be negative.

Okay.

Just one other question.

You talked in your comments and it was in the release about the investment that you have made in some new systems.

And can you just help us understand, how much of that investment is really addressing your existing markets?

And, what, if any amount of the investment in the new system may address incremental market opportunities that perhaps weren't available to you prior to this system upgrade?

David I would say three things to think about on that.

One, the system that we replaced was about 20 years old.

It is just a system that drives the core payroll platform.

So it is a heart transplant, if you will.

In a business like this or any business for that matter -- I spent almost 26 years at IBM.

When all of your core systems at some point you are going to need to upgrade those core systems.

You can't stay on a platform forever.

Part of it was just getting the system upgraded and getting it into all the latest and greatest in terms of data bases and system architectures and so on.

Part of it is that.

Part of it is, as you put the new system in place, you obviously replace everything you have and then you make whatever improvements you can that will affect the targeted audience.

In this case as we built the new system, we put lots of work flow improvements into it, we put lots of usability function into it.

It will be far easier to train payroll specialists on this system than our old one.

The system has lots of feature functionality that will make the day to day work of a payroll specialist in our Company go easier because of some of these workflow things that we did.

The third piece, which some could argue is the most important, anybody who has older systems knows that one of the biggest problems with older systems is it is incredibly difficult to interface or integrate them with anything new do you want do because you are dealing with older technologies, you have very difficult user interfaces that you are dealing with and so on, so with the new system part of what you are doing is creating a platform you can use to create a whole series of new functionality that will drive you into new markets.

In the existing system as we have put it in, does it have functionality geared specifically at new markets?

No.

It has a lot of functionality geared at making our existing world better and more productive.

The early return so far would say we are getting an 8% to 10% bump on productivity of our existing payroll specialist and that is just based on the number of clients that they can handle and the work they can get done in a day.

We haven't got a hard number yet on what it is doing for us in terms of how fast we can get people up to speed on new hires in the payroll world.

But the main thing, as I said, going forward, it is a new system, and by definition it's got interfaces and architectures that will allow us to add new things into it and improve our functionality going forward.

Specifically, is there anything about this system that would allow you to more aggressively pursue larger businesses?

Perhaps in the middle market?

Not so much about the system pursuing it.

But the system will be the base for all the functional enhancements that we'll do for the -- for what we call the middle market, for the larger clients, so yes.

Very good.

Thank you.

My pleasure.

Our next question comes from Chris Mammone of Deutsche Bank.

Your line is open.

Thank you.

Just back to another metric I think from the press release.

I think that you said that the client base declined 2.1% since the beginning of the fiscal year; and I think the comparable number through the first six months was less than 1%.

Does that imply a wave of attrition that happened in the February quarter?

That doesn't really reconcile with some of your other comments about retention getting better?

It almost mirror images what happened a year ago.

The selling season and the loss season are the heaviest in the third quarter.

That is when it's going on.

We talked about client base being relatively flat for the first six months.

It was relatively flat a year before, and we basically had the experience that was very close to the same we got.

We are hoping to do better, but we knew we were optimistic.

Based on what actually happened, if we really got reasonable, what happened is pretty close to what we should have expected to happen.

It is a prime example.

This isn't true for all things, but it is a prime example if you looked at one data point where if you looked at sequential you would come to the wrong conclusion.

Right.

That makes sense.

Follow-up question from reading through the 10-Q last night, it looked like there was a change in town based on our read.

In the previous Q, you talked about in cost control mode, capital preservation mode, it seemed the language changed in last night's Q, toward more aggressive investing ahead of growth over the next couple of years.

Am I reading that the right way?

Is there sort of a significant change of tone there, leveraging what you just completed with the new payroll system upgrade?

And, is that -- what are the implications for potential for margin expansion because of that more aggressive investing over the next couple of years?

I think you are trying to read too much in.

I would say we haven't changed dramatically.

This is the time of the year when we are thinking more about future investments (indiscernible) We're looking for the coming year, because we continue to run our business on an optimistic basis that the future would get better.

I wouldn't say there was any significant change.

We feel better, while we feel better we have a couple of things, where as you would say disappointed.

So we are still optimistic.

Okay, thanks, guys.

Our next question comes from Adam Frisch of Morgan Stanley.

Your line is open.

Thanks, guys, good morning.

Lots of things were already asked.

Just wanted to dig into a couple of things.

Jon, you said the competition with ADP, you are swapping more.

Is there anything different than what we have seen in the past?

We tend to see flare ups every now and then, but is it anything different or things that are changing between you the two of you guys that we should think may change the landscape in the industry in terms of pricing or something like that?

I don't think so.

There was nothing noticeable or dramatic that I can happened through the sales season.

There is no question -- we have talked about it before.

There is no question they have gotten a lot more aggressive in discounting and gotten a lot more aggressive in using price as a weapon.

We haven't changed what I have told you in the past.

We are not going to use price as a weapon, but we are not going to allow someone to take share from us.

So, we are careful about existing clients, we are careful about how we battle with new clients.

I will tell you to the extent that occasionally we'll see a situation and it could be ADP, or one of our others, we'll see when they put a price at it that will guarantee that you will not make a nickel worth of profit from that client in its entire life and we will walk away from those.

We have been pretty aggressive in terms of holding market share and maintaining our clients, but we have not been the aggressor is an easy way to say it.

When I think about the quarter, it is natural whether there are less buyers in a market that is normal and the same number of sellers.

It is normal that you are going to see some tussles in the marketplace, but nothing that's happened that I'm aware of during the selling season that would suggest anything hugely different than what's been going on in the past.

Sounds good.

Then just the other question.

Obviously, sales were down.

You said it was a weaker season than you were expecting.

Talk about the sales force a little bit.

Retention rates or turn over, however you want to put it, how the morale is there?

Any change in compensation strategy or anything?

Obviously, you don't want to lose them at what is likely the bottom.

Who knows how long we will be bouncing along the bottom, but you don't want to lose momentum there at this stage of the game.

Our retention on the sales force is about the same as where it was last year.

It's a lot higher than I like.

So there is still work to be done there, but the thing about our business that is a little different than others, most of the retention issues that we have are with employees that are within one or two years of having joined our Company.

Typically, when our sales people get into three, four years, and they have got success under their belt, those we don't tend to have a great deal of trouble with.

So, my way of thinking is that it's got more to do with who we are hiring and how we are on-boarding them and how we are managing them in their early years.

We have lots of things that we are doing to try to improve that process.

On the meat of the point you were making there, are you doing the things do you have do to make sure you are key players, I would say the answer to that is yes.

Now, the type of company that we are, with care a great deal about our employees, and we know that the difference between us being great and us being mediocre has everything to do with our people and their moral and how they support one another.

We work pretty hard around here to create an environment that allows us to compete for the best talent in the marketplace and allows them once they get here, to stay here.

It has a lot to do with making sure that we're listening to them, that they understand we are listening to them, that their opinions are valued that when we need to make changes, we make those changes.

We train them and give them the skills that they need to be successful.

The way that we manage them that we make sure we are there to help them be successful, as opposed to supervise them or watch clocks and so on.

I feel like we are in pretty good shape there; there is always room to get better, no question about that.

I feel like we are in pretty good shape.

Cool.

I guess the last question.

Ancillaries have been such a big part of the growth and the margin of Paychex and ADP for that matter over the last several years.

You guys did release some numbers on it, but qualitatively could you just give us a little flavor of what is going on in the ancillary market in the mindset of the buyer?

I'm sure most small businesses are feeling good to be holding on at this point.

Can you talk about where their mind set is in terms of ancillaries and how high on the priority list or low on the priority list it may be for them.

First off, when you use the term ancillary, you have to change it a little bit.

I think we all had.

We used to talk about tax pay and direct deposit being ancillaries.

They are buried in the payroll production.

I'm talking about the other stuff, John.

You take HRS, we are getting good attraction in every area.

The only area we are not getting a lot of client attraction would be 401-K.

We are doing okay on 401-K, because we put in better plans and we are getting better swaps.

Clients are coming in with larger plans.

That is the only one that would say we are not quite on the unit.

The one that has been a great surprise is adding the PEO across the country and Paychex Premiere.

Now, that's the most expensive product we have; it is the one you would think they would avoid the most, and that product continues to do well.

The HRS products are continuing do well and we are really encouraged to see HRS revenue growth when I take out this two week non-recurring item, actually got to double digits this quarter.

Hopefully, it will stay there and get a little higher.

Overall, I think the acceptance in the client base is still pretty good.

Great.

Thanks guys.

Next question from Jim Kissane of Bank of America.

Your line is open.

John, can you justify give us a little better sense of where retention is currently running?

Given that you said you think you can get it back up to 80%, 81%?

Basically, we ended lat year around 23% and we hope it will be slightly better.

You can gather that from what the comments were because I said that we were slightly better than a year ago on the BCB, that calculation.

Got you.

And for John Judge, over a more normal cycle, how fast do you think Paychex can grow?

Top line and bottom line, incorporating in the new platform?

It sounds like it can drive margins; at the same time you want to invest in growth longer term.

When you say more normal times, you mean a more normal economy?

That's right assuming the last two years are very abnormal.

A more normal cycle, rate, environment.

We talked a little bit about that when we did last year's year end.

We tried to bridge from where we were to a more normal.

Our financial model is 12 and 15.

If you looked at where we are and we looked at 12 and 15, and then we did a GAAP analysis to see what was driving the difference in performance.

It turned out that is where I said that the thing that makes us feel so good about where we were was that the things that were causing us to be off the 12 and 15 were almost entirely explainable in the economy.

I'm not talking about excuses or anything else.

We lost $65 million to $70 million dollars on our bottom line from Float a Loan.

The difference between fed funds rate being at 4%, 4.5% and being at 0% or essentially 0% with a yield for us of 2% or whatever it is.

When we looked at the difference in the volume of new businesses that we brought on board versus the volume that would be normal, a very large percentage of that came from the fact that there were less new business formations.

Now, we look at the new business formations, we look at the percentage of those we get to converge to our platform.

The percentages have stayed almost exactly the same.

The only difference is there is less new businesses in play than there were three or four years ago.

What that tells us the proclivity to outsource is still there.

The issue is a volume issue.

Once that thing rises, we'll be better.

We looked at the economic impact that the losses at 23% had on us versus losses at 20%.

From following us, our historic loss rate has been right around 20% for a very long time.

Roughly 11% or 12% from companies going out of business and the other pieces that add up to that.

You take the difference between the 20% and the 23% and the economic impact on us and put it into the model.

The net of it is when we go through the key things that are effecting our business that come out of the economy, you can bridge it almost 100%.

That is why I keep saying the $64,000 question here is how long is this dig out going to be?

We are absolutely convinced that if the economy returned to normal tomorrow, we would be right back at the 12 and 15 business model.

Would we get there immediately?

Maybe not, but we'd get there pretty quick.

It all comes back to that.

In the meantime, we are looking at all the different things that we can do, the different levers that we can pull to try and drive it, with some of the changes that we are planning on implementing with Dell, the new sales leader, some of the things we're going to do to try to get better with the things we can control.

We are constantly trying to figure out ways to get new products into the marketplace and then drive them when they are there.

Things like time and labor management, which we put in place, and a better HRO product, and so on and so on.

There's lots of different things that we are trying, but the short cut to the answer to your question is we get the economy back to where it was, you are going to see Paychex back at where it was.

Very helpful thanks.

Our next question comes from Ashwin Shirvaikar of Citi.

Your line is open.

Hi, John and Jon.

Most of my questions have been answered.

What is the suite benefit you talked about.

Is that something that benefits (indiscernible) through the year?

Or is that on the early part of the year?

Only in the early part, and over the limits so the biggest impact would be right in the first quarter.

It was bigger than I thought, but we'll take every little bit we can get.

Right.

Any quick read on the impact from both the HIRE Act and healthcare reform?

The HIRE Act is clearly something that will benefit our employees.

Obviously, we will help them both with the recording of the potential benefit and the filing for the potential benefit, so one would hope that would cause more hires.

The benefit's not huge.

I'm sure you probably read the jobs bill.

You are talking about 6% or 6.2% of the payroll tax that the employer gets to keep, plus if they keep the employee for 52 weeks, an additional $1,000.

The total, I'm not sure, but if you did a quick calculation, the total would probably be in the $3,000 to $4,000 range in terms of the benefit for the employer.

Anything that will help would be great, so to the extent that that will help some of our clients bring on more people, that's obviously good for us.

More employees in our client basis is definitely good for us at Paychex, so that part will help.

On the health bill -- the health bill, if you think about it, is probably more geared toward more individual health insurance than it is toward small groups, which is where we are.

The 39 million people that are going to come into the system, I think it might be 39, that are geared to come back into the system, some large number of those, some percentage of those will be on subsidy.

My guess is they will be coming into the individual rate versus not.

The way we look at is we think is going to be a modest improvement for our business in the small group.

We think it is probably going to be a bigger hit for the individual than not.

Beyond that, the only thing where we could get hurt is if there is any commission compression.

Again, if you look at the bill the opportunity for commission compression is not really in the group.

If it it is going to happen at all, it will probably happen in the individual, where they pay much larger commissions to get the attention of the individual -- the individual agents that sell the products.

Overall, when with look at it, we think it is a modest improvement to our health business and the jobs bill to the extent that it puts new employee into the work force that will be helpful to us.

Thank you.

Next question comes from [Tenjin] Wong from JPMC.

Your line is open.

Thanks, I'll ask a couple of quick ones, if you don't mind.

Just the conversion of the new -- to the new platform.

Now, that that's completed, what kind of savings should we expect from that going forward?

And secondly, you can talk to how it compares to ADP's new run platform they talked about?

Basically the savings will be ongoing through productivity.

But we did our usual convert on the cheap, but not give up the service.

We -- our people did a great job doing this conversion without adding all kinds of people when we did it.

We did it in a very timely manner.

I'm not sure anybody ever converted 470,000 plus clients to anything.

On Run, I'll let Jon talk about it.

There is no comparison to that and Run.

What we are talking about is the new, it is a new payroll platform for 500,000 plus clients versus Run is a new capability for them to go after a new market.

It is much smaller; the two are 500 apples and one orange.

Got it.

From a savings standpoint, it sounds like we shouldn't expect (indiscernible) to step down, because you didn't hire any incremental people to --

No, you are not going to see any staggering amount.

Plus you are going to amortize the amount over the next two years.

We should be able to do our business with, without having the hire; as our business improves, we probably won't have to hire as many payroll specialists.

Getting them to be proficient should be quicker, which has impacts on client service.

There's definitely things that will happen to help the business.

We didn't do it with that in mind.

We did did for other reasons.

Good.

That's good to know.

I'm sure incremental margins will be better.

Last one, just it does sound like you are confident you are going get back to the 20% attrition and some of the old targets.

Just to be clear, do you feel confident you can get back to the 3% to 5% pricing benefit as well?

As we have seen?

That is an interesting question.

We have this debate every year.

It is always interesting to me when we get to the debate people believe you can't and people believe you can.

I would say this, that there was more pressure on price in the last seven or eight quarters than we have seen in a long time.

But I would also say that two years ago we put in a price increase that yielded 5% or something like that, maybe even a little bit more.

Last year we put in a price increase that was 3% or something in that range.

We haven't had the discussions yet about next year, whether we are going to put a price increase in or not.

There is nothing that I could see that would tell me if I'm back in a normal environment, that we would have issues with that.

The reason, remember, is if you look at price increases, in this segment of the industry, on a percentage basis, you get one conclusion.

You say there is no way you can increase price 3% to 5% every year, forever.

If you look at it from another perspective, which is your talking about $80 or $100 spread over 26 pay periods, it is not that big a deal.

We have the luxury having a large number of clients that have a small number of employees, but when you multiply the large number of clients with the small number of employees, you get to the point where you are paying 10 million people every pay period.

If you could do something that would increase that a penny a pay period, that is $10 million a pay period.

There are certain things you can do with the law of large numbers that is helpful to us in the aggregate and it is not very noticeable or irritating at the individual's site and something that works well.

So it sounds like the decision will be made based on the shape of the economy and you typically do it in May, correct?

We typically do it in May.

The economy is there and the economy will color it.

But, it is really done more from the standpoint of what we think the market will bear and obviously functionality that we add and service that we add and how we feel it will position competitively, and so on.

It has really more to do with that than not.

Perhaps, we're saying the same thing.

If everybody else decided to cut their prices by 30% we decided to raise it, you probably would think that I ought to get fit for a straight jacket.

We'll stay tuned for that as we get closer to May.

Appreciate the time.

The one thing I would say, Tenjin, is the thing that's been amazing to me is that every year we have had these discussions and every year there is a lot of hand-wringing in some quarters and so on and we put the price increases in and we have gotten literally almost no flashback at all.

That is why we ask it every year.

Thanks.

No I'm with you.

Our next question comes from Tim McHugh of William Blair.

Your line is open.

Yes.

Most of my questions have been answered.

One I'll throw in quickly would be if you can update us on uses of cash and how the acquisition environment looks and if you would start to consider repurchases again over the next six to 12 months?

We are in the same position we were the last time we talked about this.

We're inquisitive.

If we find the right thing, share repurchases are not high on our list at this time because cash is too valuable, doesn't mean we wouldn't do it, but not looking to do it.

Okay, thanks.

Our next question comes from Mark Marcon of RW Baird.

Your line is open.

Wondering if you could give more commentary with regards to MMS?

How big it is, at this point, and how big it could get?

Well, it is basically $450 millionish, growing at double digits, because that is the market that is very outsourced, but we don't own most of it, although we have come a long way from where we were.

(Indiscernible) revenue now that we have some HRS products in it, it actually grew just slightly under 20%.

This year it may not be quite that high, but assuming double digits, I'm going to say 14%, 15%.

We see a good future for it and we are continuing combine our stuff and put new products in there and it's just been a great situation.

Great and with regards to the productivity enhancements from the new platform, you mentioned 8% to 10%.

How much of that have you seen, thus far?

I'm going to come back to it.

This is one of those things we are very open, which we want to be.

We are committed to increasing margins every year.

We are going to keep doing that.

Maybe this platform with help us get it.

We are not going to be greedy on getting it because we know we've got to keep investing in this business, so it isn't like 35% is going to suddenly go to 40.

The other thing is when you look at the profit levels we're at, as I said to Galisano one day, it was in the last recession back in 2002, John wasn't here yet, he said what are we going to cut?

I said the biggest thing we have is profit, we don't want to cut that, so we are going to keep cutting costs and watching it, but you aren't going to see anything exponential.

You are going to see us continue to do what we have always done.

Okay.

The new services that you could potentially offer through the new platform, are those already in development or those are things that you are green fielding?

What I was referring to, Mark, was more of the architecture of the technology and its ability to take on new functionality, new systems that would be the back one.

Our world depends on the IT infrastructure, right?

Sure.

It is sort of our factory.

When you have old systems, in the case of this last one, 20-year-old system, what you have is you have a horribly difficult IT environment when you want to add new features, new functionality and so on, so the thing that this new system will do -- it is not that we are building new systems that we are ready to talk to you about.

The point I was trying to make is one of more modern architecture, more infrastructure that will make it easy for us to add new systems and new functionality and integrate it into this platform.

Got it.

Then John, can you just give some more color about the sales from new business?

You said that it was up 1.2% for the first time in seven quarters and the trend's been positive.

I wasn't sure if you meant year-over-year or sequentially because I thought there was also a different number in the 10-Q.

What that was referring to is whether we look at the physical volumes of new sales that we get from different sources.

So, we get -- a large part of our new sales come from businesses that were formed in that year.

Sure.

Understand that.

The last seven quarters, that number, the physical number, was declining.

The physical number went north this quarter for the first time.

That's what I was referring to.

Physical number meaning number of clients or revenue?

Number of new sales.

For argument sake, if I did 50,000 new sales from businesses in 09, and I did 51,000 in 08, I lost I did less sales.

So the physical number of new sales, think about it as companies that came on to our platform that the source of that sale --

Right.

The company that originated in that, in that fiscal year, that's the number I was referring to.

Okay.

So if client retention is stabilizing and that's improving, and employment is improving, then the remaining variable would be pricing as it relates to core payroll.

Yes, but you are on a different thing.

This is new sales.

We are talking about selling new clients into the Company.

Yes and I know there are still established companies our there and what their proclivity will be in terms of outsourcing.

That will be the other variable.

Right.

I want to make sure I'm clear with you.

So, when you are talking about new sales, which is important to us normally in the out years, when you are talking about new sales, they come from multiple sources.

The important number is how many new sales did you get?

Right.

When you go underneath it, you kind of segment in those sales.

How many of them came from new businesses?

How many came from so on?

That is what I'm talking about.

Now, you are looking at our total business model.

I understand.

I understand.

But, obviously, sales from new business is the majority of your new sales, so that is targeted.

It is typically north of 50%.

It is not 70%, slightly north of 50%.

Right.

But it is an important part of our business model.

And subsequently, when new business formation is down, it hurts us.

Got it.

Great.

Thank you.

Yes.

My pleasure.

Next question comes from Gary Bisbee of Barclays.

Your line is open.

Hi.

Just one question.

As we think about the potential at some point in the next, hopefully, six or nine months for interest rates to start going up, when I looked at the last recession, it looked like when the fed funds rate moved up for the first time in one of your quarters, your yield that you earned on the client float started to move up sequentially that same quarter.

When I then looked at some of the data on your 10-Q last night, specifically talking about roughly half the portfolio that's been available for the sale of securities, the likelihood of a notch down, when you have the reinvestment rate risk over the next year, are we likely to see a similar pattern the last time?

Or has the duration been lengthened such that there might be some sort of a lag between fed funds and a return fund?

No, there will be an immediate, as soon as you change that thing, it affects us.

Now, long-term rates, look at this thing right now, there is some reinvestment risk on the long-term, but I don't think it is significant.

The thing about the portfolio, we looked back at what rates would be on an average basis over the lat ten years, to get a true basis.

If you do that, the long-term portfolio yield would be at the low end of what you would normally expect, but I wouldn't call it abnormally low.

Okay.

You look at the short-term thing when you are getting five basis points, I can't even describe that as abnormal.

That basically says they are not going to recognize you have cash.

Basically, when those rates go up the short-term portfolio will move almost immediately.

On an overall blended basis, you would expect that to happen, as well?

Yes.

And then the second part of the question, this quarter, if you back out the realized gains over the last few quarters, the average yield notched down quite a bit more than it has over the last few quarters.

I thought that was somewhat curious given that you're earning somewhat more on variable demand rate note.

Taxables, non-taxables, you are bouncing all over.

Yes.

So should our expectations for the next couple of quarters, if we assume there aren't rate increases, be that it is probably more modest bleeding lower, but not another 40 basis point move?

Or is it just too tough to tell right now?

Tough to tell, but probably with no changes modest slight bleeding, but not very big.

Okay great.

Thank you.

Thank you, our next question comes from Tim Willi of Wells Fargo.

Your line is open.

My questions have been answered.

Thank you.

Thank you.

Thanks, Tim.

We like those.

Our next question comes from Jim MacDonald for First Analyst.

Your line is open.

One quick follow-up on Tenjin's question.

If you are thinking about pricing but looking at sort of a disconnect, if your checks per client is down 2.2% and your number of clients is down 3% and you have a 3% price increase, could you talk about how you get to a 6% payroll decline?

Is the delta discounting?

Or is there some other delta there?

If it is discounting, can you talk about your thoughts on that going forward?

You've got all kinds of effects.

I wish it worked that simply, but it doesn't on timing.

No, the four variables you've got are, obviously, client growth, price increase, checks per client, which that variable doesn't always move the last revenue check you lose is the lowest revenue check.

My might be the most profitable check, and discounting.

We are not going to talk too much about discounting specifically only because we have a competitor out there I'm sure is paying attention to what we say and we are trying to hold our price as much as we can and we are not leading the discounting and we are not going to quantify it any more.

Do you think that formula will get back to -- it has been closer to kind of normal, where you add it up and you get to your growth?

I don't think you will get back to that, because I think when the economy gets a little bit stronger, (indiscernible) ADP's discounting is related to whatever difficult they see in the market.

I'm not sitting there with them, so I don't know.

They want to sell as much as they can.

For some reason, they feel the need to discount more than we do.

I think if you get back to more normal conditions, I think that will go away.

But, I don't know that for a fact, but I think it will.

Besides the last check being the least valuable check, any impact of ancillaries?

I think ancillaries are doing well, right?

One or two checks doesn't usually affect the ancillaries; one or two checks off doesn't change an HR service.

It does change tax pay and direct pay.

Basically, I want it to make sure that last check is the lowest revenue check, but it probably is the most profitable check.

Right.

The incremental cost of doing is it is near zero.

All right.

Thanks very much.

Yes.

Our next question comes from Rod Bourgeois of Bernstein.

Your line is open.

Hey, guys.

When you look at the commentary across the payroll market in the last few months, you can't help but recognize that ADP's commentary about the demand environment in their small business segment has been reasonably good and definitely better than the commentary from you guys that the selling season was difficult and still struggling to be better than it was a year ago, where there was a lot of macro turmoil.

What I'm wondering, is there something in terms of timing or competitive position that ADP has done in recent history that is giving them a little bit more momentum as things turn than what you guys are currently experiencing?

Could it be something related to the timing of the platform rollout or something else in terms of how they are going to market?

What I can tell you is this.

I can't really speak for or explain ADP's comments.

But I -- we know what their numbers are and we know what our numbers are and our numbers are better than theirs, in some cases, materially better than theirs.

So in terms of explaining some of the adjectives they use, I'll leave that up to you.

Is there anything --

If you find a conclusion that they are beating us in the marketplace, it is absolutely the wrong conclusion.

All right.

Would you say their aggression with discounting in the last year has not really resulted in a big impact on your own revenues?

No.

It's got some impact on my revenue.

It hasn't changed the marketplace.

They might have gotten more clients than others.

I think we'll just leave it.

You can look up and see their client growth is down in the last 12 months and I don't think it is the same as ours.

You look at the quote, because I don't want to quote their data, because I wasn't there when they gave it, I only can read it.

We don't understand how they are seeing exactly what they are seeing, but I'm sure they are seeing something.

At the end of last year, they were down 10% or 12% and we were roughly flat on a year-to-year basis of new business brought into the company.

When you look at the numbers, my suggestion to you is, if you are trying to rationalize it, don't listen to the adjectives.

Go look at the numbers.

Okay.

When we kind of look at the numbers, and we don't have pure numbers here, but it sounds like your sales and your client losses are still struggling to be better than the year ago period where the macro-environment was in outright turmoil.

So are you guys feeling it's a little odd that we are still struggling to do meaningfully better than the year ago period when this fact, a lot of the macro-indicators have really improved?

So is there a reason for that disconnect?

Have you guys been somewhat surprised with that?

Do you think they are doing better?

Well, I mean, there is a lot of evidence that their bookings activity in the small business segment has picked up better at the beginning of this year.

Still looking at the adjectives.

That is the adjectives.

Look at what their client growth has done.

I don't understand.

The client growth is down and client growth has to be down in a small sector.

There aren't enough clients in the upper sector to affect it.

All right.

So your view is that there is really no one in this market is seeing a meaningful turn in bookings in the small business space?

I don't think so.

Okay.

But are you guys surprised we are not doing better than -- meaningfully better than the year ago period and clearly the macro-environment and even the decision-making environment in a lot of out-sourcing segments has improved in the last year, but you guys aren't seeing it yet is that a little surprising to you guys?

Again, I'll go back to the way we look at the market.

We look typically as it relates to what you are calling bookings is the source of where it is coming from.

Yes.

In all cases, when you put a campaign together to go to market to sell you have a -- you segment the markets you are going after and you have a pretty good view of who the buyers are by segment.

We do that.

We have been doing that for a very long time.

We have a pretty good understanding of what those segments are and which ones of those segments are doing well and which ones of those are not doing well, vis a vis, the past, and I have talked to you about this.

The new business formation is not running that well.

There is a little bit of softness in the proclivity to outsource.

In other words, companies that are holding pat for the time being.

Not at all unusual, given the economy that we are in.

I can't talk to you about what the other guys are telling you.

You are going to have to figure that out yourself.

But, I do know the numbers and the numbers do not lead to the conclusion you started your comment with.

Great.

Thanks, guys.

That's helpful.

Okay.

Our next question comes from Barry Haimes with Sage Asset Management.

Your line is open.

Yes, hi.

Good morning.

The question I had, given that there was so much weather going on in January and February, March, perhaps is a little bit of a cleaner month.

If you just looked at checks per client, can you give us any sense of how March is going so far?

I won't look at checks per client on a one month basis, because in payroll the calendar is irregular.

The thing I will say, though, we have been very pleased where this, checks per client have held very constant since May 31.

There has been a little seasonality thing, but it's the most optimistic thing we have.

This is what the thing normally does; it finally takes place and it holds; and it tells you the good stuff -- the other good stuff -- should be coming.

Sometimes it takes awhile.

But checks per client, I don't expect any surprises there.

One other separate question.

In terms of the competitives out there as we have gone through the economic downturn, obviously, there is the one big competitor.

But in terms of smaller other competitors out there, have there been any that have gone out of business or are struggling?

Or is it pretty much the same competitive set that we were looking at before the down turn.

Thanks.

The only payroll companies that really go out of business are the ones where the owners basically steal the float funds and they can't balance it, but in a payroll business, it is very unique.

When times get hard, one way to revert to make money, stop selling new clients.

It is a heavy expense.

These owners are the sales people.

Most are not making as much money because of the fact that the float money isn't there, but we are not seeing a lot of companies going out from under.

They are not publicly held companies.

The owner owns them.

Generally, they have been very profitable, so they have got to dig in their pockets, and dig in their pockets.

I think the competitive landscape has pretty much stayed the same.

Thank you.

Our last question comes from Jennifer Dougan with Lazard Capital Markets.

Your line is open.

This is Jenny, in for David Parker.

I had a question.

In a normal year, what percentage of your sales occur in Q3?

My reason for asking that is do we basically immediate to wait until the beginning of the next calendar year to really see -- hopefully see -- a pickup in new clients?

Well, 25% take place in the month of January.

I don't know the exact number for the quarter.

But, I'm going to guess the number is between 30 something.

The next good quarter is the fourth.

And the next one is the fourth?

It does seem like probably you need to wait awhile before we can really tell whether new sales are improving, we'll probably need to wait until early next year?

Yes, I don't know the exact numbers either, but it is 25%.

An average month is probably in the 7% to 8%.

So what would that be?

15%?

Somewhere in the high 30%, low 40%, would be my guess.

I would imagine the remainder of the year, probably you have a higher percentage of new clients coming from new business formation.

As we see new business formations does pick up, we see some pickup, would you agree with that?

There is no question if we see new business formation pickup, you will get more clients.

That is the point I made earlier.

When we look at what's going on in the new business formation and what percentage of new businesses that form we end up getting clients in that year, that number has stayed very constant through the recession.

So as the number of new businesses fell, our yield from them fell.

But as a percentage of the total new businesses, it stayed constant.

What that says is the proclivity to outsource hasn't changed, our competitiveness and ability to capture the clients hasn't changed, the raw number is just down.

Bring the raw number back up and our number will come back up with it.

Great.

Thanks.

Thank you.

We have no other questions at this time.

Okay, I want to thank everybody for joining us today.

It's always interesting.

A lot of great questions and good going back and forth.

The good news from my perspective is, I'm looking out and there is no white stuff on the ground.

We are on the right side of the mountain for the golf season, so take care.

Thank you.

That concludes today's conference.

Thank you for you participation.