沛齊 (PAYX) 2010 Q4 法說會逐字稿

Welcome, and thank you for standing by.

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

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

(Operator Instructions)

Today's conference is being recorded.

In you have any objections you may disconnect at this time.

Now I will turn the meeting over to Mr.

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

Sir, you may begin.

Thank you for joining us today for our fiscal 2010 year end earnings release.

We will begin today with a review of fiscal 2010 financial results including guidance for fiscal 2011, then Jon Judge, our President and CEO, will provide you an overview and we will end with a Q&A session.

Yesterday afternoon after the market closed we released our financial results for the fiscal year ended May 31, 2010, 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, and 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.

Early in fiscal 2010, we slightly decreased our service revenue guidance while maintaining our operating income and net income guidance.

Our actual fiscal 2010 results were very consistent with that guidance as the year for the most part played out as we foresaw it late last summer.

Our operating income, net of certain items, as a percent of service revenue was 35.4% for fiscal 2010.

The poor economic conditions of 2009 and 2010 impeded our revenue growth as they have contributed to declines in new client sales, client retention and checks per client.

Despite this, we ended the year encouraged by the modest improvement in some of our key indicators and most importantly, checks per client.

We'll talk more about that later.

Our served payroll client base declined 3.2% to approximately 536,000 clients.

Our client retention was 77% of our beginning of the year client base, slightly better than the prior year.

We have begun to see signs of improvement as lost clients decreased 6% compared to fiscal 2009, when lost clients increased 18% over the prior year.

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

The equity markets hit a low in March 2009, with interest rates remaining low since then.

The federal funds rate has been at the range of 0 to 25 basis points since December 2008.

Our combined portfolios have earned an average rate of return of 1.5% for fiscal 2010, compared to 2.1% for fiscal 2009, and 3.7% in fiscal 2008.

We now share our latest results on some of our key indicators.

Our most positive trend relates to checks per client.

Our checks per client have shown modest improvement in each sequential quarter of fiscal 2010.

Checks per client declined 2.6% for the year, with a quarterly breakout as follows; declines of 5.0% in the first, 3.7% in the second, and 2.2% in the third, followed by an increase of 1.1% for the fourth quarter of fiscal 2010.

The increase in the fourth quarter was the first quarterly increase since the quarter ended February 28, 2007.

For the fourth quarter of fiscal 2010, the actual checks per client number was slightly higher than at the end of fiscal 2009.

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

While the new sales units were down approximately 5% for fiscal 2010, this is improved from the 8% decline experienced in fiscal 2009.

There was some improvement in new business formation, but the levels still remain low.

Clients lost due to companies going out of business or no longer having any employees decreased 11% for fiscal 2010 compared to increasing 17% in fiscal 2009.

We continue to invest in our business primarily in our sales force, new and enhanced products and technological infrastructure.

Our sales force grew 2% for fiscal 2010, and is expected to grow another 2% for fiscal 2011.

We have invested over $60 million in an enhanced platform for our core payroll processing capability which allows us to leverage efficiencies in our processes and continue to provide excellent customer service to our clients.

During fiscal 2010, we completed the conversion of almost 500,000 clients to our new platform, which may be one of the biggest conversions probably taking place in America of a system of that nature.

This was fully implemented, again, in fiscal 2010.

We continued expansion of our insurance services nationwide.

Our insurance services client base which includes our workers' compensation insurance clients and our health and benefits services clients grew 7% to 92,000 clients served as of May 31, 2010.

Health and benefits services revenue grew 49% to $31 million in fiscal 2010, as we continued to take advantage of this growth opportunity.

We believe the new healthcare reform is slightly positive for us.

We see our insurance services as an area that continues to offer significant opportunities for future growth.

We strengthened our position as an expert in our industry by serving as a source of education and information to clients and other interested parties.

In fiscal 2010, we launched a new Paychex Insurance Agency website that helps small business owners navigate the area of insurance coverage.

We also provide education materials on our website to help existing and prospective clients understand the impact of regulatory changes.

Recent examples include the HIRE Act and the federal healthcare reform bill.

We are the premier supplier of 401(K) record keeping services as we had total assets in the plan surpassing $11 billion, and 51,000 clients, meaning we are serving one in every ten 401(K) record keeping plans in the US.

Our Paychex Premier and PEO are being offered to Paychex HR solutions.

We integrated the sales and service model and expanded these comprehensive human resources outsourcing solutions nationwide.

This reduced redundancies and creates more flexible options for potential clients.

PEO services will continued to be sold by a registered and licensed Paychex business solutions subsidiary.

We continue to generate significant cash flow to support our business and have paid almost $450 million in dividends to our shareholders.

This represents 94% 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.

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

First, some highlights on fiscal 2010 followed by further color on certain areas.

Payroll service revenue decreased 5% for fiscal 2010, to $1.4 billion.

This is the result of the economic impact of our client base, check volume, which was discussed in our opening comments.

Human Resource Services revenue increased 3% for fiscal 2010, to $541 million, I will give you a better look at HRS service revenue growth in a few moments.

Combined interest on funds held for clients and investment income decreased 28% for the year.

Yields available on high quality securities continued to remain low.

Operating income decreased 10% to $725 million for fiscal 2010.

In the third quarter, we recognized an expense charge of $18.7 million to increase our litigation reserve related to the Rapid Payroll litigation which has now been fully settled.

Operating income net of certain items excluding interest on funds held for clients and the expense charged to increase the litigation reserve decreased 6% to $689 million for the year.

Operating income net of certain items as a percentage of total service revenue was 35.4%, compared to 36.4% for fiscal 2009.

Net income and diluted earnings per share increased 11% to $477 million, and $1.32 per share.

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

The decrease in combined interest on funds held for clients and investment income reduced our diluted earnings per share by $0.04.

HRS revenue growth was affected by a couple of non-recurring items.

In October, we told 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 8%, versus 3% reported for fiscal 2010, and 8% versus reported 11% for fiscal 2009.

Some of the highlights are, Paychex HR solutions client employees served increased 11% to 502,000 employees as of the end of the year.

We have seen positive results from expanding our PE offering into 11 more states during the past year with now 21 in total.

Also in fiscal 2010, our client size in our Paychex HR solutions has begun to increase as the rate of client employees grew faster than the related 8% growth in clients.

As previously mentioned, our insurance services clients increased 7% to 92,000 clients as of May 31, 2010, and we will continue to focus on the expansion of our insurance services nationwide.

Health and benefits services revenue grew 49% to $31 million in fiscal 2010.

Human Resource services products that primarily support our major market services clients have experienced growth for fiscal 2010 compared to the same period last year.

The software as a service solution continues to be an area of opportunity.

Dampening our revenue growth was the influence of weak economic conditions on client-based growth.

This particularly affected retirement services, however, we have seen client growth for retirement services rebound late in fiscal 2010, as client losses improved compared to the prior year.

Retirement services clients grew 3% for fiscal 2010, to 51,000 clients.

Excluding the expense charge to increase our litigation reserve, total expenses would have decreased 2% for fiscal 2010.

This decline was generated from cost control measures and lower headcount offset slightly by costs related to a continued investment in our business.

In fiscal 2010, we had a freeze on salary increases and made no matching contributions to our 401(K) plan.

We reinstituted salary increases beginning March 1, 2010.

The freeze saved us approximately $15 million for fiscal 2010.

No decision has yet been made on the reinstatement of the 401(K) match where we saved approximately $15 million for fiscal 2010 from its suspension.

We do not expect our final decision will have any material impact on fiscal 2011 operating expenses.

As 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, the first time since we had divested of these back in September of 2008.

Variable rate demand notes are municipal issuers with liquidity or letter of credit enhancements provided by the US government, like Fannie Mae and Freddie Mac, highly rated corporations and higher education or highly rated banks.

February demand notes have either daily or weekly liquidity to investors.

In September 2008, we divested of our holdings in these securities as 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 there have been investments in variable rate demand notes again, although at considerably lower levels in the past.

For fiscal 2010, we earned 21 basis points after tax for variable rate demand notes compared to approximately 7 basis points for U.S.

agency discount notes.

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

We have maintained our conservative investment strategy.

We have no BP exposure in our portfolio and have not recognized or realized any impairment losses for our investments.

As of June 18, 2010, the total investment portfolio contained net unrealized gains of approximately $62 million.

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

In these turbulent markets, we have managed these sizable investments with no losses of principle and have met all of our clients' daily needs related to the 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 flow.

Now to move on to the balance sheet.

Our liquidity position remains strong with cash and total corporate investments of $657 million as of May 31, 2010, and no debt.

Our cash flows from operations were $611 million for fiscal 2010, down 11% from fiscal 2009, mainly due to lower net income.

Funds held for clients as of both May 31, 2010, and 2009 were $3.5 billion.

Funds held for clients vary widely on a day-to-day basis and average $3.2 billion for the fiscal year, down 5% from a year ago.

In fiscal 2010, we have been experiencing lower average invested balances primarily as 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.

The stimulus package went into effect last April and its impact on year-over-year comparisons of investment balances abated in the fourth quarter.

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

As a result of these two factors, average investment balances from funds held for clients grew 3% in the fourth quarter.

Total stockholders equity was $1.4 billion as of May 31, 2010, reflecting $449 million in dividends paid during fiscal 2010.

Return on equity for the past 12 months was 34%.

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 trend lines, we do project current trends in the 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.

That said, our current outlook for fiscal 2011 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.

We project payroll service revenue growth will be flat compared to 2010.

Human Resource Services revenue growth is expected to be in the range of 10% to 13%.

Interest on funds held for clients is expected to decrease 12% to 17%.

While investment income is projected to decrease by 24% to 27%.

Operating income net of certain items as a percentage of service revenue is expected to range between 34% and 35% for fiscal 2011.

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

Net income is expected to improve slightly over fiscal 2010.

However, when the impact to the expense charge to increased litigation reserve is excluded from fiscal 2010, net income growth for 2011 is expected to be flat.

Our combined funds held for clients and investment income are expected to continue to be impacted by the low interest rate environment.

The average rate of return on our combined interest on funds held for clients in corporate investment portfolios is expected to be 1.3% for fiscal 2011.

As of May 31, 2010, the long-term investment portfolio had an average yield to maturity of 2.9%, and an average duration of 2.5 years.

In the next 12 months, slightly over 15% of the portfolio will mature and it is currently anticipated that these proceeds will be reinvested at a lower average interest rate of approximately 1.0%.

Investment income is expected to benefit from ongoing investment of cash generated from operations.

We expect investment income growth to be higher in the first quarter of fiscal 2011 than in the remainder of the year due to easier comparisons.

Purchases of property and equipment in fiscal 2011 are expected to be in the range of $80 million to $85 million as we continue to invest in our technological infrastructure.

Fiscal 2011 depreciation expense is projected to be in the range of $65 million to $70 million, and amortization of intangible assets for fiscal 2011 is expected to be approximately $20 million.

We also estimate the change of a 25-basis-point decline in short-term interest rates would be approximately $3.5 million of income after taxes for a normal 12-month period.

At this time, I'm going to turn it over to Jon Judge and when he's finished we'll open the meeting for questions.

Thanks, John, and thank you to everyone on the phone for taking the time out of your day to spend with us to talk about Paychex.

John gave you a good summary of our year.

It was a challenging year for us and most everyone else.

For the second year in a row, we fought our way through a very difficult US economy, plagued with high unemployment, high business failures, difficult credit conditions, very low investment income rates and depressed new business formation, all of which had a direct impact on our business.

And while the battle wasn't a particularly fun one to fight, I'm very proud of how our team responded to these challenges and how the year played out.

Make no mistake about it, I would much prefer a report like the one we gave you at the end of fiscal year 2008 where the majority of the US was well into the recession and we reported our 18th consecutive year of record-breaking revenue and profit.

But given what we had to deal with, our team managed what they could manage and delivered a set of results consistent with our plan and with our guidance.

Amongst the strengths of the year's performance were very high customer satisfaction, we continued at the highest levels in the industry.

Excellent expense and cost management.

Strong positive cash flow generation.

Excellent profit margins and an impressive dividend payout for our shareholders.

Also improving were most of the key economic indicators that affect our business, especially in the second half of fiscal 2010.

And specifically, in the fourth quarter.

Let me give you some examples.

Checks per client, as John mentioned, went positive in the fourth quarter.

And I expect it will stay positive through fiscal 2011 and potentially give us the best year we've had in that measurement in ten years.

Sales to newly formed businesses were up 12% in the fourth quarter.

That was the first time that happened in two years.

That number was minus 20% in the fourth quarter of the prior year.

Losses due to business failures got better by 14% in the fourth quarter versus worse by 19% in the fourth quarter of the prior year.

There was a similar story in losses that were caused by price value problems.

Better by 7% in the fourth quarter, where they were worse by 49% in the fourth quarter of the prior year.

Total losses finished the year at 22.6% versus 23.3% in fiscal 2009 and we plan that to improve by a point or so in fiscal 2011.

In addition, discounting appears to be quieting down.

Our price increase went into effect in May with no issues and we continue to make modest improvements in market share, best as we can tell.

So a challenging year, but we controlled what we could control.

We delivered solid profit margins and profit dollars and paid out a very healthy dividend to our shareholders.

Looking forward, our focus is squarely on top line revenue growth and returning Paychex to the normal Paychex, the Paychex that delivered 18 consecutive years of revenue and profit growth that occurred through fiscal 2008.

For us to return to the normal Paychex, four things have to happen.

First, interest rates have to return to normal and by normal I would say somewhere in the 3.5% to 4.5% range.

Second, new business starts need to return to normal.

Third, losses need to return to normal.

And fourth, unemployment needs to return to normal.

Now, there's no doubt in my mind that that will happen.

It's only a matter of when.

The economic indicators that I just mentioned earlier have clearly shown that some of the return has started to happen.

In the meantime, we're driving other areas of our business to drive improvements in outcomes.

On the core payroll side, our not so new now Senior Vice President of sales is instituting new sales approaches and new support vehicles that I'm certain are going to help drive productivity.

We've got much more rigorous activity management reporting going on now.

We have new approaches to drive referral levels.

We have new and better lead generation techniques including a different approach to how we're dealing with Google, for example, and some other new things that we're doing on our national sales support systems.

New and better sales collateral.

New performance management and measurement approaches.

When all of this gets said and done we expect to have productivity improvements from our reps in the core payroll world of somewhere of the 10% or 15% range.

We've also created new bundles and new offerings that simplify pricing and drive more ancillary sales while decreasing discounting.

On our HRS side, Premier and PEO are going very strong as John mentioned and will continue to do so.

PEO is now in over 20 states.

We've cross-trained our sales force to sell both Premier and PEO and we're getting excellent results.

Insurance continues to grow and we continue to invest in sales and systems to support future growth at high levels.

The 401(K) business is the market leader by a lot, as John mentioned, and it's benefiting from the investments that we've made in open architecture and it's being successful in converting existing clients to our record keeping services.

And it will greatly benefit from our payroll new sales picking up as the economy continues to recover.

MMS has been strong through the recession and will continue to get strong.

We will continue to invest in MMS with additional sales people, enhanced products and systems to support that growth.

And we obviously continue to look for new revenue sources, either through M&A or in-house builds.

So I hope that commentary was helpful to you and I'd now like to open up the lines and John and I would be happy to entertain your questions.

Thank you.

(Operator Instructions) The first question is from Adam Frisch of Morgan Stanley.

Thanks.

Good morning, guys.

The slower selling season that we had in the past couple of quarters obviously had an impact on the fiscal 2011 outlook.

Two questions here.

One, is there material upside or down side potential to your outlook, and then, two, what would drive any delta there?

Adam, I think one thing there, we went into the recession a year later than everybody else and when we went into it, our results were not very volatile.

And it's my belief and it's been this way for a long time that our results never change rapidly.

I can't remember them ever changing surprisingly.

So if you want to talk about any significant upside or down side it would have to relate to either some very significant change in interest rates or some very significant change in the economy.

Without that, those things happening, we can predict what revenue's going to be within 1% probably 95% of the time.

Okay.

So then there were a lot of data points in the fourth quarter that shows material improvement and the guidance is a little tepid.

What's kind of holding you back a little bit at this point?

Is it the sales season you already had which determines next year's [res], is that the major driver here?

Adam, this is Jon Judge.

That's part of it.

Part of what John was trying to get across is that when you have a business model like ours that has very high recurring revenues, when there are changes that happen in the economy, they take a while to work their way through.

Right.

Us coming, getting affected by it -- you remember in fiscal year 2008 we had a record year when the rest of the world was already into the recession.

We went into it in 2009 and now 2010.

So you start to see all these economic indicators run positive for us.

And that's fantastic news.

As John said, the interest rate -- if the interest rate jumped to 4% tomorrow you'd see an immediate difference in us and it would be very sizable.

When the interest rate went from 4.5 to basically 25 basis points or less, that cost us $70 million on our top and bottom line.

So something like that coming back quickly would help us.

If the losses change dramatically, that's obviously a huge help to us because all those losses that happened over the year we would end up having that revenue for the whole year.

On the sales side, it's what you said.

When sales typically in a year will only affect our top line somewhere in the neighborhood of 10% to 12%.

That would be at probably the maximum level.

So we could go crazy selling and unless it all happened in the early months of the year, then it would have a modest help to us in the 2011 and would have obviously a much bigger help to us in 2012.

Okay.

Thanks, Jon, for that color.

Last question, good to see you still investing in the sales force.

I know it's only 2% but at least you're still trying to grow that, boding well for the future.

Sorry for the obligatory question, but how is the pricing environment progressing here?

You still seeing some aggressive tactics from your largest competitor?

That's a very fair question, given the environment that we've been in.

What we are seeing is that it is starting to calm down.

Sort of the crazy season appears to be over.

I can't tell you what's causing it.

I would -- I just don't know, obviously we don't manage the other side.

We only manage our side.

Our philosophy has not changed.

We talked about it openly in the last several calls.

We're not going to let anybody take business away from us.

We have zero interest in getting aggressive in the discounting side.

When it starts to abate from the other forces then it will clearly abate from our side.

Okay.

Thanks, guys.

Good luck to you.

Yes.

The next question is from Jason Kupferberg of UBS.

Thanks.

Good morning, guys.

Just wanted to come back to the pricing a little bit.

Can you quantify what the price increase was that you did just put in?

We put in 3%.

[Payroll] revenues around $1.4 billion.

Okay.

And then if you come back to the four factors, Jon Judge, I guess that you reviewed that need to really improve in order to get back to the quote, unquote, normal Paychex, can you kind of rank order for us the importance of those four factors, and just confirm whether or not you still consider the quote, unquote, normal Paychex to be the 12% top line, 15% operating income growth that we were accustomed to in the past?

I know we've been talking about a lot on that the last several quarters, but wanted to see if that's still your comfort level there?

The four that I mentioned, all four of those have differing effects for us but they're all important.

As I mentioned, the interest rate environment going from a normal interest rate environment to basically zero, that has about a $65 million to $75 million impact on us.

So that one's pretty easy to quantify.

All have you to do is look at our prior years.

New [biz] starts, it was good to see what happened in the fourth quarter.

When we looked at the new business environment, what we have seen is that our share of new businesses that originate in a year has not changed through the recession.

So said differently, that's something that's been a fairly significant hit to us in terms of the sales that we did not get or normally would get, and so when that starts to return to normal, obviously that's a help for us.

The fact that we didn't lose share of the market through the recession says the issue is that there just aren't enough of them right now.

It's not that something else is changing, like buyer behavior.

That's part, it's important to us.

Losses, you know from what we reported today, we're about a point better than we were, maybe even a little stronger than a point better than we were at the height of losses.

And as business failures continue to come under control, as losses due to price value continue to abate then that number gets better.

So -- and I mentioned to you that we're going to try and drive that number a point or more better in 2011 than we did in 2010, and so my view on that is we've got a lot of years of history that say the normal level for this environment, the sector that we operate in, the type of clients that we have, is about 20%.

And so that's what I'm expecting we can get back to and that obviously will have a pretty big impact on us, because as I mentioned when Adam was talking, when we lose a client, we lose that revenue immediately and forever and so that's an important thing for us to keep driving towards.

And unemployment, the unemployment, where the unemployment hurts us mostly is in checks per client.

And you saw that in the fourth quarter that started to turn and so hopefully it's going to keep turning.

What I can't tell you is when.

I wish I could, but I can't, but to me when I look at the difference between where we are and what normal is, if we fill those four in to get, if they go back to normal then we go very close back to normal and so, therefore, very close back to 12 and 15.

Will we get back to 12 and 15?

Who knows?

My personal belief is yes because the thing that took us off of it is not that we're losing market share.

We're in fact gaining share.

So the question is when is that going to happen and will the economy come back as strong as it was in the past.

The one thing I will tell you is the Feds have been reporting on is that there has been some pretty significant productivity improvements that have occurred through the recovery.

What that means to me, what that says to me is that there is a possibility that people will be doing more with less employees.

So take that for what it's worth, whether that's something that's more of a large company thought or a smaller company thought, I don't know.

But I feel pretty comfortable, though, that we will get ourselves back into a more normal Paychex environment when the economy gets back to a more normal economy.

Okay, that's helpful.

How much of a productivity benefit from your new processing platform has been baked into the margin outlook for fiscal 2011?

Is that significant?

It's not significant.

It's worth -- because we'll get here anyway.

When you talk about the margin environment, some people will go how can that be.

We have about $15 million plus some.

We've made the assumption on the 401(k) match which we're probably going to be pretty close to,, so i don't see much risk.

But I'm not going to disclose what it is because we haven't discussed that with our employees yet.

Or the Board.

Or the Board.

Anyway, you're talking, if you put what that effect is in, the margin percent would be an all-time high.

It doesn't take much to move it.

Some of the margin is under pressure because we have to put the cost back in which includes basically the 401(k) match, the wage freeze, but also some selling costs assuming they're going to get back to a normal year.

So when I look at the margin, which is not far off record years, in this environment to be at that level, we feel very good about it.

So we're definitely getting productivity.

We're getting productivity out of the new system.

But these things are just like we talked about before.

The beauty of Paychex is nothing changes dramatically quickly, but it goes all ways.

That's the way the whole thing is.

You really can forecast with a fair amount of degree of certainty and you can get some upside and I think you hope in this world there's more chance for upside than downside but who knows but nothing is going to change a whole lot overnight.

But we're going to keep pushing those things.

There are a couple other points, though, on the system that are important to mention.

One, we replaced a system that was 20 years or 25 years old, something in that neighborhood, and so it had all of the issues that anyone who's dealt with 15, 20, 25-year-old legacy systems have.

We don't have those issues anymore.

So as a consequence, it's going to be a lot easier to put new service offerings on top of this platform where in the past it was brutally hard and the other piece, just the newness of the system.

So we've got an environment now where we've got all new technology, all new architecture and that will keep us in good stead for some 15 to 25 years hence.

So that's just -- it's a big potential problem behind us.

It's a lot of stability.

It will help us with our existing clients and it will give us a platform to add new additional offerings on in a much more easy and implementable way that will drive future revenues.

Understood.

My last one, just new sales trends, any notable differences among various geographic regions within the U.S.

and new sales expectations for fiscal 2011?

Well, there's obviously new sales expectations for fiscal 2011, but in terms of trends, I would say in the last quarter, there's nothing really significant to point out.

We had a pretty strong May but I'm not so sure -- there's things that could be affecting that like qualifying for recognition events and so on.

But I would say in general there's nothing significant in trends that I would point out, but there's clearly our expectations for the new year are clearly up and they have to do with some of the things I mentioned about new approaches and new tactics that we're using to dramatically improve some of the activity-based side of the selling process.

And I'm actually pretty excited about it.

Great.

Well, thanks for the comments.

Yes.

The next question is from Gary Bisbee of Barclays Capital.

Hi, guys.

Good morning.

I guess, first question, can you give us a sense how the various operating metrics have trended sequentially?

I think we understand that year-over-year comps easier and that's part of the improvement.

But have the new business starts, the checks per client, and some of these other metrics gotten better this quarter versus last quarter versus the quarter before?

I would say that there's gradual improvement throughout the year.

I wouldn't say every quarter had improvement in it except for the fourth, nothing got worse in the fourth and everything had slight improvements.

The most noteworthy is checks per client.

Put that in perspective.

I don't think in the history of the Company we've ever seen a 1% improvement in that for a year.

We don't even have many quarters where you see improvement.

So I've been pretty steadfast about saying I think that's flat, flat, flat.

But we got 1% in the fourth quarter and we do think that's going to hold because we're seeing great stability in the clients we have.

That doesn't mean there isn't a part of America that's struggling, there is.

The small business part we seem to have now, the bankruptcies are down, they're doing some hiring, they're not letting as many people go.

We think that's the best indicator we have.

It's not like it's taken off.

But it's 1%, I'll take it any day.

And I guess just thinking back historically, I think you've commented that the new sales are much more important than that in terms of the ability to really drive the revenue growth.

So has that one seen much improvement?

That 10% number you threw out for new business starts, is that all just about the fourth quarter last year was awful or was that one that's always seeing some sequential improvement?

I don't know how to answer that.

Whenever you look at either sequential or year-to-year, it's a comparison.

So is your point was it an easy compare or a hard compare?

Is that your point?

The fourth quarter was tough.

If the fourth quarter last year was worse than the third quarter last year.

Optically, things look easier when I look at a growth rate this quarter versus last.

It's just the comps, you know what I mean?

We're not seeing any dramatic change.

You look at these comps.

Like some of the quarterly ones, that one I don't because that didn't happen during our peak selling season.

So we just got to wait and see and see what happens.

But I wouldn't draw too much into that one.

The good news here, I think, is we stabilized, nothing's diminishing, we're putting our costs back in.

We've got our earnings flat.

I don't like flat.

I wish it was up.

But we're ready to go in the right direction.

And then, can you -- every couple years, I think, you've told us how large the average client is.

You talk about MMS having done well.

Has that number moved up meaningfully or is it still in the 17 range?

It's not up meaningful.

It's down from 17 some but it hasn't changed dramatically.

Okay, and then just one last question.

I know you've said for a long time now that share repurchases are not high on the list of priorities.

I guess at what point do you have so much cash on the books that you'd consider some of these secondary strategies particularly if you can't find suitable M&A?

Well, we talk about that almost every Board meeting.

Our cash, we're not going to get -- we won't be in a point where we would consider that we've got too much cash and we need to do something immediately until that number gets north of a billion.

But I would say that the sentiment would be much more strongly in favor, certainly my sentiment, and I believe it would be accurate to say it's the Board's, much more favorable for M&A than a share repurchase.

But as we've said in the past, if we get to a position where we've got more cash on the books than we think is prudent, and we don't have an imminent M&A in front of us, we probably would execute either an increase in dividend or a share repurchase.

Those are the two that the last time we studied it in detail, were the two most acceptable strategies, the other ones that people frequently talk about were not acceptable to us.

A one-time special dividend is not something I would expect you to ever see come out of Paychex, but -- so that's kind of where we are.

But we're not in a position yet where we feel we have so much cash on the books we feel like we have to do something tomorrow.

Okay.

Thank you.

Yes.

The next question is from David Grossman of Thomas Weisel.

Thanks.

Jon and John, I think you gave some metrics about your assumptions for next year, retention, I think, getting a little better, pricing up 3%.

And if you're guiding to flat revenue growth, I believe that implies client growth will be down again in fiscal 2011 which would be --

No.

I wouldn't agree with that.

The problem you've got to realize is we have headwinds going in.

In other words, the negative client growth, the 3.2%, is a negative revenue growth next year of 2%.

You got some discounting carryover.

You've got a 3% price increase.

I'm not going to say a monstrous client growth built in there.

But it isn't negative.

So how does that trend compare to the prior cycles when you look at the downturn you had back in the 2001, 2002 timeframe, I don't know if they're that comparable.

The problem with prior cycles is in the prior cycle, first off, we never went negative.

ADP did.

Okay?

We also took advantage in that cycle and spent $800 million on two acquisitions with payroll business that helped us generate some revenue, and not see some of the issues that we have to deal with with in this situation which is far worse than any that I've seen.

The other thing is in the last cycle, small business did not get -- I'm not even sure small business was even in it to any large extent.

They had some because we had a 4% drop in checks in one year.

Because there was no credit crisis.

No credit crisis.

To me, to compare this to anything, you have to go all the way back to 1990.

At that time, Paychex was so small, recession didn't affect it the same way.

I'd say in general, though, it's acting similar to prior recessions.

But remember, this recession, if you look at the raw numbers on the recession, this is unmatched, probably going back to 1929.

It's a little different from that standpoint.

The other point is what I mentioned.

The fact that there was no credit crisis in the other recessions and you didn't necessarily have the same impact on new business formation that you had in this one.

Right.

So as you look at kind of the metrics, I guess, Jon, that you laid out about kind of a recovery to a more normalized environment for Paychex, is it really -- are we kind of looking to the first calendar quarter of 2011 during the big selling season where we get a better indication of whether or not we return to kind of a more normalized client growth environment or is this something that you get to see as the year progresses, based on retention and other kind of sales metrics that you look at?

The things that we can control we're going to do everything in our power to control.

So there are things that we're trying to do to drive top line growth that will help us.

There are things that we're doing to try and improve retention even though we're the best at the game, so the things we can control we will control.

But the tough part is if the Feds can't figure out with all the economists they have when all these things will return back to normal, it will be really hard for us to do that.

I can't tell you when the interest rates will go back to normal.

I can't tell you when the unemployment numbers will go back to normal.

I know they will.

I just don't know when.

Okay.

And let me ask John Morphy a question on the expenses.

I think you hit this partially a few minutes ago.

As you start to ramp, let's say the top line does start to recover a bit.

Are there any other expenses now that, I think you mentioned you obviously had pretty tight controls over expenses last year, putting the wage increase back in this year, haven't really decided about the 401(k), but is there anything else we should think about about expenses if in fact revenues do start to accelerate with improving metrics?

No, the only unusual thing that you get in a downturn that are significant, actually you could argue four, is, first one, is wage freeze, those things you put in place, those two, that's the only two we had that were significant.

We have watched the spending.

I don't think there's anything that we'll say we'll put that back because don't need to put it back.

The other two is you get sales selling costs and I'll be thrilled to be on this phone and talk about my costs being too high because I sold too much.

That will be a great day.

You have that one and the last one, you can have some executive bonus things.

A year ago we didn't pay very much in executive bonuses.

This year we're not paying a target but we're better.

We think we stayed close to the plan.

We did stay very close to the plan that we generated.

We actually were right on the plan, off revenue some.

Basically, I don't see any others that are going to do that and you've just got to work your way through it.

No, I don't think we've got any expense challenges coming.

As soon as things get better, I think you'll see us back to margin expansion.

The margin expansion in this year's plan, if I didn't have to stick those two things back in, would be as good as any we've ever had.

So we're doing all the things we normally do.

We'll keep doing them.

Sometimes you get a little wind in your face.

It's a good question.

We get it a lot at conferences.

One of the ways I answer it is you can't be a 40% pre-tax Company, if you don't have focus on expense at all times.

So we're pretty proud about the fact that we spend money easily and willingly on things that we think will drive our top line and our bottom line.

And we're very critical of expenses that we don't believe are necessary and the easiest way to look at that is even in a normal environment we're running a 40% pre-tax margin and our nearest competitor in the industry is running about a 25%.

We're not going to ever let that erode.

Our Board wouldn't let it happen even if we thought we wanted to, so it's kind of baked in our culture and our management systems.

Great.

Thanks very much.

Good luck.

Thank you.

The next question is from Julio Quinteros of Goldman Sachs.

Great.

A quick question for Jon Judge.

Just to go back to the comment that I think you made about productivity improvements and it sounded like you were alluding to jobless recovery and what that could actually mean for you guys.

Could you dive in a little bit there?

If we are looking at a jobless recovery type of situation, then obviously the other three or so of the factors here would end up having to make up the slack.

Is there enough new business formation, I guess, interest rates and other drivers to really get us back to the historical levels there if we really are staring at a few years of potential jobless recovery?

I wouldn't necessarily -- I may have mischaracterized what I was talking about.

What I mentioned on that was that if you look at some of the data that's published by the Federal Reserve, what they would tell you is that part of what they're noticing as the GDP is improving that the unemployment rates are not and their view of the reason why the unemployment rates are lagging things like the GDP, which I think they expect to be up about 3.5% in 2010 and more so in 2011, is two things.

One, it's the fact that they believe that they've seen indications that there are productivity improvements driven by companies who have either figured out how to do more with less or have implemented tools that allow them to do more with less.

I'm not -- my comment that I made was that that may be something, that may be a large enterprise, more of a large enterprise discussion than not.

As you know, the majority of the data that's in the Department of Labor on unemployment (inaudible) is large enterprise data not small business data.

So that was that piece.

The second piece that they talked to, not quite as detailed, is the fact that the base numbers that they're looking at that determine the unemployment rates, the people that are not looking for work are not in those numbers.

And so there's a natural phenomenon that's happening that as a economic indicators start to get better and people start to feel that there's more of an opportunity to get a job they enter into the labor pool.

And so part of that is until that slack is taken up you're probably going to see the unemployment numbers stay in the high, [mid-9%s] or something like that.

As it relates to small business, I don't know that it does.

The conclusion that you made from my comments was that, therefore, it's going to be a jobless recovery and the unemployment's going to hurt us.

We've already seen an increase in the checks per client in the fourth quarter and we think that it's going to be a positive, maybe as much as 1% for all of next year and if that happens then obviously that would say that in the small business environment, that the jobless recovery is not something that you would conclude.

You would conclude the opposite.

Perfect.

That sounds great.

And then, Morphy, a couple of quarters back you talked about the new business formation being stymied by a lack of credit and people not having access to things like their home equity lines to start up new businesses.

Any update or any views around how some of that environmental stuff might be changing if you guys have any sense there at all?

My sense is that the banks are loaning to small businesses but primarily to small businesses they already knew or had relationships with.

I think the credit being issued to a company that's starting up, I don't think that's quite started yet.

Also, when you talk about these things, we still sold about 100,000 clients this year.

So it's not like nothing's going on out there.

Right.

Okay.

Great.

And then just as a quick check on the margin guidance that you have, does it or does it not include the assumption here for the 401(k) match?

Just want to be clear on that.

We have an assumption we think that's going to happen.

I'm not going to disclose it.

We believe it's covered.

The Board still has to approve it.

That's why I added the comment, I don't expect -- whatever we do will not have a material impact on what we told you.

I'll tell you this from our discussions with the Board, the Board is, I would say if you were trying to handicap this, they will either do what we recommend or something that will have a lower expense impact, not a higher.

So said differently, the number that's in the plan I believe is either right on or conservative.

There's no way that it's going to be -- that we'll have a problem with it.

Right.

But it is in the 34% to 35% range that you've (inaudible).

It is.

Okay, got it.

Great.

Thanks, guys.

Good luck.

Both of them are in that, the salary, return to merit increases and the 401(k) are in the numbers that we released.

Philosophically, so you understand how this process works, and it's one of the best things about Sarbanes, when you get the guidance, and we have to do this every quarter, and clearly now you have to have a Board meeting or audit committee meeting and we show the forecast if it's during the year, and we show the plan to the audit committee.

And the guidance that we provide has to be consistent with those plans and forecasts and that's something we require.

So when you look at that, we would never give guidance on something that we knew could happen or high likelihood that would change the guidance, especially downward.

So wouldn't happen.

Got it.

Great.

Thanks, guys.

The next question is from Rod Bourgeois of Bernstein.

Great.

Hey, guys, back on the margin front.

Do you get any meaningful operating leverage in the business if payroll revenues are flat and then the beyond payroll revenues show some decent growth consistent with your guidance?

Yes.

We're getting it this year.

As I said before, if we didn't have to put those expenses -- those expenses are costing us almost 200 to 300 points of margin.

So, no, we would get it.

You don't really need the payroll business to have kind of mid-single-digit growth to get some substantial operating leverage?

It's sufficient to have the beyond payroll stuff positive to get the leverage?

All you need is -- I wouldn't say flat makes it harder but I don't need five to do it, two.

Okay.

All right.

Great.

You mentioned that new business starts were a bit better.

I'm wondering what metric you're using to track that?

And then if you could quantify how much better new business starts got?

Well, the number was, the number that I gave was in the quarter.

And it was -- it wasn't -- it was sales from companies that were formed in that fiscal year.

Right.

So that's the number that we look at.

And so it's our own metric.

Right.

But you don't have an outside metric to track what's happening in the broader market?

We do.

But the trouble with it is there's no -- you have to triangulate to get to it.

There's no government source that reports new business formation.

Right.

No, exactly.

I wrestled with that.

Just a question on --

Just compare notes, Rod.

If you're going after it, our belief is that that number is somewhere in the neighborhood of a million.

If you have a substantially different number I'd appreciate if you'd call me and tell me what you're looking at.

Yes, I'll call Morphy about it because it -- the numbers are always dicey on that front, though.

Right.

And they tend to be too lagging to be that useful as well.

But on the strategic priority front, how are you prioritizing investing to drive new sales in the very small client segment versus in the mid-market?

So I guess what I'm specifically looking for is should you perhaps be shifting your weighting of investment in favor of the mid-market given that there's more cross-selling potential there for ancillary products and also given that the very small client segment may see economic challenges for a while?

We're in both.

We're in more than just that.

The process that we use, it's natural for us to look at it by the way we're organized, so we do look at our sales forces by core payroll, MMS payroll and then the HRS and HRS is broken into PEO and Premier insurance, so on.

So we do look at the separate sales forces that make decisions independently about where we place our bets.

The same thing is true by the way when we look at investments that we make on either build and buy decisions relative to the products, so it's not so much it's an exclusion.

We do -- you could could get to a point where you would say I just can't make all these investments and so I have to go and prioritize and typically we prioritize based on short-term, medium-term and long-term returns on that investment.

And you can have a case where a long-term return is compelling enough to trump a short-term return and an example of that would be the moneys that we put forward to start up the insurance business.

But I would say that in general, when we go through our investment strategies, we do have a bias towards investments that will get us short-term and near-term returns.

Right.

But when you deploy your sales force and you have a priority in a normal year where you're balancing the sales force targeting the very smallest clients versus the mid-market, are you incrementally shifting that in this environment towards the mid-market?

Or is your balance of sales force sort of prioritization kind of a normal balance between small versus mid?

It's not so much shifting from one to the other.

We look at each of them.

The very small client by the way is a fairly large part of our business, and so some of it also is gated by the fact that one might be 70% of our business and the other might be 20% or 15% of our business.

But we look at both of them and if we think that we can continue to grow by adding salespeople and adding territories in a specific market, we will do that.

If we think we can grow better by consolidating territories and driving higher productivity from our existing sales forces, we'll do that.

But right now, no big change on that front, the priority hasn't shifted in any meaningful way for next year?

We like them both and we're investing in both.

Got it.

All right.

Thanks, guys.

The next question is from Tien-Tsin Huang of JPMorgan Chase.

Hey, thanks.

It's Tien-Tsin.

A couple quick questions.

First, on the retirement services, it sounds like it rebounded a little bit in the fourth quarter.

Is this a -- is this a good leading indicator for HRS demand picking up and new sales overall?

I'm just trying to think back and see how that could be predictive (inaudible).

Hopefully it is, but that was struggling all year and I don't want to make too much of a judgment off one quarter.

We put some things in place to help retention.

Some of that improvement is not just what the economy got better, it's what we did got better.

Would you expect the client number on the retirement side to grow at a premium to what you're looking for in terms of HRS revenue growth?

No.

Still grown at a discount?

No.

Okay.

If you look at 401(k) -- if you take the three major -- what will be the three major revenue producers, I would call healthcare, 401(k), and Premier, healthcare and Premier will grow faster than 401(k).

Okay.

Okay.

So we'll be watching that.

My last question then is kind of related.

In terms of these new sales of ancillary products, I'm curious, are you seeing any change at all in the rate of clients dropping services or taking services in-house?

I'm just curious as to any contribution there?

It's actually the opposite.

I mean, it's -- the tax pay numbers are now up in the 94% range from 93%.

So the tax pay's a little bit stronger.

Direct deposit is a little bit stronger.

So initially in the year we thought we were seeing things where there were clients taking payroll without tax pay which is kind of unusual because we've gotten to the point where something like 99% of clients that took payroll took tax pay.

When the year finished, the tax pay numbers were actually up.

The direct deposit numbers were up.

So it continues to defy gravity in my opinion.

Okay.

Great.

Thank you.

The next question is from Tim McHugh of William Blair & Company.

Yes.

I just have one question left here.

I was going to ask about the sales force.

You mentioned 2% growth.

But I believe in the MD&A last night you commented that most of that will be in kind of the HRS areas.

What are you going to do with the core payroll business?

Are you looking to grow that this year?

And related to that, would you be slower to grow it, I guess, given the productivity improvements you might hope to have given the changes you made?

I would say we obviously are hoping to grow that.

I mean, it's the biggest part of our business and I would say it's one of the most important parts of our business relative to getting back to the normal Paychex.

So we're clearly trying to grow it.

The thing I would say in this particular year, in core payroll it's more the productivity of the existing sales force is where the growth is going to come from, rather than adding new salespeople.

We will add salespeople in the other sales forces, but in core, it's some of the things that I talked about with driving activity, driving management, measurement systems and driving some of our referral channels to higher levels of productivity and production.

We would expect, I think, to probably add to the core sales force in a year.

This year we're focusing, I think Jon has talked about, we've got a new guy at the top, so we are watching the environment closely, but I think we'll be back to adding people in a year.

I would agree with that.

Okay.

Thank you.

The next question is from Chris Mammone of Deutsche Bank.

Hi, thanks.

Sorry if I missed it, I think you said that you expect the client base to grow in 2011.

Did you give a number?

No.

Can you give us any color around what magnitude.

I don't believe it's acceptable to plan for negative.

We never have, nor will we.

It isn't a big number.

So it doesn't matter what I tell you the number, it's not like four or five.

We have to work hard to get the sales force productivity to where we want it to be, hope the economy picks a little bit up and we think losses are going to get better.

Hopefully, we'll be on this call a year from now saying we had client growth of X and that will be good.

But, Chris, we told you that we expect the losses to be less and we expect to get improvements out of the core which as I said earlier is one of the biggest parts of our business.

So the easiest way to think about it, it's a combination of less losses and more sales.

Okay.

I guess and then just a follow-up, I guess on your comments on being -- on maintaining the current dividend level.

I know it's a Board decision at the end of the day, but are we to assume, unlikely to raise the dividend this summer, given the current payout ratio?

Well, it's up to them.

The dividend is very important to us as evidenced by our behavior for a long time.

I can't say what they're going to do.

Nobody's alarmed by where it is, especially with the cash balance and the outlook that things are going to get better, the earnings aren't dropping.

We know we have some margin because if interest rates get anywhere near normal this 94% goes to a lower number.

As far as raising the dividend, some people ask would you have to get back to 75%?

I think you have to watch the game get played.

We'll see what happens.

And you know that our Board favors dividends and if it makes sense to raise it, they'll do it.

Okay.

Great.

Thanks.

The next question is from James, is it Kissane, of Bank of America-Merrill Lynch.

Hey, guys, it's actually Georgios Mihalos filling in for Jim.

Just had a question around retention.

As you guys continue to see strong growth in MMS, do you think there's a chance longer term that you could push retention levels higher than that 80%, given that segment should be more stable?

There isn't -- the number of clients in MMS isn't quite enough to move that needle when you measure it by clients.

Okay.

Do I think someday we'll be under 20%?

Yes.

We were under 20% once.

If I had the ops guy here, Mr.

Mucci, I'd say, Marty, you are going to do that and he would look at me and smile and say no problem, John.

Got you.

Last question.

Just to make sure on your guidance, the outlook that you guys have from a checks per client perspective, is that about plus 1%?

Approximately.

Okay.

Thanks.

The next question is from Glenn Greene of Oppenheimer.

Thanks.

Good morning.

Just wanted to drill down a little bit on the attrition trends, the 23% or so that you sort of realized the last couple of years.

Could you sort of talk about the composition of that attrition?

Sort of historically, I remember bankruptcy was sort of 12 to 13 points of that.

I don't know if that's meaningfully changed, but just sort of looking for a little bit of color on that 23% attrition bankruptcy versus competitive.

Well, the 12%, 12% to 13% is a little bit high but it's in the ballpark.

But you have some percentage, call it 12% to 13% of clients that went out of business, there's another point of two that clients that either lost the ability to pay so we took them off the service, or they got so small that they stopped using, they stopped processing, and those two numbers would normally be in the 1% to 2% range.

You have some number of clients who leave for either they need a feature or functionality that we don't have, or they're unhappy with something or other that number normally is in the 5% to 6% range.

Those are kind of the basic numbers.

The history would tell us, in a lot of years of history would tell us that when you deal in a marketplace with small, medium business, you're going to lose about 20% of your clients if you're a well-run Company driven by those factors.

And the factors that are sort of leading you to think that the attrition rate is going to sort of pick up at least a point or improve a point or so next year in 2011?

The two major drivers of that are less companies going out of business and less of an issue from clients with the price value consideration.

Okay.

And then on the HRS side, is it right to sort of conclude that the growth is really being driven by really, I guess, expansion into the new states or is it more than that?

I'm sorry.

I missed that.

Being driven by what?

Expansion into new states.

No, I mean, that's part of it.

The PEO has had good growth but it's not -- the PEO, it's not a huge number compared to the total.

So it's pretty much across the board.

We had a very strong year with the combination of Premier and PEO so that clearly is a driver.

The PEO piece you mentioned is helping.

I think the 401(k) is going to continue to get better and insurance is, because it's a relatively small and relatively new business, is growing at pretty high rates.

And then just finally, on the -- I guess from a sales perspective, organizationally, with the new head of sales, what's sort of been done that's sort of changed, that's going to help sort of drive productivity?

Have incentive plans changed at all?

Territorial realignment?

Just a little more color on the sales force organizationally.

Yes, it's some of what I talked about earlier.

It's a very aggressive approach to activity.

Particularly in our core business.

A salesperson's success is going to be driven almost entirely by activity.

Said differently, in that world you don't have the opportunity to land a whale and have your year made.

The only way that you can drive success in that world is you got to show up every day and you've got to work hard every day and you've got to work on the right things and on the right channels.

Our various channels, CPA referrals, current client referrals, bank referrals, leads have come out of our national sales support system, leads that are generated through Google and other methods that are similar to that.

They all have much different levels of close rates and much different levels of success and so you not only have to work your channels but you have to work the right channels.

So it's all about activity and we've just gotten a lot more aggressive on our execution and on managing the activity of the sales force to begin with.

Secondly, it's got a lot to do with the way that he's approaching training in specific areas, salespeople that are having difficulty closing are going to go into special courses that were developed to help them improve their closing rates.

There's a little bit more mentoring going on than was going on in the past.

There's a whole series of things that all add up to just a much more heightened focus on execution and better sales collateral and better lead generation, techniques that we feel pretty comfortable based on the last four to six months of the time that he's been with us, we feel pretty comfortable is going to drive higher levels of performance.

All right.

Great.

Thanks a lot.

Yes.

The next question is from Tim Willi of Wells Fargo.

Thank you.

Good morning.

Just a quick, I guess, add-on to Glenn's prior question about sales.

Has there been any notable change or at least appreciable change in how you think about recruiting and adding to the sales force, and sort of calling out maybe the bottom performers to over time have a shift and, if you will, sort of the culture of the sales force, as opposed to what it had been, just any thoughts you might have around that?

Well, I would say yes on one and no on the other.

I've always been a high believer that when you have attrition in the 25% to 35% range which is about where it is with most of our sales forces that there are two issues that are probably at play.

One is you're hiring the right people, because in our world the majority of our attrition happens in the first 18 months to two years of a person's employment.

And so what is it that makes one person stay for their career or get to the point where they would want to stay or get allowed to stay, versus another.

And I would argue with you that some of it has to do with who you hire and some of it has to do with the relationship between the first line manager and the employee.

We're working on both of those things.

So that would give me reason to believe that if we work on it, that we should see some level of improvement.

The part -- there was another point you that mentioned that just slipped my mind where I was saying --

it was just about -- I think the second part of my question was just how you ascertain who needs to be sort of culled out of the sales force?

And the reason I say no on that is we have been -- if you just looked at it from 20,000 feet, you might conclude that we have been Olympic-level performers at culling out people who aren't performing well.

I'm more interested in getting people to perform well, not figuring out who is not and shooting them.

I think that we've probably have done better on that score than we should have and I think there's a lot better opportunity for improvement by hiring the right people and then doing what has to be done to get them trained and get them the skills and the experience and the coaching to be successful.

Great.

Thank you very much.

Pleasure.

The next question is from Giri Krishnan of Credit Suisse.

Hi.

Thank you.

Just had a couple of quick questions or clarifications.

I think in your prepared comments you may have said that discounting, did that moderate a bit?

Was that a comment specifically addressing ADP or just a broad industry (inaudible) and if so, what's driving that?

It was -- I made the comment.

This is Jon Judge.

What I said was that it was quieting down a bit.

It had gotten pretty aggressive for a while and it seems to be quieting down and our biggest competitor is obviously ADP.

We compete with the regionals as well.

But we compete normally in a different footing with the regionals.

They tend to discount severely and have forever.

So the discounting issue really was not something that was materially different with the regionals.

It was more with the nationals.

And we'll see how it plays out.

I'm just sort of reporting the news as we see it.

It's not terribly scientific, so I'll tell you that up front but it seems like it's getting -- it's quieting down some.

We're also doing some things in the business to try to make sure that there aren't discounts that are occurring just because somebody thinks there's an issue.

There's a little more discipline that we put in our system just to make sure that we're managing as appropriately as we can.

And as I mentioned, we've created some bundles that are helping us both with simplifying the sales process and also helping us get control on some of the discounting just because we don't allow discounts in bundles to go beyond a certain level.

We'll see how it all plays out.

In general my feeling is that things are getting better on that front.

And have you -- how have your win rates against ADP trended in the last quarter?

How has what?

Your win rates.

I don't have a great answer for you on that.

I mean, I know the number of accounts each year that we lose to them and the ones we take -- that we take from them.

We're still positive on that front so that's a good thing.

And reporting from our field salespeople on competition against the various competitors, we continue to do well on those measurements.

So it's always -- I'm always a little bit suspect in those measurements because they're self-reported, but there's nothing there that I see that would tell me anything has changed.

Okay.

And just looking at client fund balances, given your guidance, is it fair to assume that with no [mid-March] changes in the economy that you could see that increase at the rates you saw in Q4, or at or above the same rate?

Probably.

Okay.

That was all.

Thanks.

Yes, thank you.

The next question is from Jim MacDonald of First Analysis.

Yes, just a quick follow-up, guys, related to the payroll guidance.

How soon is your thinking that you could possibly sequentially return to positive client growth?

Could that happen next quarter?

The last year -- it could happen next quarter but that might not be a good indicator.

Basically what's happened in the last two years is payroll client growth has been flat in the first six months.

All of the down happened in the next six months.

So I think the time to know whether payroll revenue growth or payroll client growth will be positive will be coming out of the third quarter February 28.

Okay.

That's helpful.

And then do you look at all at the national jobs data, and did that sort of plateauing last month spook you at all on your payroll guidance?

I don't look at it because I think most of what's in there is large companies.

You have to remember that we're -- 40% of our client base has four or less employees.

We're paying about 10 million people in a market that's probably 30 million but we're on the bottom of the pole or the top, depending how you want to look at it.

I think also you're going to have to wait.

You're talking about the large amount of census workers that were in that and there were actually something like a positive 40,000.

Yes, that's what I'm talking about.

Yes.

I think, that one to me looked a little strange and you know if you watched it the DOL data, every once in a while you'll see something strange and two or three months you'll find out somebody didn't report or there was something funny going on with the data.

That one, who knows, maybe there will be something funny there.

But as John said, the Department of Labor data and our data with small business don't normally -- trendwise you could argue there's some correlation but they don't normally on an actual specific data point basis they don't normally trend together.

Okay.

Thanks very much.

Yes.

The next question is from Mark Marcon of R.W.

Baird.

Was wondering if you could talk about the healthcare initiative just in terms of how you think that's going to progress over the course of the year?

And looking out even a little bit further?

Basically, we're off to a good start.

We're pretty close to our goals, which any little miss we have we think is totally economy related.

We're aggressively adding to the sales force again this year.

We think we have the right products.

We don't think the healthcare bill is probably slightly positive to us, not a big deal.

So we're kind of on the same truck we've been on and we learn more and we've got more and more people getting experience in the industry and we've hired a few people in to get more, some marketing, I think it's moving right along.

It's about consistent with with what we thought and like everything else in Paychex you sit here and like it to grow faster but you've got to be patient here.

That's what you've got to do.

I mean, at what point do you think we could -- when we look out over two, three years, at a certain point you would expect that it could get to $100 million or so or -- ?

We'll get to $100 million within a reasonable period of time.

I can't tell you when that is.

It's not 10 years from now, though.

It's shorter.

Hopefully, it's somewhere between three and five.

But to say exactly when that point is, I don't know.

The next 12 months will probably be a better indicator of that because -- as you're small, you get a growth velocity, and you've got a lot to pick from.

As it gets a little harder, then the growth velocity either maintains or slows down.

Do I have any concern this won't be a $100 million business?

No, this will be a $100 million business.

It's just a matter of when.

And, Mark, the problem with the delivery mechanism in the industry is not going to go away.

The independent agents do not want to deal with small clients.

And this is one of those things that is somewhat of a perfect storm for us in that we're already talking to these clients.

We have very broad distribution capability.

We talk to quite a few clients, or potential clients every year.

So the business is going to be there and it's hard for me to imagine that anybody else could go after that business in the way that we're going after it, given how we approach the market for other purposes.

So it's not going to be independent agents for sure.

I think that business is going to continue to grow as John said and I'm absolutely with him 100% that we'll get to the $100 million.

It's just a matter of when.

Okay.

And then with regards to the margin guidance, I appreciate all the color on the expenses, is they anything else that's being factored in?

No.

So it's just that there's nothing above and beyond that?

No, if anybody -- no, we're realistic.

We haven't really changed anything on how we do it.

It sounds like a leading question, Mark.

Do you have some suggestions you'd like to make?

Well, I was just wondering, in prior calls we've talked about pricing a number of times.

It sounds like it's quieted down.

I was just wondering to what extent that may be a factor or whether it's just 100% just the new expenses that we're adding in?

No.

It's pretty much the same old, same old, except for those two things we -- three things, the bonuses, the commissions and the two wage factors.

There's nothing more than that and it's, unfortunately on payroll when the darn number goes negative it doesn't go positive right away.

Right.

And you remember it.

It doesn't sound like much, but payroll revenue is almost minus 6% this year.

So getting back to flat isn't like it didn't move at all, with in an environment that's not exactly red hot.

Right.

And you're basically expecting client growth that's going to be somewhere in the [1-percentish]?

You guys keep asking for an answer I said I wasn't going to give.

So I'm not going to give it.

But you can keep asking.

(laughter) All right.

Thanks, John.

The next question is from Joseph, is it Foresi, of Janney Montgomery Scott.

Yes, it is.

I wonder if you guys could talk about what you're seeing sort of on the small business front?

Is there a possibility that there might be some pent-up demand just because those small businesses aren't getting started due to a lack of capital and could there be a possibility that things improve quickly should that capital become available to the smaller businesses?

Logically, I would say yes.

But are you -- I know that makes sense logically.

But I was wondering if maybe you've heard anything from your client base that would lead you to -- to mood back up your logic?

I haven't.

No?

Okay.

Haven't heard anything that doesn't back it up either.

It's not like John and I are in touch with the client base.

I have a saying, if I took my average client to play golf at my country club I'd blow the margin for two years.

Hopefully, you don't play any of that, guys.

Just on the -- what's more important to the business?

Is it really the business starts at the small business level or is it adding employees and which do you think would improve first?

It's business starts.

Adding employees, we've talked about that on other calls, really we're in an unusual environment here.

We're adding employees and it's benefiting us.

Usually it doesn't, it's stabilized.

It's definitely, health of the economy and business starts.

Okay, and then just lastly, I know you talked a little bit about acquisitions, but maybe just your thoughts on that going forward and what type of area, if you do have any thoughts on it, that you'd be looking to target?

I can only touch on it in general terms.

That is I would say it's one of our highest priorities.

We would love to find something to add to the organic growth of the business, obviously, when we think about that.

We buy payroll companies, so we'll continue to buy payroll companies.

We won't buy them for amounts of money that would guarantee that they would be profitless for life, so we have to find the right ones, so that will always happen.

But in general the things that we look for, we look for companies that offer solution that is inside of our relationship with our clients.

Clients need it, it's something that natural for us to sell through our existing sales forces, or we can add sales forces if required.

You obviously would like to get leverage off the existing infrastructure.

So examples of that are we bought a time and attendance company.

It was a natural thing for us to do.

We bought a time and attendance company.

We then developed a whole series of time and attendance offerings that were geared towards small and medium-sized businesses.

The basic company that we bought was actually geared towards larger-sized companies.

Once we completed the whole new offering set and learning what we needed to learn about time and attendance offerings and so on, the piece that was left, just didn't make a lot of sense because they were interested in clients that were far larger than the clients we were interested in so that's why we sold off Stromberg at the end.

Those types of things are naturals, where you can find the business that has an offering that we can leverage with our infrastructure and is something that's needed by our clients.

And the focus remaining on the small business level?

Absolutely.

Great.

Thank you.

Small, medium-sized businesses are clearly our focus.

Great.

Thanks.

Yes.

The next question is from Kent Newcomb of Wells Fargo.

Thanks, my questions have been answered.

Okay, Kent.

Thank you.

We like those.

Next question is from [Thomas Ripple] of [Schaefer, Benson, Weiss].

This is [Tom Ripple] of [Schaefer, Benson, Weiss].

Thanks for taking the question.

I'm just wondering on the 536,000 payroll clients that you're reporting, would down about 18,000 from the last fiscal year, and 36,000 from the fiscal 2008.

I'm wondering if you could break that down by those clients that are, went bankrupt or out of business, those that took payroll in-house, maybe a competitive loss or some other reason that I don't have here?

Basically about half of them would be bankruptcies.

Maybe 10% would have some type of service issue and the others would be really a direct result of first off they just don't want to spend that amount of money anymore, they try a smaller solution, we know some of them go back to doing it on a sheet of paper.

Those are just the losses, right?

So roughly half would be from losses and half would be from sales that we didn't get that would be normal for us to get.

And on the half that are from sales that we would normally get, better than half of that is caused by business formation being down.

Probably the second biggest -- that would be the biggest.

So it's, roughly you could think about it, and we don't normally go into this granularity, but about half of it from clients we didn't get that we would normally get and half of it from clients that we lost, and as John said on the loss side, the biggest part of that is bankruptcies and clients not processing.

Okay.

Do you think you're losing clients to people that want to do it in-house and just use some software, and that's cheaper?

That's always been there.

The people that are interested in doing self-service have always been there and they always will be there.

The market that we serve is not that market.

The market that we serve is the market that wants to fully outsource.

It's the people who come to us because they want to use their critical resources on things that are revenue-generating, not back office operations and they choose not to go and try and keep up with all of the rate changes that happen every year and if you don't subscribe to them fully or comply with them fully you end up paying large penalties.

But there are people out there that are perfectly willing to do it themselves.

They've always been there, they always will be there.

The two rarely cross boundaries.

It's very unusual for someone who is a fully outsourced client to decide to do it themselves and it's rare for someone that likes to do it themselves to outsource.

There's some minor movements that will happen back and forth but it's not significant.

Okay, thanks, Jon.

There are no further questions at this time.

Okay.

Well, we thank you very much for your interest in Paychex.

I thought it was good call.

Hopefully, you got everything answered.

If not, you know where to find me.

I wish you all a great summer.

So thanks a lot.

Bye.

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