沛齊 (PAYX) 2011 Q2 法說會逐字稿

Welcome and thank you for standing by.

At this time all participants are in a listen-only mode until the question-and-answer period.

(Operator Instructions) Today's conference is being recorded.

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

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

Thank you for joining us today for our second quarter Earnings Release.

Also with us is Marty Mucci, our President and CEO.

During this teleconference call we will review our second quarter 2011 financial results, guidance for full year fiscal 2011, and Marty will provide an overview of the business from his perspective, as well as we will conclude with a Q&A session.

Yesterday afternoon after the market closed we released our financial results for the second quarter ended November 30, 2010.

We have also filed our Form 10-Q with the SEC, which provides additional discussion and analysis of the results for the quarter.

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

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

We are pleased with our favorable financial results for the second quarter.

Results were very consistent with our first quarter results, and given another quarter of positive results, we have improved our outlook for fiscal 2011 accordingly.

I will discuss this in more detail in a few minutes.

Our key business indicators of checks per client, revenue per check and client retention continued to improve.

Checks per client, the number of checks issued during the period divided by the average client base, represents our most meaningful barometer of how the economy is doing.

Our checks per client reflect an increase of 2.5% for the second quarter, and 1.8% for the six months, compared to the same periods last year.

We saw checks per client gradually stabilize last fiscal year with positive growth of 1.1% for the fiscal 2010 fourth quarter, and 1.2% for the first quarter of fiscal 2011.

Fiscal 2011 has generated increases in revenue per check.

The increases are consistent with the annual price increase we implemented in May of 2010, and also reflect some positive results related to decreases in discounting.

Our client base in the quarter has benefited from better client retention as our client losses for the first half of fiscal 2011 were 12% lower than for the same period last year.

Our client base has improved slightly since May 31, 2010.

On December 9th, 2010, we announced that we have entered into an agreement to acquire SurePayroll, Inc., a leading provider of software as a service payroll processing for small businesses for approximately $115 million.

SurePayroll serves approximately 30,000 small businesses, with its online payroll product.

The transaction is expected to close by the end of calendar 2010 and revenue for SurePayroll for the 2010 calendar year is expected to be approximately $23 million.

The dilutive earnings impact on fiscal 2011 is expected to approximate $0.01 per share with most of the $0.01 related to the amortization of acquired intangible assets and deal expenses incurred and expensed in the year of acquisition.

In summary, our second quarter was a very good quarter, quite similar to our first.

And our six months results were slightly better than we anticipated at the beginning of the fiscal year.

One of the many benefits of filing our Form 10-Q on the same day as a press release is that we get to wake up early and get a preview of how Wall Street is responding to our results.

For some early morning comments on guidance, our guidance policy remains unchanged since well before the recession entered our lives.

Normally the guidance we give at the beginning of the year remains unchanged except for actual changes in interest rates.

The recurring revenue nature of our business provides for a predictability very few other companies enjoy.

The improved guidance for fiscal 2011 relates primarily to better than expected checks per client and sooner than expected operations productivity related to the implementation of our Core Advanced payroll platform in fiscal 2010.

We did not include any revenue growth or slight earnings dilution for SurePayroll in our guidance, since the transaction has not yet closed.

If we had included anticipated results for SurePayroll, the change to guidance, if any, would have been minimal.

There were also some comments on operating margins.

Operating margin improvements at Paychex are a way of life as all of our employees recognize our need and desire to continually improve operating margins.

We experienced some backward movement during the recession as our cost reduction efforts could not outpace the effects of reductions in checks per client and negative client growth.

It's very good to be back on our normal trend of improving operating margins in the first half of the year, watching some erosion in the second half of the year related to normal investments in the business, with the expectation of new operating margin improvements will appear in the first half of the next fiscal year.

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

Payroll service revenue increased 1% for both the second quarter and the six months to $355 million and $716 million.

The primary reason for the payroll service revenue growth is the aforementioned increase in checks per client, increase in revenue per check and better retention.

Offsetting some of these positive factors was our lower client base compared to a year ago.

We have seen a slight increase in our client base since the end of fiscal 2010 with a more meaningful period for changes in the client base coming up in the next six months.

Human resource services revenue increased 10% for both the second quarter and six months to $145 million and $291 million.

HRS revenue growth reflects modest improvements in economic conditions coupled with our annual price increase.

Some additional highlights of contributions to HRS revenue growth were Paychex HR Solutions client employees served increased 14% to 532,000 employees as of November 30th.

We have seen positive results from expanding our PEO offering throughout the country.

In addition, improving economic conditions have resulted in growth in the number of employees per client for our HRS solutions.

Health and Benefits Services revenue increased 29% to $10 million for the second quarter, and 35% to $20 million for the six months of fiscal 2011, driven primarily by a 29% increase in the number of applicants as of November 30th, 2010 compared to a year ago.

Somewhat offsetting the impact of the previously mentioned factors is fluctuations in PEO workers' compensation, which negatively impacted PEO net service revenue.

Our workers' compensation costs will often fluctuate quarter to quarter.

Combined interest on funds held for clients and investment income decreased 8% for the second quarter and six months.

Yields available on high quality securities continued to remain low.

Expenses increased 1% for the quarter, and 2% for the six months, due to costs related to continued investment in our sales force, customer service and technological infrastructure.

Improvements in productivity within operations which relate to lower headcount have somewhat offset this increase.

Sales representative headcount is at the expected level going into the third quarter, our main selling season.

Operating income increased 6% for both the second quarter and six months, to $204 million, and $405 million.

Operating income excluding interest on funds held for clients increased 7% for both the second quarter and six months to $192 million and $381 million, respectively.

We continue to manage expenses contributing to this growth.

We do anticipate that expenses in the second half of fiscal 2011 will be slightly higher, bringing our operating income, net of certain items, as a percent of service revenue down a little bit from the 37.8% seen during the first six months of the year.

Net income and diluted earnings per share increased 6% to $134 million and $0.37 per share, respectively, for the second quarter.

The six months net income increased 7% to $266 million, while diluted earnings per share increased 6% to $0.73 per share.

High quality investments continue to earn very low yields.

Starting in November 2009, we began to invest in select A-1/P-1 rated variable rate demand notes and have gradually increased our investment in variable rate demand notes to $700 million as of November 30, 2010 from $226 million as of May 31, 2010.

For the first six months of fiscal 2011, we earned an aftertax rate of approximately 24 basis points on variable rate demand notes as compared to approximately eight basis points on US agency discount notes which are our primary short-term investment vehicle.

Our long-term portfolio was also invested predominantly in municipal bonds, general obligation bonds, pre-refunded bonds which are secured by US government escrow and essential services revenue bonds.

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

Our investments are high quality credit securities with AAA and AA ratings and short-term securities with A-1/P-1 ratings with more than 95% of our portfolio rated AA or better.

We limit the amounts that can be invested in any single issuer.

Our priority has been and will be to ensure we can meet all of our cash commitments to clients that took place as we transferred cash balances from their accounts.

Our financial position remains strong with cash and total corporate investments of $690 million and no debt.

Our cash flows from operations were $319 million for the six months of 2011, up 14% from a year ago as a result of higher net income and changes in operating assets and liabilities.

Funds held for clients as of the end of the quarter were $3.3 billion, compared to $3.5 billion as of May 31.

Funds held for clients vary widely on a day-to-day basis and averaged $2.9 billion during both the second quarter and six months representing increases of 3% and 2% over the prior year periods.

This growth in balances was due to an increase in state unemployment insurance rates for the 2010 calendar year and the increases in checks per client, offset somewhat by the lingering effects of the difficult economic conditions.

We expect the recent tax legislation will reduce funds held for clients by approximately 3% over the next 12 months.

Our total available for sale investments, including corporate investments and funds held for clients, reflected net unrealized gains of $61 million as of November 30th, 2010 compared with net unrealized gains of $67 million as of May 31, 2010.

Our stockholders equity increased to $1.4 billion as of November 30th, 2010.

Our return on equity for the last 12 months was 34%.

Guidance.

Our 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.

Our guidance is consistent with the net income trends we've experienced in fiscal 2007 through fiscal 2010, when net income for the second half of the fiscal year was slightly less than the first half of the year.

This relates primarily to the timing of the annual price increase in May, timing of additions to our sales force, the year-end payroll processing occurring in our third fiscal quarter and higher levels of selling expense in the second half of the year.

Our favorable second quarter financial results were a continuation of the first quarter and our outlook for the full year 2011 has improved accordingly.

Our fiscal 2011 guidance does not reflect any anticipated results from SurePayroll, as the anticipated revenue impact is less than 1% for the balance of the year, and the anticipated earnings dilution is expected to be approximately $0.01 per share due to the amortization on acquired intangible assets and one-time transaction costs expensed in the year of acquisition.

Our 2011 guidance is as follows.

We project payroll service revenue to increase in the range of 1% to 2%.

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

Total service revenue is expected to be in the range of 3% to 5%.

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

Investment income net is projected to increase by 29% to 32%.

Net income is expected to improve 4% to 6% over fiscal 2010.

Operating income net of certain items is expected to increase at a rate close to the first half of the year but, as a percentage of total service revenue, decline slightly to approximately 36% for fiscal 2011.

The effective income tax rate is expected to approximate 35% for fiscal 2011.

Interest on funds held for clients and investment income for fiscal 2011 are expected to be impacted by the low interest rate environment.

The average rate of return on our combined funds held for clients and corporate investment portfolios is expected to be 1.4% for fiscal 2011.

As of November 30, 2010, the long-term investment portfolio, which excludes variable rate demand notes, had an average yield to maturity of 2.7% and an average duration of 2.5 years.

In the next 12 months, slightly less than 20% of this portfolio will mature, and it is currently anticipated that these proceeds will be reinvested at a lower average interest rate of approximately 1.1%.

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

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

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

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

Purchase of property and equipment for fiscal 2011 were revised to the expected range of $95 million to $100 million as we continue to invest in technology and infrastructure.

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

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 a discussion of forward-looking statements and related risk factors.

At this time I'm very happy to turn the meeting over to Marty Mucci.

Thank you, John.

I'm pleased to join with you today and talk about our results.

I've been in the new role for just about three months and we are very focused on executing on our plans to continue to be the leading provider of payroll, human resource and benefit outsourcing to small and medium sized businesses.

My focus is on driving growth in terms of clients, revenue, and profits, while continuing to provide great service to our clients and employees.

We are pleased with our financial performance in the first half of fiscal 2011.

Checks per client, revenue per check and client retention have all demonstrated consistent improvement.

Checks per client have improved for each of the last three quarters and client retention has improved in all categories for five quarters.

Improving client metrics and benefits from implementing our new Core Advanced payroll platform are enabling us to improve our operating margins, as well.

And we continue to invest in our employees, our products, and our services.

We are also pleased with the efforts of our employees on many fronts.

Client satisfaction results are at the highest levels ever in our history in both core and major market products.

Our employees remain dedicated to our client satisfaction, and being an essential partner with our clients, and all of us are well prepared for our year-end processing coming in just a few weeks.

As you know, we converted our core clients to a new application over a year ago that contained significantly greater functionality and we continue to build from there, releasing new enhancements approximately every six months.

Recent enhancements have included a new design for our online reports back in June and new online W-2s and online pay stubs just last month.

We have also introduced a new smart time clock solution for our clients with less than 20 employees.

Our major market business is heading toward $400 million in annual revenue and offers a complete one source solution for our mid-sized clients including online HR administration, time collection and management, and benefit enrollment.

We are very competitive in this space and continue to make major investments in this product set including recently enhancing the integrated user experience, allowing our clients to navigate between applications and integrating the data behind these applications with web services.

Over 532,000 client employees, up 14%, utilize our Paychex HR Solutions services through both a national PEO and ASO model for HR outsourcing.

This is more than our largest three competitors combined.

We also service one in ten 401(k)s in the country, with assets now over $12 billion.

During the first-quarter call, we discussed some new core sales initiatives that were implemented on October 1st, 2010.

At that time, we introduced new pricing and packaging of our core products and we have made some changes in our training programs to expand the knowledge and selling skills of our new sales representatives.

We have also made a number of changes to bolster our field sales management team and we are fully staffed in all sales positions and are currently deploying the latest in technology tablets to support our sales team and improve their efficiency and production.

It is really too early to tell the report on the progress of some of these initiatives until we get through January, as you know, an important selling month for all of us.

Looking at some of the other areas of importance that I have discussed in the past few months, I am actively pursuing interviewing for executive positions leading sales and marketing.

We are separating the marketing from sales by establishing a new Vice President position that reports directly to me and allows us to capitalize on our brand strength and accelerate the work with channel partners and lead generation for our sales teams.

We expect both positions to be filled in the next 45 to 60 days.

And of course we announced our merger agreement with SurePayroll on December 9th and expect this transition to close in just the next few weeks.

SurePayroll, with their 30,000 clients, provides us an entry into a new segment of the payroll online market, a segment we think is positioned to grow as the five million small businesses who calculate their payroll manually move to the web.

Paychex already has 40,000 clients using online input but SurePayroll with its software as a service model will offer another alternative for those clients looking for more of a self service alternative.

Both companies offer quality service, and from a client control standpoint Paychex will now be able to offer a full range of payroll outsourcing alternatives.

Clients who want more control have SurePayroll, clients who want high level of personal interaction with a dedicated payroll specialist have the Paychex model.

We are excited by the SurePayroll employee team, talent and leadership in this marketplace.

The leadership team that has led SurePayroll since its start in 2000 will remain in place and focus on growing their business within the Paychex family.

It has been an extremely busy and productive time since taking the helm a few months ago and I'm proud to be the CEO at Paychex and lead an outstanding team of employees in sales and operations who are excited about taking Paychex to our next level of performance.

With that, I'd like to open it up for questions for John and I.

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

(Operator Instructions) First question comes from Julio Quinteros with Goldman Sachs.

Sure.

Hey, guys, real quickly.

John Morphy, for you, real quickly on the two metrics, just want to make sure we have the new client sales metric for the November quarter.

I might have missed that one.

And then once you're done with the anniversary of the easier comps on the checks per client, where do you expect the checks per client number to essentially stabilize once we get past the -- looks like by the third quarter of this year you anniversary the declines?

What was -- say the first question again?

Sorry, the new client sales number.

We did not give new client sales number but the sales were up slightly but not much.

And this is the sixth month that is really the most important six months anyway so it's the next one.

As far as easier comps, I don't even think of it in terms of easier comps because normally checks per client doesn't go up.

So I would say that the comps didn't have much to do with it because the comp was only worse than the last recession by 1%, at 5% versus 4%.

I think one of the things that's affecting checks per client slightly on a positive basis is the fact that new business formation isn't as good as anybody would like it to be so as a result you're not introducing some of the smaller base clients at the bottom.

Now, would that change 2.5% to zero?

No.

The checks per client to me is stronger than what I would have anticipated.

I think we'll ride this horse for as long as it'll run.

It's surprising it's gone this far but we don't see any weakness in it.

When we look at the economy, the part that we see that's the most encouraging is the businesses that are in place seem to be pretty good right now.

Bankruptcies are definitely down, falling off.

Retention's getting better in every area.

They are definitely hiring people, maybe not like crazy, and they're not letting that many people go.

We're seeing some real good stability and we've seen this for nine months.

Great.

Thanks.

Next question comes from Jason Kupferberg with UBS.

Thanks, guys.

Just a couple of questions here.

I wanted to talk about some of the bank partner relationships that SurePayroll looks to be bringing to the table here.

Can you talk about how you might plan to leverage those relationships, not just on the SurePayroll side but also for the core Paychex business going forward?

I think the positive piece about that is they do have these bank relationships through Sure.

We have bank relationships through Paychex that we've had from outsourcing the referrals to a full outsourced product.

And I think we can leverage by combining those.

I think the banks can understand that they can either stay with the Sure product or they can go with a full outsourced product, whatever their clients want at the time.

And all the agreements that are in place with Sure bank partners now will remain in place.

Okay.

And I think on the call in October you guys had suggested that you would look to provide some new long-term guidance before the end of the current fiscal year.

Is that still the plan?

Are there any more specifics on expected timing there when the Street should expect that?

We basically said next June.

Okay, so your Q4 call?

Yes, I think we go look at what it should be for the following year, we'll know a little bit more.

I think most people are settling out.

I don't think when we come out with it, it's going to be any surprise.

Okay.

Thanks, guys.

Good luck.

Happy holidays.

Next question comes from Rod Bourgeois with Bernstein.

Okay, great.

So three months ago you guys talked about a different approach to pricing in the market.

And I wondered if we could get an update on the kind of traction that new pricing strategy is getting in the market and whether it's helping you recapture some share.

Rod, it's a little early to tell at this point.

We just put it in in October.

There was a number of sales in the pipeline coming in so we saw most of that happening in October from the previous months.

I think once we get past January, we'll have a better sense of how that's going.

I think things are generally pretty good.

We've made some tweaks to it already but I think we feel pretty good about it and we're waiting to see how January goes.

We're watching it very closely.

Certainly the sales reps have all been trained and are pretty supportive of what we're doing and we're out there selling as best we can.

We'll let you know after the next quarter, I think.

All right.

And Martin, I just wondered if you could lay out your top one or two priorities as you take the helm as CEO in terms of improvements you'd like to see at Paychex, either changes to your strategy or enhancements to prior strategies where you think there's big room for opportunity.

I go in feeling very good about the level of service.

As I said, we're at the highest levels we've had in the past.

I feel good about the product set that we've rolled out, both in the small and mid-market.

Very strong competitively.

The focus is all on growth, how do we get the sales engines going again.

We've taken already some steps through making sure that we have the right people in place in the field leadership positions.

We've got new training that we've rolled out already.

We're giving them the best technology through tablets and online.

They can basically load a client on their tablet today and send it back through the process to do that faster and more productive.

I think the next big piece of that growth focus is going to be getting a new leader at the head of sales that I told you I'm actively interviewing for now and expect to have in the next 45 to 60 days.

And a new separate position on marketing which will generate more leads and better brand recognition.

I think sometimes one of the biggest frustrations for me over the years have been that we had marketing as part of sales and we have a very strong presence in product, in knowledge, and certainly a leader in this space but we're not always known for as complete an outsourcer as we are for benefits and HR outsourcing.

So it's all about growth and it's getting the leadership in place at the very top and focusing a lot more on the marketing side of it to help generate that growth.

And Martin, just real quick on the effort to hire a new sales leader, are you looking for somebody that can bring a new approach to sales or somebody who can just manage the current approach in a really disciplined way?

I think it's a little bit of both.

We have a great sales engine here that we've had for many years.

We have 2,200 sales reps out there that continue to probably provide the best productivity in the industry.

So it's a little bit of both.

You need someone who is going to fit in the culture well and drive the organization.

But I also think even from a more marketing position, probably more in the marketing position, it's bringing a little bit new disciplines.

We're good on the web.

We could be better and we could get our brand out there stronger and generate more leads.

I think the sales leadership is probably more about executing really well and driving some of the things that we're doing now, maybe looking at things like lead generation and so forth and supporting the sales forces.

But the marketing will be a bit of a new strategy there, certainly an enhanced strategy.

All right.

Good luck with those hires.

Thanks, guys.

Next question comes from David Togut with Evercore Partners.

Thanks and good morning.

Could you comment on your recent head-to-head win rates in the small business payroll services market against your principal national competitor?

We've never disclosed that.

They would love for us to tell them.

I would love for them to tell us.

Can you give us a sense of whether your win rates are trending up or down?

I think the win rates actually over time don't change much at all.

They've highlighted their new run product down market as being a significant source of advantage for them.

Have you seen any impact from this?

I haven't seen a significant one.

I'll let Marty comment.

No, I don't think so.

The impact I would say we're getting from the sales reps, I've talked to an awful lot of them in the last few months, I don't think we're seeing a big impact one way or the other.

I think, as John said, it hasn't changed much over time.

I think we're both pretty aggressive in our sales forces.

We obviously have very quality service and we haven't seen a big change there.

Great, thanks.

And just finally, John, with EPS now starting to grow again, would you anticipate growth in the dividend over the next 12 to 24 months?

That really is a Board decision.

Let me say it this way.

We're comfortable with where the dividend is.

When we established that dividend level, we knew that paying 75% rate of earnings was okay.

I don't think you'd have to get back to 75% of earnings to basically say there will be a dividend increase but it really will be up to them.

I think some of that will be based on what fiscal '12 looks like when we get to the July meeting.

I'd be hesitant to say because I'm really not sure what exactly -- we're very dividend friendly.

That hasn't changed.

A lot of it would be based on what maybe we saw were some acquisition opportunities.

I think the factors that would cause that decision to be made will be what's there at that time.

Right now it would be too early.

Okay, thank you.

Next question comes from David Grossman with Stifel Nicolaus.

Thank you.

It sounds like you're pretty optimistic going into the selling season.

I'm wondering if you could just help us understand how much of that optimism is cyclical versus your confidence in some of the actions that have been taken over the last several months?

And part and parcel with that, perhaps you could comment on just some of the early activity that you've seen in the month of December.

One thing, I think we are optimistic, but cautious and you won't know until you get there.

The one thing, don't read into, is when you look at guidance for the year we've reached the stage of the year where what they sell doesn't affect this year too much.

So we're optimistic we're going to have a good selling season but we're also to the point where guidance at this stage, unless you really get a pretty significant economic event, the guidance should stay pretty consistent.

I'll let Marty talk about how he feels about the selling season.

I think it's still early.

The initiatives we took in October and continue to take, I do feel good that we have a very pumped-up sales team that's out there.

We've got the right products and services.

We've got quality service.

Certainly great value for our clients and good field leadership.

I think it's just a matter of time to make it all gel and come together.

And while I'm optimistic, as John said, it's a big selling season for us in December and January and it's still a little too early to tell.

The other thing we don't know, David, is we've seen a lot of improvement in the marketplace, what's existing, and a lot of this new business formation, and these payroll pickups, happen in January, like it or not.

And you really don't know until you get right on top of it because when you're selling core payroll, most sales are sold in one visit so there isn't a lot of queueing up of the business.

MMS we feel real good about.

They're off to a good start and that business queues up probably six to eight weeks ago and we feel good about that.

We've just got to go in there and play the game and see what happens.

Just looking at your comments, John, about rates and balances, when you roll all the different elements together, because it sounds like you're expecting some headwinds to balance this because of this new legislation, and you've got 20% of the long-term portfolio rolling off next year, does that seem to suggest that if rates stay relatively flat, everything put together, that we've got a headwind to funds for clients or could that balance perhaps grow next year, given all those parameters?

I think when you look at interest on funds held for clients, with all the parameters in place, I think you could see a drop of about 10%.

We're getting down to a number, that isn't a big number.

That might not even be $0.01.

I think when you look at interest on funds held for clients, the impact of that going forward, until rates go up, really isn't going to be very significant.

So everything else being equal, investment income for clients would actually be down next year?

Could be down a little bit but not a lot.

I see.

Do you have any idea what kind of rate level we need to see before that starts growing again?

I'd have to ask my Treasury people.

The reinvestment rate is 1.2% in the long-term portfolio, I don't think that could go any lower.

The short-term rates, we've gotten a little bit of the bps back.

When they come back up, I don't know they're going to come up 25 basis points a crack.

I have no idea what they'll do.

If they picked up 100 basis points, that would be pretty big.

I think they're going to keep rates down for as long as they can keep them down.

Just one last thing, on the investments.

It sounds like you've got a plan for the second half of the year.

And is there any more specifics you can provide, over and above what you've already said, about how those investments translate into incremental growth and profitability going forward?

When we look at the margin expansion, some of it's related to investment.

Some of it's just we've got a philosophy that's been in place for a long time that when you ask for expense growth, you're not going to get it equal to revenue growth.

Unfortunately, when the recession happened you've got the two negative impacts that we can plan to but if we're not willing to let people go or do layoffs which we weren't, it's very hard to offset.

That's checks per client coming down which that last check is the most profitable, that's where we're seeing some of the margin expansion, and negative client growth.

Hopefully negative client growth now is behind us but we won't know until we get to the selling season.

We were flat for the six months, we were flat a year ago.

But we know retention is better.

So hopefully, we'll get a reasonably good answer there.

I don't think we're going to get a surprising answer but we'll get one.

The checks per client keeps going up.

We continue to make investments.

One thing we haven't said too much about, we are really spending a lot more money on product development.

The Core Advanced platform is really product development.

Now we're on to the MMS product.

Our IT expenses are up dramatically.

I'm talking pretty significant double digits as we try to get this product portfolio stronger and stronger.

So we balance all those things with what we're doing with the other costs because we believe margins have to keep going up.

They might not go up quite as strong as they did this year because we've got some good benefit out of checks per client.

But I've learned never to say never because you don't know what's going to happen.

We're going to continue to focus on those things and see what we can get.

The Core Advanced platform now has been fully in place for a year and what's happening is the people are responding, the training is easier.

We've got a lot of experienced payroll specialists.

But the other thing is, the response times on the machine are getting better and better.

And they aren't finished yet.

So we knew we would get some things out of this and maybe we didn't target specifically as much as maybe we should have but some of that was a little bit of trust that if we got it we would get it.

To me, things are moving in the right direction, we're getting what we need to get and most of it should continue.

The good news is, that productivity enhancements, we pour that money back into the investments for more technology in both the small and mid-sized.

That's not going to stop.

We'll continue to do that, but that's baked into the numbers that you're seeing in guidance.

Thanks very much.

Next question comes from Adam Frisch with Morgan Stanley.

Good morning.

This is Nathan Rozof on for Adam Frisch.

I wanted to ask what you guys are hearing from the field about the recent changes to the tax rates or for the tax extensions that we had recently coming out of Washington, DC.

Are clients starting to signal any increased confidence from that that could translate to a willingness to invest and hire?

One problem we have in our business, because we have so many clients and we have the ops touching them, and they're talking to sometimes lower level in the organization.

I wouldn't say we have a lot of color on that subject.

I think when you look at the tax rates, I don't know whether it's much of a boon.

I think the Social Security thing could be because people have a little more money to spend.

But all we're really doing is continuing what was in place.

So I think to me, it's not so much you hit at a positive, except you got rid of some unsureness is you didn't drag something out that probably would have been negative.

The Social Security thing, that money, it's the same amount of money basically goes to everybody.

The lower income people are going to get the same amount.

It will be interesting to see what happens with all that.

We have not heard a lot.

I think it's a little early to see.

We'll just have to watch what they tell us about consumer spending and those things in the next three to six months.

I think the good news is obviously we've seen the checks per client grow so they are hiring a little bit and the business failures for going out of business has improved for five quarters now.

Obviously something is kicking in, whether it's business tax credits and other things happening or not.

The bottom line is they're going to hire more when they've got demand for their services and products.

I don't think it's hurting any but we haven't seen a lot of positive coming just from the tax changes.

Switching gears to the investment portfolio, we realize you guys take a lot of care there and investing in AAA and AA quality securities.

But with the recent concerns that have sprung up in the munis market is that causing you to take or to look to any additional safeguards?

We're always looking at more and more safeguards.

We keep talking about this.

We haven't seen a reason to change our position yet based on where we are.

But by the same token, it doesn't mean we can just sit here and say, oh, life is perfect.

We've got to keep looking at that.

Lastly, just on the SurePayroll acquisition, two lines of thought here.

Number one is, is their SaaS technology something you're going to integrate into your existing online product?

And then can you give us any insight into how the financial and growth metrics compare between the SurePayroll product and growth rates and your existing online product?

Thank you.

You're welcome.

I guess the first one, we're not looking necessarily to integrate it into the online technology because they're very different products, one much more self-service than the Paychex online product.

We will look to leverage and integrate into our back office through our tax calculation, payroll calculation and so forth.

But the front end for the client perspective, we're not looking to do that at this point because they're very different.

From a metrics standpoint, obviously they're seeing pretty strong growth.

They're about 30,000 clients and they've grown pretty well and we continue to think that they will grow very strongly in that marketplace, particularly as some of these 5 million businesses that are doing their payroll manually will come over.

We're expecting higher numbers than our normal growth because they're still relatively new, about 10 years old.

This really participates in a segment that we think is going to be growing.

Actually, it's a replacement segment.

We believe right now that approximately 5 million businesses, a little over half the market, granted, way at the low end, is doing payroll basically using a pen and a government pamphlet.

Hard to believe, but that's what they're doing.

They're not on QuickBooks.

There's no computer anywhere in the process.

Pen and a pamphlet.

If you look at how the world is evolving, I don't think it's going to happen overnight but the kids of today are not going to use a pencil.

They're going to use some type of a handheld device.

And they're not going to really care all the time whether a salesman calls on them.

We believe this market that we're going into or this product will be what replaces manual payroll over the longer haul and we've got to make sure we've got something.

We don't see much cannibalization here.

This is a product that will grow faster than our products because it's smaller.

The revenue characteristics will be much smaller.

By the same token, the service requirement will be much less.

Our goal on something like this would be out of 100 payrolls, only touch about three of them.

So it's a whole different concept, and the customer's looking for a different concept.

This really is the person that is the do-it-yourselfer, that wants to do it himself, doesn't want a lot of help except when he needs it, he wants to be able to call somebody.

So it's an exciting opportunity but it really doesn't have all the same characteristics of our other business which is really worry-free.

We think you'll get the margins off of the fact that when you get to many, many clients you won't be touching this stuff very often.

Thanks again and happy holidays.

Next question comes from Ashwin with Citigroup.

Hi, John, hi, Marty.

So I wanted to follow up on that SurePayroll comment that you had with the lower revenue per client and then down the road lower cost per client.

Does the SurePayroll product support the pyramid approach of selling more stuff to the payroll client or is this going to be extremely low touch always?

They are low touch but they also do have a model that is similar to ours in selling 401(k) and insurance and so forth.

But again, more of a low touch approach to it.

But they do link other products to their payroll service and have been doing that for some time and have the relationships built.

I'd still say it's at a pretty low penetration rate but it's something that we hope to further expand as needed in that marketplace.

It's going to be depending what their needs are now.

For example, in the way they've got it structured right now, tax pay and employee pay are a requirement for every one of their clients.

I heard an interesting thing on the way in today.

They're talking about Social Security checks I think by 2013, a person has to take either direct deposit or a debit card.

So maybe that's a move towards direct deposit being able to be required in this country.

I don't know.

Great.

And speaking of debit cards, and there's been I guess a lot of commentary recently about debit cards, prepaid cards and so on.

Could you comment on where you stand with regards to rolling out payroll cards?

We were the first in the industry to have them.

We've had it for almost 10 years.

And need and desire to have them just hasn't been that strong but we have a product that's as good as anybody's.

We've been doing it a long time and got the whole thing covered.

But there's a lot of talk about this but when you get down to people asking for it there hasn't been that much need yet.

It's more for the unbanked, I guess what we would call unbanked employees.

It has limited growth, to some agree.

As John said, we've had it out there for a long time.

If they have a debit card, most employees of our clients already have debit cards because they just use the one account.

If they don't have an account and they want to pay through the card, that's the kind of client that will request it.

But we have had it out there for a long time.

It's still pretty small penetration and doesn't seem to be growing a great deal even though we market it quite a bit even to the employees directly.

That could change dramatically.

If you told somebody you're going to do direct deposit, and if you don't do that, you've got to have the card, we're not going to send you a check anymore.

If that happened, you would see the utilization of those cards go up dramatically.

This thing with the Social Security needs to be followed closely to see what happens.

Switching gears, last question is on margins.

Could you maybe address the idea of peak margins.

So in your view, are there structural changes in the business that happened during the last downturn that affect peak margins in the recovery?

Can you sustain, let's call it a 50, 100 basis-point type of year-over-year margin improvement and get to a low 40s level?

I don't know what's possible exactly because all I know is since 1990 the margins of Paychex have gone up almost every year.

We continue to operate in this philosophy.

We continue to leverage the model.

I assume when you get to 100% gross margins you probably have peaked.

Where it peaks between there and then I don't know.

But just when I might say to myself, can this go any higher, it goes higher.

Our goal is to keep them going higher or you've got to find some way of revenue growth that's greater than what we have.

And some of that's a trade-off.

I'm sure if we were willing to just totally cave on price you could have more business but you won't make any more money.

I don't think we've reached the point at which you would say that margin expansion is not possible.

Fair enough.

Happy holidays, guys.

Next question comes from Jim MacDonald with First Analysis.

Congrats on the SurePayroll acquisition.

You talked about the operational side a little bit.

How about on the sales side, do you see that being pretty separate or any integration there?

I think, Jim, it's a little too early to tell.

We haven't closed yet and we're still working through that.

They obviously sell through telesales and not feet on the street and that's part of the model, given the lower revenue per client.

So we're continuing to look at that.

We also want to maintain a strong territory integrity for our reps but we're still balancing that out and we'll wait until after we close to make a final determination of how that's going to go.

How about web sales?

You were doing some more web sales and they're doing web sales.

How do you avoid a mixed message there?

I think it's all in how you portray the brand of the product.

That's one of the reasons we left the SurePayroll -- we're going to leave the SurePayroll brand out there, either powered by Paychex or provided by Paychex.

It is very important that they're very different products and so we will market them differently and look to certainly gain a different client.

As John said, we don't expect a lot of cannibalization.

It's really about client control.

The client who wants more control in self service will go to SurePayroll and it will be advertised and sold as such.

Those who want a more full service, dedicated person to them, whether it's online or not, will come to Paychex.

And so I think it's all in how we present it and brand it for the client, which we think will help by having two separate names.

Great.

And one last minor question on the quarter.

You mentioned that workers' comp in the PEO impacted revenue a little bit.

Can you quantify that at all for the quarter?

No, we don't quantify.

It's less than $5 million.

It bounces around, sometimes up, sometimes down.

Okay.

Thanks very much.

Have a great holiday.

Next question comes from Tim Willi with Wells Fargo.

Thanks.

Good morning.

I just had one question going back to I think Rod's questions about strategy and any sort of thoughts.

Could you talk about on the M&A front, Marty, is there anything that you think about from M&A where there might be more of a focus than in the past?

And then just in general thinking about the environment for non-payroll businesses like healthcare or retirement and how you think about that and the environment around selling prices right now?

I think from an M&A, we are constantly and have been for years, looking and always searching and investigating possible M&A opportunities.

When you look back at our product set, particularly for the mid-market, the HR administration online product that we had was through an acquisition.

The Time and Attendance, TLO, what we call Time and Attendance Online, we purchased as well.

And, of course, SurePayroll.

We're always looking at where we can either add through acquisition.

It's just it's always tough when you're looking for something that's we think reasonably priced and will add value to our product set.

We do look well beyond payroll.

And of course we're always doing small payroll acquisitions all the time but we're always looking for product additions and anything that will add value to our product set.

We feel pretty good about the environment.

As we see the checks per client and the business losses looking better, we certainly feel better about the 401(k) business and certainly on the HR Solutions which is our PEO and ASO.

As John mentioned earlier, as we move the PEO nationally, that's been doing well.

We're now able through the same sales force and same service group, which we combined, to offer either the PEO or ASO model and that continues to grow.

I think we're 14% in the number of employees served by those two solutions so that continues to go well.

We see a definite environment where more clients of all sizes are looking to outsource their HR support to us either through the PEO or ASO.

And on the insurance market, workers' comp, been around a long time, continues to do well there.

And health insurance had good growth in revenues and we think as the healthcare reform, depending on where that quiets down, clients will continue to purchase health insurance.

I think we're getting better and better at being able to take health insurance from a broker that's already there in the market, so where a client already has health insurance.

I think we were good at starting them up on their first health insurance and we're getting better at hiring and training our insurance reps to be able to compete more effectively with a broker or an agent position already in place.

Okay.

Thank you very much.

Next question comes from Kartik Mehta with Northcoast Research.

Good morning, John and Marty.

John and Marty, I wanted to ask you about, in the past you've talked about potentially leveraging your sales force to sell other products and one of the examples you gave was the merchant processing business.

I was hoping you could provide an update as to where that stands and if you've found any other areas where you could use your sales force and leverage them to sell other products into your customers.

Kartik, this is Marty.

That's continuing to move along.

I think we'll have some information on that shortly for you on the merchant service side.

We still think that that's a nice opportunity for us.

It's not huge but we think it's a nice opportunity to use our distribution model, our sales team that are meeting these businesses for the first time as they just start up and be able to help them through that process.

More of a partner than an acquisition type model.

And on other things that we're looking to sell, we're always careful not to dilute the sales team.

We have, again, the most productive sales team I think in the industry.

And we're always careful not to have them get diluted with too many products, but we do a great job of I think passing referrals between sales forces.

We'll always look for other things that can leverage that sales force without diluting them from the basic goal which is to sell more payroll and get those new clients signed up so that we can sell them other products, as well.

And John, you stated that you increased your investment into variable notes to $700 million.

Obviously you're feeling more comfortable about that investment class.

I was wondering if you're looking to change at all the structure of the portfolio now that maybe the environment's changing a bit.

I think we'll still move back into these investment choices that at one time we thought were very safe, that we got a little worried about for a while.

I don't see a major change in what we're going to do in the portfolio but I do think you've got to keep looking at it and you've got to look at it with a little more gusto, a little more thoughtfulness than what you might have.

I think we've had a strategy that has worked for a long time but I think when I talk with my investment people, we sit here and we say, yes, we think this still works, but you know what, we've really got to rethink the whole thing.

Doesn't mean we'll change it but I think you've got to look at it from every aspect you can think of.

And then just last question, John, I think you said SurePayroll might be about $0.01 dilutive in fiscal 2011.

So if you looked at 2012, would you expect that dilution to be somewhere around $0.03 to $0.04?

No.

Because I think a lot of it's going to be the amortization, some of the expenses have got to be expensed in the first year.

I think if I looked out I'd still say it might be $0.01 but it's not $0.03 or $0.04.

Pretty unhappy people if it is.

Thanks, John and Marty.

I hope you guys have a great holiday.

Next question comes from Jim Kissane with Bank of America Merrill Lynch.

Hi, Marty and John.

Great job.

On SurePayroll will you be offering that through the CPA referral network in the future?

I think we're still working through that, Jim.

It certainly is an offering that just like the banks, I think will appeal to some CPAs and the fact that a CPA can handle whatever a client wants through one company, will be very strong, both for the banks and the CPAs.

So we're still finalizing how we're going to do that, waiting to close in the next few weeks here.

But we're working through that right now and certainly see it as an opportunity to give the CPAs choice for their clients.

Okay.

Not to get into too much of the detail, but I saw they had an iPhone app.

Will you be putting that app on top of your core payroll service?

Right now that would be on the SurePayroll service and if there's anything that goes on the Paychex side, it would come much later.

Okay.

And not to put you on the spot, but can you give us a long-term target for where you think you can get net new client growth back up to?

Is it 3%?

4%?

5%?

I think we said the goal is 3%.

That does not have SurePayroll in it.

In other words, we've either got to get to 3%, the reason I put SurePayroll in is it isn't always a client to client to client because there would be smaller clients with smaller revenue capacity.

But, no, we feel we've got to get back to 3% and we're doing everything we can to do that.

Great, have a great holiday.

Next question comes from Mark Marcon with Baird.

Good morning, Marty and John.

I was wondering if you could talk a little bit about the benefits that we've seen from the new core payroll platform combined with how we should think about the incremental expenses that layer on during the new calendar year, specifically 401(k) match.

What's the incremental change that we're going to see from Q2 to Q3 in terms of the expenses that you're adding back?

I think if you look at the guidance, you can figure it out.

I did that.

Just double checking.

I'd say I already told you.

We've got some expenses there.

They're not that big.

The bigger impact in the second half really is selling expenses which are always higher.

The operating characteristics off the Core Advanced System in the first half of the year were great.

Actually operating expenses went down a little bit.

We still continue to invest.

It's people and it's working faster so I think the beauty of this right now is we had a lot of good things happen but by no means is it over.

That's exactly what I was trying to get at.

We're going to see some incremental expense growth above and beyond the normal sales commission pickup that we're going to see in Q3.

But it sounds like the core platform still yields some benefits above and beyond those incremental expenses going forward.

That's what we're continuing to see.

The platform itself has helped the payroll specialist to be more productive, even a little bit better than we expected from an improvement standpoint, because the performance is good, it's easier to train on.

It's got a lot more functionality for them to be able to pop up screens and so forth to be able to help them through the calls faster, and so they're seeing a lot more productivity from it.

And that was a little bit better.

Where it will continue, we continue to think that we're going to see that.

At some point, obviously, it's going to level off but we're not sure if we're there yet or not.

We don't have a lot more to do to improve the speed.

There's a few things.

It seems to be working extremely well and we're certainly getting great feedback from the payroll specialists who are using it as well as the clients who use it from the online system feel very good about it as well.

You mentioned that client satisfaction scores are near record levels.

Client retention has been improving.

The environment is getting better.

The companies that are still around have been stress tested.

Do you think the client retention rate on a seasonally adjusted basis going from this calendar year to next calendar year may end up being higher than what it has been historically?

What do you mean by -- you mean get worse?

Get better.

It will get better.

It's definitely going to be better than last year.

I don't think we'll get -- we won't get to the historic high but we've made a pretty big dent in it from what we can see at this point.

January is obviously a big month.

That's exactly what I was getting to.

Could the December to January trend be materially better than what we've seen over the last couple of years?

Better but I don't think materially.

I think this is going to be something that keeps gradually improving.

In other words, we gave the range of 19.5 to 23.

I don't think we'll be under 21 yet.

I don't have you there yet.

So no, I think that will come down gradually.

Okay.

Great.

And then can you just mention a little bit what you're going to spend specifically in terms of -- you mentioned CapEx is going up in 1Q.

We put $9 million into a building in Rochester that we had a lease on it.

It's one of those things I probably should have bought four years ago but I missed it.

We had a long-term lease on it.

The people came to us and said they wanted to sell it.

We had the right of first refusal.

The lease was going to run long enough that it didn't make any sense not to buy it.

The only place we really buy buildings is in Rochester where we know we've got a long-term presence.

We've got multiple buildings and we're not moving in and out of them.

The branches, we're continually trying to match the size of the branch requirement, also with new service type requirements.

So you really don't want to be owning buildings that you've got to sell.

Great.

So it sounds like this is a one time bump.

It was a one time bump, about $10 million of it.

In Rochester, I don't think we've ever sold a building.

Great.

Happy holidays.

Next question comes from Gary Bisbee with Barclays Capital.

Hi, guys.

Good morning.

Just two quick questions.

First one, on the payroll revenue growth, I'm wondering why it decelerated a little bit from last quarter, particularly with checks better and retention and revenue per check.

You can't -- quarter-over-quarter doesn't mean anything for us.

You've got to look over the prior year.

That's what I mean.

Versus the prior year it was 1.1, last quarter it was 1.8.

You're cutting it too close, the checks per client.

You've got to remember, if checks per client goes up, I don't get dollar for dollar because if the checks per client goes up the average revenue per check goes down.

Price increase.

I've also had to battle against the client base drop that was in the prior year, 3%.

So you're into minor nuances here.

We look at the revenue growth and we felt it was pretty consistent.

You've got a little bit of noise.

One thing we didn't do, we didn't put a W2 price increase in.

When you put a W2 price increase in, it generally is a true-up that affects this quarter.

That wasn't in there.

There's nothing that I would call systemic but we always have a few differences.

When you want to look at something, when you're looking at it, often as not it's going to be a misleading assumption.

Okay.

And the second question, regarding the SurePayroll, it sounds like a real good addition to the portfolio of offerings.

And I understand how this could expand the market to the really small people doing it themselves.

But is there also a defensive component here to the extent that have you witnessed any share loss or people trading down to a cheaper offering around the economy?

Is that part of the angle as well?

Or do you see this much more as -- ?

We haven't witnessed anything but you've sure got to have some concerns.

I look at this as definitely an offensive move but also a very defensive one.

We believe, and I can't tell you exactly when, but I don't think it's five years from now, if you don't have a pretty much hands-free, no touch product, that's a market you can't participate in.

And whether you're going down or coming up into it, that would not be a good place for us to be.

You certainly saw with the economy over the last couple years there was more pressure on price but that's not really -- we didn't see this as a defensive move in that way.

We saw it more just as John said, we see this as a growing market where those doing it manually will move to this.

It's a hard group to move to a full outsource sometimes but we know there will be a number of them that will want to go to a self-serve but it will be web-based, not calculator based.

One advantage of this over time will be -- right now the do it yourselfer, the true one that's doing it with a pencil and the manual, is not connected to anything.

He's just out there by himself.

If you could get him or that person into a mode where they were basically doing it this way, that would start to get them connected to you where you would have a chance to sell them more or to up-serve, move them up.

So it really is, it's both offense and defensive.

I think when you look forward, the way this world is going, to not have a product in this product offering would be a real mistake if you're a payroll outsourcer.

Yes, it keeps us solid right from the self service, right to the full outsource and the small, right to the mid-size.

We're feeling good about filling out the whole product set from start to finish.

Great.

Thanks a lot.

Next question comes from Joseph Foresi with Janney Montgomery Scott.

Hi.

My first question here is I just was curious, how do you balance the margin profile with the pricing changes?

Do you really make it up in any kind of market share gain or increase in checks?

It's a combination of a lot of factors.

The pricing change we made, we haven't seen all the dynamics.

There still is discounting in the marketplace.

We're just trying to put controls on the margin to expand it.

Everything is in.

Remember, we often run high margins.

So you take the gross margin at the branch level before you get to other stuff.

We don't have much stuff that's probably less than 75% margin.

Is it really about gaining market share and then the incremental checks will push the margins or is it a volume game?

I'm just trying to get a good feel.

It's all of it.

Hard to say it's any one piece of it.

Any changes that you guys are hearing early on in the characteristics of the sales cycle or the pipelines?

Is there any behavior changes on the part of clients?

No.

On the core, it's going to be a one or two sale visit.

MMS, it's probably a two or three month visit.

Okay.

And then just lastly, I know you've talked a little bit about new business accelerating or potentially maybe getting better.

I'm just wondering on the timing of the new business coming back and any expectations you guys have for the upcoming sales cycle?

We haven't seen enough yet to know.

We're watching it closely.

We haven't seen anything really change in this way.

Maybe a little bit better but not enough to be able to measure.

So just to characterize it, really what you're seeing is that there's stability out there and you're waiting to see if there's going to be growth?

Yes.

Thanks, guys.

Next question comes from Glenn Greene with Oppenheimer.

Just the first question, back to SurePayroll, any plans to change how it's been marketed given that it still has a relatively small customer base and you're talking about the 5 million small businesses doing manual.

My guess is they haven't marketed as aggressively as they could under the Paychex umbrella.

Any thoughts there?

I think we'll definitely see more investment going there.

I think they've marketed well online in the way they've presented themselves.

But I do think going after the 5 million users who are doing it manually will be a new initiative and we'll be able to invest in that, in SurePayroll, to be able to do that.

I'm not sure exactly the best way to do that yet but that's certainly part of the job of the new head of marketing that will come in and take the lead on that.

And then John, just on the revenue per check and the checks per client, obviously they've been improving.

Do you expect the same sort of continued improvement in the back half?

What are you thinking about in the back half in terms of those trends?

This second quarter jumped up a little more than I thought.

Whether that will continue, I don't know.

But it won't dramatically change what we're forecasting so we'll wait and see.

I wish I knew.

I never thought it would go to 2.5%.

I should never say never.

Happens to me too.

I would have thought the 1% to 1.5% was going to be sustainable for a while and we'll see what happens.

I think the mixed thing is going to be here.

The mixed blessing is going to be I think when new client sales pick up, which I think eventually they do, then you'll see checks per client affected somewhat by the smaller client size being added in.

I'll be glad to get the new sales.

But at this point you're thinking probably 1%, 1.5% for the back half?

Yes.

And on the revenue per check?

That was slight.

It's off pricing and discounting got a little bit better.

We put the new pricing model in which changes discounting a little bit.

Actually got to look at it hard because we changed the pricing model.

I don't see all the discounting right now.

We've got ways to look at that.

But that wasn't the biggest change.

The biggest change was checks per client.

But the revenue per check did get better.

Right now, the price increase that we put in in May we've got it.

Last year we gave it all back.

Any way to frame how much you've tightened the discounting?

Not yet.

Meaning you just don't want to share it at this point with us?

Don't want to share it.

And I don't quite know yet, some, they'll lower the price.

We've got to look at the net-net.

Okay, great.

Thank you very much, guys.

Next question comes from David Parker with Lazard Capital Management.

Thank you.

Good morning.

Marty, I was wondering, you've talked about the differences between the online Paychex product and the SurePayroll product.

Can you just provide some more color on the thought process behind the decision to acquire rather than build from what you had previously?

I think when you look at the resources that we have on building, we have really a full slate of products already that we're building on, including the mid market.

We're making constant improvements there and we feel we've got a very competitive product and we have a lot of focus on it.

So when you looked at this opportunity that came up with SurePayroll, it was do you want to take upwards of a couple of years, two and-a-half years to build something like that or do you take some of the experience that they have and the product that they have and build on top of that.

And we found that that was a much better approach to take.

I didn't want to wait long to have it and I also think there's some experience that over the 10 years that they had in building that product and focusing very much on self service, which is really not our model.

Our model has always been that full outsourced expert that's there to answer anything and set you up and so forth.

And we just felt the combination of their experience and the product that they had over the last 10 years would be a much faster way to get into this market, and actually invest in them and support them to build an even better product as that market grows.

Great.

And then just in terms of the sales force, are you doing anything differently on the recruiting side, just with that process and trying to stem the sales turnover that you've seen in the past historically?

I think the recruiting was another piece of some of the changes that we put in.

We're doing a lot more recruiting in house now.

We were using a lot of external agencies, spread out across the country.

We've modeled that now into coming inside.

We have a new head of recruiting that is handling the recruiting side of it and we're working with the sales managers and leadership in the field on, again, what's the best method to find the right person and what you're looking for.

And so we have made a number of changes in how we're looking at it, how we're recruiting who we're using to get those candidates, and then making sure, reinvesting in an on-boarding tool.

On-boarding meaning, here's what their first six months looked like, here's what their first 12 months looked like, and be sure that they're fully supported.

Because once you get them in and past that first 12 to 18 months, it's a lot easier to retain them.

It's in that first six to 12 probably that they struggle the most and I think we could -- we've re-invested now and revamped our on-boarding to that we help them be successful from the very beginning.

John, any one-time costs associated with the departure of the former CEO that was in the quarter?

No, they were all in the first.

We disclosed what that agree was, so if you wanted to look for it, you could find it.

Thanks, guys.

Next question comes from Tien-Tsin Huang with JPMorgan.

Hi.

Thanks, just wanted to ask a couple quick questions.

On SurePayroll, I liked that acquisition a lot.

I'm curious, what kind of metrics would you provide here on an ongoing basis to help us track the performance there?

Any ideas, John Morphy?

We haven't decided.

$25 million in revenue.

But we'll see what happens.

We'll decide that in the future.

I recognize it's small.

But obviously thematically it seems like there's some real potential there.

That's why I asked.

It's probably like everything else in America, if it does great, we'll tell you, if it doesn't, we won't.

Yes, we've noticed that.

I'm kidding you.

I know.

On the 401(k) match can you remind us what the impact on the P&L will be?

The P&L is about $6 million or $7 million.

$6 million or $7 million, starting in January.

January.

Not going to have it the following year.

You won't hear us talk about it anymore.

Okay.

That's good.

From a modeling standpoint just want to know when.

From my frame of reference, we put it back in.

It is what it is.

An expense, like everything else.

It's not like we don't have a lot of expenses.

It's just there.

We wanted to explain some of the metrics of how it's moving.

Obviously in the first half of next year, you've got it a little into your wind but I don't think you'll hear us talk about it.

Last one.

Then I'll let you guys eat lunch.

I know Jim and David asked about Ron and mobile.

I think you guys were talking about a tablet for your sales force.

But I'm curious just in terms of self help or online or mobile tools for some of your customers, above the SurePayroll threshold, what's the status on when we might see some of those things come to market?

I don't think we'd say at this point.

It's not something I would want to say publicly.

We're looking at it.

Remember, our clients, our whole model and the way we sell is we'll l take care of everything for you.

We're not looking for our client base as much to be able to use those tools other than for input if they want.

We've always been able to have you can do it by phone, fax or online.

We have over 40,000 clients that use online for input today but we still like them to be able to rely on us for the full package of expertise and so forth.

And so we're looking at that but that's not as critical to our client base as it is to the SurePayroll base.

It's not something I would probably talk about publicly at this point.

But one thing that's interesting about our product I don't think everybody understands, in our MMS product, the client does a lot of it themselves.

When you talk about having this no touch at the bottom, then you think of other people that they really want to use software, it's like the ultimate software model, our MMS is not really far from their model.

It's just they sell a software, we don't.

But in the end you've got maintenance one way or the other.

It really is almost the same thing.

We have products where if a client wants to do an awful lot themselves, you want to do an awful lot in not normal work hours, we have solutions for them.

Sure, there's online for the core set.

As John said, the whole mid market, the major market product of one source solution, everything is basically online and packaged and fully integrated and the client does the input.

I see.

That's a good overview.

I appreciate it.

Next question comes from Gary Krishnan with Credit Suisse.

Couple quick questions.

Could you update us on what you've seen recently or what you expect to see this peak selling season with respect to pricing from your large national competitor?

We'll be out there every day and he'll do what he's doing and we'll react to it but right now fortunately his pricing activities haven't changed too much over the last six months.

Okay.

So it's not less or more, just about the same.

Yes.

And then within your full year guidance, what's implied revenue from your health and benefits product?

Consistent with what we had, we had 29% growth so it's in there but again, it's not a big enough number where if it misses a little bit it's going to make much difference.

Not at this stage.

Will eventually but not this stage.

Thank you.

We have no further questions.

Thank you very much.

Again, we really appreciate your interest in Paychex.

We think we have a good process here and we wish all of you, your friends and your families a wonderful holiday season and a safe one.

So thank you very much.

Thank you.

This concludes today's conference.

Please disconnect at this time.