沛齊 (PAYX) 2012 Q1 法說會逐字稿

Welcome and thank you for joining Paychex first-quarter results conference call.

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

(Operator Instructions).

Today's conference is being recorded.

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

I'd like to turn the meeting over to Mr.

Martin Mucci, President and CEO of Paychex.

Sir, you may begin.

Thank you.

And thank you all for joining us for our first-quarter fiscal 2012 earnings release.

Joining me today is Efrain Rivera, our Chief Financial Officer, and John Morphy.

Efrain will review our first quarter financial results and guidance after my opening comments.

And then we'll open it up for any questions.

We are executing our plans to continue to be the leading provider of payroll, human resource and benefit outsourcing to America's businesses.

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

We are pleased with our operational and financial performance during the first quarter.

Checks per client have improved 6 consecutive quarters, with first quarter growth at 2%.

Payroll client retention has demonstrated continued improvement in the first quarter.

Payroll ancillary product penetration also increased for the first quarter over the same quarter a year ago.

And although the selling environment remains challenging in light of weak new business formation, all of the initiatives we completed in the past fiscal year that we have talked about in previous calls are in place.

Including the updated compensation plan for representatives, our revised training programs, and next generation sales force tablets with improved lead generation and tracking tools.

I believe we have everything in place to continue to support our sales team's ongoing success.

In the first quarter we have experienced an improvement in payroll sales representative turnover, a statistic that had increased in the same period just a year ago.

I would also like to take a moment to talk about the recent hiring of our new sales leader.

As you're aware, Mark Bottini, formerly at Ricoh, will be joining Paychex in mid-October as the Senior Vice President of Sales.

I'm excited to have Mark onboard and look forward to working with him.

Mark brings extensive experience with a 24-year career in sales at Ricoh and Ikon, and strong leadership, having managed over 3,500 sales reps at Ikon and Ricoh, and is responsible for all US sales for the Company.

He was able to join me at our recent year-end sales recognition event last week and his presence was received positively there.

And he was able to have focus sessions with many of the Paychex top sales performers.

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

Client satisfaction results continue to be at exceptionally strong levels.

We find this a particularly telling metric, in light of the increasingly complex payroll and human resource services rules and regulations our clients are required to adhere to.

While continuing our product development investment in Paychex next generation applications, we were able to achieve strong operating margins in the first quarter through continued productivity in our operation team.

While our results for the first quarter were encouraging, we have not changed our expectations on full-year guidance from that provided in June.

Our expectations are that increases in checks per client will moderate through fiscal 2012 as quarterly comparisons become more challenging.

We expect the favorability in expenses and leveraging to moderate as we continue our planned investments.

Our 2 acquisitions in 2011 are creating excellent opportunities in both their markets.

SurePayroll providing us our anticipated entry into the online market, software-as-a-service product, an area positioned to grow as the 5 million small businesses who calculate their payroll manually move to the Web.

We continue to penetrate the financial advisor marketplace with ePlan Services, further expanding our successful 401(k) service growth.

Both SurePayroll and ePlan offer quality service.

And from a client control standpoint, we offer a full range of payroll outsourcing alternatives.

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

I would now like to turn the call over to Efrain Rivera to review the financial results.

Efrain.

Thanks, Marty.

Yesterday afternoon after the market closed, we released our financial results for the quarter ended August 31, 2011, and we filed our Form 10-Q.

It provides additional discussion and analysis of the results for the year.

These are available by accessing the IR page at Paychex.com.

This teleconference is being broadcast over the Internet and will be archived and available on the website for approximately 1 month.

I'd also like to take a moment to thank John Morphy for his presence here today and for his invaluable assistance in my transition to Paychex and to introductions to the analyst community.

As Marty said, we're pleased with the financial results for the first quarter of fiscal 2012.

I'll discuss some of the key highlights here.

Checks per client, as Marty indicated, increased 2% for the first quarter.

This was consistent with the growth we saw for the fourth quarter of fiscal 2011.

Total service growth grew 9% in the first quarter, but excluding SurePayroll and ePlan, our total service revenue growth would have been 7%.

Operating income, net of certain items and as a percentage of service revenue increased to 39.6%, from 37.3% last year.

This increase is driven by the management of personnel costs, expenses, and timing of spending on certain investment projects.

Typically, our first quarter reflects the highest operating income net of certain items as a percent of total revenue in a given year.

Operating income, net of certain items as a percentage of service revenue over the remaining quarters, is expected to moderate and to be more consistent with our full-year guidance as we continue planned investments for the balance of the year.

The interest rate environment remains at historically low levels.

Fed funds has been at a range of 0 to 25 basis points since December 2008.

Our combined portfolios have earned an average of 1.3% for the first quarter compared to 1.5% for the same period last year.

In the first quarter we shifted from variable rate demand notes to FDIC insured deposit accounts, as the earnings on these accounts are currently outperforming the yield on other high-quality short-term investment vehicles, particularly agency discount notes.

Now I'll take you through our results as presented in the consolidated income statement with some additional highlights for the first quarter.

Payroll Service revenue increased 6% for the first quarter to $382 million.

Organic growth in Payroll Services revenue, excluding SurePayroll, was 4% for the quarter.

We benefited from strong checks per client and improved revenue per check.

Revenue per check increased as a result of price increases and improvements in discounting in our overall client base.

Human Resource Services revenue increased 17% to $170 million for the first quarter.

Excluding ePlan, HRS revenue growth for the first quarter would have been 14%, which is comparable to the 13% growth in HRS revenue for the fiscal 2011 first quarter if we exclude revenue in the prior year from our Stromberg operations divested in October 2009.

Our first quarter HRS revenue growth reflects client growth and price increases.

Some additional highlights of contributions to HRS revenue growth are -- Paychex HR Solutions client employees increased 12% to 587,000 employees as of the end of August 2011.

We have seen positive results from increases in both clients and client employees.

Our product offering, Paychex HR Essentials, contributed to this growth in clients and client employees.

Insurance services has experienced continued growth, as both workers' comp insurance and health and benefit services advanced in the first quarter.

Health and benefit services revenue continued its strong growth since inception, increasing 24% to $12 million, driven by an increase in the number of applicants.

Human resource service revenue quarterly growth can fluctuate from the timing of set-up fees, PEO workers' compensation, and basis points earned on retirement services client employee funds.

The greatest impact on basis points comes from fluctuations in the financial market, in addition to asset value of funds invested.

PEO net service revenue also exhibits greater variability between quarters due to a number of factors, including changes in workers' comp claims experience.

Combined interest on funds held for clients and investment income decreased 7% for the quarter.

Yields available on high-quality securities continue to remain low.

Expenses increased 5% for the quarter, largely due to the inclusion of expenses from SurePayroll and ePlan.

In addition, continued investment in product development and supporting technology contributed to the increase for first quarter.

Operating income net of certain items, which excludes interest on funds held for clients, increased 16% to $219 million for the first quarter.

As discussed previously, operating income, net of certain items as a percentage of total service revenue, was 39.6% for the first quarter, compared to 37.3% for the same period last year.

Now let me take you through our financial position.

It remains strong with cash and total corporate investments of $718 million as of August 31, 2011, up from $671 million at the end of last year.

Our cash flows from operations were $187 million for the first quarter, a slight decrease as a result of changes in operating assets and liabilities due to timing, partially offset by higher net income.

Funds held for clients as of August 31, 2011 were $3.1 billion, compared to $3.6 billion as of May 31, 2011.

But funds held for clients vary widely on a day-to-day basis, and it's better to look at the average which was $3.3 billion for the quarter, a year-over-year increase of 10%.

Higher average investment balances are primarily a result of the inclusion of SurePayroll client funds, wage inflation, increases in state unemployment insurance rates for the 2011 calendar year, and an increase in checks per client, which we discussed previously.

Total available for sale investments, including corporate investments in funds held for clients, reflected net unrealized gains of $70 million as of August 31, 2011, compared with net unrealized gains of $59 million as of the end of last fiscal year.

The 3-year AAA municipal securities yield decreased to 41 basis points at the end of our first quarter from 80 basis points as of May 31, 2011.

Our investment strategy is conservative.

We have not recognized or realized any impairment losses for our investments.

Our investments have high credit quality with AAA and AA ratings and short-term securities with A-1/P-1 ratings.

More than 95% of the portfolio is rated AA or better.

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

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

Total stockholders equity was $1.5 billion as of the end of August, reflecting $112 million in dividends paid during the first quarter.

Return on equity for the past 12 months was 35%.

Now turning to fiscal 2012 guidance.

The guidance that I'm about to speak to is based on 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.

Although first quarter results were encouraging, we anticipate fiscal 2012 results will be consistent with the expectations we had when we issued our guidance in June of 2011.

Our expectations are that checks per client will moderate through fiscal 2012, impacting quarterly comparisons in both Payroll Revenue and HR Services revenue.

We don't expect the expense leveraging realized in the first quarter to continue throughout fiscal 2012 as we continue with planned investments in technology.

Reaffirmed guidance is, Payroll Service revenue to increase in the range of 5% to 7% compared to fiscal 2011.

HRS revenue growth to be in the range of 12% to 15%.

Total service revenue expected to increase in the range of 7% to 9%.

Interest on funds held for clients expected to decrease in the range of 12% to 14%, due to longer term investments maturing and being reinvested at lower rates.

Investment income net is projected to be in the range of flat to 2% growth.

This is lower than what we normally experience due to the cash outlays in fiscal 2011 for business acquisitions.

Net income is expected to increase in the range of 5% to 7%.

Operating income net of certain items as a percentage of service revenue is expected to be approximately 36%.

And the effective tax rate for fiscal 2012 is expected to approximate the first quarter tax rate that was 35.6%.

That's a tad higher than we discussed in June.

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

The average rate of return on combined interest on funds held for clients in corporate investment portfolios is expected to be 1.2% for fiscal 2012.

As of August 31, 2011, the long-term investment portfolio, which excludes VRDNs, had an average yield at maturity of 2.5% and average duration of 2.6 years.

In the next 12 months, approximately one-fifth of the portfolio will mature, and it's currently anticipated that these proceeds will be reinvested at a lower average interest rate, approximately 1%.

Under normal financial market conditions, the impact to earnings from a 25 basis point decline in short-term interest rates would be in the range of $3.5 million to $4 million after taxes for a 12-month period.

Such a basis point change may or may not be tied to Fed funds.

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

Purchases of property and equipment in fiscal 2012 are expected to be in the range of $90 million to $95 million.

Fiscal 2012 depreciation expense is projected to be in the range of $75 million to $90 million (sic - see Form 10-Q).

And amortization of intangible assets for fiscal 2012 is expected to be in the range of $20 million to $25 million.

Up due to intangible assets acquired with SurePayroll and ePlan.

Before we go to the Q&A, and I turn it over to Marty, I just wanted to make sure that everyone understood.

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

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

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

Thank you, Efrain.

Operator, we'll now open up the meeting and conference call to any questions.

(Operator Instructions).

Jason Kupferberg of Jefferies.

Just a couple of questions here to start off.

I don't know if I missed this but did you guys give any of the specific metrics around client losses, retention, new sales, growth in the overall client base?

Because I know we usually pick some of those up in the 10-Q.

No, normally we pick it up -- we give it at the year-end but we don't give specific client growth numbers except for pretty much the end of the year.

What about on the retention side?

I thought you usually did give those on a quarterly basis.

Normally what we say, Jason, is how we're doing overall.

And what we've seen on client retention is improved -- continued improvement.

It's about 7 quarters in a row now that we've seen some improvement.

It's moderate but it's still showing improvement over certainly the first quarter last year.

Jason, there were selected quarters last year where we discussed particularly losses and retention, simply because the environment, we felt it was important to give that disclosure so that people understood what was happening in the environment.

We'll return to more normal practice as the environment seems to have stabilized and report typically at the end of the year.

Are you guys in a position to comment whether new sales were positive versus flat or negative, any directional sense, just on a year over year basis?

I know you can't give specific numbers but anything directional you can share?

We know what the information is, obviously, but here's the challenge.

If you look back at previous years and you try to project off of what we were seeing on a quarterly basis, without taking into account the fact that our big sales quarter is in the third quarter, you end up making erroneous assumptions.

So we try not to go with quarterly updates because, frankly, until we've gotten through the selling season, the numbers won't be meaningful.

I know you recently hired a new head of sales, so congratulations on that.

Would love some color just in terms of the qualities you saw in this individual to make you believe he'll be a good fit.

And should we expect any meaningful changes in sales strategy going forward?

I know he hasn't officially started just yet but just any color there would be helpful.

And maybe as part of that, if you could give us any update on actual sales force turnover.

Sure.

I'll start with the sales force turnover.

I did mention in my comments that we saw an improvement in the number there.

We peaked up last year, started to go a little bit higher around the first quarter.

We've come down substantially.

We're actually a little bit lower than the normal.

I think we've given that before, that the norm is low 30%s -- 30%, 32% -- and we were lower than that in the first quarter.

So we felt good about that, although that can fluctuate quarter to quarter.

But just from comparison to last year first quarter, it certainly has come down.

And we feel good that all of the steps we took place last year -- new comp plan, new sales tablets and tools, new training -- all those things we got done in the last fiscal year to start the new fiscal year, we felt have been received very favorably.

On Mark Bottini, thrilled to have Mark join Paychex.

He comes to us with a 24-year career at Ricoh and Ikon before Ricoh took them over about 3 years ago.

He was at the same place for 24 years.

Started as a sales rep, moved his way up with increasing responsibility over his career.

And has been in the last few years leading all of US sales for Ricoh, over 3,500 sales reps.

So he had the experience of a very large sales force.

He had the experience of dealing with small and mid-sized business clients, renewing and getting their business, new all the time, which was important to me, as well.

I also felt that he fit in very well with the culture here, based on his background.

He's a person who is very focused on results, very quantitative in the way he approaches things.

I don't see major changes right off the bat.

What I like about Mark's approach already is he came to the sales conference which we had last week, which honored some of the top-performing sales reps.

He was able to fly in on a Sunday and back out on a Monday to visit there with the top-performing sales reps.

Came off very well and gave a general introduction to everyone at the general session we had there.

So he's very involved, gets well into the details, and is learning very, very quickly about Paychex even before he starts.

So to me, it was great experience, a large sales force, certainly a lot of experience with small and medium-sized business clients, and gaining new business all the time from them.

And certainly a good cultural fit, a person of very high integrity and someone who really gets into the details and focuses on results.

Just last quick one from me.

What are some of the specific investments that you're expecting to increase during the balance of fiscal '12?

I know you said there's some timing issues there and more of that will be over the last 3 quarters of the year.

We've continued to invest in what we call Paychex next generation applications.

And you'll see some of these things roll out.

We have basically releases over the year.

And we've continued to invest in this actually for the last number of years.

About 2 years ago we finished our conversion of our entire payroll base over to what we call core advanced or advanced application that we built over the preceding number of years.

And now the next generation, Paychex next generation, is taking that and building on top of that.

And we have releases throughout the year on that that our customers will see.

We don't release all that information until we're ready to announce that it's coming out.

But the first thing will be you'll see an expansion of our reports and iPad technology, so tablet technology, to be able to receive all the reports and so forth in the next few months.

So we'll continue these investments.

They've been continued investments but they do fluctuate quarter to quarter.

Joseph Foresi of Janney Montgomery Scott.

My first question, I was just wondering maybe you could talk a little bit about the market size.

Is it safe to say that with new sales growth stunted the market size is basically stagnant?

Joe, part of the challenge that we have is that the authoritative data is only available on a 9-month lag.

And so what we know is that at the end of 2009, the market had dipped to about 700,000 new business formations.

This is Bureau of Labor statistics data.

And then in August they released the 2010 data, which showed a bump-up of 3% to 4%.

So what we're seeing, or what we can infer from that data, simply is that there's very, very modest growth.

That compares, by the way, as many of you know, to a traditionally 750,000 to 850,000 new business starts.

So we're still below what would be normal business starts in the environment, and just gradually inching our way up.

We will see with the release of the first quarter data where we're at.

The point of my question was, I was wondering, have you seen any changes in the behavior in the competitive environment, given the slow incremental increases that you just cited?

Any changes on pricing?

Any new competitors entering the market?

Any of your other competitors and yourselves as far as market share gain?

Because I know you cited, obviously, the retention number a little bit.

Not necessarily.

We haven't seen much change in the competitive environment.

It's been pretty much the same.

There's really 2 major players out there, then there's some of the regionals.

We've actually, I think, seen a little bit more of a pick-up from the regionals and some of our pricing bundles and so forth over the last year.

And as far as the other national competitor, it's pretty much the same.

Haven't seen a lot of changes.

And in fact, I think we talked about we introduced a price increase in the May time frame and have seen really very little reaction to that.

So we feel that the pricing power has been good.

And the discounting, it seems to be well under control.

And then just the last question from me.

Maybe you could just talk a little bit about SurePayroll, your judgment how it's performing, what the integration has looked like and how that's gone, and maybe your expectations for that piece of your business going forward versus more of the services side of stuff.

Yes, sure.

SurePayroll has, I think, done very well.

From a sales standpoint they have been pretty much right on track with some of the numbers that we had expected.

I think they're performing very well from a service perspective, as well.

And we somewhat left them with their name and their product out there, but keeping them very close as far as any integration that we can do behind the scenes and so forth.

And we've made some of those steps already to integrate some of the back room functions and so forth.

But they're doing fine.

They're right on track with our expectations and I see that business just continuing to grow double digits, as they have been.

Julio Quinteros of Goldman Sachs.

This is actually [Roma Lionick] for Julio.

First, can you go over maybe the items that drove the strong margins this quarter?

And I understand that the ongoing investments are going to be a partial offset in the remainder of the year but why won't those signs repeat themselves?

First, Julio, we mentioned checks per client.

That was an important factor in the year.

While we counted on the price increase, it stuck and we always expect a little bit of give-back.

But that was a positive.

The other part is that with respect to the IT spending, the project spending, it ramps during the year.

It ramped a bit slower in the first quarter.

We still remain committed to spending on the project.

So we got some favorability on that, in that end.

And the other thing I would say is that Marty and I and John really made an emphasis at the beginning of the year, given the uncertainty in the economic environment, to make sure to ensure that spending remained at moderate levels.

And that we didn't open the flood gates until we had a better sense of how the year was going to perform.

And I think that the culture here, the culture of the Company, is a very disciplined culture when it comes to cost.

And I think that people took that advice and were careful.

And we were able to get leverage in a number of areas, particularly on the operations side, that helped drive favorable margins.

And then on your guidance, I know you can't speak to specific numbers but just in terms of your expectations for sales, can you tell us maybe directionally whether sales in the first quarter were in line with expectations, above or below?

And we're in October now, so how that's trended after the first quarter?

I would say this, that we won't get into a quarterly sales comparison, frankly again, because until you've gotten into the sales season, whatever we say about a specific quarter, frankly, won't mean much until we have those results.

So we'll update as we go through the year.

Gary Bisbee of Barclays Capital.

If I could just probe the cost side a little bit more.

The 10-Q had a line in there that there were some costs that were delayed or deferred.

Is that that IT and project spending you mentioned earlier?

Are there any other areas that you would expect costs, or would you be willing to quantify at all how we should think about cost growth trending from here into next quarter and the 1 after?

I think the comment was really around the ramp of spending, that we didn't delay or defer costs in that sense.

What we assumed we would spend on that side, we're going to spend for the year.

And now that you're closing in on, or maybe it is 2 years since you launched the last upgrade to the core payroll processing platform, how much productivity benefit has the Company achieved to date on that?

I remember early on after the roll-out there was some commentary for a few quarters there about being very optimistic, relative to initial plans.

But I don't feel like we've gotten real follow-up on the magnitude of savings that have been achieved over the last year.

Yes, I don't know if we ever got specifically asked.

I think if you look at it from a clients per payroll specialist, that's how we look at it, if you went before the upgrade to the new platform we were probably, a few years ago, back in the high 180s, and are now closer to 220 to 225.

And so pretty significant increase in the productivity of the number of clients we're able to handle.

In addition to that, you have more online functionality that the clients have.

So they can get the reports much easier, they're much better reports, I think, and easier to use.

And they can also input their payroll online in an easier fashion with the new platform we've been on for a couple years now.

But fundamentally, if you look at it from an operational savings perspective, it's that increase in the number of clients that each specialist can handle.

And there's other things like training of new specialists that's much easier and so forth.

But that would be the big one.

While we don't separately disclose that, I think that you can get a good sense that we've been able to offset a lot of increased IT spending from savings on the ops side which is part of why we've been able to maintain the margins that we've been delivering.

And then just one last question from me.

Efrain, now that you've been at the Company for several months, any thoughts on your end about maybe having different views than what's been done historically, whether it's thoughts around reinvestment of the substantial excess capital and maybe how much cash you need to keep on the balance sheet.

Or any other thoughts around maybe investment versus the constant drive to generate margin gains.

Or anything else.

Or are you pretty much looking at things similarly to how it's been done historically?

Thank you.

Most of my friends who know me, know I'm a pretty independent thinker.

So I came in and I looked at what Paychex did.

And certainly coming out of the life sciences area, there are many, many differences in the business.

I will say this.

One of the things that distinguishes Paychex from other companies that I've been associated with is we literally have opportunities to grow in every single segment of the business, which frankly is what drove a lot of the strong performance in first quarter.

I think with respect to our approach on excess capital, I really think that we've done a really good job treating shareholders correctly.

And we always need to be looking at a combination of return of capital based on higher dividends and, where applicable, while we are not being sole decider's, we would recommend to the Board, I think that as cash builds up in the past we have used that to purchase shares.

That's something that certainly warrants a lot of attention.

I think the fundamental business model, the point I want to make here, is this isn't simply a statement about drinking the Kool-Aid, it's that Paychex has a very, very powerful business model.

I think we have opportunities for growth literally as we run up and down each of the business segments that we participate in.

And I think that if we can get the right kind of execution, we'll continue to drive positive results into the future.

Rod Bourgeois of Bernstein.

So on the margin expansion front, it's nice to see the growth start to the year.

But on the margin front, you're not planning to achieve margin expansion in fiscal '12.

I wonder, are you confident in being able to return to margin expansion in the fiscal '13 time frame.

And if so, can you dimension for investors why the investments you're making in fiscal '12, seemingly most of this on the technology front, why those investments will not need to be made to the same extent in the future, after fiscal '12?

Okay, you've got a compound question.

So I'll start with that and then turn it over to Marty.

With respect to the margin expansion question on going forward, it's a little early to look at what's happening next year.

Frankly, a lot of that will depend on what's happening in the business environment, what is happening with sales.

I will say this.

We have a discipline of leveraging expenses against sales growth, so to drive margin expansion.

Now, how will that look?

Frankly, it's a little bit early in the game to quantify that but we'll be looking to do that in the year.

I would remind you, Rod, of one other thing, that while it isn't apparent completely from the guidance that we issued, both in June and reaffirmed now, remember that we have cost of acquisition that are masking leveraging that existed in the underlying business.

So yes, we expect that we will be able to continue to leverage going forward.

With respect to continuing investment on the IT front, I'll turn that over to Marty to talk about how we're looking at that going out into the future.

Yes, I think Efrain makes the first point, Rod, that certainly we're always looking to leverage the revenue growth.

The focus is very much for the whole team on growth and leveraging that to drive additional margin, just as we have in the past.

We've always focused on also driving productivity in the operations side, as we just talked about, to fuel a lot of the investments in IT.

The IT spend is up and the operations spend is pretty flat because of the productivity.

And we've always tried to drive that into IT investments.

Those investments I feel will continue for quite a while.

You want to continue to stay on the leading edge on the product side, as we also continue to look at acquisitions and how they can help add either on products or in more technology to the existing products.

So you'll continue to see us add continued investments there but we're always looking to leverage the growth that we have in the revenue and the top line.

I think I should probably throw a comment in, in fairness to Efrain.

He was not here when the budget was done.

When we did the budget, we did it without the acquisitions basically.

Originally we had our normal 2 points of leveraging above revenue growth.

Then when you laid the acquisitions in, the amortization of intangibles eliminated that.

So we were basically flat on that in this year but we got some good growth in revenue.

And I would expect that when you get to '12, unless there's something else like that, which we don't know of at the moment, you'll be back to leveraging.

So really, the year of leverages, it's just the 2 new acquisitions that caused the intangibles.

One other question.

So on the MMS business, can you give us any update on the MMS business and how it's doing relative to the rest of the business?

And if you could specifically comment on whether Paychex is making progress and beginning to win deals with larger-than-normal clients.

In other words, are you moving up the food chain?

I would say we're continuing to be pretty steady there.

The MMS business, we've added a lot over the last few years.

Time and attendance online and HR administration online.

Partnered either through those acquisitions or builds, or also partnering with expense reimbursement partners and so forth.

And then of course BeneTrac, when we purchased BeneTrac to offer full enrollment, benefit enrollment type engine to clients.

So our focus has been, over the last couple of years, to then take all of that and integrate it, and we're continuing to do that.

And I think, actually just coming out of a sales conference with our top sales performers and talking to the MMS top 10 performers, very competitive.

They feel like they have all the product they need and we're continuing to perform well against competition.

I wouldn't necessarily say that we're moving up market.

I think we've always had a pretty broad range there.

But certainly with the additional tools we've added, we've done very well competitively, I think.

Is MMS continuing to outpace in terms of growth the rest of the business?

And can you give us an order of magnitude of by how much, if so?

It continues to outpace the core payroll business.

We won't give an order of magnitude for competitive reasons.

Tim McHugh, William Blair & Company.

Yes.

First I wanted to ask if you could just give a little more color around HR Essentials which seems to be ramping up nicely for you guys.

Can you talk a little bit about just -- I probably don't understand it as well as I would like to -- how that fits into the product suite relative to the ASO model and just how significant is that now?

You seem to be talking about it more.

The way I look at it, HRS is a 3-legged stool with services, solutions and insurance.

And then within the solutions business, we have a smaller 3-legged stool which is HRE, ASO and PEO.

Our salespeople can meet the customer at a number of different price points.

One of the things that I thought was a good innovation last year was we found that there were customers who didn't want the full outsourcing solution either in the PEO form or in a co-employer status or even at the ASO level.

And what they wanted was documentation and telephonic access to an HR representative.

That is really frankly taken off and is selling very well.

And so it basically forms, I would say, 1 of the 3 legs of that stool and the more value-priced option for HR outsourcing.

I think it gives us a chance to offer those clients who don't want the full ASO or PEO, a way to get in and get a handbook, an employee handbook, as well as telephonic support.

You can actually either go back to them later and sell them the full, as they grow.

Or as they have additional needs that we may see from the telephonic support, we have an opportunity to go back to them as well and say, would you now like a full HR person that is available to you and is dedicated to you, to your company.

Is there any risk of cannibalizing the prior ASO or PEO sales as people trade down, now that that option is more available?

We haven't seen much trading down.

I think there was always the risk when you go in, do they buy the lower priced HRE instead of the ASO or PEO.

We haven't, from what we can see, we haven't seen too much of that.

Obviously we are looking for expansion of those business opportunities.

And I think what you do find is, if there is some people taking the lower priced HRE, it's probably because that's where they were going to end up anyway.

And they would take the full ASO but then after 6 months or so decide this is too much for me, I don't need all this.

The HRE is fitting very well for those clients right off the bat.

So they're getting a handbook and telephonic support.

So we're not seeing cannibalization of prior sales.

And right now we're not seeing, we don't think, too much of a loss of folks who really needed the full service ASO versus HRE.

And then Efrain, I wanted to ask about just if you could talk a little bit more about the yield on the client funds in relation to the Fed's operations that they've announced to try and drive up short-term rates and drive down longer term rates.

We've seen the 5-year Treasury move down a fair amount.

Can you talk a little bit how that impacts the portfolio and if it at all changes how you think about the yield and what you might be doing?

Yes.

A couple of comments on that.

First, just as backdrop, at the end of the year we were more heavily invested in variable rate demand notes.

That was about an 8 bips return on those.

There was a lot of uncertainty around what was going to happen with Congress and the whole debt issue.

We moved into FDIC insured deposits which is where we have reasonably good returns.

That's more on a net basis up in the 10 bip range.

That has a little bit of an impact on the tax rate, by the way, because those are taxable.

Our mix of taxable versus non-taxable has changed.

Really, frankly, too early to tell.

We're not seeing a dramatic change in any of those factors.

And it's a little bit hard to peg yet what's going to happen on the real short end of the interest rate curve.

We don't expect a significant change, I would say that now.

Give you an example.

We were at a point heavily invested in agency discount notes which are yielding 0.1 of 1 basis point.

So down on that end where we need to preserve liquidity and safety, I would say the only impact we could have is if we see some lack of availability on investments that have been available to us.

And it's a little bit early to call.

We were watching with interest the development that Bank of New York Mellon started.

Fortunately, that has not spread to other banks around charging for deposits.

We expect, based on what we see, the environment to stay about where it is now.

David Togut of Evercore Partners.

Efrain, you mentioned a reduction in discounting within your overall client base in the August quarter.

Could you quantify the actual reduction in discounting and how that compares to what you saw in the previous 12 months?

Yes, we don't get that specific around the impact of discounting.

I'll just say that we saw more of our units sell closer to the price that we had planned.

And in some cases actually slightly above that, because we have tightened up the parameters around discounting.

We talked about that in prior calls.

So there's less ability to discount.

And I think that field sales now understands that pricing parameters are tight.

Can you give us a sense of what the average level of discounting is versus list price?

I wouldn't do that, because it's a competitive issue.

We monitor that very closely.

We know what our competition is doing and we don't want to give them any more information than they need to have.

Just a quick follow-up then.

Marty, you highlighted some next generation applications for the payroll services business, particularly an iPad application.

How does that iPad application stack up against ADP's run product which also has an iPad app?

We certainly think it will stack up very well.

We feel we've been very competitive with them.

I think that as they've introduced some things this fall, I think we'll be very close to, certainly very competitive with what they have.

When you say very competitive, do you mean you have the same functionality at the same price?

Can you give a little more insight?

From a competitive standpoint I don't think I want to give too much out there.

But I certainly feel that we're very price competitive and I think very feature and functionality competitive, as well.

Glenn Greene, Oppenheimer.

Just wanted to drill down a little bit on the 2% growth in checks per client.

Obviously it's been pretty steady here, I think you said, for 6 quarters.

Are you surprised it's held in as well as it has, especially given the deceleration in the broad employment trends we're seeing that seem to have stalled out and flattened?

Are you expecting it to flatten out by year end?

I think we have felt that it will moderate as the comparisons get tougher.

And if sales from new businesses pick up, typically they're smaller and that drives it a little bit flatter, as well.

But right now, we're seeing that the current client base, both from a retention standpoint, meaning fewer going out of business, and the checks per client on a year over year basis continues to improve.

So we think the current client base is still adding employees and we feel pretty good about that, obviously.

Having looked at checks per client for 15 years, my feeling would be that this statistic will stay about where it is unless small business decides to dump employees, which usually happens in a short period of time.

And we have no indication of that happening at the moment.

So I think there's still going to be hiring, and as long as new business starts aren't strong, that number could stay positive for longer than we anticipate.

Unless the shoe really drops on the economy and small business says -- we don't have confidence, we're going to start shedding employees.

Again, I want to reaffirm, we have not seen any of that at this point.

Yes, it seems like, actually hopefully we're past that kind of worst point.

You never know.

But we certainly haven't seen it.

Is there a read-through that small business from hiring perspective is somewhat better than the broad economy?

I don't know that.

They don't hire and fire people the same way.

The larger companies, they react immediately.

It doesn't matter.

It's good, bad or indifferent, it's the way it is.

They just dump people.

I'm not saying they don't care about their people, but they do what they've got to do.

The small business person knows his people.

He doesn't lay them off unless he has to.

And once he goes through the issue of laying them off he doesn't hire them back any time quick.

I think they just perform slightly different because they're not on quarterly reporting, obviously.

They're owned by owners who can have longer term outlooks.

They're just not the same types of businesses.

Just on the pricing side, and I know the rate card increase looks like it's stuck.

You've tightened up the discounting.

But maybe you could talk a little about the pricing dynamic competitively, going after new business, both from regionals, from the big national vendor, and maybe even from some of the do-it-yourself vendors, what you're seeing competitively on pricing for new business.

Haven't really seen much of a change from the competitive environment there.

I think both are still very competitive.

We're still running into them about the same number of times.

And we have not really seen much of a change.

We felt good about the fact that the price increase could go in in May and be held and that discounting is holding, as well.

So I haven't seen a lot of change in the competitive environment.

So nothing's gotten irrational.

No.

No, pricing is in 2 pieces.

On the client base, pricing is better.

Price increases went in -- the last 2 or 3 years have still done quite well.

This one probably went better than the rest.

And the new pricing on new sales remains competitive but the discounting isn't quite as crazy as it was.

Jim MacDonald, First Analysis.

Could we go back to the HR services area?

Was there anything special in this quarter that's not expected to repeat throughout the rest of the year?

I think as you look at it, we had the new acquisition, ePlan come in, so that did give us a pop there.

That will be there until the comparison shows up and moderates that.

But we've had good growth, we felt, in HR Solutions.

The HR outsourcing had continued good growth, the health and benefits, health insurance basically and our workers' comp.

And in 401(k), as well.

Obviously 401(k) was up about 12% with the acquisition, and about 4% without.

But we're still seeing additional retirement service clients.

And we're still really number 1 in that industry, so we feel really good about starting the most new plans of any other company.

Jim, I'd say that we saw strength, frankly, in all 3 of the businesses.

We typically don't come out of the gate charging that way.

We talked about HRE, that helped the results.

401(k), Marty just mentioned.

And insurance was another part of the business that did very strong.

Do we expect it to be that strong for the rest of the year?

No.

More in line with the guidance that we had.

But frankly, that's pretty strong guidance so we expect that we'll have a good year on the HRS side.

And specifically on the PEO, anything there?

I noticed in the Q that your direct costs were lower actually this year.

Does that mean the business is shrinking?

No, it's not shrinking.

In the first quarter, as I mentioned before, you've got 3 options in terms of the sale that you can make on the solutions side.

PEO, ASO, HRE.

HRE and ASO were strong in the quarter.

PEO was relatively weaker.

I would say you can't infer anything from that, simply because we're going into renewal season.

We now know what our rates are for things like health and benefits, and we'll get a better read on that as we get into next quarter.

And just a quick follow-up there.

Any thoughts on what type of health increase you're going to have to take to the market?

Is it more than or less than the market at this point?

Look, I won't quantify it but I'll say it's less than market.

Tien-Tsin Huang of JPMorgan.

I just wanted to ask about the pricing.

How much of that is a function of the new pricing model?

I know you talked about competition and what-not.

I wonder how much is a response to the new pricing.

Can you clarify the question?

I just want to make sure I understand.

Yes, I'm sorry.

In the past you guys talked about changing your pricing model a little bit.

Not the levels but just the way you go about pricing.

So I'm just curious what you're seeing about pricing sticking, if that's a function of that.

Okay.

I would say, what we did is, last year, last fall we reset some of the bundles of products and so forth and some of the pricing with those.

And then changed some of the parameters of discounting.

But the price increase on top of that was fairly normal in the May time frame and I don't think that had a lot to do with it.

But it did stick.

So we felt very good.

As John said, for the last 3 years, this was probably the best one.

I don't think it had too much to do with that because that pricing, the new bundles had been set last fall.

So we felt pretty good about, from a competitive standpoint, that the pricing stuck and the discounting has moderated.

The pricing changes we made a year ago, we modified some in relationship to how ADP reacted.

And right now I think we're not as strong on it as we would have liked to have been but we're better than we were.

Just on SurePayroll, it sounds like it's performing well versus plan.

Has it changed your thinking at all about growing the self-service sales market at all?

No.

From our standpoint there's still a big opportunity that we knew wasn't going to happen overnight.

But as 5 million businesses, small businesses that do payroll on their own manually with pen and paper and calculator, we still feel that that's going to be happening over time and that they'll be perfectly positioned for that.

And in the short term they've been performing very much on what we expected.

So we feel very good about that market continuing to grow and be an expansion for us, not really a cannibalization but more of an expansion.

Given that -- last question, just on the acquisition pipeline -- could we see more from Paychex in the way of more on the self-service side?

Or is it more adding to the products with the full-service suite?

I think probably it's more on the product side but we continue to look at all kinds of opportunities that are out there.

I think it's a pretty active environment and it's just always obviously getting the right value for something that's there and if it fits.

But it's always typically more on the product side.

But when you look at ePlan, when we purchased ePlan for the retirement services, that was more of a self-service but focused on the financial advisory community for 401(k) set-up.

So that fit both.

It gave us additional product breadth in 401(k) retirement services but it also targeted an online service alternative for financial advisors.

So it could be a little bit of both.

I think both are of interest to us, that's for sure.

They'll be smaller and they'll tend to be tuck-in acquisitions.

Matthew O'Neill, CLSA.

This is Matt O'Neill on the line for Craig Maurer from CLSA.

Just had a quick housekeeping question.

I noticed in the release the payroll client number wasn't updated from the 564.

And I don't know if that's maybe no longer relevant with the SurePayroll acquisition.

I was just curious about that or how to think about that.

Matt, I think someone else asked that question earlier.

We don't do that every quarter.

We'll do that on occasion if we think there's some significant shift in the market that the analyst community should be aware of.

Marty mentioned earlier retention looks good, losses from business failures continue to moderate.

We're back to a more normalized environment.

So we won't be releasing that on a quarterly basis.

Okay, sorry about that confusion about that number.

Likewise, with SurePayroll, is that being viewed at all internally as a potential market to look to upselling any of those clients whose needs may change and may be looking for a more comprehensive solution as they might grow?

And now you guys have the full Paychex corporation behind SurePayroll clients to look to with that?

Sure, it's always an opportunity.

And I think SurePayroll had started to do a pretty good job of adding ancillary products even to those clients on what they had.

So offering 401(k) and so forth.

And we'll certainly add to that.

If clients want to move from doing it themselves and more of self-service to the full service, we certainly have that, as well.

And they're ready and there's a good connection already between the 2 sales teams.

So where SurePayroll does everything over the phone, if someone calls in and wants to upgrade, they certainly will pass that lead on to the Paychex sales force to close.

And frankly, on the other side of it, is our sales force is out selling and sees if there's a client that doesn't want full service, but is looking for a self-service alternative to get started, they will refer that over to SurePayroll.

So we've nailed that down on both sides.

So certainly as there's opportunities there we're going to capitalize on it.

Mark Marcon of RW Baird.

I wanted some clarification with regards to the client retention questions.

Aside from just the pure decline in terms of the number of companies that are going out of business, are you seeing retention improve aside from that dynamic?

We don't always break all that out but I think we've seen it continue to improve.

I think this is the seventh quarter in a row that the overall numbers continue to improve.

And it's not just the out-of-business.

I would say that that certainly is a number that continues to improve but across the board it's gotten better.

And then in terms of the clarification with regards to checks per client in terms of the moderation, certainly understandable why you wouldn't expect it to continue to grow at 2%.

But can you give us a little bit more of a framework?

Are you thinking 1% or even by the end of the year that it could potentially go flat, assuming that economic conditions don't change?

I would say this, that we're expecting by the end of the year as we lap some tough comparisons, that's we'll be down to a more flat environment.

Slightly up but not very much.

But we actually really don't know.

Yes, nobody really does.

But just wanted to know what was underlying the assumption.

That's our planning the assumption at this point.

Obviously it's been a little stronger than we expected and we continue to think it will moderate at some point.

But we're certainly pleased that it's been better than we thought.

In terms of the product improvements that are coming out in terms of next generation, it sounds like early in the fall we'll see the first iteration of improvements.

But it sounds like there's a series of improvements that are coming up.

Is that correct?

Yes.

We've of planned out through what we call Paychex next generation application releases throughout the years.

And we've got these basically planned out now for the next 2 to 3 years, and we monitor them very closely from a development standpoint.

So you've got to stay very much competitive and we feel very good about where we are on that.

We, 2 years ago, had to convert the whole base, the core base.

And then now as we move forward you'll see the application, the basis and the software combine across both the MMS and core markets.

And you'll see improvements come out all throughout the years.

My impression, and please correct me if I'm wrong, but my impression has been that a lot of the improvements that have occurred thus far were a little bit less transparent to potential new sales candidates.

But that the new ones will be a little bit more visible.

If that is in fact correct, can you talk a little bit about how you would expect those improvements to impact sales productivity?

And how you would stack up not only relative to the national player but also against some of those discounting local players?

I think from stacking up against the national players is obviously very important to us and I think we'll be very competitive there, and already feeling very competitive.

But we're going to stay on top of that with the changes.

From a regional player standpoint, obviously it puts you in even a better position because they don't have the resources to continue to modernize as much as we do and increase on the Web.

Really the growth is adding additional functionality.

It's making it easier for everyone to access it online.

We added W2s and pay stubs online last year.

We've continued to add other things.

We don't make a big deal out of it but we certainly roll them out to current clients, as well as new sales.

I think it's going to impact both new sales and it's going to certainly support new sales and current clients because both will have the advantage of using the new application.

And then lastly, the way that you expressed things it sounded like you held back a little bit on the budget, not being sure about how things were going to unfold.

Now you're feeling a little bit more confidence so we're going to go ahead and spend in terms of these technology initiatives.

Can you also describe how you're going to grow or how we should think about the sales force expanding from here?

As far as sales force expansion, it's fairly light.

We're watching the market to be sure.

When Efrain explained the expenses, I wouldn't say it's going to open the flood gates.

It's just we always start out very carefully until we make sure the base is growing and that the revenue is growing, and then we add expenses very carefully.

I think, as John has always said over the years, we're very good about not allowing expense to get in and we continue to do that.

I think that you won't see a major shift in that.

We've continued to invest.

I think the savings in the first quarter that Efrain talked about from an investment standpoint was some of the projects ran a little bit behind as far as what was hiring and so forth and getting folks in.

It hasn't really impacted the delivery of the product.

But that will wash out over the years.

So the investments have continued really for the last few years.

We get the productivity in operations and we fuel it.

We fuel the IT growth with that.

Are you going to expand the sales force by, say, 2%, 3% over the next 12 months?

I don't know if we've said but we'll continue to look at doing that as we see a need to.

I would say that it's up a little bit less than that right now.

And depending on which sales force, actually it probably does average around a couple percent and we'll continue to look at that.

Our standard over the years has been to increase 2% or 3% but you've got to certainly follow where the market is and what the opportunities are.

Tim Willi of Wells Fargo.

I think this has been touched on in a couple of answers prior.

But I was just wondering, when you talk about the tablet technology and just thinking about how fast mobile and everything is moving, relative to a lot of the smaller mom and pops who may not have the scale and margin that you do, do you feel at all that there is actually a technology advantage around delivery and service that you could be in the process of building that would obviously continue to show up in numbers in terms of market share gains and things along those lines as we move forward?

Or do you feel like what you're developing, and all the tools out there around technology, probably enable a lot of your competition to keep pace?

Certainly over the regional players, the smaller, we certainly have an advantage from just the wherewithal of the information technology department and the development folks, and resources that we have.

So we're going to continue to develop those.

And I think that as more and more folks and client employees look to online, and look for integration of multiple services, from your retirement services to your payroll services to your HR administration, we certainly have advantage over smaller competitors.

Because there's just a big investment that you have to continue to make and stay on top of.

And then I think it's just very competitive with the national player, the other national player.

On the regionals, one thing we've noticed over the last 6 to 8 months is we're doing better against them.

I think one of the reasons is, one thing that hurts them is this product becomes more spread geographically because of the Internet, meaning it's harder to focus on a region to do your clients.

Small locals and regionals generally don't do payroll across the whole US.

They can't do it across the whole US because of the local state tax regulations.

So I think there are some things going on tied to technology that are going to help us against the lower end people that aren't as qualified as some of the others.

(Operator Instructions).

Nicole Conway of Stifel Nicolaus.

This is Nicole Conway on for David Grossman at Stifel.

I was curious if the current economy stays the way it is and new business starts continue to be weak, do you still expect to have positive new client growth for fiscal '12?

Can you get there without having that metric via other drivers such as new products?

Let me answer that in 2 ways.

The first one, a very direct one, is that we assume that if the environment continues currently without a change, that we are aiming at getting positive client growth.

So we expect that we can grow.

Now, obviously the magnitude of that growth is going to depend on what the growth in new business starts ends up being.

But I'd say one other thing that's important.

That I think this quarter demonstrates that we've got a model that can produce revenue growth and income growth even when conditions aren't necessarily favorable economically.

And we will simply adjust based on the conditions that we see.

We're not pegging our results in the future solely on what's happening with new businesses.

I have no further requests at this time.

So I would like to turn the conference back to Mr.

Martin Mucci for any closing remarks.

Thank you.

At this point we will close the meeting.

If you're interested in replaying the Webcast for this conference it will be archived until October 28.

I do thank everyone for joining us.

We're very proud of our first quarter and we look forward to the rest of the year's results.

Take care.

Thank you everyone, for your participation.

The conference has concluded.

All lines may please disconnect.