沛齊 (PAYX) 2013 Q1 法說會逐字稿

Welcome, and thank you for standing by.

All participants will be on listen-only until the question-and-answer session.

Today's conference is being recorded.

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

I'd now like to turn today's meeting over to President and CEO Martin Mucci.

Thank you.

You may begin.

Thank you, Melinda.

Good morning, everyone, and thank you for joining us for our discussion of Paychex's first quarter fiscal-2013 earnings release.

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

Yesterday afternoon after the market closed, we released our financial results for the first quarter ended August 31, 2012, and filed our Form 10-Q, which provides additional discussion and analysis of the results for the quarter.

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

This teleconference is being broadcast over the internet, and will be archived and available on our website for approximately one month.

On today's call, I will review highlights for the first quarter in our operations, sales, and product development areas.

Efrain will review our first-quarter financial results and discuss our full-year guidance.

Then we'll open it up to your questions.

We are focused on driving growth in revenue and profits, while providing industry-leading service and technology solutions to our clients and their employees.

We had a good start to fiscal '13, with the first-quarter results meeting our expectations.

Our client base, checks per client, and client retention results all improved.

Year-over-year growth metrics for Q1 were moderated by the volume and frequency of payroll processing.

Efrain will go into more detail on the financial results and comparisons, however, I'd like to provide you with some highlights for the quarter.

Our checks per payroll has improved for 10 consecutive quarters, with the first-quarter growth at 2%.

As expected, this growth moderated from the 2.4% growth experienced in the prior year first quarter, but was still at a 2% rate in Q1.

Payroll client retention remains strong.

In fiscal 2012, we saw client retention return to near historic levels, and our first quarter has us on track to another strong year of retention and historic results.

Execution and operations remain solid, as evidenced by exceptionally strong client satisfaction results.

Moreover, we began measuring net promoter scores last year, and our initial results place us among industry leaders.

It is our exceptional client service, breadth of products, along with our technology that really sets us apart from our competitors.

We also continue to see improving sales execution in the quarter.

As planned, we expanded a number of territories, and have placed new focus on franchise and banking opportunities, among others.

We expect to see additional penetration of our products and services within our client base, with the goal of increasing our share of revenue from our clients.

Our SurePayroll business also continued to do well in Q1.

During our July Investor Day, we reviewed our plans for sales channel segmentation.

Those plans are well underway, and this month we launched a wholesale 401(k) sales force solely focused on building relationships with financial advisors and plan sponsors.

We will be helping financial advisors create client opportunities to build their retirement plan businesses and also provide quality retirement plan expertise.

In addition, in the retirement services area, we recently added dimensional fund advisors to our Paychex open fund select and advisor select platforms.

These funds are highly respected in the financial advisor community.

We are pleased to be able to offer them to our clients as part of their 401(k) plans.

We remain very proud of the fact that we are the leader in the 401(k) record-keeping marketplace again this year.

Over the last year, we introduced enhancements to our Paychex online and mobile applications with single sign-on to reach all product information efficiently and effectively on tablet, iPad, and Smartphone applications -- Smartphone just released last June.

These applications have been well received and continue to gain traction.

They offer diverse capabilities for both employer and the employee on the go.

From a technology perspective, progress continues on integrating our leading technology in our world-class customer service through the Paychex next generation application suite.

Next month, we will be introducing new, best-in-class online reporting services for our clients and CPAs.

In sum, we are off to a solid start for fiscal 2013.

I'm pleased with all of the work of the Paychex employees across the country, and as Efrain will discuss next, we have reaffirmed our financial expectations and guidance for the full year.

I will now turn over the call to Efrain Rivera, our Chief Financial Officer, to review our financial results in more detail.

Efrain?

Let me start out by saying that you should be aware that certain written and oral statements made by management constitute forward-looking statements within the meaning of the Safe Harbor Provisions of the US 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 the cautionary note regarding forward-looking statements in the press release for our discussion of forward-looking statements and the related risk factors.

As Marty indicated, our first-quarter results for fiscal 2013 met our expectations and represented a solid start to the year.

As we previously indicated, we expected growth rates to moderate due to tough comparisons to the first quarter of last year.

In Q1 of fiscal 2012, we benefited from a number of factors, which included higher volume and frequency of payroll processing in the same period last year, due primarily to timing.

We estimate that this impacted our growth rate by approximately 1.5% in our payroll services business.

We also had stronger checks per payroll.

In the HRS business, we had higher asset fees from retirement services funds held, higher work site employees in the PEO business, and we had the ramp up of sales of our HR essentials product, including some timing also of payroll processing in that business.

The absence or moderation of these factors impacted our first-quarter comparisons this year.

Let me talk about some of the key highlights for the quarter, and I'll go into greater detail in certain of these areas.

Total service revenue and total revenue grew 3% in the first quarter.

Interest on funds held for clients decreased 9% to $10 million, impacted by the low interest rate environment.

Expenses increased moderately for the first quarter as a result of excellent expense control.

We continue to invest at a higher rate in product development and supporting technology, but this was partially offset by increased productivity within operations, which allowed us to maintain solid operating margins.

Our operating income, net of certain items, increased 4% to $228 million.

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

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

Net income increased 3% to $153 million, and diluted earnings per share increased 2% to $0.42 per share.

Now let me talk about payroll revenue in a little bit more detail.

It increased 1% for the first quarter to $386 million.

We benefited from increases in checks per payroll and revenue per check.

As Marty already mentioned, our checks per payroll continue to improve, increasing 2% compared to the same period last year.

This reflects a moderation in last year's rate of growth in the first quarter, which was 2.4%.

Revenue per check increased as a result of price increases, partially offset by some discounting.

Our growth rate, as I mentioned previously, was moderated by the impact of higher volume and frequency of payroll processing in the same period last year.

This was due to timing, and as I mentioned previously, we estimate that this impacted our growth in payroll services by approximately 1.5%.

This is a trend that tends to occur to us periodically based on how our clients' processing days, either weekly, biweekly, or monthly, fall within the quarter-end calendar.

Let me turn to HRS.

Human Resources Services revenue increased 7% to $182 million for the first quarter.

Our first-quarter HRS revenue growth reflected favorable trends in checks per payroll, price increases, and client growth.

Some highlights of the contributions to HRS revenue growth include the following.

HRS was positively impacted by checks per payroll, price increases, and growth in both clients and client employees.

The rate of growth was tempered by lower client employees within our PEO, and some effect of HRS product mix.

Insurance service revenue grew more than 20%, with continued advances in both workers' compensation insurance, and health and benefits services during the first quarter compared to the same period last year.

Health and benefit services revenue continued its strong growth, driven by an increase in the number of applicants, while workers' comp insurance delivered increases in both clients and in premiums.

Retirement services revenue benefited from client growth and an increase in the average asset value of retirement services client employees funds.

This was partially offset by the impact from a shift in the mix of assets within these funds to investments earning lower fees from external managers.

HRS revenue quarterly growth can vary to the volume of clients, PEO workers' compensation, and basis points earned on retirement services client employees funds.

Basis points change due to fluctuation in the financial markets and the 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' compensation claims experienced.

Now turning to our investment portfolio, we maintain a fairly conservative investment policy.

Our primary goal is to protect principal, and optimize liquidity.

Our priority has been, and will continue to be, to ensure that we can meet all of our cash commitments to clients.

On the short-term side, our primary investment vehicle was high quality variable rate demand notes and FDIC insured deposit accounts.

In our longer-term portfolio, we continue to invest primarily in high credit quality municipal bonds.

The interest rate environment remains at historically low levels, and our combined portfolios have earned an average rate of return of 1.2% for the first quarter, compared to 1.3% for the same period last year.

Interest on funds held for clients decreased 9% to $10 million for the first quarter, and this decrease was driven by the decline in the average rate of return on this portfolio to 1.3%, partially offset by a 1% increase in average balances.

Our average rate of return this quarter was also impacted by our allocation of investments to a greater percentage in tax-exempt securities within our short-term portfolio.

As our interest on funds held for clients and corporate investment income are reported before taxes, the return appears lower on average with a greater mix of tax-exempt investments.

Average balances for interest on funds held for clients increased 1%.

The increase was the result of favorable trends in checks per payroll and payroll tax administration clients, offset somewhat by calendar impacts.

The first quarter last year reflected strong growth in average balances due to the inclusion of sheer payroll client funds, and favorable impacts from state unemployment insurance and checks per payroll.

Our investment income increased 30% to $1.9 million.

This is mainly due to higher average investment balances resulting from investing the cash generated from operations.

I will now walk you through highlights of our financial position.

Our financial position remains strong, with cash and total corporate investments of $871 million as of August 31, and no debt.

Our cash balance at the end of the quarter somewhat magnified due to the timing of quarterly income tax payments, and our first-quarter payment was due September 15 for approximately $70 million.

Funds held for clients as of August were $3.7 billion, compared to $4.5 billion as of May 31.

Funds held for clients vary widely on a day-to-day basis, and average $3.3 billion for the quarter, a year-over-year increase of 1%.

Our total available for-sale investments, including corporate investments and funds held for clients, reflected net unrealized gains of $59 million as of August 31, 2012, compared with net unrealized gains of $60 million as of the end of May 2012.

Total stockholder equity was $1.7 billion as of August 31, reflecting $116 million in dividends paid during the first quarter.

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

Cash flows from operations were $218 million for the first quarter, 16% increase compared to prior year.

The increase was driven primarily by timing related to changes in our operating assets and liabilities, and also higher net income, net of non-cash adjustments.

Let me talk a bit about guidance for the remainder of the year.

As Marty indicated, we are reiterating guidance for fiscal 2013, which we presented to you in June.

I'd like to remind you that our outlook is based on our current view of economic and interest rate conditions continuing, with no significant changes.

Our payroll revenue growth is based on anticipated client-based growth and modest increases in revenue per check offset by some moderation in growth and checks per payroll.

Our HRS revenue growth is expected to be in line with recent historical experience.

We anticipate minimal impact from prior acquisitions.

Operating margin is anticipated to be approximately 37%.

This is obviously lower than what we achieved in the first quarter, but as I previously mentioned, our first quarter tends to be our highest margin quarter for the year.

We don't expect the expense leveraging realized in the first quarter to continue throughout fiscal 2013, as we continue planned investments in technology innovation.

We do anticipate an increase in the percentage of tax-exempt investments in our short-term portfolio.

Okay, thank you, Efrain.

Operator, we would now like to open the meeting to questions.

(Operator Instructions)

Kartik Mehta, Northcoast Research.

Good morning, Efrain an Marty.

Good morning, Kartik.

Marty, I wanted to ask you about new sales and where they are in consideration to your expectations.

And the second part of that, if you've seen any change in channels, where you're getting your new sales.

I think, Kartik, we feel good about the first quarter.

We're off to a good start.

We don't give a lot of detail until we get past the selling season, but I would say that we feel good about a good start and I think we're driving more revenue per client.

So not only getting good revenue from the clients coming in on payroll, but also driving more of the HRS services, so we're feeling good about that.

Regarding the channels, we -- in the Investor Day we talked about market segmentation and feel very good of the fact that we're well on our way, we've introduced all of the plans that we had put in place last year strategically for market segmentation.

Market segmentation was about refining our approach to all of the different channels in payroll, we went after very specific segment and split that up, that's going very well and 401(k) was going after a larger and the wholesale market, which we just introduced that sales force, they're now all getting licensed and has all been approved and they're out there.

And we went after the franchise and banking business and we signed one of the largest franchises in the country already to an agreement as a preferred provider of payroll.

So we feel we're off to a good start that will keep us on with the guidance.

And then just a final question, Marty.

Paychex has been amazingly good at controlling expenses where you don't let your expenses get out of control considering revenue growth, but do you think in this -- during this environment, is there a need to maybe invest more now so you can have greater revenue growth going forward?

Or, are you pretty happy with the way investments are and there's really no reason to increase those investments?

We feel very good about the investments we're making.

As Efrain and I have talked about a number of times, the IT and the product development has been a double digit percent for two or three years now and we feel very good about that.

Its been the right investments and obviously we've been bearing the fruits of that.

With the new technology and what you'll see next month as we rollout the new and probably, I think, the best in the industry online reporting suite and so I think that investment has been good.

The productivity from the operations team has been important that, that continues to help us fuel the IT and development investment, while still gaining great margins that we're known for.

So I feel very good about the level of expense.

Efrain anything?

No.

Thank you very much.

Joseph Foresi, Janney Montgomery Scott.

Hi, Joe.

Hi, how are you?

Good.

My first question is just taking a look at your comments again just about the new business growth, are you tracking in line with plan, ahead of plan?

And then any impact or any thoughts on what could take place here for the election on the demand front?

I think our new business growth, I think we've about met expectations.

So I think we still see kind of a gradually improving economy, no great shakes but it has met our expectations and we're pleased with that.

And I think where we feel really good is the revenue we're driving per client has certainly met our expectations or even a little bit better.

So we're feeling good about that first quarter start.

And then on the elections, any change in the demand environment post or pre?

Oh, I'm sorry.

I think it has probably slowed some new business development.

I think new growth but that's just speculation.

I think that whenever there's an election coming up and certainly the fiscal cliff on taxes and healthcare reform changes, it is all kind of holding businesses back a little bit from investing if they're on the edge of whether to start their business or not.

And I think there's pluses and minuses to either way the election goes.

With more regulation our services are more in demand but with more regulation in taxes, I think fewer new businesses start up, so we'll make the best of it either way and we feel good about the year at this point.

Then on the margin outlook, obviously you're giving guidance there, is it fair to say that margins are being held back a little bit by some of the investment you're doing on the technology side and can you give us some time frame for when you would expect them to start to expand again?

Joe, what I'd say is first, the rate of spend on IT investment is what we planned, it's moderated a little bit from prior years.

So it's not holding back margins, that's not the only area where we obviously spend money, so we'll see some expansion.

We just didn't want to call it any higher than we did in the guidance as we go through the years.

So I don't think we're being constrained in terms of margin expansion by the level of spend we're doing.

Okay, and just one last one for me.

Just on the demand environment itself, are you seeing any shifts in market share win rates in any which way?

Not really.

We're seeing the competitive environments about the same, including the pricing and so forth, I think its always been pretty healthy and we haven't really seen any change plus or minus for that.

Great.

Thank you.

Okay.

Glenn Greene, Oppenheimer.

Thank you, good morning.

Good morning.

The first question just going looking at the payroll services growth and it sounded like there was 150 basis point drag from the year over year comparison.

Yes.

It might be helpful so just to understand that first of all, and then there's a follow-up.

Does that suggest there are more processing days in the year ago quarter?

Yes, and it might.

In my comments what I said was that we have three principal frequencies of payroll processing weekly -- monthly, biweekly and monthly.

It looks like on the semi weekly, or semi-monthly, biweekly, we caught a little bit more activity in the prior year quarter, that's basically what ended up that will even out.

Okay, so no change to your confidence to deliver on the 3% to 4% for the year?

No.

I just want to reiterate something, Glenn.

If Marty and I had not said it enough, any plan of course involves risk and there's a chance that you won't hit it; however, Q1 came in as we expected it to come in.

So we planned, we knew this, we knew it frankly six months ago, so there was no surprise to us.

Okay, and then just a clarification on the relative, the pricing commentary, the revenue per check and the pricing increase and then there was increase in discounts, so what I'm getting at is the net pricing, net of the discounts, how is that tracking relative to recent quarters or even relative to a year ago?

It's tracking pretty comparable to what our expectations were.

Very close to what we've seen in the past, so that's why we don't really see where the competition, that kind of thing, the pricing impact has not changed much at all, and it's still pretty much the same.

It was as expected.

And then just a final one.

Any change from a macro perspective in new business formation?

It's interesting.

If you look at the BLS data that was available in August, for the full year 2011, you had 758,000 businesses formed, versus 742,000 the year before.

Business formation is just dragging ahead slowly.

It's getting a little bit better, we still aren't in an optimal environment.

That 758,000 still compares to 844,000 before the great recession started or the year it had started, so it's gradually getting better but it's almost imperceptibly better.

I think the good news is, as you may have seen today, consumer confidence is up, it seems strongest its been since February early in the year and the housing starts are up a little bit.

So at a macro level, those things hopefully will drive more to invest in business but again as asked earlier, I think the elections could be holding it back a little bit too.

Okay, great.

Thanks a lot.

Thanks.

Gary Bisbee, Barclays Capital.

Hi Gary.

Hi guys.

I'm wondering this is going on two years now that you've been getting really good productivity from the operation staff and I think a big part of it you've talked about is the payroll service folks are handling a lot more customers with the current technology and the prior technology.

Can you give us a sense what inning we're in there?

Is there still more room for further improvement or are you going to need to find productivity elsewhere as we move forward over the next year or two?

Gary, I think that it certainly -- I think it's moderating some.

Certainly get a big bang out of the technology when it first comes out.

We've continued to improve that and we find other ways to gain the productivity.

The field operations team are just great at continuing to drive the productivity and by the way, keep that client satisfaction rates at the highest satisfaction scores we've ever had, so we watch both of those very closely.

We're certainly asking a lot from our operations team, but they just come through over and over again.

I think its moderated some but we're always feeling that there's ways to leverage and find new ways to productivity.

So I'd say we're probably in the middle inning or later innings where its moderating, but then you find a new gain.

Okay, great and then I know you told us that you were going to stop providing all of the HRS metrics but it's always difficult when you first do.

Can you give us any incremental color on any of those and what I'm most interested in is how bad, maybe that's a wrong word to use but how bad is PEO?

How difficult is that?

How much of a drag is that relative to the other parts of the HRS revenue line?

Good question.

Gary, and Jim MacDonald, I did promise that I'd call out changes so our growth rates, some up a little bit, some down slightly, but if you look at fourth quarter growth rates in those clients they basically are very, very similar to what you saw in the first quarter.

So in other words, the growth rates coming out of first quarter were comparable to what we saw in fourth quarter.

So you're comparing in some ways to more robust growth in that quarter but in the first quarter of last year, but they were comparable to where we ended the year.

PEO has been a disappointment for us and we are down in that business year over year.

I called that out and the positive on that, when I say that we're down and it's a disappointment, it's a disappointment relative to where we were a year ago but I think we've taken a number of actions to stabilize that business and we think it will be a good story this year for us.

And I think we've seen some of that moderated by the ASO, so we've got that balanced.

The good thing is we have the PEO being sold by the same folks who sell the ASO, so we've moderated some of that.

But as Efrain said, we feel we've got a much better year ahead of us than certainly what we saw behind us.

Would it be safe to say that with the insurance pass through there that the impact on profits of maybe more customers moving to ASO and essentials and away from PEO isn't nearly as big as what we're seeing on the top line?

Yes, that's correct.

That's a fair assessment.

Thank you very much.

Thanks.

Glenn Fodor, Morgan Stanley.

Matt Lipton in for Glenn this morning.

Marty you'd commented and congratulations on hitting record highs on the client retention side.

Just curious how that plays out though in the growth in the client base overall.

I know it was flat for the full year '12.

As you look at the first quarter, was it flat, up, down, is the retention driving allowing you to increase the client base or are you still muddling along at a flattish pace here?

Yes, we only give client base once a year but I would say if you looked at the fourth quarter as Efrain said on some of the other indicators, there's not much difference there.

I think it met our expectations and I don't think there was any surprises.

And then on the sales force, you commented that some of the segmentation plans are now being enacted.

Are you guys going to have all that finished before the selling season starts in December or January?

Yes, Matt, it's already pretty much all in place.

The last piece really was the wholesale sales force for 401(k) and that's because we had to get approval, regulatory approval for that and are getting everyone licensed and already have a number of sales I think that are getting in the hopper for that.

So all of the segmentation work that we said we were going to do and the expansion territories are well underway.

Great so we'll look for the results next quarter, thank you.

Thanks.

Jim Kissane, Credit Suisse.

Hi, Marty and Efrain.

Not to harp on the timing issues but want to make sure there's no shift in client behavior, maybe extending the payroll cycles at all.

No, not at all.

We went back, Jim, and looked at seven years worth of data to make sure we had the number right and we saw this six years ago precisely the same thing, and it's just a function of calendar timing.

Got you, that's helpful and then just on pricing, is the net pricing sticking above your 2% target?

Well we did say 2% although some clever people have figured that out, so I won't comment specifically on that, but yes we're in that range.

Marty, any update on the performance of SurePayroll?

Yes, continue to do very well and certainly meeting our expectations and a little beyond.

So we still feel that the clients going there are very different from those going to Paychex, so we're pleased with the results of the SurePayroll, the sales team and the operations team, they both are hitting our expectations on sales as well as their performance on client satisfaction and retention.

Excellent.

Thank you.

Okay.

Thanks.

Sara Gubins, Banc of America Merrill Lynch.

Thanks.

Hi, good morning.

Another question about the timing issue.

Sure.

Does it have any impact on the second quarter or any other quarters this year?

That timing issue, no, not really.

Okay, so it was a one quarter thing?

In other words, Sara, just want to clarify.

What I mean is you'll have relatively clean compares there quarter over quarter, it really was a first year issue.

Okay, and --

First quarter issue, sorry not first year.

Okay, second question, you've talked about expecting deceleration in checks per payroll and that's been a pretty common theme.

If I've got the numbers right the comparison actually looks a bit easier during the rest of the year than it was in the first quarter, so could you talk about the assumptions that are going into thinking that you'll see that decelerate?

Yes, well I think we start with the idea that historically we've never seen a period where we had this level of checks per client increase for now 10 straight quarters, so we're being guided a bit by history.

But I will concede that if you look at the history, we've been under a little bit in terms of what the trend has been.

We've got the trend right but it's moderated more slowly than we've expected and I'll leave it at that.

Just last question, any update on thoughts around M&A, what the landscape is looking like and how that may be influencing your views on share repurchase potential?

Thanks.

As far as M&A goes we're very actively looking, always looking to expand the product set here and to be able to generate more revenue per client, we have been pretty active in that; however, it's always a timing of finding the right valuation and the right fit for us.

But we're very active and confident that there will be some things out there that will help us along.

That doesn't -- our focus is on the organic growth but we're always looking at opportunities from the M&A standpoint.

Next question?

Jason Kupferberg, Jefferies.

Hi, Jason.

Thanks, hi how are you guys?

I just wanted to ask a follow-up question from one earlier, so just to clarify for the current year the core payroll services growth at 3% to 4%.

Are we basically saying that's almost all pricing with very little volume growth?

Is that essentially the way to think about it?

Not really.

We assumed some volume growth, Jason, but it builds through the year and volume growth you don't get it all in the year.

We do expect some volume growth, especially billed revenue to grow through the year and we have some pricing in there too.

There are elements like product mix that play into it that are also factored but no, we expect some revenue to build through the year.

And then do you need to see the core payroll revenue growth accelerate beyond this year to get any meaningful operating leverage in the business because I know at the Analyst meeting over the summer you'd talked about beyond fiscal '13 seeing some operating margin leverage in the business.

Look, it helps the more revenue you've got the better you can leverage but I think we've shown, even on quarters like this one, where we're operating -- I'm sorry, revenue growth was pretty moderate that we can get leverage.

So I think the thing about Paychex, unlike my previous experience, is that if we put our mind to get leverage, we get leverage and generally our mind is on getting leverage.

Yes.

And then just lastly on pricing.

I know at the Analyst meeting you'd talked about longer term target of 2% to 4% a year net of discounts, so can you just talk about your confidence in being able to maintain that range beyond the current year as people start to think about the degree of competition in the market and maybe some of the deflationary impact of the mix shift towards more of the SAS-based solutions.

And maybe as part of that, can you give us a sense of what the difference in average annual revenue is between a SurePayroll customer and a client on the traditional Paychex platform?

Jason, I think you get the award for the best compound question.

I'll take part of it and Marty will do it.

So I think we have good confidence on our ability to get that pay increase.

One thing I'll mention to you, one way in which we know that is that we do, before we start the plan process, we do sensitivity analysis around our customer base and can predict with a fair degree of accuracy what our retention rates will be at different price levels, because we know these customers, we know their behaviors.

So when we go out and say 2% to 4%, we feel pretty comfortable that it will be 2% to 4% unless, obviously as you're hinting, there's some sort of tectonic shift in the market which we continue to say we're not seeing.

And then I'll let Marty talk about the do-it-yourself SurePayroll market versus elsewhere and see what's happening there.

I think the point is that, as Efrain said, we haven't seen any shift in the market, there's always been that group that wants to do it themselves and use a SurePayroll model where they do it themselves and have service to back them up and those who want to outsource and have all of it come to someone like us.

And I think our pricing and our continual growth in the client satisfaction, as well as the technology support for the clients on the tablets and Smartphones and now online reporting center, I think all add that you can still get the price.

So we've seen it consistently to be able to get the price that we've modeled out and we don't see that changing.

We always watch it close.

That can change but at this point, we still feel good about being able to have the pricing power to get that.

Okay, thank you.

Thank you.

Jim MacDonald, First Analysis.

Hi, Jim.

Hi.

Thanks for the PEO color by the way.

Sure.

I was hoping maybe you could give some more color on MMS and SurePayroll.

Are they growth rates still in high single double digit type growth rates or anymore color on the growth rates?

We don't usually break those out.

We've been very positive from an MMS, the major market perspective, the addition of the other products set, the single sign on adding time and attendance and HR online and our BeneTrac offering.

So we've seen the revenue overall grow on a client basis and the penetration of those services continue to do extremely well.

So we feel good about the product offering, the integration and that, again, more of those clients will be given even more technology in the future.

They're all on our road map for Paychex next generation, so we feel good about the major market.

On the SurePayroll side, as I said earlier, feel very good about where they are.

They met or exceeded expectations for the quarter on their sales as well as the retention, so really feel that all those markets are doing what we expected.

Just a technical question as a follow-up.

Can you talk a little bit about the VRDN rates you're seeing now and how that compares?

Yes, so that was part of what I mentioned before.

So last year compared to this year, last year we were predominantly doing FDIC insured deposits and not to get too much into the weeds, suffice it to say the way that works is that you get a credit that you can use and you get a rate that you paid on a pre-tax basis and then a credit that you end up being able to use.

So you have impacts both on interest on funds held for clients and you have below the line impacts on expense.

When you net the two we were ending up somewhere around 8 to 10 basis points between the two.

VRDNs are a little bit better.

It seems kind of funny to talk about this, but VRDNs now at least you get typically higher than that sometimes into the teens or 20 basis points, which is what the environment looks like.

So we're doing a mix of both this year so you may see a little bit lower interest on funds held from clients.

But from a bottom line perspective, the impact is negligible.

Thanks very much.

Sure.

Bryan Keane, Deutsche Bank.

Hi, Brian.

Hi guys, good morning.

Just a couple clarifications.

The volume and frequency issue that impacted growth by 1.5 points, normally when you see that it's just a days thing or a calendar thing and then in this case you would think the second quarter would then have that positive impact but it doesn't seem to be the case so I want to make sure I understand that.

Yes, well it was just basically a quarter over quarter issue, so impacts where you saw it, if you remember last years results, that's where you would have seen it.

In the first quarter our organic growth was 4.2% in payroll services and in the second quarter it was 2.8%.

So you actually see it in three quarters, not to muddy the waters anymore but you see it in Q4 of '11 some impact on Q2 and then sequentially, you saw some in -- I'm sorry Q1 and then Q2, so you went from 4.2% down to 2.8%.

I've got some questions on the call.

Part of that was in processing revenue that changed, but this had an impact on that also.

Okay, and does this volume and frequency issue have any impact to the HRS revenue?

A little bit.

We called out a little bit of an impact but it's not significant.

Not as significant for core payroll.

So then in HRS, coming in at 7%, I know the guide I think is for 9 to 11 so where will we see the pick up in HRS, because it sounds you're comfortable you get back in that range.

The first thing is basis point fees were just exceptionally strong in Q1, so we think that the compares get easier and we'll get reasonable growth.

The second part was we normalize that the HR Essentials product launch effect that we had in Q1 and then we expect the PEO effect to lessen as the year goes on.

Okay, helpful.

Thanks so much.

You're welcome.

Rod Bourgeois, Sanford Bernstein.

Hi, Rod.

Hi there.

So is there any evidence of late that deals with clients that Paychex would have traditionally won are actually now being won by lower price online players like SurePayroll or other players in that online low price market?

No, Rod, not seeing that at all.

Again, all of the research that we've done and the feedback from the sales team and who they're seeing and who they are competing against and what deals we're getting in and out, there's no evidence that we've seen that drop at all and we're not seeing it -- having the SurePayroll side of it, we're not seeing it there.

That's still clients going in who want to control, want to do it themselves, going on the web, search, find them and buy over the phone from them.

So we haven't seen a shift there.

Let me ask you this on the SurePayroll side, are you getting more referrals into Paychex from SurePayroll or more referrals into SurePayroll from the Paychex side?

I would say both are pretty minimal.

We're able to shift back and forth if there's not a good fit there but that's one of the things I'd say that we've seen for the last 1.5 years now with SurePayroll is there has not been much referral back and forth.

It's available there if the sales teams, both of them, find there's a client without a good fit and they're a better fit for the other Company, but we have seen very little activity on that at all.

Great and then at the risk of beating a dead horse on this timing of revenue growth topic, should we be assuming that we won't see a lumpy positive timing event over the next couple of quarters because that's already transpired or is there actually going to be a lumpy positive side to the negative timing that hits you in the August quarter?

No, no.

We saw the lumpiness last year and what you should be expecting to see is a build through the year.

Okay, I've got it and then just on this topic, I know that the practice is to not give quarterly guidance but in cases where there's a known timing issue that's meaningful, 1.5 points and this business is pretty meaningful, do you consider going forward and giving more specificity in the guidance for the next quarter when that's expected as an issue?

Thanks for the advice, we stay away from quarterly guidance and I think we did as reasonable a job as we could to tell people where we ended up.

And I think if you look at consensus revenue being off $6 million without having to guide directly to what the number was, I think it was reasonable, especially also people I think understood what the earnings compare were.

So I hear you, we'll consider it, thanks.

Got it.

Thanks, guys.

Okay.

Jeff Silber, BMO Capital Markets.

Just wanted to shift back to your investment policy.

You talk about the mix of taxable to tax exempt securities.

Can you tell us roughly percentage wise where that is now, where do you expect to go and how do you think that will impact both your interest rate and your portfolio tax rates?

Thanks.

Yes, let me, so the portfolio remains 50/50 at the moment, 50% being invested in short-term vehicles, 50% in longer term.

We anticipate remaining long term and tax free municipal's, that's not going to change.

But I would say on the short-term, opportunistically we'll look at VRDNs if we think they offer a superior return to FDIC insured deposits, which is the next best option in terms of available investments.

So I can't give you precise percentage.

We'll do it opportunistically when we think that the VRDN market looks a little bit better.

Well would it make sense at least to maybe for modeling purposes to model the interest rate down a little bit and the tax rate down a little bit as well?

I think a touch but I don't think it will be significant.

Okay, great and then just one more modeling question.

You talk about the investments in IT and product development.

Which specific expense line item is that in?

That would be in our G&A line.

Great, thanks so much.

Okay.

Vishnu Lekraj, Morningstar.

Hi, Vishnu.

How you guys doing?

Good.

Just wanted to touch here on the payroll service growth, maybe beyond here the next couple quarters.

Let's assume that the small business environment gets back to normal.

How should we view growth out of that division in terms of a gross dollar, not necessarily percentage because that's going to change over time, but a gross dollar versus the historical norm?

I can't quantify it on a gross dollar.

I would say that we get up to more normalized new business environment, we should be above certainly mid single digits.

Got you, okay.

Can you give a little color as to what the competitive environment is looking like today, not just with the SAS or DIY products, but all around from just specifically with your payroll services basically?

Are you seeing more competition today versus a year ago or vice versa?

I'd say about the same.

I think we've had a pretty stable competitive environment.

I think there's always discounting going on, there's always pretty aggressive competition but it hasn't -- I wouldn't say its gotten anymore difficult over the last two years or any more difficult or any less.

It's about the same.

Great.

Thank you.

Okay, thank you.

Michael Baker, Raymond James.

Yes, thanks a lot.

The health insurers are starting to talk about potential impacts for 2014 as it relates to the exchanges, pointing out that they anticipate employers with 10 employees or less to push workers on to the exchange.

And I know there's been some softness in the PEO and I'm wondering how much of that is attributed to you guys proactively adjusting your sales effort there and what type of impacts do you guys expect?

And I know there's some offsets that you have as well.

Yes, I think first from the PEO standpoint, that really hasn't been an impact on the PEO.

The impact there was some higher -- an increase in higher insurance premiums than we had expected in last year, really and the year before and that caused some issues with us retaining clients and selling.

And we moderated some of that with the ASO, but that was the issue there.

It wasn't anything proactive that we tried to do from the health reform standpoint.

From the health reform standpoint, we feel pretty good that we play that expert role that as this agency has gotten more and more traction, our insurance agency has gotten more and more traction is now the 28th largest in the country, that we're always going to be that expert.

So whether clients -- it's really the fact that clients are going to be more confused and in need of help than ever to know whether to go to an exchange, whether to go off health insurance or whether to find other methods for the best methods and most efficient methods as a small business, I think we are going to be well positioned to do that.

Already with the payroll, we're able to help them with immediate access to reports that we provide them that help if they qualify for the small business tax credit, if they are going to -- if you need to put the information on the W2 like the greater than 250 employees we can put that very easily, so I think there's a nice tie with health reform no matter which way it goes.

Margins commissions from the insurance carriers certainly going to get squeezed a little bit but I think we'll be very active in being the expert for the small business.

And then I was looking for an update on workers comp, how claims are shaping up relative to reserves, I would assume there was no major negative development there but just in general some commentary around workers comp dynamics might be helpful.

Yes, no significant issues.

We, I think on the workers comp side, related to the PEO the claims experienced there was what we expected and then on the sales side it continues to be a good story for us.

I think we do a very good job on the book and there's been no surprises, its been right at our expectations.

Thanks for the update.

You're welcome.

David Grossman, Stifel Nicolaus.

Hi David.

Good morning, hi.

Just kind of a bigger picture question.

You've got several initiatives under way to accelerate growth.

It's new client growth expanding the addressable market with things like SurePayroll and increasing revenue per client and you've done a good job of running some anecdotes on your progress.

However, can you provide any more specific metrics that help us benchmark your progress against these initiatives and perhaps even more specifically, can you help us understand whether the aggregate of these efforts can actually impact the growth rates if the economy continues to stagnate or new business creation continues to be relatively moderate?

Yes, I'd start by saying, to have a guidance at 3% to 4% in this kind of economy that just continues to slowly improve, we're pretty happy with the fact that we're 3% to 4% there and we're 5% to 6% overall, mid single digit growth in this kind of economy.

We feel good about it and the fact that also we're leveraging that and continuing to maintain a very high profitability and a good dividend.

So I would say all these things kind of contribute to that.

I would say also that when you look at 401(k), no matter what's changed in that environment and we've continued to add services that keep us number one and I think -- so one of the things quantitatively is we're still number one, we have over 59,000 plans at the end of last year, we continue to provide more new plans than anyone else.

I think that's because we're constantly innovating.

And on the SurePayroll side, I think as you mentioned it, we see good growth there as exactly as we expected and that expanding into that market that does not really cannibalize as we see it, Paychex is very good to help drive that growth too and drive client base and be able to sell other products into it.

So we don't try to give too much specificity in each one until we're done with the year, but I think the fact we're reaffirming guidance, that we have mid single digit revenue growth expectations in this kind of economic environment is all those things playing together.

So maybe asked another way, Marty, then if we go into the next year without any real noticeable macro improvement, would you expect that mid single digit growth rate to improve based on your progress against all of these different initiatives?

I think it would be comparable.

I think to be able to continue to push mid single digit growth on the revenue side in a slow economy is something that we'll still be able to do and continue to try to drive it incrementally better, but I think that's where it will be.

Long term as the economy comes back we saw ourselves, as we said at the Investor Day, in high single digit growth revenue and still trying to drive a great profitability as well.

Okay, thank you for that and then, Marty, you mentioned this major bank that you signed as a channel.

Can you help us better understand what that opportunity is and how that can play out?

Yes, that was a franchise.

We're pushing both the franchise now and the banking.

We've always got referrals from banks but I think we really worked together with SurePayroll to provide both a white label opportunity to the bank or a total outsource, and we'll be able to go in there together and we come in much stronger I think that way.

On the franchise side, what I was mentioning was that we signed an agreement with Subway in just the recent month or two, and we have a good relationship with them to be the preferred provider of their payroll and they are, of course, the largest franchisee in the US.

And so we feel very good about that, winning that from a competitor.

So I think the opportunity there is you're the preferred provider, it gives us great leads, still early to tell but we certainly feel good about that and that's opened up a few other franchises that we're actively pursuing as well.

Okay, got it.

Thanks for that.

And finally Efrain, I wanted to make sure I understood your comment about the tax rate.

Did you say you'd be in the 37% range or 36% or was that a function of where you fall out on the tax freeze over the course of the year?

No, I think we said our tax rate would be about 36%, actually in the guidance we said it would be comparable to first quarter.

We're around 36%.

Got it.

Okay guys, thanks very much.

You're welcome.

Tim McHugh, William Blair.

This is Steven Sheldon in for Tim McHugh today.

Thanks for taking my questions.

Hello.

Just overall, I think you talked about growing your sales force 3% to 4% this year.

I was just wondering if you guys could give an update on where you guys stand right now on that initiative.

Yes, we're in good shape.

We went out, we're hiring, we're pretty well filled in all spots, we've expanded some of the territories as we said we would.

So we found additional territories based on our modeling and that's one of the first years and a few years we've done that, which is expand out into additional fringe territories I'd say off of some of the areas we're already in and we achieved the increase in the sales number.

In sales, met our expectations in the first quarter and I think are doing a good job of setting us up for the guidance with driving more revenue per client.

Okay, and then a follow-up question to the segmentation, specifically for the financial advisors segment, could you maybe provide a little color there and how large that sales force may be?

Yes, the sales force is -- I wouldn't give necessarily a number because from a competitive standpoint, but it's a new team that is dedicated right to those financial advisors.

In the past, as we're the largest 401(k) record keeper provider and have been, we're very good at going directly to clients and working with financial Advisors.

We've got a lot of relationships but what we didn't have was necessarily a pure focus on going directly to the financial advisor, building the relationship with a large financial advisor and giving them a direct service, a dedicated service process and that's what we changed.

So we have a sales force that is smaller dedicated to building the relationships, then they will bring in and sell to the financial advisor to help them build their book of business and have a direct service line for them.

So it's not just directly to clients, it's now directly to the financial advisors as well and we think that will help accelerate the growth of the business which, by the way, is still growing to our expectations.

Okay, great thanks.

You're welcome.

Paul Thomas, Goldman Sachs.

Hi, Paul.

Hi guys.

Just wanted to follow-up on new business formations and the comments earlier.

Is your sense that new business formation is a little more positive or do you see it as weaker because of the election and maybe we might see some acceleration post-election?

I think based on Efrain, the numbers Efrain gave and that always lags a few quarters, I think it's still relatively flat.

So I don't think -- we certainly haven't seen it gotten worse, but I think it's gradually improved.

The only point of color to it is a couple things.

One, I think the election does slow that down a bit because those on the fringe of starting investing or not investing are waiting to see how things fall out.

I also think it's still tough to get cash where they could get it from home equity or friends or banks, it's still a little bit tough to get cash.

But the positive news is that consumer confidence is up this morning to the highest its been in probably six or seven months and also the housing starts and when those things start to come back, that should drive some demand which I think starts the businesses that support housing et cetera.

So I think some positive numbers today, but I don't think we've seen a major change yet or anything.

Okay, thank you.

You're welcome.

Mark Marcon, R.W. Baird.

Hi, Mark.

Good afternoon or good morning.

I'm actually in Europe calling from the road.

So just curious, can you talk a little bit about MMS and what you're seeing there?

You did say that things are going well but I was wondering if you could give a little more detail in terms of is the growth profile about the same as it used to be in terms of where the growth is coming from, how much of an expectation are you building in terms of continued growth, particularly with the product improvements coming along, how should we they about that?

And then I have a bigger picture.

Hi, Mark.

A couple things on that.

We certainly expect MMS to have growth rates that are in excess of our core business, so we certainly -- when you consider all of the services that are part of the typical MMS bundle see that, what you see, MMS is a little bit more complex sale than core because as an MMS client comes on to payroll there are other services that typically are associated with that sale, online services that also help fuel that growth.

So we've been seeing very, very good results on the online portion of the services that MMS customers get and we've seen steady growth in MMS sales themselves, so we expect it to grow faster than the rate of core.

It is not as fast as it was probably four or five years ago, but still is pretty reasonable growth.

I'd just add Mark that the good thing we're seeing is much more package of all of our products in the full suite of products going to those clients and we've got a great sales force there that knows how to sell the combined product portfolio, and they're going to continue to see the technology integration of Paychex next generation.

So we're very well primed for the future with that as well.

Great and are you seeing same sort of wins in terms of both smaller clients graduating up to MMS, as well as competitive wins or how should we think about that part of the equation?

Yes, it's always been more there's some movement up but there's not a lot of movement up from one product to the other.

Now that will be easier in the future as we're all on one product suite, but we don't see a lot of movement there.

It's more competitive wins and I don't think, as I said earlier, that competition has changed much from a competitiveness, from a pricing or who is in there fighting with us.

It's pretty much the same kind of pricing or same kind of competitive atmosphere, so not any big changes there.

They're primed and ready to go and have met our expectations, and we'll keep pushing to see more growth there.

Great and then free cash flow is very strong this quarter.

Its been very good over the last 12 months.

Cash balance continues to build.

How are you thinking about that at this point?

As that builds, I would just characterize it has our conversations about its return to shareholders intensifies.

Lots of options out there that we always talk about.

Obviously a Board decision in the end, but we always have those conversations.

And as you've said before, we don't necessarily need to grow earnings in order to get to a 75% pay out ratio, we can do it sooner than that, right?

In order to boost the dividend?

Yes, that's correct.

Great.

Thank you.

Thanks, Mark.

Rayna Kumar, Evercore Partners.

Hello, I'm calling in for David Togut.

Can you please comment on your head-to-head win rates and small business payroll services against your principal competitors, and particularly if you've seen any impact from ADP's new run product?

No, and run has been out for some time and as well as Paychex next generation.

Our side of it I think we haven't seen much change in the competitive environment.

I think the effect that our service is so strong, our results and the fact that we rolled out a lot of technology and have been seen more as a technology leader in the past will help us and has helped us in what we're demonstrating to clients.

But I have not seen it and really don't give out the closing rates on the sales and never have, but we see the environment very similar to what it has been.

Thank you.

You're welcome.

Ashwin Shirvaikar, Citi.

Hi, Ashwin.

Hi, guys.

So a couple of questions.

One, you have obviously numerous initiatives including the ongoing effort to use better segmentation.

My question is which channels have you seen better client growth in and which are not doing as well, both among the traditional channels and the newer initiatives?

Well, I think what we've seen as we've said pretty much on our expectations for the first quarter, I think some of the segmentation is fairly new.

We certainly feel good about the run rate for the 401(k) in particular.

I think that organically what we've already had is continuing to do well at good growth rates and then the new -- I think this is not going to do anything but continue to propel us to be even stronger in 401(k).

The HR outsourcing has done well with -- we've kind of taken a hit from the PEO in the past, but I think we're well positioned in this selling season for that along with the ASO and the HR Essentials product, which is the telephonics support.

And on the payroll side, it really felt that we've met expectations as to where we feel and given this economy I think we're well positioned.

I think the segmentation has made it much cleaner for our sales teams who are world class to say this is who I sell to and this is who the other team sells to, and there's been a lot of good work there and feedback, so I think that started off well.

In addition to I think we've been driving more market growth thinking, so those payroll sales teams refer more clients -- refer our other sales team into those clients.

So things like workers comp and health insurance are picking up as well from those referrals.

Are there areas where you think need more management attention where you haven't been doing as well in terms of channels?

I don't think so.

I think we feel pretty good across-the-board and I think we've got a great leadership team in sales that are very focused on revenue growth.

That would be the big thing this year is we focused a lot of their incentive is to driving revenue per client and selling additional services, and that we feel started off very well in the first quarter.

And I'm just trying to understand obviously in the traditional part of your business, cross-selling and off selling is a terribly important part of what you do.

What about for SurePayroll?

Is there sort of a path up in terms of SurePayroll?

Have you seen clients on SurePayroll as they grow bigger graduate to the traditional set and give you a better revenue opportunity?

Is that an option for them?

We don't see that change that much.

The clients don't -- usually if they go to SurePayroll it's a different type of client that wants to do it themselves so they stay on the product, but what SurePayroll was doing and is working with us now to enhance that even more is selling additional services.

So let's take workers comp for example.

They had -- when you had SurePayroll small companies selling a lot of new payroll clients, they had a small team selling workers comp.

We've added them and directly linked them into our workers comp team, which has been industry leading in driving workers comp penetration into our base and now we're selling more workers comp to the SurePayroll clients, and health insurance and 401(k), et cetera.

So where they've had fewer resources to be able to do the additional products but had it set up and started, we've been able to enhance that and we'll see higher revenue per client at SurePayroll, but not necessarily by going to a different payroll product.

Got it.

Last question if I can.

Just a clarification and you've been asked a few questions about the elections and the impact.

Are you actually making in your guidance any specific assumption on post-election trends for employment or pick up of business creation or are you not doing that?

No.

We think that I'm not sure it will have a big -- I think the biggest impact we hope will be that there's a drive for new business formation, but we haven't made any adjustments for either candidate or how the election comes out now.

Okay, got it.

Thank you guys.

You're welcome.

That was our last question?

Thank you, that was our last question.

Okay, at this point, I'll close the call and if you're interested in replaying the Webcast of this conference call it will be archived until October 25.

Our annual meeting of stockholders will be held October 23 at 10 AM in Rochester.

That meeting will also be broadcast over the internet.

I thank you for your taking the time to participate in our first quarter press Release conference call and for your interest in Paychex.

We feel good about the quarter and reaffirming guidance, we feel good in this economy and we're continuing to push and I'm very proud of the all of the work on behalf of our 12,000 employees across the country.

So thank you for participating and have a great day.

Thank you.

This does conclude the conference.

You may disconnect at this time.