沛齊 (PAYX) 2015 Q3 法說會逐字稿

Welcome everyone and thank you all for standing by.

(Operator Instructions)

Today's conference is being recorded.

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

Now I'd like to turn the call over to Martin Mucci, President and Chief Executive Officer.

Thank you Mr. Mucci, you may begin.

Thank you and thank you for joining us for the discussion of Paychex's third-quarter FY15 earnings results.

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

This morning before the market opened we released our financial results for the third quarter, ended February 28, 2015.

Will file our Form 10-Q, which provides additional discussion and analysis of the results for the quarter, by the end of the day.

Our earnings release and Form 10-Q will be available on 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 update you on the highlights in our operations, sales and product development areas; Efrain will talk through our third-quarter financial results and our guidance as we wrap up FY15.

And then, we'll open it up for your questions.

We were pleased with our third-quarter results, as we continue to make good progress toward our key initiatives.

Our selling season execution was very strong, producing double-digit growth in new annualized revenue sold.

We were pleased with that.

We also continued our success in adding new bank and franchise referral arrangements and increasing our web leads in addition to our CPA referral channel.

We remain focused on selling great value to our clients, helping them realize the full breadth of technology and service that Paychex has to offer.

Demand for our HR outsourcing solutions continues to advance, with gains in both clients and worksite employees.

This has made a significant contribution to our double-digit growth in HRS revenue.

Payroll service revenue continues to advance as a result of increases in revenue per check and client-based growth.

Total service revenue increased 8% for the third quarter, 9% for the nine months.

As we have expanded our portfolio of SaaS-based bundled offerings, Paychex Flex which includes online time and attendance and HR administration among many other capabilities, we have also greatly enhance our personalized, dedicated service.

Paychex Flex offers powerful workforce management capabilities in a simple and streamlined user experience.

Our new service initiative also offers clients the flexibility of choice for their service needs.

This approach gives clients access to a variety of customer service options based on their size and complexity, including our 7 by 24 customer service.

Our mobility app continues to see a fast growing number of users, both clients and [new] client employees.

This app provides a single easily accessed mobile source to all of the products and information that the client subscribes to from us.

We have continued to add more functionality, including last quarter's web time punch capability.

We're also gaining additional market acceptance of our new full service product to help clients navigate healthcare reform.

We are uniquely positioned to leverage payroll data with our nationally recognized insurance agency and our clients -- and offer our clients assistance and value in understanding the requirements of the Affordable Care Act.

And, its impact on their business and employees.

We help our clients navigate these complex requirements, avoid fines and penalties and reduce the administrative work necessary to remain in compliance with the law.

Our operations team led us through a good year in for our clients, producing industry W-2s, ahead of schedule and continuing to keep our client service and retention at record levels.

We recently released the newest version of our applicant tracking system, myStaffingPro, which has expanded mobility and new features designed to enhance the job candidate experience by reducing data entry, improving completion rates and providing ability to create candidate differentiators.

This improved candidate experience helps our clients increase their applicant pools and can also utilize the enhanced tools to better screen their applicants.

In summary, we had a solid quarter and made progress on many fronts including strong sales execution, service delivery, product development and deployment and financial performance.

I appreciate the great work of our entire Paychex team across the country.

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

Efrain?

Thanks Marty, and good morning to everyone.

I'd like to remind you what I customarily remind you of, that during today's conference call we'll make some forward-looking statements that refer to future events and as such, involve some risk.

Refer to the 10-Q for full discussion of these risks.

Before I get into the specifics of the quarter results, just like to say the fourth quarter expectations for payroll and interest revenue indicate that we'll meet the full-year guidance that we provided throughout the year.

More on FY15 guidance later on.

In addition, we introduced our minimum premium plan health insurance offering for PEO clients and worksite employees in the third quarter of last year.

We have just passed the anniversary of this new health insurance offering and we have seen strong acceptance by our PEO clients.

Due to the self insurance provisions within the new offering, certain PEO direct costs are now classified as operating expenses.

Rather than a reduction in service revenue.

This change had no impact on operating income, although it did have some impact on margin as those of you who have been looking at our results over the last three quarters understand.

This new health insurance offering did not have an impact on our FY15 third-quarter and nine month results.

As Marty indicated, our third-quarter financial results for FY15 represent continued progress, building on solid start we experienced through the first half of the year.

Here's some of the key highlights, I will provide detail in certain areas and then I'm going to wrap with a review of our full-year 2015 outlook.

Total service revenue grew 8% for the third quarter to $694 million, and 9% to $2 billion for the nine months.

Interest on funds held for clients increased 2% for the third quarter and 3% for the nine months, to $11 million and $31 million respectively.

These fluctuations were driven by an increase in average investment balances.

Expenses increased 10% for the third quarter and 11% for the nine months, primarily in compensation related costs and the PEO direct costs that I mentioned previously.

Driving a portion of this increase in PEO direct costs, the new health insurance offering accounted for approximately 3 percentage points of the growth in total expenses for the third quarter and 4 percentage points of the growth year to date.

The plan has grown significantly in the number of worksite employees enrolled in the plan since it began a year ago.

The increase in compensation related costs was driven by higher employee benefit related costs, together with higher sales headcount and performance-based comp costs associated with the strong sales execution that Marty mentioned.

We also continue to support investment in product development.

Operating income net of certain items increased 6% for the third quarter and for the nine months, grew to $254 million and $771 million respectively.

We maintained strong operating margins and anticipate that our full year will remain within our guidance range which I'll discuss shortly.

Diluted earnings per share increased 5% to $0.46 per share for the third quarter and 8% to $1.41 per share for the nine months.

Net income increased 6% to $169 million for the third quarter and 7% to $514 million for the nine months.

Turning to payroll service revenue, it increased 2% for the third quarter and 4% for the nine months.

We benefited from increases in revenue per check and client base.

Revenue per check growth resulted from pricing increases net of discounting, along with the impact of increased product penetration.

Checks per payroll grew, but at a more moderate rate than we had projected.

We expected payroll revenue results for the third quarter to moderate as we shared during the second-quarter earnings call.

As we indicated in last quarter's call, timing shifts between the quarters and lower checks per payroll drove the results.

We expect a return to more normalized growth rate in the fourth quarter, expect it to be comparable to the first half of the year.

And, full-year guidance for payroll revenue remains unchanged.

Turning to HRS, revenue increased 19% for both the third quarter and for the nine months.

We experienced strong growth in both clients and worksite employees of Paychex HR services.

The new minimum premium health insurance offering also contributed 5 percentage points of the growth in HRS revenue during the third quarter.

Retirement services revenue benefited from pricing, together with increases in the number of plans and average asset value participants' funds.

Insurance services benefited from the ramp up of our new full-service offering to comply with healthcare reform requirements.

A moderate increase in the number of health and benefits applicants and higher premiums in our workers comp insurance product.

Our online HR administrative services continued to experience growth in clients.

Turning to our investment portfolio, our continued goal was to protect principal and optimize liquidity.

We invest in high-quality, lower risk instruments, primarily variable rate demand notes and bank demand deposits for short-term funds and municipal bonds for our longer-term portfolio.

Our longer-term portfolio has an average yield of 1.6% and an average duration of 3.2 years.

Our combined portfolios have earned an average rate of return of 0.9% for the third quarter and 1% for the nine-month, consistent with the same periods last year.

Average balances for interest on funds held for clients increased during the third quarter and nine month, primarily driven by wage inflation.

Together with growth in the client base.

We are now on a gradual upswing from the impact of the decline of rates that began in 2008.

Our average reinvestment yields are now meeting, or slightly exceeding, the weighted average yield on our longer-term portfolio.

As such, we are not seeing a significant negative impact from turnover in portfolio.

The Fed has indicated that it is possible that they will raise rates later in the year, which could have a positive impact on our interest income earned on our client and corporate portfolios.

I will now walk you through highlights of our financial position that remained strong with cash and total investments of approximately $1 billion as of the end of the quarter, and no debt.

Funds held for clients as of February 28, 2015, were $5.1 billion compared to $4.2 billion as of May 2014.

Funds held for clients vary widely on a day-to-day basis, and average $4.4 billion for the quarter and $3.9 billion for the nine months.

This reflects growth of 3% for both periods.

Total stockholder's equity was $1.9 billion as of February 28, 2015, reflecting $414 million in dividends paid during the nine months, and 1.7 million shares were purchased for approximately $70 million.

Our return on equity for the past 12 months was 36%.

Cash flows from operations were $693 million for the first nine months, a slight decrease from the prior year.

The change was the result of fluctuations in working capital, partially offset by higher net income.

The fluctuations in working capital between periods were primarily related to the timing of income tax payments.

You look at the prepaid line on the cash flow statement and you see that and collections from clients, payments for compensation, PEO payroll.

It's common for our working capital to fluctuate between quarters.

Now, let me turn to FY15 guidance and I'll keep it fairly short.

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 change.

And I'll just summarize it by saying our guidance is unchanged from what we provided, beginning of the fiscal year.

Before I turn things over to Marty, I want to let you know that Paychex will be hosting an Investor Day in mid-July.

We are working on a transportation friendly day.

So, you can get in and out on the same day if you are on the East Coast or the Midwest.

Sorry for those on the West Coast.

Can't figure out how to make that work.

It's going to be scheduled for Wednesday, July 15 here in Rochester.

We'll post a save the date message on our IR website and we will be providing registration information and other details in mid-April.

We hope to see many of you in the summer.

I'll turn it back to Marty.

Thanks, Efrain.

We'll now open the call to questions.

(Operator Instructions)

David Togut with Evercore ISI.

Can you provide a little more detail on the underlying drivers behind the double-digit growth in new annualized revenue, as sold during the peak selling season?

In particular, breakdown between payroll service and HR services bookings?

Well, David, you know, we don't usually give that much detail on it.

But I will tell you that we were strong across the board.

I would say both payroll -- all areas of payroll -- as well as HRS were both very strong.

And, probably the best sales.

And we had a pretty good sales -- we've seen over the last year -- but, this is probably the best sales result in a selling season we've seen in, I would say, seven or eight years.

What accounts for that?

Well, I think very good execution on the sales side.

I also think that the channels that we've been developing from our constant CPA channel has been continued to be strong.

The bank channel, we picked up a lot from the bank channel from a referral standpoint.

We've also added a number of franchise arrangements, where we're the supported or the preferable company for payroll.

And I think we've just done a good job, overall, also team selling.

So, going in is not just payroll and then coming back to sell the other ancillary services, but going in right up front and selling the full value of all of the products to the client right up front.

So, we've seen good growth in payroll.

We've seen good growth in HRS.

In the Affordable Care Act products, our employer shared responsibility product has been strong and certainly, HR outsourcing, both PEO and ASO.

All have been strong, I think it's execution, I think it's a lot of the work that the head of sales, Mark Bottini, has been doing with that team to build a good referral and pipeline as well.

With that rate of new annualized recurring revenue growth taken together with your current client retention trends, point to a change in your revenue growth rate for FY16 and FY17?

Well, I can't really get into guidance now.

I think we'll have a better sense of that at the next quarter to talk about 2016.

Certainly bodes well for a start, anyway.

Thank you very much.

George Mihalos with Credit Suisse.

Just wanted to start off on the core payroll side, the growth of 2%.

I guess I'm closer like 2.4%, the way we calculated.

But, anything else to call out there aside from timing, was there any sort of slippage on the pricing side 2Q to 3Q or a slower rate of decline growth, or anything else?

Good question.

Client growth, no.

Pricing, no.

Checks, a little bit less than we expected.

So, a little bit of color on that.

We've seen moderation in checks per payroll.

We're not calling it out specifically because when it's trending around 1%, it really is not a significant contributor to revenue, overall.

But, what we did see was checks that have just been a little lighter, a little bit lighter in the quarter than we anticipated.

Now, just two more points of detail on that.

What's interesting about that number, is, again, I ruled out client and I ruled out price because that's not a driver here.

Timing is primarily the reason, but secondarily, what's going on is that even though we saw an increase in the amount of bonus dollars that we paid in checks, that's what we seem to be seeing in the data, we actually saw a slight decrease in the amount of bonus checks.

So, it looks like people were being paid a little bit more in bonuses.

But, the size of those bonuses resulted in lower checks.

So, it was a little bit lighter and that really kind of drove much of the -- much of the difference in payroll service revenue.

We've accounted for that, as we look forward.

I think we're just in this environment now, where check per client or check per payroll growth is going to be moderate going forward.

So, that's some color on that point.

Okay.

Appreciate that commentary.

My second question, on the prior earnings call, I think you guys talked a little bit about M&A and your appetite to do something there.

Just curious what you're seeing out there in the marketplace and if you still have an appetite for, a guess what you would consider a large-scale acquisition in addition to any tuck-ins.

Yes, we do.

We still see a lot of available.

We're looking at more than we probably ever have in the past.

Everything is pretty highly valued, so we're going to be very selective as to what we do.

But, we're looking at both something that would be product tuck-ins but also just add to -- add to the base because we think whether it's PEO, payroll or other services, we think we're pretty effective at what we're, how we're executing and it's a good time to acquire.

May not find something, but we are pretty deep into a number of things we're looking at, at the time.

Size would be, we'd be very selective.

But we certainly have the cash to do it if that makes sense.

Just to be clear, you're going to be sticking to sort of a payroll acquisition or something in that area or in HR services, and not any sort of areas?

Yes, that's correct.

Thank you.

Jason Kupferberg with Jefferies.

This is Ryan Carey calling in for Jason.

I just want to build on George's question.

Although you reiterated the full-year guide of 3% to 5% for the payroll services, has your outlook on where you might fall in that range changed at all after this quarter meaning, do expect 4Q to make up for the moderate softness or a little bit below that range we saw in 3Q?

You know, excuse me, when we issued guidance we expect to be somewhere around the middle for the year.

I think that's where we're at right now.

Okay.

Great.

Do you see any material changes in the competitive environment as you got deeper into the peak calendar year-end selling season?

I have to ask a question on pricing as well.

Last quarter you seemed comfortable pricing 2% to 4% band.

Has that been any material change in either direction over the last quarter?

I would love an additional color.

Thanks.

I don't think so.

We didn't really see -- actually, we felt very good about the quarter from a selling perspective.

I would say the competitive environment was about the same.

Didn't see an extra pricing pressure.

There's always competitive pricing pressure out there, but we didn't see anything pick up necessarily.

There was no big competitor plans or things that they were doing that we saw that made any big difference there.

I'd say pricing is generally holding like we thought it was last quarter and competitive environments about the same.

Great.

Thanks so much.

Sara Gubins.

Efrain, you mentioned that some payroll service revenue was being deferred from third quarter into fourth quarter.

Can you give us a sense of magnitude of that, and this is David Ridley-Lane for Sara Gubins.

It's implicit in what I said.

That we expect to be somewhere in the middle of the range.

If you heard my comments earlier I said that fourth quarter was comparable to the first half of the year.

And I'll kind of leave it at that.

Okay.

And then could we get an update on the sensitivity of the portfolio to the first 25 or 50 basis points of interest rate increase?

Yes.

On the short-term it's going to be about $4 million, somewhere in that range.

A little bit less, a little bit more.

That just assumes the short-term rate prices.

What that does to long-term rates is a good question.

I don't have a crystal ball on that.

Timing, at this point, you know our best guesstimate is Q2.

Again, our crystal ball has been exceedingly fuzzy.

Got it.

Thank you very much.

Smitti with Morgan Stanley.

I just had a couple follow-up questions on the minimum premium plan.

Maybe you can talk about how the claims have trended versus your expectations on whether you got in any closer throwing out the offering to more states?

Yes.

So, I would say that claims experience, thus far, has been about what we expected.

We're pretty conservative in terms of our approach and takes a belt and suspenders feel from an actuarial perspective.

We have two actuaries look at it and have pretty extensive conversations about how we set prices.

I think one thing that I'd just like to reiterate, from our perspective, the PEO is not an insurance play it's an HR outsourcing play.

So, we understand the perils of selling cheap insurance in the PEO and it's not a direction we want to go in.

So, I think claims have trended about where we expected them to be.

I didn't -- I forgot the second half of your question, Smitti.

Can you give us an update in terms of your plans to roll out the offering to more states?

At this point, we're still getting through kind of a full year of this one.

We feel very good about, as Efrain said.

I think we've done very well on the claims and so forth, but it's a year into it and we don't have any immediate plans to expand it outside of the area, but that is where a big amount of our sales are.

So, I think we'll give it a little bit more experience before we look to expand it.

Just following along on the minimum plan.

Can you talk about how the client ramp has looked like over the past year and whether you switch existing clients over, or whether it's really new clients signing up for the product?

Is primarily new clients that we're signing up.

When we initially did it, we obviously moved existing clients on to the plan.

Now what we're doing is selling new clients.

I'd say PEO client base is growing nicely, double-digit.

So, one thing I hope we're not leaving the impression that it's the minimum premium plan driving PEO growth.

It really is that there is a lot of interest in the market now for bundled HR outsourcing solutions, plus that it also include healthcare and that's driving the market.

Okay.

Thank you.

Tim McHugh with William Blair.

Can you help us contrast the double-digit growth in annualized new sales?

What was that number a year or two ago?

How much of an improvement is that versus what you've seen in the last couple years?

Well, I would say it's certainly gone from single digit -- fairly flat, actually -- to single digit and now double-digit growth in part, annualized revenue.

So, this is, as I said, I think this is probably the best selling season we've seen in seven or eight years.

I think very good execution.

I think it's much stronger than last year, which was pretty good.

And, as I said, it's very much across the board, so it's not just PEO in the HRS services.

It's a good team selling.

We're seeing good -- both payroll and HR outsourcing, 401(k), really across the board.

Very good execution.

I do think, obviously, the market is coming back a little bit from a small business and midsize business environment, too.

So, I'd say -- I want to characterize it as the best in seven or eight years from an increased standpoint, from a total par standpoint.

Last year was improved, but that was still kind of mid single digits last year even?

It was in single digits.

I wouldn't characterize it as mid-single digits.

Okay.

Does it change your thoughts -- I think, you've talked about trying to get unit growth or client growth back up to kind of somewhere in the 1% to 3% range.

Where is your thoughts on that, as you exit the selling season based on what you saw?

It's still a combination.

I mean, we want the units and the revenue both, and that's the way our comp plans and our incentives are set.

So, we're still looking for both and we're still trying -- we certainly expect to be in that range.

You know, from client growth perspective.

But, you want to be -- I guess -- I was trying to see if you would increase that range, given the sales season?

Or, if it's -- I guess if you still with a 1% to 3%?

Yes.

I would say in that range from client growth perspective.

This is an ability to sell higher revenue per client as much as product, it is selling more complete bundles to clients and more complete and more ancillary services, as well.

So, I think the client growth, you know, would still be in that same range.

I wouldn't necessarily bring that up, but I think we're selling more revenue per client because of the better execution in team selling, et cetera.

Okay.

Great.

Thank you.

Kartik Mehta with Northcoast Research.

You talked a little bit about the float.

Are we at a point, now, if we assume that rates stay kind of where they are and don't worry about increases, that float income year over year should be flat and if rates go up you could start seeing an increase there?

I think you could should see it pick up modestly.

I think that's where we're at.

We weathered the storm and the storm appears to have passed.

Hopefully we're not in the eye of something.

But it's -- it seems to be that the worst certainly is passed and from the perspective of the portfolio and how we will manage it, interest rates, now just represent upside.

As I like to say, the embedded optionality of the stock.

Marty, you talked a little bit about price increases and this quarter we haven't seen, really, any increased competition.

As you look at the next price increase, which I think you usually do sometime in the May timeframe, anything change in the environment which would change your mind as to the type of price increase you would do this fiscal year compared to what you were able to do the current fiscal year?

No.

I think we'd still be in that same range.

We've gotten more sophisticated as to kind of where we put the price increase, based on clients, products, and the competitive nature of those products with the portfolio of different products we have.

But, I still think you'd expect us to be -- you should expect us to be in that 2% to 4% range.

One last question.

Efrain, you alluded to this a little bit when you were talking about the PEO.

I'm wondering, is there a way to quantify any ATA benefits you're getting?

And, if that benefit goes away next year?

Or, is the PEO at least the way you look at it and the HRS business, the trends are fairly strong, so we should continue to see the growth you've been witnessing?

My initial answer to that, is that I would expect a continuation of trends.

Having said that, we are going through the planning process and having our usual discussions with sales about what we think is attainable.

I think it's fair to say we're in a favorable environment.

How we set that for next year's plan still remains to be decided.

Thank you very much.

Gary Bisbee with RBC.

Just going back to the minimum premium plan for one more question.

Can you give us a sense, is that going much more quickly than other PEO?

Now that we've annualized you adding that, I'm trying to think, will that be growing faster and thus be somewhat of a drag on margins even though there's a little profit impact for several more quarters?

Or, is most of that behind you now that you've got the introduction of that?

I think next quarter is when it'll pretty much anniversary, Gary.

We'll still see a little bit of drag into next quarter.

Starting the following quarter, it should be more fair compare.

The point you're making, is a fair one.

To the extent that more PEO clients attach healthcare, it does have a slight drag on margins, because we don't get much of a margin flow-through.

But, after fourth quarter, it shouldn't be significant.

Okay.

Great.

We all know PEO -- because of the pass through, somewhat lower margin.

When you look at the mix of new business, the composition of your growth in the last year or two going forward, how do we think about the puts and takes around margins?

Is stuff -- a lot of stuff coming in at a lower margin?

Or, some of it is incrementally more profitable to existing customers?

What are the main issues?

Gary, that's a good question.

The answer is, if you look at most of HRS with the exception of PEO.

If I take all of those products, they're all growing pretty strongly and they all have margins that are comparable to payroll.

One exception to that is insurance, but it's still too small to exert an overall drag on margin.

So the answer is, we shouldn't see significant dilution.

There may be a moderate impact if PEO really, really starts to grow much faster than everything else.

It's been growing nicely, but it's part of the mix and it's reflected in our results.

So unless that really took off, it shouldn't have a significant impact on overall margins.

Great.

One last one.

Last time the company got north of $1 billion of net cash in corporate investments there was a sizable buyback.

I think it seems like you've been more likely to do some steady buybacks over time rather than the one big dip.

I wondered if you've given any thought to maybe a special dividend or some other way of returning more quickly a portion of that excess cash?

Yes.

So, I guess my nuanced answer to that, is when it's above $1 billion we have to think about what we do with it.

It's a function of where we are with respect to opportunities within the M&A portfolio.

To the extent we don't see those materializing in a shorter-term timeframe, then we have to have that conversation with the Board and they're ultimately going to decide what makes sense.

But, we'll be having those conversations.

Great.

Thank you.

Jim Macdonald with First Analysis.

On the double-digit new bookings growth, do think we'll see that more in HR or somewhat in payroll?

How is that going to play out?

I think both of them have been pretty strong.

I think it's a little stronger in the HR side.

That's obviously where we have more opportunity to sell the ancillary, the wide breadth of ancillary products that we have.

A little bit stronger on the HR side, particularly as Efrain said, between PEO, ASO, 401(k), our online services, time and attendance and everything.

Everything but payroll is in there.

I think it's certainly been a little stronger on the HR side, but both have been good.

I'd say this, Jim.

Marty mentioned it was double digit.

It was in the fourth quarter -- third quarter, it was double digit in payroll.

So, to Marty's point, we were pretty strong across the board.

Great.

I think similar to other questions, but as people continue to adopt the minimum premium plan, will you continue to get a little bit of a tailwind in revenue growth that you sort of had this year from the new revenue recognition?

Yes.

That's a good question.

You really don't see as much of it next year.

We really obviously got two things.

We obviously got an uplift this year.

We've been careful to call it out because we don't want people to misunderstand what's going on in the underlying numbers.

Most people understand it.

We were within $3 million of what the street had on revenue.

So, everyone understands, kind of, what's going on.

You get a modest tick up, but after this year, the impact is not significant.

Okay.

One thing on the repurchase.

Your share count started to drift back up again.

Any thoughts on that?

Yes.

I wish the share count didn't drift up.

Yes, we -- I would say we'll repurchase opportunistically.

I think that's where we're at right now.

Before, Gary's question earlier, on would be do something more?

We'll have to take a look at where we are with M&A and address whether we think something larger is warranted.

Great.

Thanks.

Brian Keen with Deutsche Bank.

This is Evan Bull on for Brian.

Real quick on the bookings growth in the December and January quarters, maybe directionally, was that ahead of your expectations, below or right at?

Just given the magnitude of those months?

I think it was pretty close to our expectations.

We set pretty high goals for the sales team in what we expected.

Particularly in the selling season, I'd say it was pretty much at our expectations because we set pretty high ones.

Sure, that helps.

You guys have introduced a number of SaaS-based products over the course of the past year.

Can you talk about the traction with those products?

And maybe the competition and kind of the competitive dynamics there?

Who are the players that you are competing with directly?

I always hate to name competitors because it just gives them credibility.

ADP is the one we run into the most.

There's a couple of other that have recently gone through IPOs you run into, but we're winning some of those clients back actually right now, over service issues and so forth.

From I think from a product standpoint we stand up very competitively.

All SaaS, the ability of the SaaS products in the bundling of these and the integration is so critical to us and we're continuing, you'll see over the next six months to really even more fully integrate a lot of, I think, the best-in-class products.

So we have myStaffingPro, for example, which is sold and integrated, but it'll see even better integration this year.

As well as stratustime which is, I think, the leading time and attendance SaaS offering that we purchased last June, and now you'll see it not only as it integrated now but it will go much more of a full integration.

We compete very well.

It's still primarily with ADP and then there's some of the pays, that we call them, that you'll see.

But, again we're starting to win those back, they're pretty small losses for them at that stage.

Thanks, that helps, guys.

S.K. Prasad from Goldman Sachs.

First one is probably just on the timing impact.

You guys talk about double-digit growth you're seeing in bookings.

How long does it take to actually see that from a revenue side?

You'll start to see that probably a couple of quarters out.

That's when -- you know -- the first quarter, not much.

Depending on where it occurred, you start to get the client setup.

There's a little bit of time and then probably after the second quarter, that's when you're starting to see the impact.

Okay.

That's clear.

If you could provide some color on some of the newer products which you guys have launched over the last few quarters?

PEO, I understand it's at a low margin profile on the group level.

Just thinking about the newer products, are there any products or services which are at higher margin than the group level?

I'd say as Efrain mentioned earlier, most of the products are at a pretty strong margin level across the board.

I think insurance, Efrain mentioned, was pretty strong margin and, but that's still a small part of the business although the insurance, the health insurance in particular, Worker's Comp has always been pretty strong.

The health insurance is really starting to pick up now.

That's in addition to the Affordable Care Act products that we have.

I think as a business we worked very hard to make sure we have the strongest margins possible, obviously, with our high margins in the industry now.

We keep trying to drive those.

I think, when you look at the newer products that we either purchased or built, stratustime from a time and attendance SaaS product, myStaffingPro from a recruitment and applicant tracking product, BeneTrac, the benefit enrollment.

All those have -- will have pretty good margins, particularly as we build scale.

And more fully integrate them into the bundle.

All those products are doing well and they are getting out of the gate and this is even before we've more fully integrate them into the Paychex Flex, our SaaS base for the whole thing.

Probably just last one, regarding float income.

Yes, there's some positive comments coming from and you might end up seeing some back from that.

Just from a long-term strategy around you portfolio, would you be open to considering options like small business lending, given your strong distribution strength and strong customer base?

Good question, SK.

We have that discussion probably, I would say, once a quarter.

The challenge we see there -- so we're looking at ways to partner.

We do partner with biz2credit on small business loans and referral arrangements.

We're just very cautious about tiptoeing into an area that could be highly regulated.

That's why we've been cautious about doing it.

It's an area of interest, if we could participate a little bit more fully, we'd look at it.

That, that's the inhibitor.

Thanks, Martin.

Thanks, Efrain.

Jeff Sever with BMO Capital Markets.

Efrain, not to nitpick here but in looking at the supplemental schedule, if you look at the operating margin guidance for the fourth quarter, 35% to 36%, I think last quarter that number was 36% to 37%.

Is there something going on that we should be aware?

Yes.

I think, Jeff, first of all, eagle eyes there -- I did not call it out except that in my comments, what you saw were some discussion about higher cost in the quarter and the higher costs were driven by, primarily, by sales related expense.

So, we're just simply calling out that we think, given strong sales performance now, we're moderating a little bit the margin, given the strong sales performance in the back half of the year.

That's what's driving that modest change.

That makes sense.

I wish I to take credit for it, but somebody pointed it out to me.

Just one other question.

You mentioned on the checks per payroll, I know it's not as big of an issue as it was before.

You expect more normalized growth in the fourth quarter.

Is that because of the bonus issue you mentioned that shouldn't really impact the quarter?

It's not going to impact the quarter and I think the timing shifts that I discussed in Q2, these happen from time to time -- I'm sorry that I mentioned in Q3 -- that doesn't occur in Q4 and then we're back at a more normalized rate, like what you saw in the first half of the year.

All right.

Great.

Thanks so much.

David Grossman with Stifel.

I was wondering if you would just step back to the cost in HRS and perhaps help us better understand ASO versus the PEO on what the trends are you are seeing in the buyers of each of those different products?

Yes.

I think, primarily, the PEO is typically been in states where they're just more comfortable and more used to PEOs.

What's expanded a little bit from a PEO side, David, is because of the Affordable Care Act, they're looking more to kind of feel more comfortable in the call employer relationship.

So, there's a little bit more acceptance, I think, to the PEO and not just the typical states, the Florida, Texas, et cetera type of states.

We do see that growing.

That's been, frankly, a lot of the Affordable Care Act has pushed more people into seeing the opportunity and just feeling more comfortable being part of a shared kind of employment service.

Those who don't need to go that far and have the ASO and both, I think the ASO is still coming primarily added from an HR outsourcing type of business.

We've seen that drop down.

So, where clients didn't think about HR outsourcing at 30 employees or 20 employees, now do because of the complexity of the regulations of the hiring and firing and other compliance issues.

So, both are growing.

I think PEO still tends to grow a little bit more from thinking -- starting to think about insurance, but then realizing that the HR support is there and that's why they buy totally.

Because, that's really how we sell it, is the value of HR support.

But, the ASO continues to be HR and I just think it's so complex now, the Affordable Care Act, there's a number of immigration reform issues that are out there for hiring and so forth.

All of these things add more people to say, I want to outsource my HR to somebody who's going to stay current.

Of course, we've been a leader in this business, and we have more client employees than anybody else in the business by far, that we service.

Over 400 individuals around the country who service the clients face-to-face and I think that's made for great growth.

And to build on that, David, I think when you look at how we are going to market and how we sell that product, ASO tends to be, as Marty mentioned, tends to be a little bit lower, typically worksite employees and within the base.

PEO tends to be a little bit bigger, and a combination of inside the base and outside the base.

So, our PEO sales are not just to existing Paychex clients, but also outside the base.

Is the relative growth rate -- just without getting into the specific numbers -- are they comparable?

If not, do you expect them to diverge at all?

I think they're generally comparable.

They're pretty close on both sides.

It's just the preference for what, how the client thinks.

I think the other thing that we probably didn't mention is selling this more upfront, we have found that typically our model was sell them payroll, then come back and say do you need HR services in three months or six months?

We're selling much more up front, if we think the client is of a 20 plus in a complexity we will go in and team sell.

I think we're winning more clients right up front an ASO or PEO basis.

Okay.

And just one other question.

Do you sell the ancillary services without payroll?

If you don't, would you consider doing that?

Good question.

The answer is yes, we do.

Although, for example, we reported, I believe last year about 580,000 clients.

We think we had in excess of 20,000 clients that don't take payroll but take other ancillary products.

I think, David, it points to the fact that the company that we were prior to the recession is very different than the company that we emerged out of the recession.

We're much more of an integrated full-service provider to small and medium-size businesses and you're starting to see that in the client base.

We'll update some of that information when we get to the end of the year.

Very good.

Thank you.

Mark Marcon with R W Baird.

With regards to the core payroll growth that you've seen, can you characterize where you are seeing the strongest growth in terms of, is it the smallest end of your other client size?

Or, just the average small client and what are you seeing on the MMS side?

I would say on the average, not necessarily the smallest clients, although new business formation has picked up some, obviously, and we're kind of getting back to where we were pre-recession levels.

And, I think our sales to new businesses are back up over last year, at this time.

So, I think there's some small, but I think primarily it's net average base, if not slightly higher I'd say, meaning one or two employees or something like that.

I think we're right in the average, and in the midmarket I think it's about the same.

We focused very heavily on the 50 to 500 in that midmarket space and I think that's been a very good sweet spot for us.

We certainly have clients that are above that, but we're really focusing the team on that 50 to 500.

It's a very hot space right now for multiple products.

Those are the clients that need multiple products that are integrated and SaaS-based and we fit really well there.

So you're seeing the same level of growth in that 50 to 500 as in that sub 20 group?

Yes.

I'd say pretty close, I'd say.

Yes.

Great.

You still have some improvements to make to that 50 to 500 product, is that right?

What I mentioned earlier is over the next six months you'll see even stronger integration.

So, all on kind of the same user interface and so forth.

They're integrated today from different levels but over the next six months, stratustime that we acquired last year, myStaffingPro and BeneTrac will see even enhanced integration.

Single sign-on, single database?

Yes.

Great.

Which will make that even a stronger product then right from applicant tracking, right through to retirement, as they say.

Particularly on the front end of the applicant tracking and the benefit enrollment.

Building on what Marty said, the way we segment markets, Mark, is under 50 and 50 to 500.

If you look at it from a unit basis, the growth is pretty comparable.

Okay.

Great.

And, with regards to the sales that you've seen, can you characterize the number of add-on modules that you're seeing now, relative to say, a year ago?

I guess I'd say, if this is what you mean, we sell a lot more bundled services.

Certainly, than stand around payroll.

That's gone up dramatically over the last four years.

What does dramatically mean?

I'd say from low double digits as a percent to mid, almost.

Okay?

Double-digit.

Where we used to sell, probably standalone payroll -- and this is a change in the whole sales team -- bundled services right up front 10% to 20% of the time, now we're selling a complete bundle probably 40% to 50% of the time.

It's pretty dramatic.

We've bundled the products, as well, and the way that sales has looked to increase the revenue per client and really to sell the client everything they need right up front as part of a bundle.

Then, what percentage of your sales are now coming from brand new businesses?

I'd say it's still close to half.

Still close to that 50%.

Okay.

But, that is picking up?

Yes.

Okay.

Great.

If the economy stays as it is, would you expect your new business revenue growth target to basically stay about the same?

I think so, yes.

Mark, it's really been typically between about 45% and low 50%s, 52%, 53%.

It's hard to envision that that changes that much.

Part of what distinguishes us from a lot of companies is that we're mining that new base to get our customers.

So, we got the three person payroll and they eventually become an 8, 10, 20 person payroll because we mine that base.

So, that's part of the way we sell how we do that, how we go-to-market over time may change, but that's really core to how we're approaching the market.

Lastly, this is completely separate from new business formation, in terms of the question.

But, specific to your bookings growth.

When we take a look at the target that was set and if the environment stays the same, in terms of how you're judged, do you think that your target level will roughly stay the same as what we've recently seen in certain documents?

That's a very wonderfully elliptical, euphemistic way of saying we typically have a pretty tough target.

Management doesn't get paid.

We don't start having conversations until we're getting close to double digits.

So, we will expect that we will have a double-digit target and we'll expect that if we don't meet it, we'll suffer the consequences.

So, that's kind of where we're at from management's comp perspective, obviously, sales has its own set of comp.

Congratulations on a good year this year.

Thanks, appreciate it.

John Williams with Topeka Capital Markets.

You had mentioned in the release a couple of things that I thought were interesting and maybe speak to what's happening in the wider world.

Specifically, regarding, number one, pricing and number two, just the fact that you're starting to see wages move up a little bit.

I was wondering if there is any read that you have, perhaps, more on the wage side than on the pricing side.

You've talk a bit about the pricing side, but I'm curious to know what you're seeing with the wider scale with wage inflation, and if that's something you think's going to become an issue in the next few months?

Wages we generally seen around 2%.

So, it wouldn't say it's anything overly strong.

I think we saw, Efrain mentioned earlier, from a bonus perspective, which we watch, bonuses were higher.

There didn't seem to be as many, necessarily, or much of an increase as we thought, but they were higher.

General wage has been pretty consistent at around 2% increase.

Think you're picking up, John, on the 3% client fund balances.

So, that incorporates not only wages but anything else that we're paying.

It looks like it's ticking up moderately.

Okay.

That's helpful.

Thank you guys.

Lisa Ellis with Bernstein.

Can you comment, just following up, on the strong bookings?

Also, increase in sales expense?

Can you just give a little bit more color around sales productivity and how that's trending compared to, say, growth in the sales force?

Yes.

I think we're showing, obviously, good productivity in this third quarter in the selling season from a standpoint of revenue per rep.

So, we're seeing pretty good productivity there.

As we projected or set our goals, I guess I'd say.

So, that always drives -- when you tie back to expense in the third quarter -- because we have a lot of sales in the third quarter with January starts for payroll, in particular, that drives the sales expense up.

I would say sales expense per sale is generally consistent with where we thought it would be.

We're continuing to get productivity out of the sales team.

I think they're executing very well, as you look over the last few years, in particular.

Terrific.

Second one, on the ASO and PEO businesses, how much of the growth there is coming from greenfield versus how many of those deals are you think that it's competitive or actually a takeout?

I would say, in the PEO side, I think it's probably 60/40.

I haven't seen that number lately, but I would say more new.

When you think about -- it trends tends to be with our overall business.

We're 50% new businesses, I think if that's what you're asking from a payroll standpoint.

I think the PEO is similar to that, maybe a little bit more on the new side, but I think it's right in that range of 50/50.

Terrific.

Last one, just a longer-term question.

In your comments up front, you talked a bit about flex and the health care reform offering in myStaffingPro and then made some comments in response to question about looking more actively at M&A.

Can you take a step back and give us an idea of looking out two, three, four years, how you envision the product portfolio evolving?

Yes.

I think when you look out it'll be a fully integrated software-as-a-service offering, meaning single database, UI, very client friendly, mobility will be tied into it very directly.

One of the things we didn't really comment on today, quickly in the comments, is mobility, our mobile app -- we've added to the mobile app and it is seeing pretty dramatic usage being picked up even more from client employees than clients.

So, we're seeing a nice rollup of client employees, which we think will add to retention, by the way, because the client employees now will be interfacing with our products and we'll -- we have very positive feedback on the mobility.

When you look out, it's going to be that single source for a client to come for us for everything from hire to retire, as they do now and I think it'll just be a very full product set.

I think the M&A piece of it is some product tuck-ins where needed, to be straightforward, we've got pretty much the products that we need.

Now, it's finishing the fully integration of a single database within this year and then it'll be adding, I think, where we can execute and add [more our] ability to make the Company more efficient.

So, PEO, payroll companies, 401(k)s always out there and any offshoot of anything from recruiting, et cetera.

Those kind of businesses.

Those are pretty wide scope that we look at from an M&A perspective.

Our job will be to drive upper single-digit revenue growth on the top line and still be one of the most profitable companies in the business.

Terrific.

Thanks, guys.

Joe Foresi with Janney.

This is Robert Simmons on for Joe.

Actually just had my first question.

What are the thoughts on international expansion?

I have been in Germany, now, for 9 or 10 years.

We doubled our size last year with an acquisition and continued sales growth.

So, we've got a nice base there.

Brazil, we started last year and we're kind of chugging along.

It didn't help that the kind of Brazil, the economy slowed down at a time where we were starting up there.

We're learning there and breaking into the business.

Winning over the CPAs so that they'll refer more of their payroll business out to us.

We're still very interested in it.

We were going to focus on two or three countries, kind of the third country.

We haven't quite found a good entryway in, yet.

We've looked at a number of them.

It'll always, I think, at this point, it tends to be small.

It's going to tend to be a small part of where we are as we approach $3 billion in revenue, but it's still of interest to us and we continue to look at acquisition opportunities and ways to increase sales and profit there.

Great.

Thanks, guys.

Matt O'Neill with Autonomous Research.

I was just hoping you could give us any updates you might be willing to provide on the short payroll business, specifically, and possibly if you could parse the client growth rate of 1% to 3% and the contribution from the SaaS side?

Thanks.

Sure.

We don't really -- the, SaaS, most of our products now, most of our clients are on SaaS.

So, well over 80% of them.

From a growth standpoint, we don't break out SurePayroll anymore.

But, they're doing fine.

Really, they've had good client growth year over year and I think they're competing very effectively with, particularly, the micro businesses for payroll.

All of that is done through web.

Marketing and sales on the phone, once people call in.

I think they've been very effective at that in growing their client base.

We continue to be pleased with that and continue to always watch who we're competing against.

Not a lot of new competitors, there.

Some startups, got quite a bit of press for a while, but then it's dropped out a little bit because they're not a full product and as sure.

So, I think primarily, it's Intuit that we run into as a competitor there.

Folks just wanting to stay manual and doing their payroll manually.

The other thing I'd add, you surf the web, there's a bunch of these different rating services, but they just won a recent award in terms of user access and appearance.

So, they are very, very formidable competitor in platform in that micro enterprise space.

Thanks very much.

Our last question comes from Ashwin Shirvaikar with Citi.

Good job on the bookings.

My question is, as the bookings roll into revenues, can you talk about, are there incremental expenses involved and taking the question longer-term, just longer-term expense growth assumptions.

Where you're making investments.

Ashwin, two things.

In a quarter when we have particularly strong sales execution, then our expenses tend to ramp up.

So, we had probably a little higher expense growth in the quarter and then in the back half of the year based on the performance we're seeing.

Hopefully, obviously, that leads to a little bit better build revenue going forward.

So, unless we set our plans too low and they constantly beat them, that's not the way we tend to do it.

We tend to set them pretty high.

The sales force has done a great job of rising to the challenge.

With respect to expense, you know, I think there's really going to be no change in terms of the approach we take.

We're going to leverage on operating expenses as much as we can.

We're going to continue to invest in IT, probably a little bit more of a moderate rate than you've seen in past years, more than has been embedded in the SG&A number, which is where it appears.

And then we're going to continue to make selective investments in sales where we think there's opportunities to grow the business.

So, I think that will not change dramatically.

Quarter over quarter, you might have some changes, as results are higher than where we expected.

So, the incremental IT investment, is that as part of ongoing transition as you move towards more product related, more cloud basis and --

Yes.

As you know, double-digit increases in IT investment for many years, and I think what we're saying, it tends to flatten out.

We've reached a very good point of the amount of productivity we're getting and the development needs and that's still -- it's become a very large part of our investment, as you would expect, with a SaaS-based company that's very much technology driven service.

Last question.

If you can help with the relative sizing of HRS offerings?

The biggest, now, certainly, as I say, is HR outsourcing.

Both ASO, PEO, and what we call our HR essentials product which is more telephonic support, HR light, HR outsourcing light, the second is our retirement services business and third, insurance.

Nothing's changed there.

Those are all businesses that are growing nicely and performing well within the portfolio.

Was hoping you'd put numbers to relative sizing.

But, okay.

Maybe you will at your Investor Day.

Your biggest followed by the next biggest followed by the smallest.

Okay.

Thank you guys.

There are no further questions in queue.

All right.

Thank you.

At this point we will close the call.

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