沛齊 (PAYX) 2016 Q1 法說會逐字稿

Welcome and thank you for standing by.

(Operator Instructions)

This call is being recorded.

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

I'll now turn the meeting over to your host, Mr. Martin Mucci, President and Chief Executive Officer.

Sir, you may begin.

Thank you.

Thank you for joining us for our discussion of the Paychex Inc first-quarter fiscal 2016 earnings release.

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

This morning before the market opened we released our financial results for the first quarter ended August 31, 2015.

And our earnings release and Form 10-Q will be made available on our investor relations page at 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'll review highlights for the first quarter in relation to operations, sales and product innovation.

Efrain will review our first-quarter financial results and discuss our full-year guidance, and then we'll open it up for your questions.

We're off to a good start in fiscal 2016 with positive results across our major product lines.

We have continued our momentum in both sales and new product enhancements.

Client satisfaction and client retention also remain at high levels.

Payroll service revenue growth of 5% was in line with our expectations.

And we also continue to see strong demand for our human resource outsourcing solutions, including double-digit growth in client work site employees served.

Total service revenue grew 8% in the first quarter.

I want to mention, very important to us that Paychex was recognized as a leader in the July 2015 Gartner Magic Quadrant for payroll business outsourcing services, advancing from our challenger position in 2014.

The 2015 Magic Quadrant evaluates the capabilities of 12 key providers of payroll BPO services across the globe.

And I'd like to read to you some of the facts that came out of Gartner's release.

Paychex ranked highest of all participating providers in overall satisfaction across payroll functions, technology, provider customer relationship, and payroll BPO service outcomes.

Our strengths, according to Gartner and our clients -- the survey of our clients -- was a clear focus on our target market, ease of implementation and use, and investment in innovation.

Paychex' integrated HCM platform, Paychex Flex, better aligns its technologies internally, and the Company has demonstrated significant innovation in mobile phone and tablet apps.

We're very proud of this and the fact that the leader designation by Gartner means that we execute well against current vision and are well positioned for the future.

So, we're very proud of that and I'm very proud of the entire Paychex team that was instrumental in achieving this designation.

It fits a lot of what we have been talking about over the last few years about our significant increased investment in innovation and product.

The launch last year of Paychex Flex, our cloud-based integrated human capital management platform, provides us the ability to deliver a streamlined and integrated workforce management solution to a broad range of clients.

This platform gives our clients the features and functionality they need today and it also allows them to easily add services as their needs change.

And the Gartner designation as an innovation leader is the result of our commitment to that investment in both technology and client service, focusing on the clients and the total value proposition to them.

At our Investor Day in July many of you had the opportunity to learn more about Paychex Flex and our integrated software-as-a-service solution suite of HCM products.

We are very proud of our leading-edge technology.

And the strength of Paychex Flex is that it's a single platform utilizing a single employee record in addition to a number of client service options.

We recently launched our Paychex Flex Hiring module which gives employers access to paperless recruiting and employee screening, along with a robust onboarding model for a seamless flow of information and data access.

At HR Tech we plan to announce additional enhancements to Flex with the integration of employee benefits and time and attendance functionality, which will round out the HCM suite.

We now have the most robust mobility offerings for both administrative users and employee self service that allow access to all of our HCM suite from a single mobile application.

Last fiscal year we launched our full service Paychex Employer-Shared Responsibility Service to assist clients navigating the Affordable Care Act.

Our ESR product includes a monthly monitoring service with automatic alerts as well as year-end reporting on Forms 1094 and 1095.

We are pleased with the level of continued client acceptance that we have experienced.

The positive momentum we saw in fiscal 2015 in sales execution has continued solidly into 2016.

Our integrated team selling approach continues to produce strong results by introducing a full suite of product value that Paychex can offer our clients up front.

Our execution in service operations has continued its standard of excellence, demonstrated by strong client satisfaction results and client retention levels that remain consistent with recent highs.

Our innovative leading-edge technology, coupled with this exceptional client service, makes us different in the market and it's what we focus on.

We've also continued to take steps to add additional value to shareholders.

In July we increased our quarterly dividend 11% to $0.42 a share, maintaining a very competitive dividend yield, one of the highest in our industry.

We've also continued to repurchase Paychex stock and acquired another 1.3 million shares of common stock in the first quarter of fiscal 2016.

In summary, we're off to a solid start for sales, service, product strength, and financial performance for fiscal 2016.

And I appreciate the great work of the 13,000 Paychex employee team across the country.

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

Efrain?

Thanks, Marty.

Good morning to all of you.

I'd like to remind everyone that today's conference call will contain forward-looking statements that refer to future events and, as such, involve some risks.

Refer to the usual disclaimers.

As Marty indicated, our first-quarter financial results for fiscal 2016 show we're off to a solid start for the year.

Here are some of the key highlights for the quarter.

I'll provide greater detail in certain areas and wrap with a review of our 2016 outlook.

Total service revenue grew 8% for the first quarter to $712 million.

Interest on funds held for clients increased 6% for the first quarter to $11 million.

Now we've had a number of quarters in a row where we've strung together increases on funds held for clients, so that part of the P&L is starting to bounce back.

This was driven in part by a 2% increase in average investment balances.

Expenses increased 7% for the first quarter primarily driven by higher compensation-related costs and growth in our PEO.

The increase in compensation-related costs was driven by higher wages and performance-based comp costs.

Operating income net of certain items increased 11% to $285 million for the quarter.

We achieved operating margins of 40%, up from 39% in the prior-year quarter.

Remember that our operating margins typically are higher in the first half of the year.

At this stage in the year, we anticipate our full-year operating margin will fall within the guidance we have provided.

We will update again, of course, in Q2.

Our effective income tax rate was 29.7% for the first quarter compared to 36.3% last year.

This change is due to the recognition of a net tax benefit on income derived in prior years from customer-facing software we produced.

During the past quarter we engaged leading specialists in the area to assess the qualification in our software for the federal, quote, qualified production activities deduction.

Based on this assessment we concluded that certain of our software offerings qualified for this tax deduction in prior years and, therefore, recognize the tax benefits and related tax reserves as a discrete item during the period.

This action dovetails with Marty's comments.

We are a technology-enabled service provider, and our spending, our costs reflect this, as does the recognition we are receiving in the marketplace.

Net income increased 22% to $209 million.

And diluted earnings per share increased 23% to $0.58 per share.

The net tax benefit I just mentioned resulted in an increase in diluted EPS of $0.06.

Let me emphasize again that the impact to diluted EPS for the quarter was $0.06.

That's what we expect it will be to the year as you look at your models.

Obviously that was not contemplated in the guidance we gave.

Excluding this net tax benefit, both net income and diluted earnings per share would have increased 11%.

Payroll service revenue increased 5% for the first quarter to $433 million.

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

In addition we had one additional payroll processing day in the first quarter compared to the same quarter last year.

Revenue per check grew as a result of price increases net of discounting.

And on the payroll service revenue, I'd just remind you what we said last quarter, that we think that the addition of extra days will result in approximately 0.5% to the growth in payroll service revenue for the year.

We won't break it down by quarters.

HRS revenue grew 15% to $280 million for the first quarter.

This increase reflects strong growth in both clients and work site employees of Paychex HR services, which includes our ASO and PEO products.

Insurance services benefited from continued growth of our full-service ESR product, assisting clients with healthcare reform, an increase in health and benefits applicants, and higher average premiums in clients in our Workers Compensation insurance product.

Our HR administration and time and attendance products contributed to the growth through sales of success of these solutions.

And as I mentioned at the Investor Day, these products are typically sold as part of the bundle in our payroll packages.

Retirement services revenue benefited from an increase in the number of plans and an increase in asset fee revenue earned on the value participants funds.

Turning to our investment portfolio, our goal is to protect principal and optimize liquidity, on the short-term side primary short-term investment vehicles were bank demand deposit accounts, high quality commercial paper and variable rate demand notes.

In our longer-term portfolio, we continued to invest primarily in high credit quality municipal bonds, corporate bonds and US government securities.

Our long-term portfolio has an average yield of 1.7% and average duration of 3.3 years.

Our combined portfolios have earned an average rate of return of 1% for the first quarter.

And as I mentioned, again, in the last year's quarter we have not factored into our guidance any changes in the interest rate environment, although it's looking like that will happen in either Q2 or Q3.

Average balances for interest on funds held for clients increased during the first quarter, primarily driven by growth in our client base.

I'll now walk you through the results of our financial position.

It remains strong with cash and total corporate investments of $954 million as of August 2015 and we have no debt.

Funds held for clients as of August were $3.7 billion compared to $4.3 billion as of May 31, 2015.

However funds held for clients vary widely on a day-to-day basis and average $3.8 billion for the quarter, a year-over-year increase of 2%, and it's the average that counts.

Our total available for sale investments including corporate investments in funds held for clients reflected net unrealized gains of $24 million as of the end of August compared with a net unrealized gain of $14 million as of the end of May.

Total stockholders' equity was $1.8 billion as of August, reflecting $152 million in dividends paid during the first quarter and $63 million of common shares repurchased.

Our return on equity for the past 12 months was 38%.

Our cash flows from operations were $278 million for the first quarter, an increase of 6% over the prior-year period.

This change is primarily the result of higher net income partially offset by fluctuations in operating assets and liabilities.

The fluctuation in operating assets and liabilities were primarily related to the timing of collections from clients.

And payments for compensation PEO payroll and income taxes working capital was what created the change there in our cash flows.

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

And I just mentioned we're anticipating that at some point during the year that the Fed will raise rates.

With that proviso, our guidance for fiscal 2016 is as follows.

Payroll service revenue continues to be anticipated in the range of 4% to 5%.

HRS revenue growth is anticipated in the range of 10% to 13%, although we were higher obviously in Q1.

We think there will be moderation in growth rates as the year progresses.

Total service revenue is anticipated to be in the range of 7% to 8%.

And net income growth is anticipated to be in the range of 8% to 9%.

Remember, please, that I called out the change in the discrete tax item, which was $0.06.

So, our range excludes the benefit of the net tax benefit we recorded in the first quarter.

Our effective tax rate for the year excluding the impact of the net tax benefit discussed will be approximately 36%.

Our interest on funds held for clients and operating income net of certain items as a percentage of service revenue are expected to be consistent with prior guidance.

And all other aspects of guidance that we discussed on the Q4 call are unchanged.

I will now turn it back to Marty.

Thank you, Efrain.

And now, operator, we will open the call to questions.

(Operator Instructions)

Our first question comes from Mr. SK Prasad Borra, Goldman Sachs.

Thanks for taking my question.

Two, if I may.

[Looking] to start off, to what extent the full-year guidance is just being more [canderigular].

And given you have such a strong stock through the year, are you expecting second and third quarters to slow down?

And is that going to be related to more processing days or something more to think about?

SK, this is Efrain.

I'll take that.

We're always glad to have a strong start to the year.

That helps and increases our confidence in the guidance for the year.

But one quarter doesn't make a year.

I will say also that we called out that Q3 was going to be somewhat weaker than the other quarters.

So, there probably is an element of conservatism in our guidance but at this point we're not going to peg it any higher.

We'll update in Q2 as we see results for the year come in.

Okay, that's great.

Probably just second question, with regards to what you were talking about at the Investor Day, the focus clearly seems to be on generating more revenue per client.

But client growth also is something which should probably benefit from sales and marketing investments.

Are you seeing progress on that?

Or would you say that from your end it's very clearly going to be just revenue per client and client per growth should stay at 2% to 3% levels at best?

No, I think we're seeing progress on both.

We don't give the client growth until the end of the year, once a year.

But it's very consistent.

I think we're showing consistency in both.

Where the team is selling the integrated selling up front is doing well on the revenue side from the packages and, of course, the new products that we're rolling out.

But it's also driving more interest in more clients and selling more clients.

We would always like it as strong as it could be.

It's early in selling season, will tell us a lot more here in the next quarter or so.

But, no, we're pushing hard for both and we're making progress on both.

Probably just last one, on competitive landscape, have you seen any changes at all given the acceleration in investments by a lot of the newer start ups, especially in the payroll space?

Not really.

I think we continue to see good results from a selling perspective.

So, while they're out there, no one has the sales team that we have, the distribution model and the number of salespeople and the effectiveness.

So, on the low end I think they sell very effectively, the low end being size.

And then certainly in the mid market I think we continue to be at the strongest position we've ever been in from a product and service perspective.

So, we really haven't seen a lot of changes.

If anything I'd say we're in a better position than we were last year at this time.

That's great.

Thanks, Marty.

Thanks, Efrain.

Our next question comes from Mr. David Togut of Evercore ISI.

Thank you.

Good morning, Marty and Efrain.

Could you gauge net price increases that you're realizing, both in the payroll services and human resources services business this year?

Yes, a little bit different on HRS.

And we typically don't get real specific about how much we take.

That's a little bit different typically from payroll services.

Some years we don't increase certain product lines.

But I would say on payroll services, we're solidly within the 2% to 4% guideline and don't appear to be having any problem holding those price increases.

Got it.

And could you ballpark for us what the bookings growth was in the quarter?

No, we won't do that.

It was strong.

We feel pretty good about it.

I'd just say this, David, not to be too coy because I get that question all the time, what really matters is how we did in the selling season.

You can have a good quarter, and we've had good quarters in the past first and second and not had a good selling season in third quarter.

We feel pretty encouraged about where we started the year.

We think it bodes well for selling season but we're not in selling season yet and we'll update when we get there.

Yes.

Very consistently we feel very good about it, as we did at the end of the year, and didn't have any bumps getting off to a good start.

But as Efrain said, the selling season makes the difference for us.

Understood, thank you very much.

Our next question comes from Mr. Smitti Srethapramote from Morgan Stanley.

Great, thank you.

First question is on the PEO space.

One of your competitors has recently seen higher medical claims costs.

And even though you guys haven't experienced this given you're exposed to different states, can you talk about whether or not that's impacted your view on taking insurance risk?

Yes, good question.

We saw the same things that have been seen in the market.

We saw the results, I should say.

Our experience is very different.

We employ teams of actuaries and set our premium expense very, very conservatively.

There's no guarantee you can't have a hiccup but we do a lot to minimize it.

We also have pretty conservative ceilings for reinsurance.

And I think all of that is great but I think the most critical part of the entire equation is what you do from an underwriting standpoint when a client is presented to you.

One of the things that we did -- this was before I got here -- one of the things that Marty instituted was a very clear line between the authority that underwriters have and sales have.

While they operate cooperatively, we task our underwriters with protecting the quality of the pool.

And that has served us very well.

There is inherent risk in that area but I think we manage it very well.

When we looked at what others were doing and how they had structured their approach to risk, it was a bit different from what we do.

Okay, thanks.

And maybe continuing on the PEO side, can you provide more details on the growth rate of your work site employee count and whether that's still in the 20s?

We won't update the work site employee count to give you specific numbers.

We'll eventually release all of that information.

But I would say it is fair to say that part of the reason why Q1 results were strong was that PEO was an element of strength in the quarter.

So, we continue to do very well in that area.

Okay, thank you.

Our next question comes from Mr. Jason Kupferberg from Jefferies.

Hi there.

Thanks for taking the question.

Wanted to just pick up on the PEO topic, as well, here, to start.

The momentum that you're seeing there, to what extent do you think it's coming from share gains versus the general rising tide lifting a lot of boats, just given the catalyst of the Affordable Care Act?

I think, obviously, a lot of it is coming from the Affordable Care Act.

There's just a lot of interest in the market.

But I think, at the same time, because we're a proven leader in this space and I have a very good sales team on this, I think we're picking up more share of what's now becoming a PEO sale.

So, I would say, Jason, it's a bit of both because there's such an interest now, particularly as it's getting closer and closer to respond to the Affordable Care Act, from a PEO standpoint, frankly, and an insurance standpoint.

And because of our positioning of our product and our success we're picking up more share.

Okay.

And then just switching gears over to Flex Hiring, if we try and just get a bead on magnitude of contribution, obviously it's an important offering.

Is there material revenue baked into this year's guidance for it or should we think of it as more of a potentially material contributor in fiscal 2017?

I'd say, yes, probably more of a contributor in 2017 because it's going to take awhile to build up.

But it's adding a lot of strength to the packages that we're providing.

Not only is it giving them full recruiting and hiring but we sell onboarding as even a separate offering, which is a paperless onboarding that doesn't have to be a mid market sale, it can be a 20-person that hires a lot.

And it's all paperless from an onboarding perspective.

So, I'd say this year it's getting started and you'll see a start to it but the bigger magnitude of it will come in future years, starting in 2017.

And just last one for me, I wanted to catch up on the M&A pipeline because it felt for a period of time like you guys had opened the aperture a little bit in terms of opportunities you were willing to consider, obviously staying disciplined in evaluating those opportunities.

But would you say there's been any directional move in the pipeline in terms of it being closer to bearing fruit versus not in recent months?

Yes, I'd say so, although you never know until you get to the finish line.

But we certainly have been very active in a number of fronts on it.

But, as you said, we're still being very disciplined.

We have a pretty wide funnel at the beginning, we bring it down pretty tightly to where we think it's a reasonable valuation that's going to add a lot of value to us.

There's a few things in the hopper now that we're evaluating.

Do they get over the finish line?

-- you never know until we're ready to announce.

But we're very active in it, that's for sure.

Okay, we'll stay tuned.

Thank you.

Our next question comes from Mr. Kartik Mehta from Northcoast Research.

Thank you.

Good morning, Marty and Efrain.

Marty, I wanted to ask you about the Paychex Flex and the percentage of customers that have converted to that particular version of payroll processing.

The basic product that we have, what was Paychex Next Generation, all clients are on Paychex Next Gen.

Then Flex adds another full product suite to that.

We're in the process of moving some of the clients over.

But there's a number of clients that are already on what I would say is the foundation of it.

A lot of clients, the majority of our clients are not going to see any movement.

They're not being moved to anything unless they drive -- this is more of a mid-market product suite that are going to see more.

And they're being offered that.

We're still offering the old product suite.

What we're saying is -- if you want to come over to a full suite for human capital management that is fully integrated within a single employee record, we will move you over.

We're in the early stages of that but it's not a big push to force everybody over.

It's more -- hey, if you want these additional enhancements, come over.

And it's really targeted more in that mid-market space.

The majority of our clients won't see a move so there's not going to be any disruption that we expect there at all.

Have you experienced greater sales of products as people have moved over to Flex, especially in the mid market, considering there will probably be more demand for some of your products?

It's early but I think yes.

That's what they are looking for.

That's why we're excited with the Gartner change to put us as a leader because that's what they are looking for, is that full suite of products, fully integrated single employee record and database.

We are seeing an increased demand there.

And I think if you were to talk to the sales team, particularly in the mid market -- we just left the sales conference of our top performers a few weeks ago -- extreme excitement about selling the product and being very competitive in the marketplace.

So, I think it's early but you'll start to see that really pick up and it will add, as we talked about a little bit earlier, much more product per client.

And then, Efrain, just any change in philosophy in how you manage [the float] portfolio considering there might be interest rate increases going forward here?

Not yet but it's on my list of objectives.

Kartik, what we need to know is when they're going to raise and then what the rate of increase will be.

And I think the Fed's been signaling as directly as I've ever heard it signal when it's going to happen.

And I expect that when they implement their first increase, they will give some direction as to what we can expect then in subsequent increases.

That will permit you to decide how to position duration of the portfolio.

So, I'm waiting for all of that information to get a better sense of how we sit down and strategize around the best way to position the portfolio.

That's coming probably in the second half of the year.

Thank you very much.

Appreciate it.

Our next question comes from Mr. Rick Eskelsen from Wells Fargo.

Hi, good morning.

Thank you for taking my question.

The first question is, you said you just came from a sales conference.

I was curious what feedback you heard from your salespeople on any potential changes to client behavior given the financial market weakness and also some of the concerns about the global economy.

I think, generally -- and we release a monthly small business index -- in fact, I was just in New York City yesterday because we've expanded it now for different industries -- we're seeing continued, particularly in the small business, under 50, we're seeing continued better employment growth than pre-recession levels of 2004.

And it's down a little bit from last year but it's consistently above that level.

So, we're feeling like it's steady improvement in small business formation and in employment hiring.

And I would say the sales folks certainly felt that way.

I think the bigger excitement at the sales conference was just about the products that we're rolling out in the full feature and the strength of the competitive offering, along with the service options -- now 7/24 service and a lot of different options, more self-service that clients can provide.

They were pretty excited, first, to be there -- obviously they're top performers -- and, second, that they got a good year in front of them they feel.

Thank you.

And then on the ESR offering that you have, just wondering if you could give an update on how that's progressing.

What percentage of the clients that you think might take it have taken it so far?

And does it feel like it's going to be a down-to-the-wire type of offering where people take it at the very end?

Thank you.

Yes, sure.

We don't really release, I don't think, how many are taking it yet at this point.

I would say it's very active and I think it will be active down to the end.

We continue to provide it to our clients.

I know some competitors have stopped providing it.

There's a lot of work involved and we're making sure that the clients up front understand that there's a lot of information needed from the client for us to do this successfully for them.

But I think we're handling it very well.

We've increased the resources who are selling it.

We've increased the resources who are supporting it because we're continuing to offer it.

And, yes, I think this will be pretty active right through the end of the year.

And I think, then, there will be another surge probably after of clients who realize -- hey, I should have had this when it comes time to file and now I need it.

So, I think we'll have another resurgence of sales probably at the end of the first or second calendar quarter of next year.

But it's going very well.

It's going very well.

Thank you very much.

Our next question comes from Mr. Gary Bisbee from RBC Capital Markets.

Hi, good morning.

First question, you've talked a lot about the success in selling bundled offerings in recent years.

But one thing I don't think we've heard as much commentary on is just how you approach upselling additional components of products into the base and what the success has been in doing so.

Any commentary you could provide on that?

Yes, sure.

Gary, one of the points I've tried to make is, one of the things we shifted -- typically our model was sell payroll and then the other sales forces with the other products come in after that pretty much on a timetable basis.

You get someone comfortable with payroll, then you come in and talk to them about the value of 401(k) record keeping, about the value of HR outsourcing, insurances, et cetera.

Now what we've found is certain client sizes and complexity of the client, we come into that client with an integrated team selling approach over the last, I'd say, year, year and a half now, and it's been very successful.

What we found was we were not selling the full value of what the client was looking for, many times, in our old approach.

So, if we see a client that's a certain number of employees, has a certain hiring pattern, has a certain complexity to their business, we'll go in with multiple sales products and sell them all at the same time.

And that's been going very well.

Once we got the sales teams comfortable with it, they've been more successful and we're getting a nice track record as we get some real momentum going.

And let me build on that, what Marty said.

So, that's the team selling approach.

On the other side of it we've done a lot of data analysis, a lot of modeling based on predictive behavior modeling.

And we have models that basically predict what the next best offering will be when you don't take a bundle.

That science keeps getting better and better.

So, we know at certain stages of your life cycle and based on what products you're doing and your client characteristics, your customer characteristics, what offering is likely to be the most successful.

So, we deploy those models out to the sales force, too.

Both of those approaches have helped us become more efficient.

And is that a telesales, the selling of more stuff to existing customers, or is it your feet on the street?

No, actually it's more of the feet on the street.

I think we're much more effective on the telesales side, as well, but that's been really more for the single product sale or a follow-up sale.

But the feet on the street have been much more on the integrated team selling approach because we have many offices that obviously have multiple sales teams but they just approach the client at different stages.

And now if the client looks like the right fit for multiple products they will go out and sell as a team and we're finding some good success in that.

Okay.

And then just the 15% HRS growth obviously continues to be really good.

But is that a clean like-for-like number or was there a little bit of benefit still from the mix with the minimum premium health plan or is that really --?

No, there's always going to be a little bit of benefit from MPP but that wasn't a significant part of what happened, actually.

We had the same product mix in the quarter but MPP really did not dramatically impact that number.

It really was strength of PEO, strength of ESR, and strength, frankly, across a lot of other HRS products.

Okay.

And just a last one -- I know you've talked about M&A, but you're going to do things only if you can get the right price, and what not.

How should we think about just the cash build from here?

I think you've indicated special dividends didn't seem of real interest.

I know you've been doing some buybacks but a lot less than your cash flow.

Should we think that the likely approach is just continuing to build cash until you do find the M&A or are there any other options?

Gary, get this question a lot and what's difficult -- my answer always is the same -- what's difficult for the Street to evaluate what we're doing is you don't have insight into the pipeline and the probability of our pulling the trigger on deals.

I will say that you can assume that most of the deals that occur in the fin tech space of any reasonable size we've looked at, and that, for whatever reason, we've decided on a valuation that didn't permit us to get to the finish line because we're pretty disciplined about how we go about it.

Having said all that, the pipeline, as Marty said, is pretty robust.

So, we see a number of opportunities that we like and would prefer to simply have the cash to move quickly and deploy it in first instance.

To the extent that we got to a point where really the pipeline didn't look as robust, then I think we would start looking at other ways to deploy cash to shareholders.

Part of the way we do that, and part of our confidence in the future, is that in the summer we boost the dividend pretty significantly.

And we have been buying back shares.

If you look at our share count vis-a-vis the last quarter you see the bias is downward, which is something that we started a couple years ago.

So, all three of those are elements to how we're looking at cash.

But in terms of large cash outlay beyond dividends we think the pipeline, there's opportunities there in the space and we think that valuations have come down to a point where there's a number of opportunities that seem reasonable now that maybe weren't reasonable 18 to 24 months ago.

Great, thank you.

Our next question comes from Ms. Sara Gubins of Bank of America Merrill Lynch.

Hi, thanks, good morning.

It sounds like your margins outperformed in the first quarter versus your internal plans.

Is that fair?

And if yes, could you talk about what drove the upside?

Boy, Sara, that's a pretty interesting deduction.

Yes, they were a little bit stronger than we had anticipated.

However, I would say this -- there's two elements that always -- typically in the first quarter we're trying to peg how quickly we go out of the gate in spending.

So, it's typically the case that we're a little bit slower.

So, some of that is timing, I would say.

And then we did well in sales so we feel pretty positive about that.

We're still not confident enough throughout the remainder of the year to call it as an upside to where we are but we certainly had a strong start to the year.

Okay, great.

And then switching gears back to healthcare reform and the ACA product, it sounds like it continues to grow strong and you think that could continue for a couple more quarters.

How much of a lift is it to the average revenue per client?

I don't think from a competitive standpoint we haven't given out all of pricing and so forth, so be careful.

I don't want to say too much.

But I would say it's a significant increase.

It's pretty significant -- I don't know.

Good uplift in it and you see it in HRS.

And we're seeing a lot of success with it.

I'm not trying to be coy about it but I just want to be careful about how I'm talking about the pricing of it because there's just a lot of discussion about pricing of Affordable Care Act.

And there's a lot of different plans out there right now that people are saying, they're doing certain things.

And I think clients got to look very carefully at pricing and what they're getting for the product that they're buying because some are giving them a lot -- I think we're giving them a very full-valued service -- and others are kind of giving them a form to fill in.

I think that's what may shake out here toward the end, is clients are going to be a little surprised maybe at what they bought and what they didn't buy.

But it continues to have really nice momentum for us.

Sales are doing well with it.

A number of sales teams are selling it.

And, as Efrain said, you're seeing it in the HRS revenue uplift.

One thing I'd add is that, Sara, that PEO was strong, ASO was strong, HR outsourcing in general was strong [too].

What ESR has done is it's had a bit of a halo effect on a number of other products.

Even when you don't sell the product it permits you to get in the door to have a conversation.

I think there are very few clients that won't entertain a call about what they're doing with respect to ACA compliance because there's so much confusion in the market about it.

Okay, great.

And then last quarter you'd said that you were about one-quarter to one-third penetrated for potential clients that might take it.

Is that as high now as half?

Is it going that rapidly?

I think that's probably a reasonable range in terms of where we're at here.

Where we end up is something that we're just monitoring to see.

I think that's fair.

Great.

Thanks a lot.

Our next question comes from Mr. Jim Macdonald with First Analysis.

Good morning, guys.

Just a couple more on the ACA.

I think you mentioned, is that an HR revenue not payroll?

Correct, yes that's reported in HRS.

And have you recognized much revenue from that or does it get recognized as you bring the clients onboard?

Or how will that like ramp up?

How should we think about that?

What you're seeing now is we really started building in the back half of last year so you start to see the benefit of that in this quarter.

You're starting to see the pick up from the number of clients that we signed on and that will wash through as we go through the year.

And by the time we're at the end of the year pretty close to having recognized most of it -- most of the increase, I should say.

By year end.

And just on a different part of ACA, with a number of the public exchanges seeing pretty high price increases for their health products, and eliminating products, can you talk about the impact of that on you guys in this fall enrollment type season?

I think it's got a couple different impacts.

One, we're not seeing it impact us much on the pure insurance sales basis too much yet because they haven't seen all of those increases aren't all out yet.

You'll see them probably, all of it, by the end of the next couple weeks, actually, as they roll out.

The other thing I would say is that because of the work in the PEO and the MPP plan, we've seen very competitive low increases there for our products.

And I think that's helped us a lot.

That's part of the reason we took on a little bit more risk in that because we felt we could manage that very well, and it's been very good for us on, I'd say, much lower increases to our clients under those plans than the national averages certainly that we're seeing or regional averages.

I think it's been a benefit, it will continue to be a benefit for us, particularly in the PEO side where we have an MPP.

On the health insurance side, haven't quite seen it yet.

But clients aren't going to have a lot of choice there if they don't have -- in most cities they are going to have carriers that are all going double-digit increases, unfortunately.

But we haven't seen a big impact to slow anything down from an insurance standpoint.

Great, thanks a lot.

Our next question comes from Mr. Jeff Silber from BMO Capital Markets.

Thanks so much.

Kind of an obscure question here.

About a month or so ago the National Labor Relations Board had a ruling that people believe could affect the franchise business where unions are going to be able to negotiate with the franchisors.

If I remember correctly, you do a lot of work in the franchise area.

Please correct me if I'm wrong.

But if you do, have you heard or seen any impact, potential impact on your business accordingly?

Thanks.

Have not seen it yet.

I do think that it's one of those things that's just another negative that's out there that it makes people a little bit slower on maybe hiring or starting up an additional franchise, let's say.

If I own a couple franchises I might be just a little more cautious on whether I start another one or not based on that ruling.

I think a lot of that still has got to shake out but it certainly adds more confusion and concern to those.

We don't have a ton of franchise sales when you look at -- in the scheme of our sales and our client base, but it's certainly increasing because we've done a lot of work in selling the franchise side.

But that's been picking up.

So I would say, don't have an impact yet, but I do think it may generally put a little bit of a damper on whether I open up a second franchise or not.

That's helpful.

Is your franchise exposure on the payroll side, the HRS side or mix?

Mix.

We sell all products for the franchises.

Okay, great.

Appreciate the color thanks.

Our next question comes from Mr. Tim McHugh from William Blair.

Hi, it's Stephen Sheldon in for Tim.

Most of my questions have been answered but I just want to ask, as we get a little closer to the key selling season could you maybe talk generally about where the sales force currently stands?

And have you been doing much hiring?

How have recent hires been ramping in terms of productivity?

Just any color on how you're positioned there would be appreciated.

Yes, I think we're in good shape going in from, first of all, just, we got all the hires in, training is done.

I think Mark Bottini and the leadership team did a great job in getting everyone in, kicking off the year really well.

We have sales kickoffs, a lot of training during the first quarter and so forth on new products.

I think we're at a great positioning of training, for example.

We do an awful lot now of web training and so forth.

And from a growth of sales, I would say we're up about like we normally add to the sales force.

We had our adds and we were pretty much right on track.

The good news is everybody is in the seats, well trained, and, particularly with all of the product changes, they are well versed in the product.

And we could feel that and the momentum of it at the sales award conference.

Okay, great, thanks.

Our next question comes from Mr. Mark Marcon from RW Baird.

Good morning, Marty and Efrain.

Congrats on a really nice start to the year.

Could we drill down just a little bit with regards to just the core payroll, the acceleration we saw this quarter?

Did you say there was like one extra processing period?

Yes, one extra processing day, yes.

And how much of an impact did that have?

Good question, Mark.

I won't say specifically for the quarter but we're going to have two of them this year.

And we think that the impact will be 0.5%.

So, if you use arithmetic averages you can figure out what the impact was.

Just to be specific, the 0.5% is for the total year?

Correct, yes.

Okay.

And the other quarter that it will see this impact will be?

I believe -- is it the fourth quarter?

The fourth quarter.

The fourth quarter?

Yes, I'm sorry.

Okay, great.

And then you also mentioned that we should be cognizant on the third quarter.

Yes.

Can you remind us?

Yes, I called that out.

I'd just refer back to my comments in Q4.

I called out, at this point we think that quarter will be just, it's more timing.

I won't go into a long amount of detail, I'll update in Q2, but that will be the weakest of the quarters.

It's mostly about timing of different revenue flows within that quarter.

And I called out HRS as a potentially being below the range of the full-year guidance.

I said that in Q4.

We'll update in Q2.

But we expect Q3 will be, relatively speaking, the weaker of the four quarters in the year.

Got it.

And then with regards to the quarter that we just had, on the core side, even when we strip out the impact of the processing date, we're still doing well.

Can you talk about the biggest single driver behind that in terms of -- you certainly saw pricing stick through, you've had good bookings, but what would you say would be the primary driver?

I think it's a combination of holding the price and retention.

When you look at that immediate quarter, sales were obviously, we were very comfortable and positive on sales but the impact is when you retain the clients.

As I mentioned, we continue to be at our best client retention levels.

And on top of that we're holding the price increase in the range that Efrain gave.

So, it was a good start to the year.

That's when you see, that first quarter you see what happened with the price and did we have to take more discounting and so forth.

And we felt good about holding the price and felt very good about the client retention, as well.

Good job on the service team.

Did the retention ramp up at all?

We don't give it.

I would say it's very consistent with where we ended the year, which was a record high.

The other thing, Mark, that I'd call out is we didn't say anything about checks per client.

Obviously there's a lot of other things to talk about that were positives.

But checks per client were flat to down in the quarter.

So, when you compare one quarter over another we still were seeing positive results in checks per client through much of last year.

We didn't see that benefit.

That's a mix issue that I've called out in the past.

So, we feel pretty good about where we were from a payroll service revenue standpoint.

Absolutely.

And then with regards to just the client segments that you're seeing the strongest growth from, would it typically be in the 6 employee to 11 or maybe a little bit slightly higher?

I'd say it's across the board.

It's not like the quarter that we're seeing any one segment pick up better.

That's the good news to us, is we're doing well in, let's say, our typical under 20 segment, and we're also doing well and better, I think, even, because of the product and the service options, in the mid market.

So, I'd say it's across the board.

And exclusive of the really small one to four where SurePayroll plays?

No, that's included in that.

So it's both.

Great.

And then congrats on the upper quadrant.

That's relatively early.

Any sense for the ability of the sales force to leverage the improved recognition?

Yes, it's pretty recent but we'll certainly find any way we can.

They are certainly very excited about it because it's always exciting to see a third party, particularly like Gartner, put you into that leadership position, and that it's based on our clients being surveyed and our clients saying this is a great product and a great service.

And then Gartner coming out of it saying -- not only is it good now but you're a leader because you're positioned well for the future.

So, we'll definitely be looking to capitalize on it.

And knowing the sales team they're well trained and well versed in the things that are happening with Paychex, they will be able to capitalize on it well.

The other thing, Mark, I'd add to that is Marty's strategy really started seven years ago about investing in IT.

And I just want to reiterate two things.

One is that this is part of the strategy of how we move Paychex from where we were pre-recession to where we are right now.

And I think it's been a long time in the making, number one.

And, second, I think that external validation is a lot better and more powerful than simply trumpeting what you think, what you believe about yourself.

I would say there's a lot of smack talk by competition about how good they are.

We don't talk that way, except right now.

And we prefer to let third parties validate how good we are and let our customers validate how good we are.

We could not have had that honor unless our customers thought very highly about what we do.

That's the second point.

And then the third point is that a lot of our spending now, our increases in spending, have been around IT and it helped us from the standpoint of being able to go and build a credible case that we were entitled to certain treatment of the expenses we were making based on the strategy that we employed.

So, I think it validates a lot of different things that the management team has put in place.

Great to hear.

Thank you.

Our next question comes from Ms. Lisa Ellis of Bernstein.

Hi, good morning, guys.

A quick question on the team selling approach as you've implemented that over the last year, year and a half.

Can you dimensionalize the range, the upside you're seeing in revenue per client when you're able to sell in the fuller suite of services?

I think it's pretty significant when you sell it up front.

It's also a timing thing, remember, because I would assume that normally we're selling those other products but a little bit farther down the road.

But we're finding, one, we're selling more of it up front; two, I think by offering the total package we're selling more of it because we're hitting the client at a time that they see the full value more than just selling them payroll, then coming back later.

I don't know if we would give the exact percentage or anything but it's certainly double-digit increase in a over kind of the revenue per client that we would normally see up front.

We just might get more of that over time but then I do think we're having more success.

We felt we may have been missing some opportunities, actually, by selling a payroll only and then coming back later when the client up front may have felt better, particularly today, in saying -- gee, I really wanted HR outsourcing altogether.

I wanted a PEO or an ASO offering.

That's what I really needed.

And that's what we're finding because that's come down a lot in employee size, so it fit the team selling very well.

Terrific, good.

And then just one quick follow-up on retention.

I think you said, I just wanted to confirm, you said retention is holding relatively stable?

Yes, that's right.

Perfect.

Thanks, guys.

Our next question comes from Mr. Tien-tsin Huang from JPMorgan.

Great, thanks.

Good morning.

Good quarter here.

Just on the HRS side I heard there was a little bit better with PEO.

The moderation comment for the rest of the year, is there anything specific there that we should be aware of or it's just the previous comments on conservatism?

First of all, there is some conservatism so we'll come back in Q2 and update.

But the other thing, Tien-tsin, is we had really strong HRS growth in the back half of the year, led by PEO.

We're going to start anniversarying some tougher compares.

There's some revenue shifts going on within quarters, particularly in Q3.

So, we want to get a little bit more of a sense of how the year is building before we do anything to guidance.

Okay, just wanted to make sure.

And then just one more, back to the minimum premium concept here.

I know it's still on the earlier side for you but have you given any sense of what the mix now is of minimum premium versus the fully insured plans in terms of what you're selling, what's taking, what's not?

It's still less than 50% of what we sell in the PEO.

And, remember, the reason why I say that is that it's only in the state of Florida.

We have PEO business in Texas and California and a number of other important states.

For at least the near future, that's where it will remain.

But Marty mentioned earlier, and I think it was in response to a question about what's happening with healthcare premium increases, we're very, very competitively positioned.

We'll see and monitor how we do throughout the remainder of the year.

We feel really good about both our underwriting standards and also what we've been able to do with that plan.

That could change as time goes on.

Okay, good to know.

Thank you.

Our next question comes from Mr. David Grossman of Stifel Financial.

Thank you.

Good morning.

I was just hoping to follow up on a question I think that's been asked in several different ways over the course of the call, and that's really getting to this whole concept of unit versus revenue per client growth and how we should think about how that's evolving.

I think you've given us several data points on what's driving revenue per client but fewer details on exactly how to think about that specifically in terms of percentages and how to think about your model longer terms in terms of how that could impact the growth rate.

I know that's a long-winded question but perhaps you could give us some more information or insight into how that should evolve and impact the growth rate.

I think, first of all, it's still very balanced.

We're going after both.

And I think we've been obviously, we probably went on the side of much more revenue per client growth the last few years as we added additional product.

That makes the sales team very successful.

And we did well on raising the revenue per client, but that's because we had so much more product and product bundles and we were very successful with that.

That shifted us back to how do you balance that.

So, I think what you're finding the sales team much more focused on compensation plans, et cetera, in training on both -- hey, we want to increase the units.

We've talked about where we wanted to be in unit growth in the past, and net client growth, and we're continuing to push to get there.

And we've seen consistency through the first quarter.

We're trying to continue to balance both of those.

We're feeling really good about the revenue per unit continuing to increase because of the fuller product set and the offerings that we have and the success in selling it.

And retaining it, by the way.

And then the unit piece, we're finding other ways to do that, not only with the sales on the street but from more of a digital marketing and web-based product or web-based service, so more people coming in that way buying more payroll-only kind of thing, and doing that with telesales.

I just want to make sure it's clear, we're looking to balance both.

I think we're going to have success in both but I would say the revenue per unit is what's been stronger the last couple years and that seems to continue.

Efrain, anything you want to add to it?

That's right.

So, should we think of the unit growth being driven more, if you will, on the smaller client size who are perhaps using one product like payroll or is that an over-simplification?

I think that's over-simplification.

I would say that's typically, obviously, where we see most of the growth because 80% of the clients are still under 20, and half our sales come from brand new businesses.

So, that certainly is fair to say.

But I would say we're feeling much better about the mid-market strength given the product suite, the human capital management full suite of products.

So, I think units are going to come from there, as well.

It's obviously a little bit longer sales cycle and so forth.

So, I think it's fair to say that since half the sales still come pretty much from brand new businesses, that the units are going to come from, at least half of them, are coming from smaller payroll-only, generally.

But I think you're going to continue to see the growth in the mid market better than it has in the last few years because of the product suite.

Right.

And then just one other follow-up question, again related to a question that's been asked several times, just about the Affordable Care Act and how it's impacting the overall business.

Could you just give us a sense -- I think you said, Marty, that you saw a surge and then you're expecting, once you get into calendar 2016 people may recognize they didn't do enough, if I understood your comments correctly.

Is that the way to think about it in terms of just very simple algebra in terms of timing of when it could affect your business differently than it has in the last several quarters?

I think so.

As Efrain said, I think, as the sales come in now, and I think at this stage they will peak probably in the October-November, the sales will, then you'll start to get the full revenue of that on a monthly basis right after that.

And then I think clients will see -- because we talked about the percentage that are taking it of the ones we think it applies to -- I think clients will see in the March-April, probably even May time frame, because the filings are in March, they will start to see -- gee, I should have done more, or it did apply to me and I didn't think so, or I just didn't take the time to address it.

I think sales will pick back up then.

I'm not sure that will have a big impact in Q4 for us because it will be a little bit late in that process but I do think sales will pick back up in April and May for those who didn't take it.

That's my guess at this point based on what we're seeing.

Because some clients are just -- some are great, they're all over it, they taking it; others are waiting late in the game.

But I think we'll see that.

Then I think you're going to see a number of them that say -- I still don't get it, I'm not going to do anything until I have to -- and then they're going to have to react in April.

Okay.

And then just one last question just on the impact of potentially higher rates, Efrain.

It would appear, at least in this fiscal year given how you're positioned, it would have a nominal impact and then you would just factor in that you're going to stay short on the curve, at least for the time being.

Or should we think about this a little bit differently if we do get an increase in rates over the next six months?

Yes, David, I think you're right.

Until I get a better sense of how that develops it's really tough to figure out what the duration is, whether we should barbell the duration, what the best value on the curve is.

You could do a lot of modeling.

We've looked at it looking at forward rates.

That doesn't really give you a sense of what's the best strategy to employ.

So, as soon as we get a sense of when they're going to raise and get better insight, because I think the Fed should tell us, and what the pace of change is going to be, then I think we can figure out what makes most sense in terms of configuring the portfolio.

Okay, very good.

Congratulations on a great start to the year.

Our last question comes from Mr. Phil Stiller of Citigroup.

Hi, guys.

Thanks for squeezing me in here.

Just wanted to ask about M&A, further on that topic.

You guys talked about the pipeline being busy.

Perhaps maybe give us a little more color in terms of what types of opportunities you're considering, whether it's market expansionary, new products.

And then also perhaps some commentary on size might be helpful in terms of how big the targets you're considering are.

I'll start at the end.

With a size standpoint it's been anything from small to pretty large.

That hasn't concerned us too much at all.

The second thing is, not as much about product now, adding product, because I think we've really done that with the acquisitions we've done over the last few years.

And, frankly, that's what's exciting now is when you see recruiting -- we don't even mention this -- but when you see recruiting and onboarding roll into the Flex product suite, that's My Staffing Pro, one of the best recruiting packages in the industry that we acquired a few years ago and now have built into our package in integrated single database kind of thing.

So, I think we're pretty solid on product.

There might be something there but we're very solid on the full suite of products.

And now it's expanding into other things, either adding more client base.

So, whether that's payroll companies, PEOs, et cetera, it's adding more and maybe a little bit of an offshoot of that but not too far.

It goes small to large.

It's not as much product as it is, I think, expanding our market share.

Maybe going off a little bit different than what we are but not too much.

Just to build on what Marty said, we typically have done smaller tuck ins.

Our largest acquisition certainly in the past five years was Sure and that was a little bit over $100 million.

So, when we say large we're not talking about transformational opportunities.

We're certainly looking at opportunities that are in the hundreds of millions of dollars but not transformational.

And there's a wide range of assets on the market that are of interest to us that fall within that range.

Would you guys consider taking on debt to fund an acquisition or is that off the table?

We've addressed that.

The answer is if it was the right opportunity we would consider it.

So, that's not off the table.

We haven't seen too many of those.

There have been some that were of interest to us.

But, again, one of the things that investors should expect when they invest in Paychex is we're not going to buy things to grow the Company in that way.

We think we have a pretty solid business model with good organic growth characteristics.

And we think there are some assets out there that are of value that can help but our strategy isn't to grow by acquisition.

Our strategy is to buy things and grow them.

Great, makes sense.

Thanks, guys.

There are no more questions, sir.

Thank you.

At this point we'll close the call.

We're very proud of the team at Paychex and our first-quarter results.

If you're interested replaying the Webcast of this conference call it will be archived until October 30.

And just a reminder, our annual meeting of stockholders will be held October 14 at 10 AM here in Rochester.

That meeting will also be broadcast over the internet.

Thank you again for taking the time to participate in our first-quarter press release conference call and for your interest in Paychex.

Have a great day.

That concludes today's conference.

Thank you for participating.

You may now disconnect.