沛齊 (PAYX) 2016 Q4 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 time.

I would now like to turn the call over to Mr. Martin Mucci, President and Chief Executive Officer.

Sir, you may begin.

Thank you and good morning.

And thank you for joining us for our fourth-quarter earnings release call and webcast.

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

This morning, before the market opened, we released our financial results -- excuse me -- for the fourth quarter and fiscal year ended May 31, 2016.

You can access our earnings release on our Investor Relations web page and we will file our Form 10-K by the end of July.

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

On today's call, I will review highlights for the fourth quarter and FY16 related to sales, operations and product development areas.

Efrain will review our fourth-quarter FY16 financial results and discuss our FY17 guidance.

And then we'll open up for your questions.

We're pleased with our strong finish to FY16.

Our momentum continued in the fourth quarter.

Efrain will talk in more detail about the financial results but I wanted to touch on a couple of key points.

First, total revenue was up 9% in the quarter and 8% for the fiscal year, reaching nearly $3 billion, a new record for Paychex.

Payroll service revenue continue to experience steady growth of 4% for FY16, driven by growth in client base and revenue per check and our payroll client base finished this year at approximately 605,000 clients, the highest client growth in recent years.

Solid sales execution during FY16, along with high client retention, in excess of 82%, positively impacted our client base.

Client retention was consistent with last year's record high retention.

HRS revenue benefited from strong demand for our comprehensive Human Resource outsourcing services, as we once again realized double-digit growth in client worksite employees that we serve.

In particular, our PEO has been an area of strong growth; in addition, our full-service Affordable Care Act product contributed to the HRS revenue increase.

During FY16 we made significant enhancements to our Paychex Flex Platform, which is our proprietary cloud-based human capital management, or HCM, solution.

Paychex Flex is a robust technology and service model that supports our clients through every phase of their employees journey from recruiting to retirement.

This model allows business owners and HR professionals to tailor a solution encompassing tools, capabilities and services that meet the unique needs of their organization and employees.

Earlier this year, we completed the integration of the remaining key HCM modules with Paychex Hiring, Paychex Time, and Paychex Benefits.

We believe we also have the best-in-market mobility offerings for both administrative users and employee self-service that allows access to our HCM suite with a single mobile application.

Paychex Flex continues to receive positive reviews, evidenced by multiple awards and acknowledgment received throughout this year.

Earlier in the year, we earned recognition from the Brandon Hall Group Excellence Awards for advancements in workforce management technology for small and mid-sized businesses; PC Magazine's review referred to Paychex Flex as excellent, calling it more robust and scalable than some of our competitors' platforms.

And most recently in the quarter we received the 2016 TekTonic Award for -- from HRO Today for the best-in-class mobile and cloud-based technology suite for comprehensive integrated HCM services.

We are very pleased by this recognition and it supports our belief that Paychex Flex technology, combined with a unique mix of personalized, flexible service options sets us apart and provides great value to our clients.

We remain committed to our investments and product development and technology to keep us a market leader.

Sales execution during 2016 was strong, with another year of double-digit growth, especially within the mid-market space.

We believe the value that our Flex platform provides is a key driver to this success.

During FY16, we announced the acquisition of Advance Partners, who joined the Paychex team during the third quarter.

Advance Partners offers customized -- customizable solutions to the temporary staffing industry, including payroll funding and outsourcing services.

Advance Partners and its leadership team has already proven to be a great addition with our positive results, an opportunity for growth in the expanding staffing market.

Throughout the year, we have continued our shareholder friendly actions.

We maintain a strong dividend yield and in July of 2015, we increased our regular quarterly dividend by 11%.

The dividend increase supports our history of providing exceptional shareholder value, while continuing to make strategic investments for the long-term sustained growth of Paychex.

We have also continued to repurchase Paychex stock and acquired an additional 2.2 million shares of common stock, or $108 million in FY16.

As of May 31, 2016, our stock price was over $54 per share and that is a total return of over 102%, or 15% on an annualized basis, over the past five-year period.

The regulatory landscape for HCM continues to get more complicated, making managing HR increasingly difficult.

We strive to be a valuable resource to our clients to educate them on changes in a system with compliance.

Recently, new overtime rules were approved by the Department of Labor that will expand overtime protection to millions of workers.

We are well-positioned to help our clients comply with these new regulations.

Our advanced suite of time and attendance products, including web and mobile tools, can assist companies with a scheduling, tracking and reporting of time which will be critical to managing this new regulation.

In summary, I'm extremely proud of the leadership team and all of our employees that Paychex who have continued to deliver great service and product solutions, resulting in continued high client satisfaction and continued high levels of client retention.

We also continue to focus on providing leading-edge, user-friendly technology and unique personalized service to our clients while delivering solid, consistent top line growth, strong operating margins and excellent returns to our shareholders.

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

Efrain?

Thanks, Marty.

And good morning.

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

Refer to the customary disclosures.

As Marty indicated, we had a strong finish to 2016.

I'll cover some of the key highlights for the quarter and for the fiscal year and then provide greater detail in certain areas and wrap with a review of our 2017 outlook.

Total service revenue grew 9% for the quarter and 8% for the fiscal year.

Interest on funds held for clients increased 14% for the fourth quarter to $12 million and 9% for the fiscal year to $46 million.

Increases were primarily the result of higher average interest rates earned, average investment balances were up 1% for the fiscal year, showing a positive impact from client growth.

This was offset by lower state unemployment insurance rates.

Total expenses increased by 8% in the fourth quarter and by 7% for the fiscal year.

These increases were mainly in compensation-related costs, resulting from higher wages and higher performance-based comp.

Strong growth in our PEO also contributed to the increases.

Advance Partners contributed approximately 1% of the growth in total expenses for the fourth quarter but less than 1% for the fiscal year.

Operating margin was 36% for the fourth quarter and 38% for FY16.

Operating income net of certain items increased 10% to $264 million for the fourth quarter and 9% to $1.1 billion for FY16.

Our effective tax rate was 34.3% for the year compared to 36.3% for FY15.

This is due to software production tax benefits as we've discussed in prior calls.

In our first quarter, we recognized the discrete item in the form of a tax benefit derived on income from prior years related to customer-facing software we produced.

This discrete item was the largest -- had the largest impact on the effective tax rate.

While we have ongoing benefits, the impact is not as significant.

Net income growth increased 11% to $178 million for the fourth quarter, and 12% to $757 million for the fiscal year.

Diluted EPS increased 11% to $0.49 per share for the fourth quarter and increased 13% to $2.09 per share for FY16.

Net income and diluted earnings per share would have increased 9% and 10%, respectively, without the discrete tax benefit recognized in the first quarter.

Payroll service revenue increased 5% for the fourth quarter and 4% for the fiscal year.

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

Revenue per check was positively impacted by price increases, partially offset by discounts.

FY16 also benefited from two additional processing days during the year; one day in the first quarter and one day in this quarter, the fourth quarter.

The extra days added approximately 0.5% to total payroll revenue, as did the acquisition of Advance.

HRS revenue increased 14% to $311 million for the fourth quarter, and 13% to $1.2 billion for the fiscal year.

HRS services continued to experience solid growth in clients and client worksite employees served.

The PEO, in particular, contributed double-digit growth and client worksite employees served.

Insurance services revenue growth benefited from continued growth of our ACA product, and an increase in health and benefit applicants.

The workers compensation portion continued to grow with higher average premiums and growth in clients.

Advance Partners contributed approximately, a little bit less than 2% to growth in HRS revenue for the fourth quarter, and approximately 1% to fiscal year growth.

Investments and income.

Our primary goal, as you know, is -- continues to be to protect principal and to optimize liquidity; combined portfolios, including both short-term and long-term investments have entered an average rate of return of 1.1% for both the four quarter and fiscal year.

We did see moderate benefit from the 25 basis point increase by the Fed -- Federal Reserve on our short-term portion of our portfolio.

But our long-term portfolio as of May 31, 2016, has an average yield of maturity of 1.7%, and an average duration of 3.1 years, fairly unchanged from last year.

Average investment balances for our client funds were flat for the quarter and up 1% for the fiscal year.

Our client growth positively impacted our average balances.

This was offset by the impact of lower state unemployment insurance rates this year.

The average invested balances for our corporate bonds were down 9% for the year, largely due to the cash outflow for the business acquisition as well as share repurchases.

I'll now walk you through the highlights on our financial position.

It remains strong, with cash and total corporate investments of $793 million as of May 31, 2016, and no debt.

Our cash flows from operations hit a milestone, exceeding $1 billion for the fiscal year, 14% higher than last year.

Our net income, non-cash adjustments, and favorable working capital changes, all contributed to the increase.

Funds held for clients as of May 31, 2016, were $4 billion compared to $4.3 billion as of May 31, 2015.

Funds held for clients vary widely on a day-to-day basis; and average $4.1 billion for the fiscal year, a year-over-year increase of approximately 1%.

Our total available for-sale investments, including corporate investments and funds held for clients, reflected net unrealized gains of $48 million as of May 31, 2016, compared to $14 million as of the end of last year.

Total stockholders' equity was $1.9 billion as of May 31, reflecting $607 million in dividends paid during the fiscal year.

Dividends paid represented the 80% of net income.

Our return on equity for the past 12 months was a sterling 40%.

Now let's turn to guidance for FY17.

I'd like to remind you that the guidance in our outlook is based on our current view of economic and interest rate conditions continuing without significant changes.

Payroll service revenue is projected to increase approximately 4% compared to FY16.

The projected growth is based on an anticipated client base growth and increases in revenue per check.

This growth is tempered by one less processing day in FY17.

So we'll have less processing day this year and that day will occur in the third quarter so I'll come back to that in a second.

So one less day, and it occurs in the third quarter.

HRS revenue growth is expected to be in the range of 12% to 14%.

Total service revenue is expected to increase in the range of 7% to 8%.

Net income is expected to increase approximately 8%, excluding the impact of the discrete tax benefit recognized in the first quarter of FY16 and that's important to bear in mind when the two years are compared.

Our operating income, net of certain items, as a percent of service revenue is expected to be approximately 38%.

We anticipate a modest impact on leverage growth as we are making investment in operations to support both mid-market and compliance solution services.

So I will get the question and I will answer it now.

So we don't anticipate -- do we anticipate leverage?

Yes, we do.

We think it will be modest because, as I just called out, we are making investments with operations and compliance service solutions to bolster and to support that growth.

With respect to the quarters, as previously mentioned, there will be one less processing day in the third quarter of FY17.

Now let me get a little bit more granular so you can fine-tune your models.

Payroll revenue for the first and second quarters is expected to be at or above the full-year guidance for Payroll revenue.

The third quarter, we expect to be below -- I just mentioned we have one less day, it will be below the full-year range and then the fourth quarter, at this stage, we anticipate will be between 3% and 4%.

So just to reiterate, first and second quarters, we expect to be at or above the full-year guidance for payroll revenue; third quarter, below and fourth quarter between 3% and 4% at this point.

HRS is expected to be within the full-year guidance range, with the exception of the third quarter, which will fall below the full-year range.

The effective tax rate for FY16 is expected to be between 35.5% and 36%.

Interest on funds is anticipated to be in the mid-single digit range.

We have not included any potential Fed fund rate increases in our guidance.

I'd like to call out that when I reviewed consensus models, many of the numbers were close to what I'm reporting but there was one important difference.

Interest on funds held for clients was higher in the consensus models and it looked like to the tune of about $0.01 to $0.02.

We are not including any assumptions with respect to Fed rate rise increases and as you well can appreciate, those look a lot more uncertain than they did even three or four weeks ago.

And then finally, with respect to EPS, we expect EPS in each of the quarters to be comparable, meaning pretty similar with the following exception.

First quarter, we expect will be modestly higher, and the third quarter modestly lower; the third quarter, in particular, because of the one less day on payroll processing so that's the fine-tuning on the guidance.

And then just want to make one final comment.

It was about five years ago that Marty started to assemble a team that has led Paychex over the five-year period and he set an ambitious goal; the goal was to hit $3 billion in revenue.

That was an ambitious goal because when we finished 2011, we were growing 4%.

This quarter, we are really on the cusp of that goal; it's an important milestone internally for us.

Marty cited the returns for the past five years.

We compared very favorably versus the S&P 500 and even against the S&P Technology Index.

Those results are a testament to both employees, the executive team, and to Marty's leadership.

We're not the kind of people who brag or smack talk but we are quietly very, very pleased that we've -- we are on the cusp of that milestone, but we are also grounded enough to understand that we have to earn the trust of our clients, employees and our shareholders every day if we want to succeed.

Every question you've asked in the last five years has caused us to think, to question, and it's challenged us and we've appreciated that.

And yes, finally, we are not satisfied, we are hungry for more.

And with that, I'll turn it over to Marty.

Thank you, Efrain.

I'd like to close the call right there but we'll open it up for questions and comments.

Tessa?

(Operator Instructions)

Jason Kupferberg.

Good morning, guys.

How are you?

Good, Jason.

I wanted to start with a question on core payroll and appreciate all of the quarterly color for the FY17; that's helpful.

I'm assuming that the first half of the year, being about the full-year guide is largely because of Advance and then obviously, you've got the headwind in Q3 from one less day.

And then you mentioned Q4 being 3% to 4%, I think, would not be burdened by processing days or by Advance so it seems like kind of a cleaner number.

I'm just trying to think medium term-ish, harkening back to the Analyst Day last year and would that imply or would it be fair to infer that then that 3% to 4% run rate is something that's realistic to sustain, assuming no other acquisitions or typical fluctuations in processing days?

Jason, so I think that is a fair number.

The only caveat I would add to that is that what that number we are giving on payroll suggests is we're just not getting an uplift from checks per payroll, which, if you went back two years ago, we were getting 2%-plus on checks per payroll, a small combination of mix.

But just very, very modest assumptions on checks per payroll just don't contribute to payroll revenue growth so I think it's somewhere in that range.

Okay and still 2% to 4% on pricing for core payroll this year?

Yes, yes.

Okay, understood, and then just switching over to leverage and that color on the reinvestments this year is helpful.

Is there anything we should be thinking about also though in terms of mix shift?

I'm thinking about areas like PEO, which are obviously growing very well for you but presumably carries lower margin percentage so when we think about the ability for the business over multiple years to drive meaningful operating margin expansion, is that an inhibitor?

Is it big enough?

Really not.

I'd just say if you look at our results this year, our leverage went down at the EBITDA line was about 100 basis points so we had a pretty good year in terms of leverage.

Now what you're seeing there is the fact that two things that are implicit there.

Number one, we had a really good year in mid-market sales.

In some areas, our win rates were really, really, really strong and as we looked into the year, we did two things this year.

In 2016, we added to the mid-market sales force, which we don't typically do mid-year but we did.

And as we added to the mid-year sales force, we were also transforming the service model.

So we made a lot of changes on the service model to improve service to mid-market clients and just in anticipation of that growth, we decided that it was important to have a year where we put more money into bolstering our service there so that's what's happened.

I think it's really more of a one to two-year thing than a long-term issue in terms of affecting leverage and finally, to your point, PEO is just not big enough to really move the needle yet.

It could, if it really grew significantly but beyond where it is now, but not affecting it now.

And just last one for me, can I get your perspective on where we are in ACA cycle?

What's assumed in the FY17 HRS guidance for ACA versus what the contribution looked like in FY16, because obviously, the overall guide for HRS is calling for steady growth?

I think, well, obviously today is a big filing day and it's been certainly a complicated process.

And probably the most complicated is just helping clients through the process, what was needed, and especially those clients that came in later in taking the product but an outstanding job by the employee teams that have been working on it.

And we feel pretty good about the filing that we're doing and a lot of work, by the way, with the IRS, too.

Our compliance team is working with the IRS for this first year of real true filing.

I think you'll see some of that sales; obviously, there was a lot of upfront sales and I think you'll see some of that slow down some.

However, when you think about how many new clients coming to us every year, we think we'll have a great attachment rate of that product.

It really is necessary and one of the costs, as Efrain said, with the investment in the mid-market, one of those costs is continuing to invest in the ACA support because, as we've learned, as we've gone through, this requires even more support of the clients and the filing requirements and a little more technology to help the clients through the process.

So feel good about it.

It's been a tough number of months to get through this but we're excited on the filing date and the additional investments we're going to make.

So -- and Jason, on the other question, this year, ACA-compliant services were -- contributed less than 1% of the growth in revenue.

Next year, it really is pretty negligible in terms of growth.

If there's some, I should say it's not zero but most of the clients, the bulk of the clients that needed the service signed up and a number of them will probably understand that they need and will have some additional clients but we've absorbed that headwind, if you will, in that modest headwind into our guidance and feel pretty comfortable about where revenue is going to land next year.

Okay, thanks for the comments.

Danyal Hussain.

Hi, Marty and Efrain.

Thanks for taking the question.

Just a follow-up on leverage.

I guess it sounds like a lot of the investment is one-time or catch-up in nature or maybe anticipatory in nature, but is the go-forward operating leverage in that model?

Is it more service-oriented and so is it lower going forward?

No, I don't think so.

I think two things; one is, you only go through a Flex transition a few times in a technology cycle, so frankly, it's a byproduct of the success we're having selling Flex so it's not a change to the model, it's really, frankly, a -- the success we're having in the mid-market, requiring -- in our world, bolstering our service a bit.

So that technology and that service is scalable, as you grow clients initially the way we are now; you just have to scale up the service component of it.

So it's more short-term in nature.

Got it.

And to that point, actually on Flex, so if you think about R&D spend, given the changes you have gone through and the product set recently, are we at the point now where maybe you can start to see more leverage on that cost?

Or is there maybe not as much opportunity given how much you have to update with ACA?

Yes, I think we're at -- well, there's always continued investment but I think we are at are pretty good place for the level of IT spend in R&D.

So I don't -- I think we -- you will gain something there but it -- we won't be going up much in that spend, I don't think but you won't see it necessarily go down a lot either so it will be at a pretty good steady place there.

I think what Efrain has talked about the most is we have to -- we're gearing up for some of the service, as you add it all -- if we added all these products, we're changing some of our service models.

And we're putting more technology in self-service for the client so if there's some things that they can do, there's more things they can do if they want to or they can still come in to the payroll specialist or our other teams.

And so I think IT is at a pretty good spend rate and they will continue to go up but not as much as they have in the past because we got to a pretty good place with the level of investment.

Perfect.

Thank you.

David Togut, Evercore ISI.

Thanks, good morning.

Given your commentary about the mid-market sales force, can you quantify your anticipated growth in the sales force for FY17 as a whole?

And if you could call out any variations versus overall growth by segment, that would be helpful.

So I'll talk to that and then let Marty give some more comment on it.

So David, this year, we had pretty strong growth, actually even a little bit higher than we had planned on the payroll services side which would include mid-market.

And as I mentioned, we had pretty healthy growth in mid-market sales so overall, we're still going to be in the 2% to 3% growth range this year but that's because in payroll services last year, we were between 5% and 6%.

So some of those adds were done in anticipation of this year.

We add selectively to certain sales forces.

You've heard in previous calls, for example, that when a year or so ago, a year-and-a-half, we added mid-year to PEO and that paid some dividend.

So each year, we're taking a look at where we think there's opportunities and adding selectively to the sales force.

Yes, I think it's consistent growth, as Efrain said, and because we added and we were very happy with the fact that we added mid-year, particularly in that mid-market area earlier than normal so instead of making sure we were staffed up to begin this fiscal year, we actually added probably three months earlier than normal into the mid-market because of the demand which was a really good thing.

But you will see overall, I think the growth would be in that normal 3% range and we add a little bit to all of them but mostly, as Efrain said, it's in the payroll space and particularly, in the mid-market.

Thank you and then for 2017, what's your anticipated client portfolio growth total balances?

Okay, so that could mean two things, David.

You mean client count or client balance growth?

Client balance growth.

I would say it's probably in the 2% to 3% range.

Unless -- so assuming rates were lower this year and it's a little bit tough to anticipate but I'm just assuming it will be wage growth and not -- there won't be a change in any of the other balance figures.

Got it.

And then in the fourth quarter, total client count growth was 2.5% ; if we strip out Advance Partners, is 1.3% a fair assessment of organic client count growth?

Advance had no impact on the client count growth --

Got it.

And the --

The payroll client base, and for the year, what we were saying was, it was over 2% for the year.

Got it.

Just a quick final question.

What dividend growth rate would you anticipate in July when the Board announces a new rate for the year ahead?

It's a good question.

So we'll let them talk about that but I'd just give two pieces of guidance.

We've said we like to keep it in that low 80%s range as a percentage of net income and we'd like it to track income so it will be somewhere in that range.

Thank you very much.

I appreciate it.

All right, David.

Gary Bisbee, RBC Capital Markets.

Hey, guys.

Good morning.

Hi Gary.

So help me understand one thing.

As I look at the guidance and then I think about how you've talked about the business in the last year, so you've got the best client growth since 2007.

You're at record retention again this year; you've had a real ramp in bookings the last two years.

Float is no longer a big drag.

You've got a seven month to the acquisition in the upcoming year versus five in the year you just finished.

I really struggled to understand why revenue wouldn't accelerate at least modestly and the guidance implies none.

Is there something else going on, like less pricing?

It just feels like something doesn't add up here with the simple math.

And I did hear you clearly that the checks per client is not as big a driver as it's been in the past but it just feels like there should be some acceleration given how strong you've been performing.

Well, I would say the first thing I mentioned is part of the answer to that, Gary.

So checks per client, when they go flat to modestly negative, because of client mix, you end up having an impact on payroll service growth, number one.

Number two, it's not seven months.

It's actually about six months' worth of revenue that we'll get from Advance so although, that's a pretty minor number, it's not quite as much as you are suggesting.

I think there's more -- I think what we've recognized, as we've gone through the year is that the higher the client growth and we've set pretty ambitious goals again next year to be between 2% and 3%.

Initially that comes at some impact in terms of what you're expecting on overall pricing so we recouped that over time but as you grow and this has been the history of the Company prior to the recession, you pay a little bit of a price on checks and also on overall rate by -- based on what's happening with client growth.

So it's all of that.

And then the third thing that I would say, which you are not factoring in, is we had a nice bump, uplift from the ACA compliance product and while I mentioned it earlier in the -- in response to Jason's question that we absorbed it in the guidance, of course, we're not having that uplift in growth this year that we had last year.

So if you stripped all of that out, you'd see underlying acceleration.

We're obviously not going to detail all of that out to get to the guidance so those are the factors that are -- that affect the overall rate.

Okay, thanks.

I'm sorry.

One other thing, by the way -- sorry about that, Gary.

We have one less day in the year so that's the other part of payroll service growth.

So all of those things imply if you made it through, it won't put you through the pain of doing you'd see that we're actually accelerating a bit.

Okay, that's helpful.

And then a question on Flex; just s how does a product road map look from here?

You've talked in prior quarters about some of the major components that were added this last fiscal year.

Are there more big pieces to the puzzle that need to be integrated or added and then also as part of that, where are you now in terms of migration of customers?

On the Flex product, I think, Gary, we've got most of -- everything, the main pieces in there, particularly the paperless onboarding and recruiting and the benefits administration now that came in from BeneTrac that we integrated in so we feel pretty good.

I think there's always other components that we're look at competitively to see if we need to add.

But for the most part, kind of the vast majority of everything is in now and integrated on a single employee record which is working well for the sales and so forth.

The vast majority of our clients have -- are on the Flex platform and so while we continue to work on some of the mid-market, the vast majority of the clients are already on Flex and there isn't a migration that's needed from that standpoint.

So I think we're good shape with people on Flex and they're gaining -- any one on Flex is gaining all the mobility addition so a lot of work now is going to making mobility and the online visibility into a simpler, easier to use, more HTML5 kind of language.

Also the options for -- we haven't talked about it but the options for Spanish.

We've really put most everything in Spanish now and we're seeing a nice uptick in sales to Hispanic businesses which has been a focus for us the last few years, from both a sales and service perspective.

So I think what you'll see now is not as much product functionality that's missing as it is the look, the feel and the mobility piece of it.

And by the way, everything is being developed now here mobile first, so basically, you make it simple so that almost everything can be done on the phone and then it grows more complex online.

Great.

Thank you.

Sara Gubins, Bank of America.

Thanks, good morning.

Within payroll service for the client count growth, I'm wondering if you're able to assess how much of the growth is coming from new business formation in the last year versus taking share of existing businesses?

I don't have a precise number on that, Sara, but I can say that in the fourth quarter, in the sales to newly formed businesses were up about 10% from the quarter before.

We had pretty nice bump.

So I think we're getting some uplift from being, I think, one, probably more competitive there, and second, from a little bit better business environment.

Okay.

And then in terms of the client mix shift, given the fast growth in PEO, the ACA tailwind, and Paychex Flex, are you seeing the client mix shifting more towards companies with over 50 employees?

No, no.

Actually, I think I mentioned in a previous call and we will put out the exact number to the right decimal in the K but in our average client size, there was 17.

We may have ended a year at 16.92 or 16.95 and no significant change.

I think we continue to have strong mid-market sales.

I would expect that number may go up, but this year was a little bit anomalous in that it skewed a little bit lower.

But timing, but it moves the needle.

Okay and then just last question on M&A.

You've talked in the past about being interested in doing some larger M&A.

What does the landscape look like?

Is that something that's on the horizon in FY17?

Yes, we are still pretty active and we've got a -- probably one of the better pipelines we've had.

Still looking.

It's a -- the decision is the value and in the fit, and we're very selective about what we've acquired.

We've done more acquisitions in the last five years than I think probably any time in history.

And we felt very good about each one of those, whether from a SurePayroll to now Advance Partners.

So I think we're still very active in it.

It's hard to say whether things will come to fruition or not, but we feel good about the pipeline that's out there and the activity that we're involved in right now.

Thank you.

Rick Eskelsen, Wells Fargo.

Hi, good morning.

Thank you for taking my question.

I guess just following up earlier on the Flex question, can you talk a little bit about how the client uptake has been on the newer modules that you've rolled out?

Yes, I think it's been good.

The -- particularly, the time and attendance piece of it as we've integrated it in and the mobility functionality that's with it, where you can punch in, punch out and so forth.

I think has been probably the most popular and I think that's because you see the overtime rules that have been approved now and it will be enacted soon.

I think a lot of -- a number of clients are looking at time and attendance as something they really have to have and they're looking at great options like ours.

I think the electronic, basically paperless onboarding and recruiting of new employees has been good.

It's relatively new and getting the sales teams to make sure it's in that first proposal has probably been more of a challenge so we'll get it all in there.

But I think that one has got a tremendous opportunity in front of it.

I think we're going to -- we're starting to really capture that now a few months into -- after the release of it.

Thanks and then just with your success in the mid-market and the team selling that you've talked a lot about recently, is there like an average number of modules that clients are taking currently and how might that compared to the last couple of years?

Are you seeing that number going up?

It's definitely going up just because we can see it from our revenue per unit standpoint.

We've seen a nice uptick over the years of revenue per unit so more clients are taking the products upfront, particularly with the integrated selling approach and that's in all sizes of clients, mid-market right down to, I'd say, 10 to 15 employees even.

There's much more of an acceptance of taking more modules and there's much more of a need for it and so the value has been much greater.

I don't know if I'd really -- if there's really an average of number but it definitely has increased, the revenue per unit and we're good at both -- I think we're much better now at the integrated selling of selling that value upfront that we talked about.

And then as we go on, if the clients don't have it, we have a great team that comes back around to the clients and said, hey, now that you have let's say Payroll and Time and Attendance, let's talk about benefit administration.

And so that can help you in the Affordable Care Act and everything else that we offer.

It definitely -- that attachment has been a big part of our -- a big assistance to our growth rate.

Last question, just following up on Sara's question on M&A.

What areas are you looking at most?

Is it things to add in payroll, in HRS or are you looking at some of the adjacent and other business areas you've talked about in the past?

Thanks.

Yes, I'd say we're always looking at payroll.

There's opportunities out there for that and we're looking also at product additions, tuck-in for product but what we've got most of that now but we're always looking for that.

And then of course, all the areas that we're in, whether it be 401(k), PEO business, we're always looking at those opportunities as well.

And then always looking outside the country as well.

What other opportunities are there for us?

It's just a matter of -- as I said, we've never been probably more active or a longer pipeline but the valuations are still relatively high and we're very selective as to what we go forward with.

But I would say all the above, we're interested in as long as they are a good fit and are good for both obviously for the Company and for our shareholders, we'd look to go forward with it.

Thank you very much.

Kartik Mehta, Northcoast Research.

Thank you.

Good morning, Marty and Efrain.

Good morning, Kartik.

Efrain, any thoughts on how you might manage the flat portfolio considering we're in a little bit of a different environment than we were a few months ago?

Have you changed your thoughts on that at all?

It's interesting you say that, Kartik.

So as I was driving in this morning, I was trying to figure out what happens if we are in an environment where the Fed doesn't raise during the year and at this stage, haven't decided to make any changes.

But it's certainly something we'd have to look at the duration of the portfolio for yield curve looks the way it is now over time and no decisions on that, but that's something I -- we'll have some discussions on as we go through the quarter.

It's just, as you can imagine, it's pretty dizzying trying to figure out what the right scenario is when, I would say three months ago, we were thinking there might be as many as three raises in the next -- in the fiscal year and now it looks increasingly like if we get one, that will be a lot and maybe zero.

So yes, we're thinking about how to create the right portfolio structure without increasing risk.

And Marty, you talked a little bit about Flex and obviously Flex is a much better product for your clients and you talked a little bit about trying to sell more value-added services.

It seems like that's just starting.

Could you see Flex, because of its -- your ability to sell other value-added products from what you've seen so far, help accelerate the revenue growth rate for the payroll business?

Well, I -- we certainly hope so.

What we've seen is more revenue per client and we've seen that consistently.

That's because the Flex platform allows that integration of various product bundles of different functionality with a single employee record and that it also allows you that access to the mobile app which has been very popular.

So I think the opportunity is there.

I mean, when we look out, obviously, as far as we'll go -- we can go is the guidance that we look at pretty closely that Efrain has detailed.

And so we certainly hope the opportunity is there.

We're keeping it and we're -- I think we are very, very competitive with it and that's certainly is our hope.

The other thing, Kartik, I'd like to add that is important and I think I mentioned this after the third quarter during -- in a number of comments.

The -- it's important to remember that when we sell Flex, a portion of that revenue is payroll and a lot of it is reported in HRS.

I caution that while we are not walking away from looking at payroll revenue as an important part of the revenue growth of the Company, increasingly when we sell Flex, a portion of that is reported in HRS.

So all of the discussions we've talked about, modules like time and attendance, HR administration, expense management, applicant tracking and recruiting, employee shared responsibility, or ACA, those are all reported in HRS.

So you need to look at both pieces to really kind of get a complete assessment of how we are doing.

Yes, we think of it more in total service revenue, because it does, obviously it bleeds over into the both of them.

That's fair.

And just for the last question, now that you've owned Advance Partners for a few months and that was a business that you were excited about in the beginning.

I'm just wondering, is that something that still is what you expected and is that business that you could potentially acquire other businesses to get additional scale?

Yes, I think so.

In fact, I -- we feel they have been performing extremely well.

The whole leadership team has come with the company, so we're excited about that.

So they performed well.

We've already been looking for opportunities to increase the scale there and have a few in the pipeline that we're looking at.

Yes, we think we're very pleased with the first six months of how that's been going, and the results that they have.

And of course, the tie-in to our clients that have a number of opportunities for them, and some opportunities from their clients for us.

So we're very pleased with the acquisition and the team there and how we're off to a good start.

Thank you very much.

I appreciate it.

Thanks Kartik.

Jeff Silber, BMO Capital.

Thanks so much.

I know you're mostly a US-centric focused Company, but I'm just curious in terms of the impact of Brexit, if at all.

Would this maybe preclude you from potentially expanding in that region?

If you think it will have any impact on US businesses at all?

Thanks.

Yes, it's Marty.

I don't think so.

We don't -- as we say, we're mostly -- outside the US, we're mostly in Germany and then we have the Brazil start-up there, so we don't see it.

Obviously, from an acquisition standpoint, there are opportunities there, that we would be probably a little more cautious about given the uncertainty over longer period of time.

But right in the short-term, it certainly has very little, if any, impact on us, at least from the UK perspective.

Okay, and then just a couple of numbers-related question.

You mentioned the investments in growth this year.

On the expense side, would that be on an operating expense line item, SG&A, or a combination?

It's mostly operating expenses, Jeff.

Okay, and then sorry, just one more.

I'm sorry.

In the fourth quarter, you had negative investment income --

I was waiting for that.

You get the gold star for that question, Jeff.

So the answer is we had some small investments that we wrote down the value.

Didn't write them off, but wrote down the value when we looked at it in the portfolio.

Very, very small things but the way that we record that is in that line, so that's why it went negative --

Do you know what the EPS impact of that was or --?

Very modest.

Maybe $0.005, if that much.

Okay, great.

All right.

Appreciate the color.

Thanks so much.

David Grossman, Stifel Nicolaus.

Thank you.

Good morning.

Hey, David.

I was hoping, maybe, Marty, that you can address your comments about the middle market.

It seems you're doing well, and as you probably know, there are several others claiming prosperity in that segment as well.

How much of that, maybe ACH or even other fundamental factors in the marketplace and obviously, you've done a lot to invest in that segment over the last several years.

And just curious if there are other factors that work there that may be driving the pocket clients to go to an alternative solution?

Yes, I think definitely a number of them.

One, I think the need -- the complications of compliance, with all of the regulations have increased, so you have ACA, but you have the recently done overtime regulations.

You have paid leave for families you've got to keep track of.

You have a lot more immigration and keeping track of who your employees are and all that, that you have to be backed up with.

And the enforcement of the rules is we see are stronger.

So more businesses are being impacted by audits, by investigations, by are you following the rules correctly?

And because the Feds are also looking more revenue sources, so states can go after things.

So I think that whole regulation side has become increasingly more complex at a lower level, so we're seeing people -- we're seeing clients buy time and attendance that normally were probably 40 employees and higher, 30 PEO tended to be higher.

Now it's coming down lower.

They're looking for help with insurance and benefit plans because they have to be more competitive.

The other second thing would be the market is more competitive now for employees, as you get closer to lower unemployment and full employment.

So people need more help with having more competitive benefits, more competitive recruiting tools, being able to recruit online, paperless, attract new employees.

I think -- there was another one there, I was thinking about it.

I think the acceptance of cloud-based technology and having -- and getting away from desktop and on-premise solutions has rapidly increased the last three to four years.

But we're still seeing that increase where, years ago, people would want to do more things themselves, have a -- worry about the security.

Now, they want to trust their security of information with a third-party outsourcer, totally reversed from five or six years ago.

Now they trust -- Paychex is large enough, and a big enough IT security team, that they're going to do their best to protect our information, where I used to have to inside.

So I think there's just a big push of regulations, compliance, and the need, therefore, pushing down to a lower level.

So we're seeing -- that mid-markets, that I would say used to be 50 to 500 or 1,000, has really pushed down to maybe 15 or 20 to 500 as a real sweet spot right now that draws a lot of focus.

So with the product set that you have now, obviously, there, at one point, historically, that was a limiting factor for you in the mid-market.

So any appetite to go after a bigger client or segment of the market or do you feel you'd rather just sit below the radar screen where others may define the mid-market?

Yes, it never feels like we are below radar but I think there's -- the real sweet spot of what has taken off and made many companies at least appear to do well and I know how we're doing well is really in that 15 or 20 to 500.

We're still selling anywhere from one employee to 1,000 but I would say, the hottest area right now is 20 to 250 or 20 to 500.

Those are the clients that really have been pushed with much more regulation and need for the products and are much more open to outsourcing.

I think we feel good about the opportunity that's ahead of us but that's going to drive our growth and it also allows us to really focus on those markets.

That's a pretty huge market one to 1000 and we feel pretty good that, hey, we are very focused on that and that's what we provide the best service and the best products, too.

Got it.

And then just one quick numbers question and Efrain, sorry if I missed this but when you take both the Advance piece and the loss of the processing day, what is the net impact on next year's revenue?

So the loss of the processing day, didn't call that out specifically, David, but if -- I'd say probably about 25 basis points.

Advance is about -- probably another 25 basis points.

So net, zero-zero?

Yes.

Okay.

All right, guys.

Thanks very much.

James Schneider, Goldman Sachs.

Good morning.

Thanks for taking my question.

I was wondering if we could maybe talk about the -- on the HR services, growth forecast?

Was there anything specific in terms of product-specific drivers you can call out, contributing to the growth you talked about time, attendance and HR administration as being drivers in the past?

Anything notable to call out as far as the FY17 guidance is concerned?

I think PEO, we haven't talked as much about that but I think PEO is still very strong and that -- part of that is supported by or helped by the need for insurance support and benefit plans and so forth.

So we still see that growing very well.

Worksite employees are double-digit growth again and so I think the PEO and ASO, both models, are continuing to grow well.

401(k) has been very steady and I think we have talked about the fact that we went after larger, what we call large market or higher asset clients and we feel that, that's got a great opportunity as well.

A lot of things kick around about 401(k)s and so forth but we're still doing very well, really introduce and sell more 401(k) record-keeping plans than anybody else and we've got a solid sales and service team that really do very well there.

So the sales have been consistent.

The client growth very consistent in 401(k) and the retention this year, probably the best it's been in our history.

I think all of those components, we don't talk to as much but they have been steady and real good components of the growth.

Thanks and maybe could you just maybe comment at a broad level about the level of discounting you're seeing in the market right now and maybe whether there's more pressure or less pressure than there was a year ago and if so, in what segment?

I think it's a little bit more pressure probably.

I think with more competitors and so forth, it's not a big change in the competitive environment, believe it or not, for the number that are out there, and all seem to be doing well but I think there's a little more pressure on price.

And on the low-end, there's a little more pressure because I think as new businesses, as Efrain said, the new businesses have come back.

And so when you have new businesses that start up, there's always a little pressure to -- for them to, first, outsource and go to someone to do their payroll and maybe their payroll and time and attendance there's a little more price pressure to get them in started but remember, that we then roll-off a lot of times the discount over a period of time.

So I think a little bit more pressure there but nothing that would be major at this point.

Got it.

Thanks and then maybe just a quick clarification.

The 8% net income guidance for FY17, does that include or exclude the tax benefit that you saw in FY16?

That's excluding that benefit rake so I called that out so it's important to remember.

Got it.

Thank you very much.

You are welcome.

Mark Marcon, RW Baird.

Good morning, Marty and Efrain.

Marty, first of all, nobody else said it but great job over the last five years.

You and your team.

Thank you, Mark.

I appreciate that.

Efrain went off script there so it -- I appreciate it.

It's a great team; very proud of the team.

So a few questions.

First of all, with regards to the mid-market, has there been any discernible change in the pace in terms of bookings growth, the pipeline post this on the mid-market, a little bit of the ACA surge in that over 50-employee segment?

There certainly has been sales growth.

That's -- as Efrain and I said, that's where we added a nice percent of the sales force mid-year which is weird for us.

We felt the opportunity was so good with the Flex product in all these modules that we added.

So sales booking have been definitely stronger.

I think the other thing you may get a mention --

I'm just saying, post the calendar year transition and that surge of activity, the clients that may have come on just because, okay, we're scrambling to get ready for this.

Now that, that scramble is over, are you seeing any change in the pace?

No.

Not really.

No.

Okay, no not -- we really haven't.

I mean, those -- and that's why we felt good about having those additional sales reps in place there because we're still seeing a strong demand and I think it's all the things that I mentioned earlier, that -- why we're seeing that.

So, no, we feel very good -- and the other thing is, mid-market, as I might -- I think I mentioned earlier.

It's funny, it used to be that kind of 50 line for us.

But I think you're seeing a lot of what you could call mid-market demand, anyway, has gotten down to an even lower size and so -- and that momentum has picked up and that gives you a lot of opportunity to sell more products as they need more.

Great and then can you talk a little bit about the -- what the right level of leverage expectations beyond this year would likely be?

How do we think about that relative to the normal historical pattern?

So Mark, I --

Ex float.

Yes, so ex float.

So we -- this year, ex float, we were at about 50 basis point of leverage which is what we typically do in a given year.

We will be less than that next year for the reasons that I called out.

But I still think that going forward, we are going to try to be in that 50-plus basis point leverage range and if we can't hit that in a given year than we will have a specific reason why we can't.

In this case, we had a lot of discussions internally about do we add the resources that, both in compliance services, as I mentioned earlier, and in mid-market?

And it was pretty clear that given the amount of growth we had to do that but I don't think that's going to happen every single year.

But it was important this year but I don't think it changes long-term the trajectory of building plans that include 50 basis points-plus because that's the way we go into our planning cycles and we think it's doable.

It's hard.

It takes a lot of work.

But we think it's doable.

Great.

Can you talk about the opportunity to go in and sell some of the newer modules, the newer solutions to some of the older existing clients in the mid-market?

What's -- how much runway do you have there in terms of upselling some of those existing clients?

Yes, I think still quite a bit of room when you think about the penetration.

These products really haven't been -- many of our products, even HR administration online and time and attendance online are older -- time and attendance product really haven't been around that long.

It's been more the last three to four years, maybe five tops, then a track a little bit longer and benefits admin so there's room there.

And I think is as they see the benefit of Flex and the mobility that comes with it, the mobile options and the whole different look and feel to it, I think that helps sell them along with that there's many more product modules available to you and the fact that it's really with one single employee record, I think that is pulling a lot of clients in, where five years ago, we would have said, A, you have payroll and you have other modules, but they are not fully integrated.

Now there's much more of a pull from the clients so I think we've got some nice opportunities still in the mid-market.

Selling new, we're selling much more integrated upfront and better attachment rates but there's still a lot of room, which we -- and we do that.

We attack, we go back into the base to sell them the value-added features that they need.

Are you doing that with the regular sales force or is there a gatherer group that goes into existing clients?

It's a mix.

We have both a virtual sales that go back into the base as well but those existing reps who have the relationships and so forth will also, with the clients, will go back and sell it, so both can sell.

Great.

And then just one numbers question.

What's the net income base, the precise net income base that we should be using for the fiscal year that just was completed as a basis of comparison for the 8% net income growth for this coming year?

Good question, Mark.

Let me post it so I don't get the wrong number.

I will post it shortly, Okay?

Okay, great.

Thank you.

In other words, just so everybody knows.

Look for it in the -- either in the slides we put up or if we have already posted them, which the team probably did, we'll just amend it to include that number, okay?

Excellent.

Thank you.

It's something off here and it will be wrong, so --

Ashwin Shirvaikar, Citi.

Thank you.

Hi, Marty and Efrain.

Hello, Ashwin.

I think Mark just asked the question and you answered this, the 8% net income guide when you said it excludes the $0.05 tax benefit, you're basically saying go off the adjusted lower EPS base, correct?

That's correct.

Yes.

Is there a specific factor that takes the tax rate down modestly this year?

This year?

It seems like your guidance was maybe 50 basis points lower --

I'm sorry, yes, yes.

It's a combination of two things.

One is some work on state taxes that we have done and also the software tax credit change has a continuing impact going forward so it's the combination of both of those and superior work by our tax group.

But beyond that, but that's it.

Okay.

I have a broader GDP sensitivity question.

When you look at the mix of business that you have now, which has a higher percent contribution from HRS which, to me, it basically says bigger share of wallet and any time you have a bigger share of wallet, it probably means a more stable client.

You have the bigger mid-market business, again, similar to solution.

You've got investment contribution that's almost a third of what it was going into the last downturn so how do you think of the potential impact of a downturn in economic expectations should it happen?

So if it should happen.

I mean, I think, obviously, the biggest impact, if I get your question right, Ashwin.

I think the biggest impact there would be new client growth because last -- any time a recessionary-type thing happens, it has impact on the payroll service revenue growth because the clients either more go loss because they can't sustain the business and fewer start up so the client growth puts obviously a damper on that.

I don't think we've definitely laid it out what exactly that would be.

It doesn't always have an impact on the number of products they buy because they typically buy those -- that bundle, let's say, because they need it for those that are staying in business.

The biggest impact will be losses to client retention and new business startups would be the biggest impact I would see.

Okay, got you.

Got it, and we get a lot of questions on operating leverage so I know you tried to clarify in your prepared remarks but I still have a question.

And that's specific to technology --

I expect no less, Ashwin.

Specific to technology spend.

Last year, I think for the first time in many that you said basically that it's the rate of growth was setting down and similar comment this year.

Is this just the kind of market and client expectation that you have to keep that tech spend up where you don't really get leverage from it but it's clearly not hurting on operating margins so you mainly say steady, steady as a percent of revenue?

Is it --

I think that's basically what I was trying to say earlier on that piece of it was it's not -- for a while, that was -- well, it was hurting margins a bit but we were offsetting a lot of it with operational efficiencies.

In driving those efficiency, those dollars back to IT for technology investment and kind of resetting the level of technology spend versus the operational spend.

So now we feel like the technology spend got to a point where it's pretty normalized.

It's in a good place; we don't see that going up dramatically.

Don't necessarily see it going down because there's always technology and we want to stay on the leading-edge from a competitive standpoint but -- and then there's not as much operational leverage.

But we continue to, as Efrain said, we're going to -- we continue to try to look.

It's in our DNA here that we're always looking, hey, if revenue growth is X, we're always trying to look for 50 basis points or so to see if we can continue to leverage the business and then obviously the better that growth rate is, the better opportunity we have to leverage and that's a constant focus.

Anything you want to add?

No.

That makes sense.

Understood; that makes sense.

So, no that is all my questions.

Happy Fourth of July coming up here.

Hey, Ashwin, before you go, so and then to Mark's question.

I apologize I didn't have the schedule right in front of me.

So net income excluding the tax event this year, the correct base is $738,600,000; in case I wasn't clear then we will just post it to the website and the schedules that we released shortly if we haven't done it already.

Okay, great.

Thank you for that.

Lisa Ellis, Bernstein.

Hi guys.

Just one quick one from me.

Can you just talk about with Advance, now that you're five or six months into the acquisition, the role they are going to be playing in your portfolio?

Are they a customer acquisition engine for you, where you will be able to sell in your existing payroll and other services or how should we think about that both for Advance and then I guess, future acquisitions like that?

For them, as Efrain mentioned, they're really not in our client count so in our payroll client count that we always give for the over 600,000 clients and they -- so it's not so much about client acquisition other than for themselves.

So we're looking for them to grow their revenue base through new clients, obviously, and selling more products to them.

To us, it was broadening really the markets that we serve.

So here's a company that is profitable, is -- had nice revenue growth.

Good leadership team; saw a lot of potential and the staffing business that they support those staffing companies, we saw as a growing market and because there is continued more temporary help and staffing help that's going to be needed, I think particularly with overtime rules and so forth.

So we saw them as a component of the portfolio to grow revenue.

There will be some overlap between us and the fact that we have a number of staffing companies that are payroll clients or other products and so we will look to refer.

We're already doing that.

Looking to see if those staffing companies were clients of us for payroll could be helped by payroll funding and other support from Advance.

But I think that's how we look at it as another opportunity to broaden our revenue growth because we see staffing companies as a real growth opportunity.

Terrific.

Thank you.

Thanks a lot.

Is that it, Tessa?

Yes, we show no further questions at this time.

All right.

At this point, we will close the meeting.

If you're interested in replaying the webcast or the conference call, this will be archived until August 1. Thank you for your interest in Paychex and thank you for your participation in our fourth-quarter and FY16 earnings release call and webcast.

We're very proud of our Paychex employees and the great FY16 we had and we're looking forward to another great year as we begin FY17.

We look forward to talking to you again in the next quarter.

Thank you.

Thank you.

That concludes today's conference.

Thank you for your participation.

You may now disconnect.