沛齊 (PAYX) 2017 Q1 法說會逐字稿

Welcome, and thank you for standing by.

(Operator Instructions)

Today's call is being recorded as well.

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 thank you for joining us for our discussion of Paychex' first-quarter FY17 Earnings Release.

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

This morning, before the market opened, we released our financial results for our first quarter, ended August 31, 2016.

Our Form 10-Q will be filed with the SEC within the next few days, and you can access our earnings release and Form 10-Q on our Investor Relations web page, as they become available.

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

On today's call, I'll review highlights for the first quarter, in relation to the sales and ops and product management, development areas.

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

We are off to a solid start for FY17, with positive results across all major product lines.

The number of client worksite employees served by our Human Resource outsourcing services grew by double digits over -- on a year-over-year basis.

Our cloud-based HCM services, including time and attendance and human resource management, continued to gain strong market acceptance in the quarter, as well as last year.

Payroll service revenue grew 4% for the first quarter.

HRS revenue increased 15% for the quarter, driven largely by growth in the client base across all major HCM categories.

Total service revenue up 9%.

We acquired Advance Partners last December, and are very pleased with their contribution to our results.

Advance Partners contributed approximately 1.5% to the growth in the service revenue for the first quarter.

Client retention has remained strong, providing excellent customer service is our top priority.

We've continued to invest in our operations and compliance services to support growth, and ensure we maintain best-in-class client service.

One area of focus has been the expansion of our multi product service center, which primarily assists our mid-market clients, who attach additional services with payroll.

We have also invested in our insurance operations team to increase support for our Affordable Care Act service clients, as we approach the 2016 calendar year filing.

We recently announced the expansion of the AICPA-Paychex partner program, to include human resources services, in addition to payroll and retirement benefits.

This program allows CPAs who refer to us to broaden their advisory role with clients, by offering them a suite of best-in-class services, and provides a strong referral channel for us.

We are proud to be the preferred provider of payroll, retirement and now, Human Resource outsourcing services for the AICPA, CPA.com, and its CPA members.

The Department of Labor's final overtime rule will become effective December 1, which will expand overtime for millions of workers.

This new legislation makes accurate time and attendance tracking more important than ever, and we have found that many business remain unaware of the legislation, and the impact on their business.

We recently announced enhancements to our time and attendance service portfolio, with the addition of Paychex Flex Time Essentials, TrueShift time clock, and an advanced scheduling feature within our Paychex Flex time module.

The investment in this technology demonstrates our continued commitment to providing industry-leading solutions that educate and assist our clients to comply with the new regulations, and stay more connected to their employees and their businesses.

These new products enhance our commitment to supporting our clients through the entire employee journey, from the posting of a position, interviewing and job offer, on-boarding the new employee, and handling all of the daily tasks and life events with a simple integrated SaaS, software-as-a-solution platform, combined with personalized and flexible service options.

We're very proud of the support our employees provide small and mid-size businesses with this broad and advanced product set, and commitment to great service, particularly as we enter our 45th year in business.

Along with that, I'm very proud of recent recognition our Paychex team has received.

Our insurance agency ranked number 23 on Business Insurance Magazine's 2016 list of Top 100 brokers of US business.

This is our sixth appearance on the list, and we once again rank as one of the fastest-growing insurance agencies in the nation.

We've been named to Selling Power Magazine's 2016 list of 50 best companies to sell for, landing at number 7. This is the fourth consecutive year Paychex has appeared on the list, moving up from the number 9 spot last year.

Very proud to be in the Top 10 of best companies to sell for.

And Paychex was once again ranked as the largest 401(k) record keeper by total number of defined contribution plans, according to the recent survey by Plan Sponsor Magazine, a national publication dedicated to the pension and retirement industry.

We also continue with our shareholder-friendly actions in the first quarter.

In July, we increased our quarterly dividend by 10% or $0.04 per share, to $0.46 per share.

Our Board of Directors also approved an additional authorization to repurchase up to $350 million of our outstanding common stock, which expires now in May of 2019.

We did not repurchase any shares in the first quarter, but we'll continue to assess the opportunity to buy back shares during the year to offset dilution.

In summary, we are off to a great solid start.

We're receiving very good recognition, and I'm very appreciative of the great work of our Paychex employee team, sales, ops, and all of the support teams in the Company.

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

Efrain?

Thanks, Marty, and good morning.

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

Please refer to our earnings release that includes a discussion of forward-looking statements and related risk factors.

As discussed, first-quarter financial results for FY17 represent a solid start to the year.

Here is some of the key highlights for the quarter: I'll provide greater detail in certain areas, and end with a review of our 2017 outlook.

Total service revenue grew 9% for the first quarter to $774 million.

Interest on funds held for clients increased 11% for the first quarter to $12 million, as a result of higher average interest rates earned.

Expenses increased 8% for the first quarter, and Advance Partners contributed approximately 1% of this growth.

Compensation-related expenses increased 6%, primarily due to higher wages resulting from growth in headcount, in both operations and sales.

Our effective income tax rate was 33% for the first quarter, compared to 29.7% to the prior year's first quarter.

The effective income tax rates have been impacted by discrete tax items recognized in both of these periods, so last quarter, last year's first quarter and this year's first quarter.

In the first quarter of this fiscal year, we recorded a tax benefit resulting from the adoption of new accounting guidance, partially offset by the recognition of an additional provision related to a State tax matter.

These items increased diluted earnings per share by approximately $0.025 per share, to be precise.

If you remember, last year in the first quarter, we recognized a net tax benefit on income from prior tax years, related to customer-facing software we produce.

This resulted in an increase in diluted earnings per share of approximately $0.06 per share for that period, so now if I could just do an editorial.

You'll see that when we talk about net income, we carefully say as-reported net income, so we're going to give you guidance on as-reported net income and net income excluding discrete items.

The punch line of that, the punch line of that, is that there's been no change.

We just need you to look at those two items, now with the discrete items, and we'll talk about that in a second, and see that essentially it doesn't change the guidance.

I have seen some notes that seem to think it does.

It doesn't.

I'll come to that in a second.

I just mentioned adoption of new accounting guidance impacting the effective tax rate.

We early adopted new accounting guidance, related to employee share-based payment.

As a result, we recognized a net tax benefit in the income statement.

This was previously required to be recorded as additional paid in capital, in equity.

On an as-reported basis, net income increased 4% to $217 million, and diluted EPS increased 3% to $0.60 per share in the first quarter.

Growth rates for net income and diluted earnings per share were impacted by approximately 5% and 6%, as a result of the recognition of the discrete items in the respective period.

So I give you those numbers so you can reconcile back to what it would look like, if you excluded those items.

Let's talk about payroll service revenue.

It increased 4% for the first quarter to $451 million.

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

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

In addition, Advance Partners, which we acquired last year, contributed approximately 1% to the growth in payroll service revenue for the first quarter.

Checks per payroll were not a contributing factor in the reported payroll revenue growth, and we expect to continue to see that to be the case.

HRS revenue increased strongly to 15% in the first quarter, $323 million.

The increase reflected strong growth in client base across all major HCM services, including our comprehensive outsourcing services, retirement services, time and attendance, and HR administration.

I take this point or pause to just say that remember that part of what we report in HRS are the modules that we sell on the HCM system.

So in order to understand completely what we're doing, you need to look at both categories.

Within Paychex' HR Services, we continued to see strong demand, which is reflected in the double-digit year-over-year growth in the number of client work site employees served.

Insurance services benefited from continued growth in revenue from our full service Affordable Care Act product, and growth in the number of health and benefit applicants.

Our workers comp insurance product benefited from higher average premiums and client-based growth.

Retirement services revenue benefited from an increase in asset fee revenue earned on the value purchased in funds, as well as an increase in plans served.

Last, Advance Partners contributed approximately 2% to the growth in HRS revenue for the first quarter.

Investments and income.

Our goal is to predict principal and optimize liquidity, as you all know.

On the short-term side, primary short-term investment vehicles are bank demand, deposit accounts, and variable rate demand notes.

In our longer term portfolio, we 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 an average duration of 3.3 years.

Combined portfolios earned an average of 1.2% for the first quarter, which is up from 1% last year.

I'll just say one note on that.

The Fed, it's very difficult to figure out what exactly is going on.

Our guidance at this point does not include or anticipate any increases in the interest rate.

As I looked at consensus model, it looked like some of you were modeling an increase in there.

At this point, it's not in our guidance.

Average balances for interest on funds held for clients decreased by approximately 1% during the first quarter, primarily as a result of lower State unemployment rates, partially offset by growth in client base.

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

It remains strong, with cash and total corporate investments of $944 million, as of the end of the quarter.

Funds held for clients as of August 31 were $3.4 billion, compared to $4 billion as of May 2016.

But as you know, funds held for clients vary widely on a day-to-day basis, and they averaged $3.8 billion for the quarter.

Our total available for sale investments including corporate investments and funds held for clients reflected net unrealized gains of $63 million as of the end of the quarter, and this compares with net unrealized gains of $48 million as of the end of May 31.

Total stockholders equity was $2 billion as of August 31, 2016, reflecting $166 million in dividends paid during the first quarter, our return on equity for the past 12 months was a sterling 39%.

Our cash flows from operations were $295 million for first quarter, an increase of 6% over the prior year period.

This change was primarily a result of higher net income, a slight increase in non-cash adjustments, and fluctuations in working capital.

Now, guidance for the remainder of the year.

So with the close of the first quarter, we're going to take the opportunity to fine tune the guidance we provided last quarter.

We remind you that our outlook is based on our current view of economic and interest rate conditions, continuing with no significant changes.

Events for the full year of FY17 is as follows: Payroll service revenue growth is anticipated to be in the range of 3% to 4%, and if you recall, this is a change.

We had said 4%, and from our perspective, it's fine tuning.

Let me give you some detail on the quarter, so you know how we expect to get to that.

On a quarterly basis, if you'll look at the second and the fourth quarters, we expect it to be in this range.

In the third quarter, which is where we lose one day this year, we expect to be between 2% and 3%, so let me just reiterate that.

Second and fourth Quarters comparable on a day basis to last year, we expect to be in that range of 3% to 4%.

In the third quarter, we expect to be between 2% and 3%.

We have one less day in the third quarter.

HRS revenue growth is anticipated to remain the same, which is 12% to 14%.

Total service revenue continues to be in the range of 7% to 8% also.

Consistent with prior guidance, income excluding float as a percentage of total service revenue is expected to be approximately 38%.

As you know, first quarter has typically had a higher margin, and we expect that operating income excluding float in the second quarter won't be as high.

We expect it to be between 38% and 39%.

Now as-reported net income growth is anticipated to be approximately 7%.

Some people took that and assumed it was a change in guidance.

It's simply reflecting the fact that we now have discrete items in first quarter and discrete items in the prior year first quarter and we wanted to give you a number that you could anchor your model on, to understand what it looks like before you subtract them.

So as-reported, I repeat that again, net income growth is anticipated to be approximately 7%.

This reflects the impact of the discrete tax items I just mentioned, which were recognized in both this quarter and the prior-year first quarter.

And it should be obvious that our previous guidance was adjusted for the discrete item in the first quarter of FY16.

Obviously we did not know at the time we were going to record a discrete item in the first quarter, or we would have told you.

When you make the adjustments, and we exclude non-recurring items, net income will be the same as our prior guidance, so there's no change to the guidance.

It simply gives you another data point on which to anchor the model.

Our effective tax rate for the year is expected to be approximately 35%, which also reflects the impact of the discrete tax items.

So you can see our tax rate in the first quarter was lower, subsequent quarters will be higher, to get us to approximately 35% for the year.

Other aspects of our guidance have remained unchanged from what we have previously provided, so I hope that clarifies the guidance, and I will turn it now back to Marty.

Great, and operator, we'll now open up for any questions, please.

(Operator Instructions)

We have a question from David Togut from Evercore ISI.

Good morning, this is Rayna Kumar for David Togut.

Thanks for the clarification on the net income guidance.

That was very helpful.

Just one more on the guidance.

I know you said you fine tuned your payroll service revenue from 4% growth to now 3% to 4%.

I guess what are you seeing that may be different in the market, that made you bring the guidance a notch down?

Well, we said the guidance was approximately 4% when we discussed it in fourth quarter, and it just simply reflects fine tuning as we look through the remainder of the quarters and the year.

So we don't think it represents a significant change from where we were, and it puts us pretty comparable to the growth rate we had last year.

Got it, so your largest competitor is seeing some client losses in the mid market.

Is Paychex benefiting from this?

I think, this is Marty, I think to some degree, yes.

I don't think we've felt like the competitive environment has changed all that much.

I do think that we're very proud of the product that we have now, very full suite of HCM total solution, including the latest time and attendance additions.

And so I think we're competing very well with them.

I don't think that its changed.

We haven't seen it change dramatically, but we certainly continue to feel very positive about where we are.

That's very helpful.

And lastly, could you just quantify on net price increases you're seeing in both payroll and HR services?

Thank you.

So payroll is different from HR services, but both are in the same range, in the range of 2% to 4%.

On HRS, we don't uniformly apply price increases across all products.

We really do that based on where we see the market, but our price increases are in the 2% to 4% range.

Thanks.

Our next question comes from Jason Kupferberg from Jefferies.

I just wanted to ask a follow-up on the core payroll outlook.

And I understand that in terms of order of magnitude, it is fine tuning from about 4% to 3% to 4%.

But historically it's somewhat unusual for Paychex to tweak its outlook really at all so early in the fiscal year

So just curious what lead to the decision to formally make that change, even though it's not a big one, given that you've got eight months left in the fiscal year?

Is it anything Company-specific or I think you said you are not really assuming any changes in the macro backdrop.

So just on the margin where was there a little bit of a adjustment from your perspective?

I guess Jason, I'd answer that this way.

So when we look at the year, there are lots of things that can affect what we expect the growth rate to be, not the least of which is what's the composition of the days in a year.

And so where we begin and where we end has an impact as we go through the year, and we look at what the run rate is on a particular day.

That's one thing that influences it.

The second thing is, what is the actual impact of one less day in a given quarter?

So in the third quarter, we have one less day.

We quantify that impact as we go through the year, and understand what we think it will be.

And that basically was what was impacting our decision to fine tune a bit.

Okay, as you look beyond this year, is 3% to 4% a new normal?

You've got the US economy that's basically running in the range of full employment.

You've still got a little bit of help from Advance on a full-year basis this year.

So I just want to make sure our expectations are properly calibrated.

Eventually unemployment will probably tick up, so is 3% to 4% a decent range, or do you think you can really be mid single digits in core payroll over the medium to longer term?

Yes, so two things I'd say, Jason.

One is it's early.

I think we need to go through the year and see.

I would say this, that we do not get the contribution from checks per payroll that we were getting two or three years ago, and don't expect that will recur.

So you've got to work a little bit harder.

And then the third thing I'd say is that I want to be careful to say that payroll service revenue is core payroll.

It is not.

Payroll service revenue is core payroll plus the portions of the HCM bundle that are payroll.

That number can vary, and it will depend on how much of those packages we sell in the mid market and what the pricing of payroll in the mid market is.

You have to look at both components of revenue, in order to understand what the trends are.

So subject to all of that, we'll update when we get to the end of the year.

Okay, just one more for me.

I think you haven't bought back any shares in, I think three of the past four quarters, but you did the new authorization over the summer.

So is the lack of buybacks just because the current price is not viewed as attractive enough, or is the M&A pipeline becoming more robust, or any other factors that you might highlight?

And thanks for taking the questions.

Yes, appreciate it.

I think that it has something to do with the timing of the authorization, and the other factors you mentioned, excluding the price of the shares.

That's really not part of what goes into our thinking.

Thank you.

Our next question comes from Danyal Hussein of Morgan Stanley.

I just wanted to ask about the relative performance of payroll versus HRS, and I know, Efrain, there's one thing you've called out before, and it's this revenue allocation process that maybe you could talk a little bit more about it.

And specifically is it that clients are being given an explicitly higher discount on payroll up front, in exchange for adding more modules, or do they only see a single bundled price?

Just a little more color there would be helpful, thanks.

Well I think, Danyal, to your point, there's no general answer I can give on that.

But certainly depending on the deal, you discount at what you think makes sense and is logical.

So it could very well be that a bundle that has more modules in it is discounted more than a bundle that has fewer modules in it.

So that's part of the equation, but there's other elements that add into it, which is, what's the composition and the size of the clients you're selling in a given quarter?

So that can be variable, so as we go through the year, we'll see where we end up.

And I think the focus, more and more, they do see a bundled price.

So I think, more and more we tend to look at the total service revenue.

The allocations between them, because we're selling more and more bundles, and the bundles are getting larger and more complex.

I think we tend to more and more look at the total service revenue growth, and where that growth is, and how we target that.

So it gets a little bit harder here, as Efrain said, to keep splitting this up and allocating it out, and getting really fine tuned on everything.

Got it and then just a question on the upcoming December 1 deadline.

Could you just remind us what the current penetration is of the time and attendance product?

And then you mentioned some of these newer, I guess, versions of it, is there any revenue uplift associated with those?

We certainly expect it to be.

What we are doing is we fine tuned the full product, the Flex Time with more advanced scheduling modules, so there's a lot more flexibility to scheduling and how you do it.

We've added a clock on the low end that gives you a wireless clock, and that's the shift time.

And it makes it easier to have a clock in maybe some difficult locations, and has a couple of other features with it as well.

And then the essentials is probably the biggest thing we've introduced.

It's basically a scaled-down version of our web-based Paychex Flex Time offering, so to make it easier for clients to get started, and to have a product that doesn't have quite as many bells and whistles on it, but that they need it.

So we do think there's going to be uplift.

We've seen double-digit increases in the sales.

I'd say the penetration is still pretty low, so it's definitely -- I would say where we are now, 10% or somewhere in there, a little bit more, but with a lot of room to grow.

And our biggest opportunity I think right now is we still see slightly over 50% of our clients based on our surveys are in businesses in general, small businesses that are impacted, are not even aware of the overtime regulation.

So we think there's going to be good sales, not only this quarter, next quarter, but I think it's going to continue as the compliance requirements and maybe some pushback on enforcement makes businesses realize that they really got to get involved and make sure they are recording and scheduling time appropriately.

That's helpful, thank you.

Our next question comes from Jim Schneider from Goldman Sachs.

I was wondering if you could maybe comment one last time on the pricing environment, and I think, Marty, you referenced the fact that in mid-market you're seeing a little bit more mid-market pricing pressure.

Can you maybe say whether that is at all a contributor to the downtick in the core-payroll guidance, or whether it's just an other fact of the bundled pricing that you referenced earlier?

Yes, on the mid-market, if I did, it might be misread.

I didn't really feel -- I don't see too much different pricing pressure there.

I feel the competitive environment is pretty much the same as it has been, same number of competitors.

I think if anything, we're feeling stronger about where we are from a mid-market product than we certainly did a year or two years ago, with the complete bundled product that we offer, and the additions that we're constantly making, almost quarterly, to the HCM bundle we have for Flex.

So we're feeling good about it.

The pricing, as Efrain said, is still in that 2% to 4% increase range.

I think we're holding price pretty well, particularly in that mid market, and we're gaining more revenue per client based on the bundle.

So we feel pretty good about it right now.

I think the only thing that we see impacting that would be more the economy in general, and we don't really see any major changes there, other than that businesses are getting closer to full employment, and we're seeing the checks per client slow.

But we expected that, frankly, for the last couple of years, as people came back from the recession.

So we feel good about the mid market, and we're fully staffed.

In fact, we increased more reps there than any other division in the mid market, because of the product investments we've made and the opportunity we have between service and product.

So feel pretty good about the mid market right now, and the opportunity, particularly for selling season.

Understand, thanks.

And then maybe can you maybe comment on the bookings environment you've seen over the past few months, separately on the HRS versus the PEO side, and whether those have been running ahead of plan, given the fact that you've been putting up a little bit stronger HRS revenue growth in the current quarter than you guided to?

I think the human resource outsourcing in total, we're reaching nearly a million client employees now, and between our product sets, and I think that need continues to grow.

So we're feeling good about overall HR outsourcing solutions that we're providing, and so I think that's going to continue.

The need, as these rules keep getting more complex, whether it's time and attendance or minimum wage, or ACA even for this year for many clients now starting to even pay attention that didn't last year, as the rules and deadlines are really sticking this year, as opposed to being delayed last year, I think that need is going to continue to increase, and we'll do well in that category.

Thank you.

Our next question comes from Rick Eskelsen from Wells Fargo.

The first one is just a quick follow-up on the question related to the time and attendance products.

Can you just confirm that's in the HRS piece of the how you report it?

So if there is an uptick, it would be in HRS?

Yes, I'll confirm two things.

One is, yes it is, and second, we did see an uptick.

Specifically from the time and attendance?

Yes, we did.

Okay, and then the next question is just more of a philosophical one about service versus technology.

With you having built out your technology platform, and it's got the full functionality here, and you're turning up the dial on some service investments, maybe if you could just talk a little bit about how you view service relative to technology, and the competitive differentiation there.

I know in the past, you talked about how you think your service is a big strong differentiator.

So how do you view that now, and what do you think the investments you're making are going to do, to continue to deepen that?

Thank you.

We've always been very much known as a service Company, and our technology was more internal than external for the client facing.

And beginning about six years ago, we really ramped up the investment in technology.

And I think the technology becomes part of the service story.

Clients want to do more themselves, they want to do it online, mobile.

They want to do it, how they want to do it, when and where they want.

And I think that the investments have been very balanced in both technology and service.

From a service perspective, the big investments, particularly the last few years, have been driving now multi-product centers.

So pulling our folks together to service multiple products in those bundles together.

Driving a little bit more self service, so clients can do more things, and their employees can, on the web or on mobile apps.

I think it's always going to be about service.

It's how you define service, and the service definition has become a lot more about technology, and how easy it is for clients to use it, if they want to use it and when and how they want to use it.

So we feel very good about the balance of investments that we have made in technology and service, and continue to make.

Thank you very much.

Our next question comes from Kartik Mehta from Northcoast Research.

Marty I wanted to ask you about, you talked about ACA and that being a benefit.

I'm wondering, as you look at the HRS business, how much of a benefit do you think that is, and can it continue into next year?

Or do you start comping against that next year?

Well I think you do to some degree.

Obviously, even last year, the big sales opportunity was that initial push for the majority of our existing clients to say, you need this, and we sell it to them.

We've done well there with the retention and the sales last year.

Now, you're selling more to the clients that in our client base they either were not aware of it, it didn't apply to them, or they just didn't bother to buy it, and tried to get through it on their own.

And then new clients coming on, of course, that now need it or are changing.

So I think you'll see that has some impact this year, because there's not obviously as much opportunity as last year, but then on the other hand, we see time and attendance in the overtime regulations, as the new opportunity, not quite as big as the ACA opportunity, but I think the comps will get tougher on that, but only more to last year, because you had that initial, I can sell a lot of clients that -- my existing client base, that doesn't have it.

And Efrain, I apologize, I know I'm parsing words here, but I just want to make sure.

You talked about checks per client not helping.

Was it a detractor, or was it just neutral?

It actually had a slight negative effect, largely due to mix.

But it's been part of the equation over the last three or four quarters.

Certainly the last three quarters.

And then, just one last question, Marty.

Advance Partners, seems like that acquisition is going well.

I just wanted to get your thoughts on your ability to maybe consolidate that industry more, and make it a bigger part of Paychex.

Is that a possibility now that you've owned it, and just your perspective on the industry, and Paychex' ability to grow in that?

Yes, Kartik, I think it is.

I think there's an opportunity there that, if we've seen the Leadership Team there and their results have been very positive, and better than we expected.

And as we've gotten to know that industry a little bit more from the Leadership Team there, and now getting to know the business even better, we do think there's an opportunity for more roll up there, with various smaller firms.

There's a tremendous amount of companies that do this on a small basis, and are niche oriented and I think could really benefit from a consolidation strategy there.

So we are certainly looking at that, and trying to be very opportunistic, and see if the valuations are correct.

I do think we have the capacity to do that, and the Leadership Team has the capacity to do that.

Thanks Marty and Efrain, I appreciate it.

We have a question from Tim McHugh from William Blair.

It's Stephen Sheldon in for Tim.

First, now that Paychex Flex is out in the market, and most products are on the platform, where are you guiding incremental investment spending at this point?

Well it continues to be into that product, like when you think about -- I think now we're getting a more probably fine tuning.

When you think about time and attendance, for example, we saw that the existing module was very good for mid-market and more complex clients, but that we had a real opportunity.

One of the difficulties with time and attendance is it's somewhat complex to get started, and that turns clients off sometimes.

And so we scaled down and rolled out the Flex Time Essentials now just this quarter.

So I think you'll see continued investments like that.

Other thing is analytics, we're getting more into data analytics, and using our reporting packages to make them more flexible and easier to gain data out of the reporting packages, to offer data analytics to our clients, frankly of all sizes.

And you'll see continued investment in analytics and reporting.

And I would say as well, continued adding more bells and whistles.

At the same time we're building out a simpler interface through HTML5 for all of our products, and mobile-first design, so everything is being designed now mobile-first, and so that it can be used very effectively on a mobile app, as well as then expand to whatever device you're using.

So more product, finding niches where the products like Flex Time Essentials can be used, and the design itself making it easier to use.

Okay, that's helpful.

And then I think you touched on this a little bit before but just wanted to ask about uses of cash from this point, and maybe an update on the M&A environment and the pipeline you're seeing, thanks.

Yes, so I think earlier I answered the question on -- Jason might have asked about share repurchase.

So we'll do share repurchases to combat some dilution that we're seeing, so that will be part of it this year.

And then the M&A pipeline is pretty robust, so there are a number of opportunities that we see could use part of that cash or all of it.

So we continue to evaluate those, and frequently get far down the road, and for whatever reason, it doesn't work out because we're pretty choosy.

But we think there's opportunities out there, and that's why in part, that cash is there.

Thank you.

Our next question comes from David Grossman of Stifel Nicolaus.

Just a quick follow-up to one of the questions.

I think Marty you'd mentioned in response to the Affordable Care Act, you thought you were pretty much comping against that strength already this year.

I just want to make sure that I heard that right.

Well I think what we're comping against is yes that big first burst last year, that we had, of being able to sell a lot to the existing client base that didn't have it.

Basically went from no one having it to a large number of our clients having it.

Now you're selling to those clients that now need it, because their situation changed, they're new clients, or they just didn't bother with it last year, because they thought it didn't apply to them.

So it does put a little bit of a push on us, that we've got to sell past the initial growth rate last year.

So stated differently, I think the spirit of the other question was that going into FY18, you wouldn't really expect much of a headwind from whatever thrust you got, or incremental sales you got from the Affordable Care Act last year?

No not in FY18.

Actually more of the pressure is this year is because we're selling.

And then the second question I had is, this week, one of the ERP vendors mentioned that they were moving down market, and I think the way they characterized it was about 250 employees.

And I know that's probably above your sweet spot, but I'm just curious what your views are on that segment, given that it seems to be getting increasingly crowded.

And then if you could tie that into your comment about the increasing focus on technology, and more interaction, if you will, with the end user?

Yes, I'm not sure exactly who that, because I guess I haven't seen that.

But there's a number of -- over the years, you know that there's been a number of large players who have said, I'm going to come down into that below-500 market and capture that.

And the issue is, usually they're very heavy in technology and complicated technology, and have a hard time bringing it down to a business that has an HR department of 1 to 5 to 10 people, and making it simple for them to use, affordable for them to use, and then being able to service them and keep the margins that they're used to.

They also tend to be much higher in software development typically, and technology only, than knowing how to service those clients.

I think we've had obviously a track record of moving up, and we do feel like in the mid market, our sweet spot is certainly anywhere from 20 to 500, in that mid-market space.

We used to think it was 50-plus, but it has really come down some with the needs of the business.

So we haven't seen much change in the competitive environment, and while I'm always concerned about changing competition, we don't see anybody right now new that's coming down, that necessarily could be that successful.

But that's why we've got to keep our products and service great, so that we can certainly compete with anybody.

Right so can you give us a sense for just how important the technology is, versus the service, as you migrate between these different break points, in terms of employees?

Yes, I think the technology gets more important as a component of service when you get 100-plus, 200-plus, because they're also, we're seeing clients move more toward pushing employees to be more self service.

But that's exactly where a number of our investments have been going, is being sure that whether it's on a mobile app for the employee of the client, or for the client itself, that they can do things, they can make changes, they can view.

So they are taking heat off of the HR departments of these companies.

And I think when you get a 100-plus, 200-plus, the technology is important, but you better have the service to back it up.

Because while it sounds great, when those employees go to do something self service, you want to have someplace for them to fall back on to call, and that's where I think we're very good at balancing both the technology investment and our service, particularly now when we've added web chat 7 by 24 service, multi-product centers, all those are appealing to that group that's looking for technology, but wants a fall back to personalized committed service.

Got it, thanks.

That's very helpful and just one last question, Efrain, for the SUI headwind, when do we actually anniversary that on the balances?

That's a good question.

I think we are going to battle it mostly throughout the year.

So I think probably, somewhere in third or fourth quarter.

My guess is probably more fourth quarter.

And then it does not then it flattens out for FY18?

David, yes.

I would expect that.

And then every year, we go through another round of seeing what's happening with unemployment rate, so we could have some variability.

Good.

Thank you.

Our next question comes from David Ridley-Lane dialing in for Sara Gubins from Bank of America-Merrill Lynch.

Wanted to ask about the pace of service headcount additions to support the mid market and the Affordable Care Act offerings.

Are you currently at the planned staffing levels, or are you planning to continue to increase through the year?

Yes, David.

At this point, we're at the planned levels.

We're staffed up in all areas, and we've got a full compliment of what we need, we feel, unless the sales take off more than we thought.

But we feel very good about where we are.

We've also made technology changes to make it easier for clients to give us the information, and for us to file, because we don't expect any delay in the filing requirements this year, so we're fully staffed and ready to handle it.

Got it, and then on the adoption of same-day ACH payments, would that have a potential negative impact on your client float balances over time?

I've been asked that a couple of times.

So same-day ACH, if the reached widespread adoption, could impact short-term cash balance, probably not long term.

It also has a benefit in that you may be able to get additional fees for running very late payroll.

So it's too early to tell.

I would say that it's a very modest negative, but that would depend on it being adopted in a widespread way.

We really see it as it's a benefit to our clients that have a last-minute change or something.

As Efrain said, there might be revenue opportunity there.

And there's also a great service opportunity, where the client makes an error, or needs a last-minute change.

We are now able to work that through the banking system with the ACH, so we are not expecting it to be like a basic payroll, where that's the norm.

It's more an additional service really that we can provide.

Got it, and then just a quick numbers question.

Does the new $350 million buyback replace the old authorization?

Yes.

So basically, we cancel that out and start at $350 million.

Got it.

Thank you very much.

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

First question, does the new share-based payment accounting treatment, should we think of that as a discrete impact on the quarter, or is there going to be an ongoing impact of putting this in?

And if so, do you have a sense what you're expecting in the remainder of the fiscal year and moving forward?

Yes, so, good question.

So it is discrete, and it will remain discrete when we record it in a given quarter.

It could have modest impacts in subsequent quarters.

We'll call it out.

We don't expect that it will have the level of impact that it had this quarter, so I'll just leave it at that.

Was there sort of a catch-up impact, or was this just, that there was for some reason, a bigger tax benefit than normal from options this quarter, and now that flows through the P&L versus historically it didn't?

Yes, there wasn't a catch up.

Without getting into the weeds on the mechanics of the computation, which are complex, suffice it to say that the combination of an increase in share price, coupled with an increase in share exercises, ended up creating a situation where we had more benefit in the quarter.

And this will happen periodically throughout, in the future, and we'll just call it out when it happens.

We don't anticipate that it will be as sharp as it was this quarter.

Okay, great.

Thanks, and then, you know there's always a lot of questions about the payroll growth versus HR.

And I guess it seems to me that you've alluded a couple of times that maybe the distinction isn't as strong as it was in the past.

But from that perspective, could you just help us understand how much of your selling efforts, headcount, time in the field, however you want to talk about it, is focused on upselling more components, the broader product set into a pretty sticky and large base, versus people who were out there prospecting for new payroll customers?

Has that changed as more of the focus, selling more stuff into the base today, than it was in the past?

I don't think that its changed, well obviously there's a lot more opportunity.

But I would say if you took probably, if you thought about core payroll and that sales team, and then the way MMS, the mid-market team goes after it, probably 40% to 50% is still on acquiring new clients, and going after them, and getting them on board.

And then the other 50% is really -- because when you think about all of HRS really, they're selling into the base for the most part, and then a number of the core MMS payroll teams are back selling more products.

But I'd say that it's probably around 50/50, and I don't know if it has changed that much.

I think they're focused, though, on selling the full package up front is different.

So while it's a little bit different than the way you were thinking about it.

We sell a lot more full package right up front.

Our old style would be, I sell you payroll, you get used to us, you get happy with us.

Six months later I come back and see if a 401(k) is of value to you, or workers comp or health insurance.

Now what we're finding is, clients want the full value up front.

They have a full need in mind, and it's not just, hey, I want payroll for now and then I'll come talk to me.

So we're selling more what we call integrated sales approach, where multiple teams will go and see a brand new client and sell them could be everything, including HR outsourcing because that's what they really were looking for, and payroll was coming along with it.

So but if you say 50/50 roughly, that would be fine.

It's just the focus is very different now for the sales teams.

From core right through.

And then can you just give us an update on penetration of some of the key categories, and what's the gating factor to further penetrating whether it's 401(k), or the fully outsourced, and some of the other major product categories?

Is it price, is it just you getting out and telling the story?

What can you do to drive that penetration higher?

Well that's something obviously we are always looking at.

I think the penetration rates are still pretty low, so lots of opportunity for us.

I think it's a combination of all of those.

It's a combination of what does the client see the value, and for like a 401(k) for example, and or do they feel the pressure from their employee base?

We're feeling more clients come to us for products like insurance and 401(k), because it's harder with full employment, or moving towards full employment, it's harder for them to capture new employees unless they have the benefit packages that they might not have needed two years ago, in order to compete for their employees.

So it's the need in the market, it's the value to the client, and it's execution.

Obviously, we have spent a tremendous amount of time training, making sure the products are available, making sure we have the training and all of the salesforce tools.

We've added a tremendous amount of tools to the salesforce, data analytics, what clients we have that are most likely to buy a 401(k), most likely to buy insurance, salesforce, all of the tools, all help execution.

So it's a number of things.

I would say penetration rates still give us a tremendous amount of opportunity.

We're moving them up, but there is still a lot of room to grow, and we're putting everything in place to be successful about it.

Great, thank you.

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

Always good to talk to you.

The slides, just looking at the slides, it looks like on the cash, on the long-term capital strategy page, you're talking about strategic accretive acquisitions.

I'm curious, accretive.

Is that a one-year sort of ambition, or are you telling us we shouldn't expect any dilutive deals from Paychex?

I would say that's a long-term issue, and when I mention this, look, if the technology is right and we think there's a strategic advantage in buying a company, a la, for example, SurePayroll that was not accretive, we'll do it.

So every deal is not going to be accretive right out of the gate.

Some aren't.

So, we're pretty tough on the criteria of dilution in the first year, but if it makes sense, we look at it.

Understood, it's good to know.

And then just on the overtime legislation, you said there was a little bit of an uptick this quarter, but is there a time frame with which we might expect a more significant uptick in attach rates on time and attendance?

Well, I think we actually had a pretty good uptick, double-digit growth in this quarter.

And I think that it will, my expectation would be, it will be into the next couple of quarters that we'll continue to see sales do very well with time and attendance.

As we're getting closer to that December 1 time frame this month, next couple of months should see probably the biggest benefit.

But I think after that, I think clients are really just making themselves aware of it.

The other thing is, there's a lot of discussion in the news about will it be overturned, could it be pushed back through some court proceeding, and but we don't see that happening at this point.

But that could be making clients say, I'm going to wait and see how it happens, so it should be a good year overall, certainly for time and attendance, but I think that this quarter and next quarter are probably the best.

Got it.

So going into and coming out of it, we could see a little bit of a lift.

That's good to know.

And just lastly, I know there's a lot of questions around payroll and HRS, but broadly speaking for the quarter, how did each of those lines come in versus your internal plan?

They were within the range of expectations.

So look, I think that part of what we look at every quarter is try to understand what we think trends are, and adjust, based on what we're seeing.

You can see we didn't change our guidance on income, fine-tuned revenue, actually HR services had a strong quarter.

We'll see where we end up with the year, but overall, we think we're in the range of what we expected.

We feel good about how we're positioned.

We've got fully staffed from a sales rep standpoint, we grew pretty much all the divisions, but in particular the payroll divisions, and it's getting these newer reps to get up to the production that we would like to see, and but we're fully staffed in that group.

We're fully staffed in the Service Teams to handle ACA, which was a struggle last year.

There was just so much change going on there.

And so we feel good that we're on target for what we expected.

Great.

Appreciate the update.

Our next question comes from Mark Marcon from R.W. Baird.

Just on the HRS services, could you just talk about what are the two most penetrated solutions that you're currently offering and what penetration rate that has, in order to give a perspective in terms of the opportunity for further cross sales?

I think the two most penetrated would probably be workers comp, and insurance and 401(k), and but the biggest opportunities are still 401(k) certainly, and I think we've talked about it.

We expanded the last roughly two years into what we call large market 401(k), so where we focused a lot on new plans for the first almost 18 years of having the product, the last couple years we added a whole team which is expanded on conversion plans.

So larger asset plans, and that group has been doing very well.

Particularly in first quarter, we had some nice growth there.

So we're building relationships with brokers who refer us now, and as these rules get more complex for brokers, I think they're bringing our talented tenured team on the large market into more deals so that's very good.

So a lot of opportunity in 401(k), and a lot of opportunity in HR outsourcing would certainly be the next largest, meaning ASO, PEO, and our HR Essentials.

So biggest opportunity, biggest revenue bases and opportunities to grow are 401(k) and HR outsourcing, by far.

And what's the penetration rate currently?

On HR outsourcing?

Less than 10%, and if you look at client employees, I did say that we're approaching 1 million worksite employees, and we've put out 11 million, 12 million W2s, so we're a little less than 10% on the employees that we're servicing.

And not all of them will need it, based on their size, but we think that penetration rate is less than 10% and certainly has a lot of upside.

That's great color, and then with regards to, there's clearly a greater emphasis with regards to selling more modules up front when you first sign a client.

Can you give us a little bit of a perspective in terms of over the last couple of years, how that's changed in terms of like typically we used to sell maybe three modules with a brand new client, and now we're up to five, six, et cetera.

What are you seeing on average with new clients?

Above the smallest clients that might just be signing up for just payroll?

I would say it's hard to look at, because of the way we bundle it, we don't think of it quite as modules.

But I would say that probably 25% of the clients to 30% of the clients are taking something, maybe 20% to 30% are taking something more right now.

This is a relatively new approach to the way we're selling, because we've had so many years of selling payroll then coming back.

I think, if you're asking how many do we sell a larger bundle up front, I'd say it's more in the 20% to 30% range that we're selling a bundle versus payroll only, and it has at least one additional service or module with it.

We've seen the revenue per client has been -- we've been successful at driving up that revenue per client year after year, so it's probably the last couple of years, so I hope that helps.

It does and then you mentioned checks per client, not getting as much help, partially due to mix.

Where are the -- you're not selling as many tiny clients anymore, are you?

Well, we sell small.

We absolutely compete very well.

It's an interesting point Mark.

So there is a tradeoff between, if you're going to go get clients you either have to take them away or you have to get them new.

And I think we've been very effective, particularly in the fourth quarter of last year, we had very good unit growth.

So we continue to see unit growth, and there's a little bit of a tradeoff between unit growth, the unit growth we've been seeing, which has been between 2% and 3% and the size of client.

So that impacts a little bit.

It has a little bit of a drag on growth in the short term, not in the long term.

And tiny, I was talking like the sub-six employee?

Yes, yes, micro.

Absolutely, but a lot of new clients are in that category, absolutely.

Remember we still get great referrals from CPAs and so forth, and so we're still seeing 50% of the sales are coming from brand new businesses, and Efrain said, a lot of the brand new businesses are sub-six.

Okay, great and then client retention, I didn't hear any comments there?

Yes, still feeling very good about it.

We're right on plan to remain at pretty much close to highest levels of client retention.

So right now we feel very good about it, it was a good quarter, continued right through from last year.

Lastly on just the strategic acquisitions.

You mentioned, maybe I misheard, but I thought I heard you say, potentially could use all of the cash?

Is that -- that sounds unusual, relative to what you've done in the past?

I guess what I was saying Mark that is we have opportunities in the pipeline that could use all of the cash.

That doesn't mean we have an opportunity that's going to use all of the cash.

That would not be the expectation?

Yes.

That would not be the expectation.

Great.

Thanks for clarifying.

Congrats.

The next question comes from Lisa Ellis from Bernstein.

Thank you for squeezing me in.

Just wanted to follow-up on the comments related to the Accountable Care Act.

Now that you're into the first quarter, I know there's been a lot of debate about whether this year is going to continue to be strong, and Obamacare has companies that didn't choose to comply last year do this year, versus whether there's a hangover effect or not.

So how are you feeling about that, now that you're a few months in?

Yes, so I think the point was, Lisa, that just last year it was that first chance to go after the entire client base, nobody basically had the product, or very few, and so we were able to sell a lot, particularly in the first few quarters of the year.

And now when you anniversary that, we're still selling the product, but there's not as much opportunity there.

So I think then the question was, what does that lock like for 2018?

2018 won't be much of an issue, because I think we'll be very consistent with 2017 to 2018.

But 2016 to this year, 2017, there is some impact that we are not selling as much.

On the other hand, we're selling more of the time-and-attendance solutions but the revenue is not quite as much, the opportunity is not quite as much there.

And it's not as probably as far reaching or as demanding or as creating as much angst with clients as the Affordable Care Act was, because of the penalty situation.

Now the overtime stuff could start to pick up, if enforcement picks up as well, but I think that's just going to take a little bit longer.

So again, it's having some impact versus last year, but it's not a huge thing, but it's having some impact.

And are there other regulatory changes or rules on the horizon that you would call out, like that you see a steady pipeline of these rules being considered, either at the federal level or in certain states, that would continue to drive the incremental secular demand from the regulatory changes?

Yes, there's been a steady flow based on current administration, and probably won't change much in the election, which could have is some impact.

But minimum wage, for example, right now, it's extremely confusing for our clients.

Minimum wage rules are different by state.

The Fed's talk about changing minimum wage, they have for government, but in some of those that are tied into government.

But states are different, cities are different, and we really help a lot of our clients -- we help them through our payroll service only, or our HR outsourcing to stay up with minimum wage changes.

Because they're not changing once, they are changing over a period of years, and you have to make sure you stay current with those.

And there's a lot of work on identifying like the immigration-type things, you've got to know your customer, you've got to know your employees, you have got to make sure you've got that well documented.

So the rules keep coming.

I don't think that helps necessarily the business environment in general, because of over regulation, but it certainly gives Paychex a lot of opportunities to go in and talk to clients about their payroll need, and their HR outsourcing need, because small to mid-size businesses just can't keep up with all of these changes.

The other thing is that the enforcement and the penalties have increased, as states and Federal Governments have looked for revenue sources.

So not only is there an issue about whether you are compliant, but if you're challenged on your compliance, we can provide a tremendous amount of help.

If you get a penalty in payroll, if you get a penalty for a time issue, time and attendance issue.

We're there to support you with expert documentation and background, and relationships with federal, state and local governments.

And that's a big plus we sell to clients, that they don't realize sometimes until they're hit with an audit or enforcement penalty.

Got it, and then just one final follow-up.

I think the last couple quarters you've called out a dynamic in the client base that's been interesting.

I think overall average employees per client have been slightly trending down, due to the strength in SurePayroll and new business formation on the low end.

But then at the same time, your mid-market offerings have been performing well.

So almost like a barbell effect.

Are you continuing to see that trend in the client base, or anything else like that you'd call out?

Yes, let me just provide a little more color on that.

So yes, if you look at average client size, it's down very, very slightly and that has an impact, but you're right.

The difficulty is, you can't see that completely in payroll.

So if you look at our mid-market platform, taken as a whole, including the modules that are typically sold with that, which are HR online, and time and attendance, you'd see nice growth over the last two or three years.

Payroll has done fine too, but it has a little bit of the headwind because of slightly lower client size, driven by something that's positive, which is increasing client growth.

So we've gone from growing the client base at 1% to growing between 2% and 3%, and hopefully that continues to grow.

The reason why we are not concerned about that is those clients eventually become larger, and purchase more services.

So we want to keep the funnel reasonably open at the top.

Terrific.

Thank you.

Good clarification, thanks.

Our next question comes from Ariel Hughes from Wedbush Securities.

This is Ariel Hughes on for Moshe Katri.

Can you provide us with some color around the correlation between rate increases and the float income?

Specifically around the expected lag time between rate and float income increases?

Thank you.

Typically, you're going to see at least one, if not sometimes two quarters to reflect full impact of a rate increase, and then we quantify in the Q, or in the K, at least, that the impact of 25 basis points translates into about $3.5 million to $4 million on an annual basis.

So that's the thought process that we have.

Okay, thank you.

Our last question in queue comes from Glenn Greene from Oppenheimer.

Two questions, clarifications really on an earlier discussion.

The first is on the ACA dynamic from last year into this year.

I guess I'm a little confused, if you're talking about sales bookings benefit last year, or revenue benefit.

And I guess I'm a little confused as to how quickly these things convert, and the order of magnitude, what we're talking about.

Was there sort of a revenue benefit last year that you're now lapping, or were you over emphasizing this?

No, that's the sales, I'm sorry.

Just to be clear, glad you asked the clarifying question.

It's not from a revenue standpoint, it's a sales perspective.

So I'm just saying that we had a big sales impact last year, we had a good sales impact last year as we sold the client base.

But this year, so sales have come down some in the ACA product itself, but revenue, because the retention of the clients has been fine, and so there hasn't been any price change really associated with that product, or anything else.

So I guess the natural follow on is the magnitude of the revenue benefit that you're realizing in FY17 related to that?

Yes, so Glenn, I was asked this periodically during the year.

We got about a point benefit last year on revenue from additional ACA revenue, and obviously, we're anniversarying that.

It's incorporated in the guidance, and are dealing with that slight drag, and particularly in HRS.

Okay, and then I know Efrain you went through this in great detail, and I appreciate, you want to have clarity out there.

And I hate to go back to the guidance, but I can tell there's still some confusion so I'm going to be specific.

So what you're talking about is take the reported FY16 net income, or roughly $757 million, grow it 7%, and just for sake of argument, we could argue what the fully diluted share count, but just using this quarter of 364 million we're talking $2.22 to $2.23 in EPS, and maybe get some benefit from share repurchase?

It depends on what your assumptions are around shares, et cetera.

But yes, you're right.

And the reason is maybe I'm being too helpful.

You're going to have a set of reported numbers last year.

We're going to have a set of reported numbers this year.

I can't give you guidance this year that now excludes one thing in one year and another thing in another year.

I could have just done it and said, it is as it is.

But my concern is someone is not going to pick up a number that they should.

The other thing I would just say is that we want to steer as much away from providing guidance that's not on a GAAP basis, so that's why we tried to clarify.

So one last thing.

So the lower tax rate, the 35% that you now alluded to in your guide, is that the good run rate to think about, obviously beyond FY17?

35%, no Glenn, because we got a benefit in the first quarter.

So that's why you, if you remember our guide in the fourth quarter we guided to 35.5% to 36%, that's a better number than the 35%.

The 35% benefits from this one-time benefit we got in Q1, which is from the one-time benefit we got the prior year.

Makes sense.

Okay, I got it.

Thank you very much.

Speakers we show no questions in queue.

All right, thank you, Jim.

Well, at this point, we'll close the call.

I just want you to know that we appreciate the interest and questions, we feel very good, as we said, we're staffed up and ready.

We've increased our salesforce, we feel good about the product and the technology and service investments we've made, and I think we're off to a very consistent and good start.

At this point, we'll close the call.

And if you are interested in replaying the webcast of this conference call, it will be archived for approximately 30 days.

Our Annual Meeting of stockholders will be held on Wednesday, October 12 at 10 AM in Rochester, and that meeting will be broadcast simultaneously over the Internet, as well.

Thank you 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 so much for your participation, you may now disconnect