沛齊 (PAYX) 2017 Q2 法說會逐字稿

Welcome and thank you for standing by.

(Operator Instructions)

Today's conference is being recorded.

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

Now I will turn the meeting over to your host, Mr. Martin Mucci, President and Chief Executive Officer.

Sir, you may begin.

Thank you.

And thank you for joining us on our discussion of Paychex second-quarter FY17 earnings release.

Joining me is Efrain Rivera, our Chief Financial Officer.

This morning before the market opened, we released our financial results for the second quarter ended November 30, 2016.

Our Form 10-Q will be filed with the SEC within the next few days.

You can access our earnings release and Form 10-Q on our Investor Relations web page.

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

On today's call, I will update you on the results of our business in the second quarter and Efrain will review our financial results in more detail and discuss our full-year guidance.

After that, we will open it up for your questions.

Our results for the second quarter reflected good progress.

We continue to see positive results across our major product lines, and service revenue for the second-quarter grew by 7% year over year.

We achieved a new milestone this quarter as we obtained a one million client work site employee served by our Paychex HR Services.

Paychex HR services is our comprehensive outsourcing services product line, and that includes our ASO, or administrative services organization, and our PEO, professional employer organization, as well.

Our cloud-based HCM services, in particular time and attendance, continued to show strong growth in the quarter.

Tomorrow is the one-year anniversary of the acquisition of Advance Partners.

Advance has been an excellent addition to the Paychex family.

We are very pleased with the leadership and the team's contribution to our financial results and the future opportunities for growth we see in that business, particularly timely as the staffing business is picking up some expanded growth today.

With the success of our HCM solutions we have continued to invest in operations personnel as we've expanded our multi-product service centers, including our time and attendance support and our ACA product compliance and service teams.

Client retention remains at consistent high levels.

We have also invested in our service and our sales organization over the last year, adding headcount across all sales teams, and we are well-positioned going into our third quarter.

We will have a better idea of overall sales performance and the impact of the fiscal year next quarter after the end of our peak sales season.

We continue to make it a priority to provide robust HCM solutions that meet the evolving needs of our client base.

At the recent HR Technology Conference and Exposition in October, we showcased enhancements to Paychex Flex that addressed two of the biggest trends in the HR industry, mobile user experience and HR analytics.

Attendees at the conference were able to view a demo of Paychex Flex which included these enhancements.

We also announced that we shifted to a mobile-first design of our HCM suite.

This approach allows Paychex Flex users to have full functionality of all application components regardless of device or screen size.

The growing trend for both HR leaders and employees is the use of a mobile device.

Shifting to a mobile-first design demonstrates our commitment to putting the needs of our clients and their employees first so that they can accomplish their HR tasks where they want, when they want, and on whatever device they want.

We continue to receive positive recognition of our Flex platform.

In November we were honored to be recognized as a leader in the 2016 NelsonHall Payroll Outsourcing NEAT, a component of the firm's speed-to-source initiative.

NEAT stands for NelsonHall's Evaluation and Assessment Tool, and is a vendor evaluation report tool that can be utilized by managers to evaluate outsourcing vendors.

This was the first time we had participated in this initiative and we were placed in the leader quadrant for three areas -- technology and user experience, analytics and reporting, and HR cloud integration.

The client feedback that goes into this ranking makes this honor even more important to us and reinforces our commitment to delivering the best and most robust solutions in the market today with our Paychex Flex platform.

This has been a transition period in the US with the Presidential election and the move to the Trump Administration.

We have been asked a few times how we anticipate the new administration will impact the economy overall and, more specifically, the payroll and human capital management outsourcing industry.

In this transition time many business owners could be hesitant to make longer-term decisions.

We see this as being more likely to impact the mid- to large-size businesses rather than small businesses.

President-elect Trump indicated he intends to lower taxes and create less regulation.

This would be a positive for small businesses.

It would lower the costs and allow them to invest and hire more.

Paychex would benefit as our clients expand and add employees and potentially see value in our HCM services.

While complex regulations tend to drive companies to an outsourcing solution, we believe any change in regulation is good for Paychex.

We remained informed about what is happening in the regulatory environment and are well-positioned to continue to educate our clients and assist them with their compliance needs through our technology and service support.

Over the last year, the Affordable Care Act has been a tall wind for payroll outsourcing companies, including ourselves.

Any rollback of Obamacare or Affordable Care Act or a reduction in compliance and administration requirements will impact the HCM outsourcing industry.

Given our target market of small- to medium-size businesses, a large portion of our client base has not been impacted by ACA.

In November, a federal court issued a preliminary injunction to temporarily block the Department of Labor's final overtime rule that would have become effective December 1. This rule would expand overtime for millions of workers.

As a result of this injunction, employers did not have to be in compliance with the new rules as of December 1. The ruling is temporary but creates substantial uncertainty for businesses.

The proposed rules created an enhanced awareness for the need for time and attendance solutions, particularly those integrated within the client's HCM product suite.

This brought an increased demand for our products that we don't see diminishing with the delay in the rules.

We will continue to monitor the status of these regulations and ensure our clients remain informed as to how any changes may affect them.

Shifting the discussion from clients to shareholders, we continued with shareholder-friendly actions.

During the second quarter we repurchased 2.9 million shares for a total of $166 million.

And we will continue to maintain an industry-leading dividend yield of over 3% with a quarterly dividend of $0.46 per share.

In summary, we have made solid progress in growth in our financial performance during the past quarter and I appreciate the great work of our Paychex employees and management team.

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

Efrain?

Good morning.

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

Refer to the customary disclosures.

As Marty indicated, second-quarter financial results for FY17 showed continued progress and growth.

I'll cover some of the key highlights for the second quarter and the six months, provide greater detail in certain areas, and wrap with a review of the 2017 outlook.

Total service revenue grew 7% for the second quarter to $760 million and 8% for the six months to $1.5 billion.

Interest on funds held for clients increased 2% for the second quarter and 6% for the six months to $11 million and $23 million, respectively.

These changes were primarily driven by slightly higher average interest rates earned.

The growth was tempered by slight decrease in the average investment balances by approximately 1% for both periods.

This is really a timing issue that we call out in the press release.

Expenses increased 8% for both the second quarter and six months, with Advance Partners contributing approximately 1.5% to this growth for both periods.

Expense growth was impacted by higher wages and related expenses due to growth in headcount in our operations area.

Selling expenses have shown modest growth reflecting strong sales performance in the year-ago quarter.

Our operating margin was approximately 40.3% for the second quarter and 40.7% year to date, comparable with the prior-year periods.

We continue to maintain industry-leading margins while investing in our operations.

Our effective income tax rate was 35.2% for the second quarter and 34.1% for the six months, compared to 36% and 32.9% for the respective periods last year.

As we discussed on our last quarterly call, we had several discrete tax items in the first quarter of both years that have impacted the year-to-date effective income tax rates.

In FY17, we implemented new accounting guidance related to employee stock-based compensation, which has resulted in discrete tax benefits now being recognized upon exercise or lapse of stock-based awards.

The impact of this in the second quarter was immaterial but had a larger impact in the first quarter.

Last year in the first quarter of FY16, we recognized a net tax benefit on income from prior tax years related to customer-facing software we produced.

Because there have been ins and outs, refer to the press release and you'll see we provide a non-GAAP EPS comparison with and without these items.

Net income increased 7% to $202 million for the second quarter and 5% to $420 million for the six months.

Diluted earnings per share increased 8% to $0.56 per share for the second quarter, and 5% to $1.16 per share for the six months.

On a non-GAAP basis, as I mentioned just a second ago, adjusted net income increased 6% to $201 million for the second quarter and 7% to $405 million for the six months.

Adjusted diluted earnings per share increased 8% to $0.56 per share for the second quarter and 8% to $1.12 per share for the six months.

Note that these two non-GAAP measures exclude certain discrete tax items previously discussed.

Refer to the table if you have any questions about that.

Payroll service revenue increased 3% for the second quarter to $441 million and 4% to $892 million for the six months.

Advance Partners contributed 1% to the growth in payroll service revenue for both the quarter and year-to-date periods.

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

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

Payroll client size impacted revenue as average client size trended modestly lower.

We discussed that in the first quarter.

We saw a continuation of that trend in the second quarter.

While we continue to present payroll service revenue and HRS revenue, I want to emphasize one important point.

With the evolving nature of our businesses to an HCM provider, we now offer more product bundles that are bundled with payroll.

Revenue from these bundles is allocated among payroll and HRS.

Payroll growth remains steady but HRS growth reflects the sale of more services to clients and greater revenue per client.

And I'd call out specifically that we had another strong quarter in time and attendance sales.

HRS revenue increased 12% to $319 million for the second quarter, 14% to $642 million for the six months.

This increase reflects continued growth across our client base and all HCM services, including our comprehensive HR outsourcing services, retirement services, time and attendance, and HR administration.

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

Insurance services benefited from continued growth in revenue from our SR services, as well as 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 reflected an increase in asset fee revenue earned on the value of participant funds as well as an increase in the number of plans served.

Last, Advance Partners contributed a little bit less than 2% to the growth in HRS revenue for both the second quarter and the six months.

Investments in income.

Turning to our portfolio, our goal is, as you know, to protect principal and optimize liquidity.

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

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

Long-term portfolio now has an average yield of 1.7% and average duration of 3.3 years.

Our combined portfolios have earned an average rate of return of 1.2% for the second quarter and six months, up from 1.1% last year.

Average investment balances for funds held for clients decreased by approximately 1% year over year, as the impact from growth in client base was offset by timing of certain remittances to taxing authorities.

We expect that in the second half of the year that will change and we expect client funds growth to grow about 1%.

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

It remains strong with cash and total corporate investments of $725 million as of the end of the quarter.

Funds held for clients as of November 30 were $3.2 billion compared to $4 billion as of May 31.

Funds held for clients vary widely, as you know, and they average $3.7 billion for both the quarter and the six months.

Total available-for-sale investments including corporate investments and funds held for clients reflected net unrealized losses of $16 million as of November 30 compared with a net unrealized gain of $48 million as of May 31.

Recently interest rates for intermediate term investments have rallied, resulting in a decrease in the market value of our portfolio.

Total stockholders' equity was $1.8 billion as of November 30, 2016, reflecting $331 million in dividends and $166 million of repurchases of Paychex common stock.

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

Cash flows from operations were $413 million for the first six months, a decrease of 2% from the prior year.

This decrease was the result of fluctuations in working capital offset by higher net income and non-cash adjustments.

Now let me turn to guidance.

We remind you that the outlook is based on our current view of economic and interest rate conditions.

And what I mean by that is we do factor in the recent Fed rate raise but we don't factor in any continuing raises beyond that.

We'll update as we see those.

We obviously expect that there will be some but they're not baked into this guidance.

Payroll service revenue growth is anticipated to be in the range of 3% to 4%.

We anticipate payroll revenue growth in the third quarter will be below the range of full-year guidance, as we discussed on last quarter's call.

We now expect that it will be approximately 2%.

Remember that the third quarter is impacted by one less processing day.

HRS revenue growth is anticipated to remain in the range of 12% to 14%.

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

Interest on funds held for clients is anticipated to grow in the upper single digits.

The impact of the recent increase in short-term rates will be modest but would be more accretive as we enter into 2018.

Operating margins are anticipated to be consistent with the guidance previously provided.

The effective tax rate for the year is expected to be approximately 35%.

GAAP basis net income growth is expected to be approximately 7%.

We said that last quarter.

Adjusted net income, which is a non-GAAP measure that excludes certain discrete tax items, is anticipated to grow approximately 8%, consistent with the guidance that we gave in June.

I turn it back to Marty.

Thank you, Efrain.

We will now open the call to questions.

Operator?

(Operator Instructions)

The first one is from Mr. Jason Kupferberg from Jefferies.

Thanks.

Good morning, guys.

Happy Holidays to you.

I just wanted to start with a question on the core payroll segment.

I was just trying to do the math here in the back of the more precise outlook on Q3 at the 2% level.

To get to the mid-point of the full-year 3% to 4% range it seems like you'd have to be about 4.5% growth in Q4.

So, just so we've got our models aligned properly, should we be thinking about the lower end, 3% to 4% (inaudible), or are there some real accelerators in Q4?

I know you're not going to have the benefit of Advance anymore but I don't think you're disadvantaged in terms of processing days, either, there.

Jason, I think to call it precisely it's a little bit tough because we need to get through selling.

But I think, at this point, we'd anticipate we're towards the lower end of that range.

Okay, understood.

And then I just wanted to check on pricing, as well.

That's an area we continue to always get questions on.

I know you talked about there being some lift from pricing.

If it is still in that historical 2% to 4% range, that would imply that on an organic basis, that volumes in core payroll were flat to down.

Are we thinking about that right?

Is 2% to 4% still the right range that you're seeing on price?

Yes, let me talk about that.

Yes, it is 2% to 4%.

This year it's probably closer to the lower end.

We've been trending somewhere between the low and mid-part of that range.

So, we still are getting price.

We still are getting volume.

Our client base is up over last year.

And we've said we would be between 1% to 3%, and last year we were at 2%.

We're in that range.

So, what accounts for the difference?

It is accounted for by the fact that our average client size is a little bit smaller.

So, to put this in context, if you go back 10 years, go back to 2007 our average client size is 17.

But some years it's 17.1, last year we ended at 16.73.

And at this point, we are trending slightly down from that number.

So, the effect of that mix is basically taking payroll service revenue down.

This happens from time to time.

It happens more when two things are present.

The first is that we start to see a flattening in checks per payroll, which is what we've been seeing over the last three to four quarters.

Actually this quarter our checks per payroll went negative.

And, by the way, that's on a same-store basis.

I want to clarify that.

What that means is that, particularly our clients in the under 50 space, simply aren't adding a lot of employees at this stage.

Will that continue?

We'll see.

It's been bouncing around quarter to quarter.

And if you look at our index that we publish each month you'll see that reflected in the numbers.

So, that's Part A.

And then Part B is that as we sell clients that are a little bit lower than those that we lose we have this drag effect.

In most years, that basically is offset by some client checks-per-payroll growth.

This is a year where we're not seeing that.

We're monitoring that and saw some of it in Q1 and we'll see if it continues into Q2.

It can bounce around.

I would just caution not to assume that's exactly what you're going to see through the balance of the year, but we're assuming at this point some drag in checks per payroll as we go through the year.

Just to add to that a little bit, when you look at last year second quarter there was a push because of the Affordable Care Act, particularly in the mid-market clients to get in and buy those services and therefore it got you in the door a lot more for sales.

That ticked up the size of the average client because we sold a little bit more on the mid-market.

It's an interesting time with the election to see how much the Affordable Care Act last year versus this year had an impact, because we sold those clients pretty much who needed it.

Now, the retention has been very strong on that product, even with the uncertainty.

But that was higher last year.

It got you in the door a lot more in the mid-market because they were interested in not only the Affordable Care Act but how you integrated with the payroll services.

So, that may have been an impact.

And then, as Efrain mentioned on our small business index, we've seen a flattening out of hiring in the small business sector, the under-50 employee sector, for a couple of months now.

And that could be around the election or not.

So, it's an interesting quarter because of the election and the possible changes coming up, as well.

Okay, that's helpful.

Just one last one for me, I think in the quarter you bought back more than twice as many shares as you had bought all of last fiscal year.

So, I wanted to get a sense of whether that's indicative of any change in the M&A pipeline in terms of the prospects there, either in terms of size of the prospects or potential timing on the prospects.

The short answer is no.

The share repurchase itself was really simply an attempt to get back down to average share count.

And if you look at it, we actually were still a little bit high compared to where we were last year, So, we'll do a little bit of, on a year-to-date basis, we'll do a little bit more buying just to get back to flat.

Actually, Marty can talk a little bit more about the M&A pipeline but it's pretty robust.

Still pretty active.

Not always finding exactly what we want but I don't think it's ever been probably more active from a pipeline standpoint.

It's just whether you get to the final deal or not based on the value and what we find in diligence.

But have been very active on that front and it hasn't slowed down at all.

Okay.

Thanks again, guys.

Thank you.

The next question is from James Berkley with Barclays.

Hi, guys.

Thanks a lot for taking my questions here.

I just want to get a better handle on how to think about new revenue growth for 2017.

I know you touched on it a little bit on the payroll side just now, but through the first half of the year you're near the high end of your guided ranges on payroll and HRS growth.

But this quarter did see the low end of those ranges.

You've got Advance Partners lapping, one less day in fiscal third quarter.

There's questions around the Affordable Care Act and time and attendance given the delay with the Department of Labor.

How do we think about all those moving parts in the back half of the year, in particular?

And what are you thinking about the ACA and time and attendance, that aspect post-Trump versus previously?

Okay, wow, that's a compound question.

Let me just say broadly, and then I'll come back to ACA and other regulatory changes, Marty obviously will have some thoughts on that, but our guidance contemplates all of those issues, obviously.

We just answered a question on payroll services revenue growth.

HRS has remained unchanged.

So, from that standpoint, we feel comfortable with where we are for the remainder of the year and for the full year.

We don't focus necessarily on quarters unless there's something unusual in the quarter we want to call out, like Q3 which has one less day.

I feel comfortable about where we are in terms of margins and expenses.

So, that outlook that we're providing basically encompasses what we understand the environment to be.

Don't anticipate it will change significantly.

Now, with respect to ACA, and with respect to other changes in regulation, it's a little bit early to call those.

The overtime rules change, at this point don't see a lot of impact on the balance of the year.

It could impact next year.

And then on what exactly happens with ACA, that's a question to be answered at this point.

What I would say is if we were to see some significant movement to repeal starting some time in late Spring, our anticipation of, if that were to roll out over a, let's say, call it a two- to three-year period, is that we would see about an impact of 1% on EPS per year.

If it was more accelerated it might be more.

We're still waiting.

That, by the way, is more of a worse case scenario, 1% to 1.5% EPS.

We think we have other options to replace that revenue but at this point we would frame the risk if the ACA got repealed in an orderly fashion.

If it got replaced and repealed immediately, that would be a different conversation.

We'll have to wait and see where we end up.

Yes, I think that the expectation, at least at this point, would be it's going to take some time.

It's pretty complicated, as you know, to change it.

And we're seeing very solid retention.

Of course, clients are looking for us to file in March now for them and I don't think you're going to see much movement at least through that filing period.

And I think that it's going to be a longer thing, which, as Efrain mentioned, we're looking at, depending on what happens, a number of products.

My guess is clients are still going to have to do something and they are going to need some support for that.

So, we feel pretty good that we'll be able to adapt to that.

It might not make up all of the revenue but it certainly has some opportunity there.

From a time and attendance, it's been interesting that we've had very strong sales of our time and attendance solutions.

And we've introduced a new one that is Flex Essentials that is a no clock, all web or mobile punch, much simpler to set up.

And we've seen an acceleration there.

So, I think the whole overtime rule issue, even though it's now been delayed and may end up never being enacted, who knows, has driven a lot of interest in time and attendance.

So, that's driven sales that I don't think somebody is going to necessarily get rid of that product and, in fact, it may keep a heightened demand now.

I think that's how we feel about it.

It's pretty good at this point and see what happens next.

That makes a lot of sense.

And thanks for the color on the ACA there.

Those numbers are really helpful.

Just one more quick follow-up here, more of a high-level question.

Just correct me if I'm wrong, I believe about 10% of your Company's revenues are driven by the PEO business, another 10% from the ASO side.

I think you got PEO growing more quickly over the last few years.

Just curious if you could talk about how fast each is growing, the trends that you've seen, whether there's been an acceleration recently versus past quarters or past years.

Just going into more detail on each of those.

And what's driving the gap between the two growth rates?

What we've said about the HR outsourcing business is that it's about half of HRS revenue.

And within that half, about half is PEO and half is ASO.

That's what we said.

We update that yearly.

PEO has been growing more quickly than ASO, but both have been growing double digits.

That's what we would say.

The only other thing I would add to that is that, because the PEO, we report healthcare attachment as part of the revenues of the PEO, when we get better healthcare attachment in the quarter then you have better PEO growth.

That really doesn't have much of an impact on margins in this quarter.

We did not have as significant healthcare attachments as we had in the quarter before but that bounces around every single quarter.

So, Q3 we'll see where we end up.

I think we feel pretty good, obviously, reaching the milestone of over 1 million work site employees that we're servicing between the ASO and PEO.

We feel good we're very well-positioned.

There's a lot of demand for the HR support.

And I think PEO, while it's been strong in certain states and we sell it across pretty much all states, it is continuing to pick up more demand, and we feel good about the future of it.

As Efrain said, the attachment of the health can swing from quarter to quarter or event month to month.

And, again, I think it's going to be interesting to see what comes out.

You had a quarter where a lot of discussion about healthcare, and you may have a number of clients deciding to hold, wait and see what's going to happen.

But we see good growth.

We've been doing well in both PEO and ASO, well-positioned to have both products.

So, if you want co-employment, you have it.

If you don't, we have the insurance agency, that's a top agency, and plenty of plans to offer.

So, feel good about both products right now.

Thanks a lot for your color and time, and Happy Holidays.

Thank you.

The next question is from David Togut with Evercore ISI.

Good morning.

This is Rayna Kumar for David Togut.

In the first quarter you really highlighted the strength in the mid-market and that seems to have slowed down a bit in the second quarter.

What's changed there?

And maybe if you can just highlight your expectations for the remainder of the year in the mid-market.

Yes, I think in the second quarter we had a very strong quarter a year ago and compares were tougher.

We're expecting a good quarter in the third quarter.

And I think Marty pointed out something that's important.

Last year, there was a drive by many mid-market companies to find integrated solutions that included an ACA compliance solution.

A lot of those clients have now selected their solution and the game now is a bit more of competitive take away as opposed to selling them on a new solution.

There obviously was some of that going on.

So, we go into third quarter, then, assuming that we'll pick up from where we were in Q2.

Certainly feel great about the product and ever-expanding functionality of the product.

And I think, as Efrain said, last year was a heightened second quarter with the Affordable Care Act sales and this year it's almost a little bit of the reverse.

I think people are being a little careful to make any changes until they see what the rules come out, how it changes.

And they probably are concerned about their filing and making a change and not getting everything filed.

We saw a little bit probably unexpected slower there.

We expect, though, once we get past the filing date, expect a good selling season here.

But it may still continue to be a little bit slow through the third quarter until we get past the filing date.

We'll have to see how that shakes out.

But we feel certainly good about the product, the competitiveness, and going head-to-head with any of the competitors in the market.

Besides client behavior are you seeing any change in the competitive landscape at all?

No, not really.

No, there's real no new competitors there.

We haven't seen a lot of change in their approach or product.

And I think, as I mentioned, we've continued to add new options to our product, more self service, more analytics, we talked about HR analytics and providing more there, mobile-first design, an increased use of mobile.

So, we're feeling very good, very competitive.

Have not really seen any change from a competitive marketplace.

Thank you.

That's very helpful.

Happy Holidays.

Thank you.

The next question is from Jim Schneider with Goldman Sachs.

Good morning.

Thanks for taking my question.

As many as I'm sure you saw, the NFIB put out small business confidence indicators for the month of November, which were substantially stronger after the election than before.

It sounds like from your overall qualitative client commentary that people are still cautious pending any changes in the regulation.

Can you give us any additional color on what you've been hearing from clients over the last month or month and a half in terms of their optimism on overall business levels, and how that matches with your commentary on the rest of the business?

Yes, I think it's exactly, it's optimism pending action.

So, I think it's a lot of optimism on lower corporate tax rates could drive a lot of less expense and more to what they could invest and more employees and so forth.

Affordable Care Act looks like those costs could come down for a lot of companies and not forcing them to have the product, but we'll see.

Time and attendance rules, although it's a little bit separate, but less regulation.

I think overall it's a very optimistic attitude from the clients but not necessarily turning that into action yet because they got to see it.

So, they are feeling good about the fact that it looks like there's going to be a better business environment.

Consumer confidence is also up.

NFIB was one of the biggest increases we've seen in over the 42-year average, one of the three times, I think, in the last almost 10 years.

So, there's a lot of optimism but I don't think, again, they are turning that into action, hiring and so forth, at least yet until they see what the first few months of the new administration brings.

That's what we're -- we are getting great optimism.

But the small business index, at least for November, our last one, would show still not a big uptick in hiring, at the same growth rate it was last year for at least small business.

So, very positive but waiting to see what happens.

That's helpful.

And then maybe as a follow-up, I think last quarter you cited the traction you're seeing in the 100 to 200-plus segment and the new incremental sales spend you've been putting against that.

Can you talk about, first of all, whether there is any change in that traction, whether you're seeing continued momentum there, and whether you think the incremental sales spend you put against that is actually adequate at this point such that you don't have to increase it more in the coming quarters?

I think we're adequate.

We're fully staffed and feel very good about being fully staffed and out there.

I think the only surprise in the quarter, we've already mentioned, which is a little bit more inactivity to make a change than we saw last year at this time.

I think that would be the only difference.

And I think that's more of a macro issue.

I think that would be the only change.

Certainly feel good about, as I mentioned, the competitiveness, no change, really, in the competitive environment.

And we're fully staffed and gaining more and more experience on the newer reps that we added at the beginning of the fiscal year.

We'll be able to talk more about it after the selling season.

The only real difference from first quarter, I would say, is, with the election, which really changed quite rapidly, at least the view of the election and who won, I think that just put people in a little bit more cautious period for switching anything or making buying decisions in the second quarter.

That's fair.

And just a quick clarification, if I could, in the quarter itself relative to the plan you had heading into the quarter, would you say that the DOL lack of bookings or the ACA shortfall was the bigger contributor there?

I think the ACA, I think just the election, if I'm getting your question right, Jim, I think what happened was, with the changes in ACA, with Trump getting in and probably a little bit more unexpected until second quarter as it got closer to the election, I think people know changes are going to happen, so they're a little bit more reluctant to make a change until they see what happens.

They are optimistic but they're not sure what's going to happen yet.

So, if that answers your question.

Now, if you're talking about the overtime rules, I think that was very helpful from a selling of our Flex Time and Flex Essentials and our time clocks.

And I think that's sticking.

The good thing there is it brought a lot of attention to you ought to be tracking time, look at the options that are out there now from a technology standpoint, punching in and out on a mobile phone, things that have not been available generally until the last year or so.

And I think that's going to stick.

That actually helped drive some sales that are recorded in our HRS services revenue.

And I think that's going to continue and it's going to stick no matter what happens with overtime rules.

Great, thank you.

Thank you.

The next question is from Mr. Gary Bisbee with RBC Capital Markets.

Hi, guys.

Good morning.

There's quite a bit of debate about how much you'll actually benefit in the short term from a float, so I wanted to ask a two-part question just to help frame that.

The first one, as you think about the float, how you manage the float, is it still right, I know there's some seasonality, but to think that roughly half of the float balance is short-term stuff, whether it's money markets, the variable demand rate notes, et cetera, and you target about half in intermediate term bonds.

And the second question, if we look at that bond portfolio, I think you said 3.3-year duration.

The stuff that's maturing in the next 12 months, are the interest rates that you would likely reinvest that in today above the rates that's maturing or is that still a negative at this point?

Thank you.

Good questions.

Yes, you're right.

Short term is about 45%.

It can be sometimes 50%, but we keep it between 45% and 50%.

So, that reprices immediately, or very quickly, I should say.

Let me just be careful; that's an overstatement.

It doesn't reprice immediately.

It typically reprices somewhere between 45 to 60 days.

So, the answer to the first question, portfolio composition, is yes.

That's correct.

And then the second is yes, also.

Yes, the bonds that we would invest in going forward currently have yields that are significantly higher than the ones that are rolling off.

So, if I were to call it today, and I am not doing that, but if I were to call it today, and I assume no more Fed increases other than what we have gotten to this point, the portfolio would be about $8 million higher in value than it is today.

I'd just caution anyone from taking that to the bank because we'll have much more granular information once we get through the next couple quarters and see what the Fed actually does.

And the reason why I say that is, we look at and we could give you a big forecast based on yield curves.

I distrust that approach.

I'd rather tell you what we think our portfolios will do based on what I know at the time I'm saying it.

But you can do some math and the numbers start to get pretty significant, if the Fed does what it says it's going to do.

And the final qualification I'd add to that is, the steepness of the yield curve also impacts how we invest.

Right now, they do nothing, I'd call it at about $8 million next year, that's annualized.

And we'll see where we go through the remainder of the year.

And just to clarify that, that's very helpful, by the way, the $8 million, that is annualizing and getting the full benefit from the Fed funds rate increase recently and also the benefit from reinvesting bonds at what the current yield curve is.

Is that correct?

Yes, correct.

And then just one other question, and maybe this is just getting too nitpicky on my end, but the buyback was pretty significant.

No increase in the guidance for earnings.

It feels like there's a couple of pennies there.

Is that just conservatism or is there some other thing we should think about with that?

Thank you.

I guess I'd say this, Gary.

There's always pluses and minuses, so you have to look at what you think are some potential upsides with some potential downsides.

I think it's realistic.

I wouldn't call it aggressive and I wouldn't call it conservative.

Okay.

And then just actually one other one, have you done the analysis and maybe it's just we don't know enough, about what risk you might face in terms of potential declines in the float portfolio balances based on some of the personal income tax changes that Trump and a Republican Congress have been floating?

Should we think of that as a potential offset to some of this, is the withholding might be less for a significant portion of your customers?

Thank you.

No, we haven't started doing modeling at this point because, at that point, the benefit, that's coupled with a bigger discussion about whether corporate tax rates go down.

If that happens then even if we face some drag from personal income taxes, the corporate tax impact simply dwarfs everything else.

So, we would look at both.

If tax reform occurs, it's pretty obvious that we would be a pretty significant beneficiary.

By significant I mean very significant.

So, we're waiting to hear like everyone else is waiting to hear.

That's a partial answer to your question.

Yes, great.

That's helpful.

Thank you.

Merry Christmas.

Happy Holidays.

Thank you.

The next question is from Mr. Bryan Keane with Deutsche Bank.

Hi, guys.

I just wanted a couple clarifications on HR Services.

I think the Street was looking for more like 14% revenue growth.

I know the guide is 12% to 14% and it came in a little bit towards the lower end.

I just want to make sure the puts and takes there, because what I'm thinking about, obviously, is Advance Partners acquisition is anniversarying and that contributed two points to growth.

So, then I'm thinking about the back half of the year.

With that coming off, do we have enough in the pipe and in sales to actually increase that growth rate for the back half?

Bryan, our guidance obviously included Advance.

We came out of the first quarter, I think we were at 15% growth.

I think I called out attach rates on healthcare in the PEO were a little bit lower than we had projected.

That can reverse very quickly quarter to quarter, so we'll see where we are in Q3.

But in terms of where we expect the year to be we're not really far off from what we expected.

I see where people might get to 14%.

I don't think our internal plans suggest we'd be at 14%.

We should be solidly, in the year, in the range of the guidance that we provided.

And, obviously, as you pointed out, the selling season will have an impact on where HRS growth ends up for the year.

But we feel comfortable with the ranges we've given.

Okay.

And then in the back half, since Advance will be now in the numbers, it won't probably push that growth rate, should we think about more towards the lower end then in that range of 12% to 14% for the back half as a result of Advance anniversarying?

I would say yes, subject to whatever we see in terms of sales in the third quarter, which is where the bulk of the selling season comes in.

I would say that although I didn't call out where we end up in Q4, our guidance is for the year as a whole and we feel comfortable for a year as a whole.

That may mean that some quarters aren't exactly in the range of that guidance.

If it's significant we'll call it out.

Okay, helpful.

And then just on time and attendance, how big is that and how fast has that been growing?

I know it's been one of the catalysts that you guys have called out.

Just how big is that as a percentage of revenue and maybe the growth rates you guys have been seeing there?

Last time we updated it, it was about, last year, 10%.

I should say online services, which includes HR Administration, which is also part of the equation.

Back up a second, so it's clear.

The fundamental parts of the HCM platform include an HR Administration module, a time and attendance module, and obviously a payroll engine module.

So, about 10% of HRS revenue is online services.

We don't break it out more than that.

That's been growing at multiples with what payroll has been growing at.

Okay, thanks so much, and Happy Holidays, guys.

Thank you.

Our next question is from Mr. Kartik Mehta with Northcoast Research.

Good morning, Marty, good morning Efrain.

Efrain, I just want to make sure I understood something you said about the float portfolio.

I think you said, obviously if the Fed did nothing it would be about $8 million.

I seem to remember, I thought in the Q you said 25 basis points would mean after-tax net income of $3.5 million to $4 million.

So, that $8 million, is there some tax impact to that that would be different, or am I missing something that you might have said, or misinterpreting?

No, you are just missing some information, which I didn't provide in my estimate.

Our disclosure is that a 25 basis point rise impacts the portfolio immediately on an annualized basis to the tune of about $3.5 million, $3.7 million, I believe it is.

But that doesn't end the conversation because then the question you have to ask yourself is what does it do to long-term rates?

If in the end your reinvestment for long-term rates stays the same, it's done nothing.

You've gotten a benefit on the short-term portion of the portfolio but very little else.

The benefit we're getting right now, and the reason why I caution about including any interest rate benefit in models yet, is that the securities that we invest in intermediate-term municipals have gone up pretty significantly since the election.

So, our reinvestment rate is higher than it is right now.

If all we got is a 25 basis point increase in the Fed funds rate, you could expect that we would get roughly what we say we would get.

But we're also getting a bit of a benefit on the long-term portion of the portfolio.

And what I don't know now and I'll have a better sense is, as the Fed keeps raising interest rates, what's happening to the shape of that yield curve as I go out over the maturities that we have to reinvest.

Right now, if everything held, I'd be, on an annualized basis, about $8 million higher.

What it will end up being I don't know until I get to the Spring and I can digest the other Fed rate increases.

Okay, that makes sense.

Efrain, will you invest a little bit differently considering the Fed might do a couple more rate increases?

Will the philosophy change at all or will you still continue to manage the portfolio like you have?

That is a discussion that we're going to have as we get into the Spring because if the shape of the yield curve is steeper on the long end then maybe I have less short-term cash and I have more long.

I haven't made that decision and we haven't had that discussion yet.

We've had some preliminary conversations about how we would do that.

But obviously that's one way to get higher yield even than what I'm talking about on the portfolio.

Those are decisions we need to look at when we get into the Spring.

Obviously competitors leverage 100%.

We've chosen not to do that.

But between where we are and where other people in the market are, there's room to move if we chose to do so.

And, Marty, as you're going into the selling season, how many payroll salespeople do you have compared to last year?

Is it the same, less or more than you had last year at this time?

Yes, up 2% or 3% from a head count perspective, and fully staffed, and just getting those reps up to speed.

But we're up about 2% to 3%, which is fairly normal for us, and it's across both small and mid market.

And where do you stand in terms of salespeople attrition today compared to what it has been in the past?

Very consistent.

Some are better than others.

Actually the mid-market, I think, tends to be a little bit better than it has been historically even, and core payroll tends to be very consistent with where it's been.

No big uptick in turnover or anything.

And just one last question, Marty, you've moved over to Flex.

Obviously the transition seems to be going well.

Have you seen an impact on cross-sales because of customers moving to Flex, either more or less in terms of product sales?

Obviously from the Flex standpoint, you've got a better integration there.

And we've built everything to integrate into that and then continue to roll things out with Flex.

So, we're certainly seeing better pick up from a penetration.

I wouldn't say it's huge but it certainly is a bigger pick up in penetration when you're selling the Flex platform because everything is built around that.

And we still have a lot of room to grow there.

So, when you think of the HR analytics that we just rolled out at HR Tech and some of the other products, like just rolling out flex Essentials, which is that lower end time and attendance solution without clocks, all of that is around Flex.

So, we expect to have better penetration growth because of the Flex platform the more we roll it out to clients.

Perfect.

Thank you very much, Efrain and Marty.

Happy Holidays.

Thank you.

The next question is from Mr. Tim McHugh with William Blair.

Thanks.

Hi, guys.

Just want to ask, digging back on to the comment about seeing a trend towards a smaller average client size.

You've talked a little bit about various parts of this but just to be clear, are you seeing slower growth in the middle market and that's why the average is skewing down, or faster growth in small?

If you can peel back for us why the average is trending smaller than it was in the past.

I'd say this, Tim, that right now the relative growth between small is tilting a little bit more towards small versus mid.

And last year, it was trending a little bit more mid than small.

So, I think that's what it is.

Look, I could also talk about losses and sales but when you net it all out, that's basically what you're seeing.

And, by the way, I just want to make it clear, our average client size has been 17 for the last 10 years.

It's not a dramatic difference.

But a tenth here or 15 basis points there does make a difference.

Not a huge change, but, as Efrain said, it makes a difference.

But I think the point we made earlier, both Efrain and I, last quarter, Tim, what we saw was there was more movement in the mid-market because of Affordable Care Act and the need.

That got people to change and sell more.

This one has been, compared to last quarter, that need has been satisfied by those who have it.

And while we're holding, certainly, the clients we have with Affordable Care Act products, we're not seeing the interest in saying, okay, I want to change because I have to have something in place.

We saw a little bit of a shift second quarter over second quarter.

And, again, it's not a huge number but it did drop the average size a little bit.

Okay.

So, it's fair, it seems like middle market, because that comp issue, probably isn't growing as fast.

Is small necessarily growing faster or is it just growing at the same rate and you're not seeing quite as much growth in mid-market and so that brings the average down?

Small is growing faster.

Faster than it was before?

It's growing faster.

Okay.

When you say faster, sorry, faster than middle market or are you saying faster than in the past?

It's growing faster than middle market.

I'd say it's probably comparable to where we were a year or so ago.

Okay.

That's helpful.

Can you remind us of the split between middle market and small in that payroll part of it?

We don't give the actual payroll dollars associated with it.

It's complicated.

And the reason we don't do that is a lot of ancillaries are primarily mid-market clients.

Our client base in the mid-market is about a little bit over 6% of our total clients.

And you can assume that, from a revenue standpoint, that's three to four times what our client base is, if that helps.

Okay, thank you.

Thank you.

Our next question is from Mr. Jeff Silber with BMO Capital Markets.

Thanks so much.

I know it's late.

I just have a quick one.

Efrain, you mentioned that if corporate tax rates go down, you think you'd be, I think you used the word, a significant beneficiary.

Can you just remind us right now roughly what your federal tax rate is?

Yes, our federal tax rate is about 33%.

And we obviously pay pretty close to the statutory rate.

It depends on whose estimate you're looking at.

If you're down in the 20% corporate tax rate, we are a significant beneficiary / But even a 5 to 10 point decrease would create significant benefits for us.

All right, great.

That's very helpful.

Thanks so much.

Thank you.

Our next question is from Mr. Glenn Greene with Oppenheimer.

Thank you.

Good morning.

Just a few clarifications on previous commentary, maybe Marty.

Going back to the sales activity, honing in on your comment of a little bit more inactivity or less slower buying decisions and switching, is that how you're contemplating the upcoming obviously key selling season?

Meaning, the factor is, the new administration, we're not going to know what the new rules are, and whatever they may do is not going to be known really until the end of the selling season.

So, are you preparing for a difficult sales season?

I wouldn't say it's difficult.

I'd just say, this was compared, really, to last year, we saw more activity.

We're expecting a pretty good selling season.

But it was certainly a little bit slower in Q2 than it was last year.

Even though things aren't known, last year we had a lot of sales, we had more mid-market sales in the second quarter because they had to make some change to get the Affordable Care Act product.

By this point, most of those had bought it by November, when you think about last year, because they had to get in.

And, actually, many of us stopped selling it after November because we had to get them taken care of for the calendar year.

So, I wouldn't say we're expecting a difficult sales season but there may be a little bit more inactivity than we saw last year.

But I would expect most of that was in Q2 last year.

Okay.

And, Efrain, on the buyback, I think it's pretty clear but the uptick in the buyback, the 2.9 million shares, this quarter, we shouldn't be thinking any change in your buyback mentality.

This was more just to get the share count closer to where it was a year ago, is what I was hearing.

That's right, Glenn.

That's where we are at.

And then, just to clarify, on the ACA, obviously a risk, and you identified what the risk could be.

But what's the order of magnitude, what percentage of revenue ACA is right now?

I think I was asked this last year.

I'm going to call it direct ACA revenue is in a little bit above 1%, between 1% and 1.5% of revenue.

Okay, great.

Thanks a lot.

Thank you.

Our next question is from Mr. Rick Eskelsen with Wells Fargo.

Good morning.

Thank you for taking my question.

Just a quick one, a clarifier from the release and your comments.

I noticed you didn't mention anything about the operating income excluding float.

Have you changed how you're thinking about operating margin and operating income here?

Not really.

I think you can basically do much of the math yourselves.

And because float is no longer a drag, it's probably more useful to just look at it in totality.

Thanks.

And then just the next one, Marty, you did mention about regulatory changes, how you do see it as a benefit for the business overall.

If you could just talk about the components of your business and where you saw the most, from a client perspective, where they did more on the regulatory-driven work.

Did it drive more people to do PEO, or ASO?

Did it drive more bundles?

Was there any split within the business on the regulatory pressure and what it drove clients to do?

Thank you.

Yes, sure.

I think, first, I think I'd say the overtime rules that have now, of course, been postponed, at least temporarily, that drove certainly a lot more interest from clients in time and attendance solutions.

So, that's been helpful to get in front of clients and offer them.

Great timing for us in the product suite that we have.

So, that drove a lot of interest and, frankly, still is.

I think it geared up a lot of interest.

Whether the overtime rules go into effect or not, I think it's going to be a plus for us.

When you start talking about overtime rules that also drags in HR.

So, whether it was ASO or PEO, that brought a lot of interest in HR support.

Companies that would have said, I'm going to continue to try to deal with the HR myself internally, now said, gees, I think with all these overtime rules, who's exempt, who isn't.

A lot more discussion about moving people to exempt or not based on the overtime rules brought in some HR sales, as well, both in the ASO and PEO platform.

And then I think a little bit, probably, of a drag might have been the fact that, okay, now the Affordable Care Act, as we've said, is up in the air as to what's going to happen, maybe I don't rush to buy as much from an insurance or a PEO side, do I need it or not.

So, I think those were the major changes.

I think right now what we expect is less regulation based on the platforms of the Trump Administration.

But I think there's still going to be enough change that those things will still help us.

And, in fact, just the level of change makes people worry about can they keep up with everything.

If the tax rates change, if the rules change on maybe when to file, if overtime is in or out, that all drives people to say, okay, I can't keep up with that, I'm going to turn it over to an outsourcer like Paychex who has over 200 people who just track compliance and realize what has to happen, and so forth.

I think those have been the pluses and minuses.

Thank you very much.

Thank you.

Our next question is from Mr. David Ridley-Lane with Bank of America Merrill Lynch.

Good morning.

In the discussion around average client size I didn't hear you mention SurePayroll.

Is that a piece that is also having a potential drag on the average client size?

SurePayroll is part of the equation.

It's been part of the equation for the last five years.

They continue to do well.

That's part of the mix of what we sell.

We sell through SurePayroll, we sell, obviously, through our Paychex outsource service, and we also sell mid-market.

So, that's part of the mix.

Understood.

And then it sounds like you're fully staffed up on sales headcount.

I would assume you're pretty set on operations.

Should we be expecting a bit stronger margin expansion in the second half of this fiscal year?

No.

The first part of the statement, David, is correct.

We are fully staffed.

Operations expenses year over year were up pretty significantly in the quarter.

We called out some reasons for that.

That compare gets a little bit easier as we go through the remainder of the year.

But, remember, that expenses in Q3 and in Q4, but Q3 particularly, increase because of the volume of operations activity that we have, and also the volume of sales activity that we have.

So, no, in the back half of the year, you see our financials, the margin actually goes down, and that's typical of our path.

I was thinking more of margins on a year-over-year basis.

Oh, on a year-over-year basis.

We feel comfortable with the guidance.

And, obviously, we're running actually a little bit ahead of it in the first half.

But comfortable where we are in terms of margins at this point.

Understood.

Thank you very much.

Thank you.

Our next question is from Mr. Mark Marcon with Robert W. Baird.

Happy Holidays, Efrain and Marty.

A couple of quick questions.

First of all, with regards to just the general environment that you're seeing in the small business arena, what are you seeing in terms of new business startups in terms of trickling up from the field, source of new clients?

And then what are you seeing in terms of bankruptcies and how that seems to be trending?

On new business startups, I think they've reached back to that level that they were pre-recession.

We've seen that now for probably a year.

And I think they've held.

Everything that we've seen would say they're not growing tremendously more than that but they are right in that place where they were.

Bankruptcies generally pretty consistent where they have been, maybe up a little, at least what we've seen.

What we see is from our losses to bankruptcies and out of business.

That's ticked up slightly but, again, our overall retention is very consistent with where it's been at pretty record high levels, pretty consistent in that range.

So, no big change there but a little bit of tick up in the bankruptcies.

Which is interesting, it doesn't seem like that should happen but we've seen a few more losses because of that.

Nothing that would change our overall number.

Okay.

And then with regards to, you've had great improvement with regards to the Flex as it relates to the smaller end of the market.

From a technology perspective can you lay out any additional improvements that we should expect out of the 50 to 1,000 range in terms of what you're offering there?

Okay, for the 50 to 1,000, I think you'll continue to see that level of integration and you'll see a big continued push on a few things.

One is the analytics piece that we just talked about at HR Tech, much more on the analytics both in the way we report the data and in the flexibility the client has.

The other will continue to be a mobile-first design.

We're seeing a good uptick in mobile usage, as I've mentioned before, not only the client but the employee standpoint.

We're spending a lot of time adjusting our language and our display much more now, pretty much 99%, over 99% of the display is HTML5.

It's a much cleaner and easier use for the client, much more flexible for the client and the employees on mobile use.

But we've still got a long ways to go on mobile adoption, getting the client and their employees to download the app and use it.

It's growing fast but we've still got a long ways to go.

I think that's going to be a big part of assisting in the value of our products and services.

The full suite is there and we're constantly adding to it, like the new Flex Time Essentials.

And you'll see a lot more paperless.

Everything pretty much can be paperless today.

Even PEO onboarding now is all a paperless function.

I think you'll continue to see us add to the functionality.

And even in time and attendance, we're adding new modules all the time.

A budgeting module we just added where you'll be able to track your time to your budget, and so forth.

So, you're going to continue to see not only the products expand but the modules within each distinct product.

That's great.

Is there going to be a step function, Marty, in terms of, by the end of calendar 2017, we should see -- we did have some step functions on the smaller side that were some real benchmarks that we ended up hitting.

Do we see something similar to that coming up?

You mean benchmark from a penetration standpoint?

Right.

I think so, although it's much more gradual now.

A number of the clients are on Flex.

We certainly have internal goals as to where we want that penetration to be, including mobile adoption.

So, you'll see more marketing push mobile adoption, you'll see more direct, trying to get the employees of the clients, and more marketing from that standpoint.

We don't really disclose it but we certainly internally have our steps that we want to get to, our different goals by year, for penetration of those products.

And I think right now we're on track, I think even a little ahead, on time and attendance because of the overtime rules.

Great.

And then on the PEO, you basically mentioned that's growing a little bit faster than the ASO, and it sounded like the momentum will continue to be very good.

At the same time, we have a bit of a pause with regards to the regulatory uncertainty because of the administration change.

But it didn't sound like your commentary would suggest that you would expect any sort of slowdown on just the core PEO.

Did I interpret that correctly?

I think so, yes.

We've seen that pretty consistent growth from the PEO standpoint.

And I think we feel very good about the carrier plans we're offering now in the work with the carriers.

So, yes, I don't think that will necessarily slowdown.

We've just seen that inactivity, a little bit of a slowness in making a change in some clients who already have it.

And even with more certification and things that are going on in that industry, I think you could see a pick up there.

And there's no real change in competition.

We haven't seen any real change from any of the competitors from the PEO standpoint.

If you have good plans, great HR service and support, and good carrier plans, insurance plans, we should continue to see good double-digit growth there.

Great.

And then with regards to your salespeople and particularly some of your alumni who may have left, are you seeing some come back?

I guess some.

I wouldn't say any major thing.

We certainly have seen where people might jump to a competitor, we've seen a few of those come back.

I wouldn't say it's any large number.

Really, with the attrition, as I mentioned earlier, the turnover has been pretty consistent.

So, we haven't seen any uptick in turnover.

There hasn't been any major exodus for anybody to come back.

So, yes, some come back, but not too many.

Okay, great.

Thanks a lot.

Happy Holidays.

Can I ask one more, sorry, I forgot.

Just on the tax filing float, what percentage of the tax filing float is actually due to the tax withholdings for federal and state income taxes relative to things like SUTA and things of that nature?

Mark, that's a good question.

It's primarily federal and state.

SUTA does have an impact but the bigger impact is federal and state.

Okay, great.

Thank you very much.

Thank you.

Our last question is from Mr. Ashwin Shirvaikar with Citi.

Thank you.

Martin, Efrain, Happy Holidays, from me, as well.

Considering I'm standing between you guys and the holiday party, let me hurry up with my questions.

M&A pipeline, you mentioned a healthy M&A pipeline.

Is it possible to potentially qualify that?

Is it going to be more what I'd consider distribution, things like Advance Partners, staffing outsourcing or more product?

I'd say a little bit of both, but probably less product these days and more expansion of what we have.

So, certainly payroll, PEO, other offshoots of what we like.

The Advance Partners, obviously that's been a very good acquisition for us, good team there.

And there's some opportunities there, as well, in that industry.

So, I'd say across the board.

Probably a little bit less product.

But there's some product things we still want to do but we've pretty much filled the majority of those tuck-in type opportunities.

Mostly what we are looking for now -- and different geographies, obviously, as well.

We're always looking particularly in Western Europe for opportunities, as well.

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

Got it.

And if taxes go down, as they are expected to, would you expect to look for investment alternatives other than I know you do a lot of treasury and muni, so the muni part -- .

Yes, you're right, Ashwin, good point.

Yes.

You open the universe up to other class of assets that we wouldn't think about as much today.

Any initial thoughts on how you are thinking about that?

Obviously, you look at taxables a lot more than we do today.

We have begun to have some of those conversations, without getting too presumption about what's going to happen with respect to taxes.

Okay, got it.

And funds held for clients have typically grown in the mid-20%-ish type of range sequentially into the third quarter, with bonuses and so on.

Would you expect that to be fairly consistent this year?

Yes, I think the pattern should be fairly consistent with what we have seen in prior years.

Great.

Last quick question, the DOL rule timing, what was the specific assumption you're already making in the outlook for this, or was it not in the outlook so it doesn't matter?

Yes, there's no real specific assumption there.

While it's been significant sales in time and attendance it isn't enough to move the needle that much, or it doesn't change our guidance or anything.

If that never went into effect we wouldn't change guidance or adjust guidance or anything.

Understood.

That's all for me.

Happy Holidays.

And we don't have any more questions on queue, sir.

You may proceed.

Okay, great, thank you.

At this point we will close the call.

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

We wish you all a very Happy Holiday season.

Thank you.

That concludes today's call.

Thank you all for your participation.

You may now disconnect.