Paychex, Inc. (PAYX) Q1 2012 Earnings Report, Transcript and Summary

Martin Mucci - Chief Executive Officer, President, Director and Member of Executive Committee Efrain Rivera - Chief Financial officer, Senior Vice President and Treasurer John M. Morphy - Vice President of Finance and Member of Executive Committee

Rod Bourgeois - Sanford C. Bernstein & Co., Inc., Research Division Joseph D. Foresi - Janney Montgomery Scott LLC, Research Division Glenn Greene - Oppenheimer & Co. Inc., Research Division Nicole Conway - Stifel, Nicolaus & Co., Inc., Research Division Mark S. Marcon - Robert W. Baird & Co. Incorporated, Research Division Matthew O'Neill - Credit Agricole Securities (USA) Inc., Research Division Timothy McHugh - William Blair & Company L.L.C., Research Division Jason Kupferberg - Jefferies & Company, Inc., Research Division Tien-Tsin T Huang - JP Morgan Chase & Co, Research Division James Macdonald - First Analysis Securities Corporation, Research Division Roman Leal - Goldman Sachs Group Inc., Research Division Gary E. Bisbee - Barclays Capital, Research Division Timothy W. Willi - Wells Fargo Securities, LLC, Research Division David Togut - Evercore Partners Inc., Research Division

Welcome and thank you for joining Paychex First Quarter Results Conference Call. [Operator Instructions] Today's conference is being recorded. If you have any objections, you may disconnect at this time. And I'd like to turn the meeting over to Mr. Martin Mucci, President and CEO of Paychex. Sir, you may begin.

Thank you and thank you all for joining us for our first quarter fiscal 2012 earnings release. Joining me today is Efrain Rivera, our Chief Financial Officer; and John Morphy. Efrain will review our first quarter financial results and guidance after my opening comments, and then we'll open it up for any questions. We are executing our plans to continue to be the leading provider of payroll, human resource and benefit outsourcing to America's businesses. Our focus is on driving growth in terms of clients, revenue and profits, while continuing to provide outstanding service to our clients and their employees. We are pleased with our operational and financial performance during the first quarter. Checks per client have improved 6 consecutive quarters, with first quarter growth at 2%. Payroll client retention has demonstrated continued improvement in the first quarter. Payroll ancillary product penetration also increased for the first quarter over the same quarter a year ago. And although the selling environment remains challenging in light of weak new business formation, all of the initiatives we completed the past fiscal year that we have talked about in previous calls are in place including the updated compensation plan for our representatives, our revised training programs and next generation sales force tablets with improved lead generation and tracking tools. I believe we have everything in place to continue to support our sales teams' ongoing success. In the first quarter, we have experienced an improvement in payroll sales representative turnover, a statistics that had increased in the same period just a year ago. I would also like to take a moment to talk about the recent hiring of our new sales leader. As you are aware, Mark Bottini, formerly at Ricoh, will be joining Paychex in mid-October as the Senior Vice President of Sales. I'm excited to have Mark on board and look forward to working with him. Mark brings extensive experience with a 24-year career in sales at Ricoh and IKON, and strong leadership where -- having managed over 3,500 sales reps at IKON and Ricoh and is responsible for all U.S. sales for the company. He was able to join me at our recent year-end sales recognition event last week and his presence was received positively there and he was able to have focused sessions with many of the Paychex top sales performers. We are also pleased with the efforts of our employees on many fronts. Client satisfaction results continue to be at exceptionally strong levels. We find this a particularly telling metric in light of the increasingly complex payroll and human resource services rules and regulations our clients are required to adhere to. While continuing our product development investment in Paychex next-generation applications, we were able to achieve strong operating margins in the first quarter through continued productivity in our operation team. While our results for the first quarter were encouraging, we have not changed our expectations on full year guidance from that provided in June. Our expectations are that increases in checks per client will moderate through fiscal 2012 as quarterly comparisons become more challenging. We expect the favorability in expenses and leveraging to moderate as we continue our planned investments. Our 2 acquisitions in 2011 are creating excellent opportunities in both their markets, SurePayroll providing us our anticipated entry into the online market. Software as a Service product, an area positioned to grow as the 5 million small businesses who calculate their payroll manually move to the Web. We continue to penetrate the financial advisor marketplace with ePlan Services, further expanding our successful 401(k) service growth. Both SurePayroll and ePlan offer quality service and from a client control standpoint, we offer a full range of payroll outsourcing alternatives. Clients who want more control have SurePayroll, where our clients who want a high level of personal interaction with a dedicated payroll specialist have the Paychex model. I would now like to turn the call over to Efrain Rivera to review the financial results. Efrain?

Thanks, Marty. Yesterday afternoon after the market closed, we released our financial results for the quarter ended August 31, 2011 and we filed our Form 10-Q. It provides additional discussion and analysis of the results for the year. These are available by accessing the IR page at paychex.com. This teleconference will be -- is being broadcast over the Internet and will be archived and available on the website for approximately one month. I'd also like to take a moment to thank John Morphy for his presence here today and for his invaluable assistance in my transition to Paychex, and to introductions to the analyst community. As Marty said, we're pleased with the financial results for the first quarter of fiscal 2012. I'll discuss some of the key highlights here. Checks per client, as Marty indicated, increased 2% for the first quarter. This was consistent with the growth we saw for the fourth quarter fiscal 2011. Total service growth grew 9% in the first quarter but excluding SurePayroll and ePlan, our total service revenue growth would've been 7%. Operating income, net of certain items and as a percentage of service revenue, increased to 39.6% from 37.3% last year. This increase is driven by the management of personnel costs, expenses and timing of spending on certain investment projects. Typically, our first quarter reflects the highest operating income net of certain items as a percent of total revenue in a given year. Operating income, net of certain items as a percentage of service revenue over the remaining quarters is expected to moderate and to be more consistent with our full year guidance as we continue planned investments for the balance of the year. The interest rate environment remains at historically low levels. Fed funds have been at a range of 0 to 25 basis points since December 2008. Our combined portfolios have earned an average of 1.3% for the first quarter compared to 1.5% for the same period last year. In the first quarter, we shifted from variable rate demand notes to FDIC-insured deposit accounts as the earnings on these accounts are currently outperforming the yield on other high-quality short-term investment vehicles, particularly agency discount notes. Now I'll take you through some of the -- through our results presented in the consolidated income statement with some additional highlights for the first quarter. Payroll service revenue increased 6% for the first quarter to $382 million. Organic growth in payroll service revenue, excluding SurePayroll, was 4% for the quarter. We benefited from strong checks per client and improved revenue per check. Revenue per check increased as a result of price increases and improvements in discounting in our overall client base. Human Resource Services revenue increased 17% to $170 million for the first quarter. Excluding ePlan, HRS revenue growth for the first quarter would've been 14%, which is comparable to the 13% growth in HRS revenue in the fiscal 2011 first quarter if we exclude revenue in the prior year from our Stromberg operations divested in October 2009. Our first quarter HRS revenue growth reflects client growth and price increases. Some additional highlights of contributions to HRS revenue growth are: Paychex HR solutions client employees increased 12% to 587,000 employees as of the end of August 2011. We have seen positive results from increases in both clients and client employees. Our product offering, Paychex HR Essentials, contributed to this growth in clients and client employees. Insurance services has experienced continued growth as both workers comp insurance and health and benefit services advanced in the first quarter. Health and benefit services revenue continued its strong growth since inception, increasing 24% to $12 million, driven by an increase in the number of applicants. Human Resource Services revenue quarterly growth can fluctuate from the timing of set of fees, PEO, workers compensation and basis points earned on retirement services client employee funds. The greatest impact on basis points comes from fluctuations in the financial market, in addition to asset value of funds invested. PEO net service revenue also exhibits greater variability between quarters due to a number of factors, including changes in workers comp claims experience. Combined interest on funds held for clients and investment income decreased 7% for the quarter. Yields available on high-quality securities continue to remain low. Expenses increased 5% for the quarter, largely due to the inclusion of expenses from SurePayroll and ePlan. In addition, continued investment in product development and supporting technology contributed to the increase for first quarter. Operating income, net of certain items which excludes interest on funds held for clients, increased 16% to $219 million for the first quarter. As discussed previously, operating income net of certain items as a percentage of total service revenue was 39.6% for the first quarter compared to 37.3% for the same period last year. Now let me look at -- take you through our financial position. It remains strong, with cash and total corporate investments of $718 million as of August 31, 2011, up from $671 million at the end of last year. Our cash flows from operations were $187 million for the first quarter, a slight decrease as a result of changes in operating assets and liabilities due to timing, partially offset by higher net income. Funds held for clients as of August 31, 2011 were $3.1 billion compared to $3.6 billion as of May 31, 2011. But funds held for clients vary widely on a day-to-day basis and it's better to look at the average which was $3.3 billion for the quarter, a year-over-year increase of 10%. Higher average investment balances are primarily the result of the inclusion of SurePayroll client funds, wage inflations, increases in state unemployment insurance rates for the 2011 calendar year and an increase in checks per client, which we discussed previously. Total available-for-sale investments, including corporate investments and funds held for clients, reflected net unrealized gains of $70 million as of August 31, 2011 compared with net unrealized gains of $59 million as of the end of last fiscal year. The 3-year AAA municipal securities yield decreased to 41 basis points at the end of our first quarter from 80 basis points as of May 31, 2011. Our investment strategy is conservative. We have not recognized or realized any impairment losses for our investments. Our investments have high credit quality, with AAA and AA ratings and short-term securities with A-1/P-1 ratings. More than 95% of the portfolio is rated AA or better. We limit amounts that can be invested in any single insurer -- issuer. Our priority has been and will be -- continue to be to ensure that we can meet all of our cash commitments to clients that take place as we transfer cash balances from their accounts. Total stockholders equity was $1.5 billion as of the end of August, reflecting $112 million in dividends paid during the first quarter. Return on equity for the past 12 months was 35%. Now turning to fiscal 2012 guidance. The guidance that I'm about to speak to is based on current economic and interest-rate conditions continue with no significant changes. Consistent with our policy regarding guidance, our projections do not anticipate or speculate on future changes to interest rates. Although first quarter results were encouraging, we anticipate fiscal 2012 results will be consistent with the expectations we had when we issued our guidance in June of 2011. Our expectations are that checks per client will moderate through fiscal 2012, impacting quarterly comparisons above payroll revenue and HR Services revenue. We don't expect the expense leveraging realized in the first quarter to continue throughout fiscal 2012 as we continue with planned investments in technology. Reaffirmed guidances, payroll service revenue to increase in the range of 5% to 7% compared to fiscal 2011, HRS revenue growth to be in the range of 12% to 15%, total service revenue is expected to increase in the range of 7% to 9%. Interest on funds held for clients is expected to decrease in the range of 12% to 14% due to longer-term investments maturing and being reinvested at lower rates. Investment income net is projected to be in the range of flat to 2% growth. This is lower than what we normally experience due to the cash outlays in fiscal 2011 for business acquisitions. Net income is expected to increase in the range of 5% to 7%. Operating income, net of certain items as a percentage of revenue, is expected to be approximately 36%, and the effective tax rate for fiscal 2012 is expected to approximate the first quarter tax rate that was 35.6%, that's a tad higher than we discussed in June. Interest on funds held for clients investment income are expected to be impacted by the continuing low interest rate environments. The average rate of return on combined interest on funds held for clients corporate investment portfolios is expected to be 1.2% for fiscal 2012. As of August 31, 2011, the long-term investment portfolio, which excludes VRDNs, had an average yield to maturity of 2.5% and average duration of 2.6 years. In the next 12 months, approximately 1/5 of the portfolio will mature and it's currently anticipated that these proceeds will be reinvested at a lower average interest rate, approximately 1%. Under normal financial market conditions, the impact to earnings from a 25 basis point decline in short-term interest rates would be in the range of $3.5 million to $4 million after-tax for a 12-month period. Such a basis point change may or may not be tied to fed funds. It is not possible to quantify the after-tax effect of a 25 basis point change in the current interest rate environment. Purchases of property and equipment in fiscal 2012 are expected to be in the range of $90 million to $95 million. Fiscal 2012 depreciation expense is projected to be in the range of $75 million to $90 million and amortization of intangible assets for fiscal 2012 is expected to be in the range of $20 million to $25 million, up due to intangible assets acquired with SurePayroll and ePlan. Okay, before we go to the Q&A and I turn it over to Marty, I just wanted to make sure that everyone understood. You should be aware that certain written and oral statements made by management constitute forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements should be evaluated in light of certain risk factors which could cause actual results to differ materially from anticipated results. Please review our safe harbor statement in the press release for our discussion of forward-looking statements and the related risk factors.

Thank you, Efrain. Operator, we'll now open up the meeting -- conference call to any questions.

[Operator Instructions] Our first question is from Jason Kupferberg of Jefferies & Co. Jason Kupferberg - Jefferies & Company, Inc., Research Division: Just a couple of questions here to start off. I don't know if I missed this, but did you guys give any of the specific metrics around client losses, retention, new sales, growth in the overall client base? Because I know we usually pick some of those up in the 10-Q.

No. Normally, we pick it up -- we give it at the year end, but we don't give specific line growth numbers, except for pretty much the end of the year. Jason Kupferberg - Jefferies & Company, Inc., Research Division: What about on the retention side? I thought you usually do give those on a quarterly basis?

I think normally what we say, Jason, is kind of how -- kind of how we're doing overall and what we've seen on client retention is improved -- continued improvement. It's about 7 quarters in a row now that we've seen some improvement. It's moderate, but it's still showing improvement over certainly the quarter -- first quarter last year.

And Jason, there were selected quarters last year where we discussed particularly losses in retention, simply because of the environment. We thought it was important to give that disclosure so that people understood what was happening in the environment. We'll return to more normal practice as the environment seems to have stabilized and report typically at the end of the year. Jason Kupferberg - Jefferies & Company, Inc., Research Division: Okay, are you guys in a position to comment whether new sales were positive versus flat or negative or any directional sense just on a year-over-year basis? I know you can't give specific numbers, but anything directional you can share?

We typically -- we know what the information is, obviously, but here's the challenge. If you look back at previous years and you try to project off of what we were seeing on a quarterly basis without taking into account the fact that our big sales quarter is in the third quarter, you end up making erroneous assumptions. So we try not to go with quarterly updates because frankly, until we've gotten through the selling season, the numbers won't be meaningful. Jason Kupferberg - Jefferies & Company, Inc., Research Division: Okay. That's fair. And I know you recently hired a new head of sales, so congratulations on that. We'd love some color just in terms of the qualities you saw in this individual to make you believe he'll be a good fit, and should we expect any meaningful changes in sales strategy going forward? I know he hasn't officially started just yet, but just any color there would be helpful. And maybe as part of that, if you can give us any update on actual sales force turnover.

Sure. The -- and I'll start with the sales force turnover. I did mention in my comments that we saw an improvement in the number there. We kind of peaked up last year, started to go a little bit higher in the -- around the first quarter, we've come down substantially. We're actually a little bit lower than the normal. I think we've given that before that the kind of the norm is low 30s, 30%, 32% and we were lower than that in the first quarter. So we felt good about that. Although that could fluctuate quarter-to-quarter but just from comparison to last year first quarter, it certainly has come down and we feel good that all of the steps which took place last year, new comp plan, new sales tablets and tools, new training, all those things we got done in the last fiscal year to start the new fiscal year, we felt have been received very favorably. On Mark Bottini, thrilled to have Mark join Paychex. He comes to us with a 24-year career at Ricoh and IKON, before Ricoh took them over 3 years ago. He was at the same place for 24 years. Started as a sales rep, moved his way up with increasing responsibility over his career and has been, in the last few years, leading all of you U.S. sales for Ricoh, over 3,500 sales reps. So he had the experience of a very large sales force. He had the experience of dealing with small and mid-sized businesses clients, renewing and getting their business, new all the time, which was important to me as well. I also felt that he fit in very well with the culture here based on his background, and he's a person who is very focused on results, very quantitative in the way he approaches things. I don't see major changes right off the bat. What I like, Mark's approach already is he came to the sales conference which we had last week which honored the top -- some of the top performing sales reps. He was able to fly in kind of on a Sunday and back out on a Monday to visit there with the top performing sales reps. Came off very well and gave a general introduction to everyone at the general session we had there. So he's very involved, gets well into the details and is learning very, very quickly about Paychex even before he starts. So to me it was great experience, a large sales force. Certainly a lot of experience with small and medium-sized business clients and gaining new business all the time from them and certainly a good cultural fit, a person of very high integrity and someone who really gets into the details and focuses on the results. Jason Kupferberg - Jefferies & Company, Inc., Research Division: That's very helpful. And just last quick one for me. What are some of the specific investments that you're expecting to increase during the balance of fiscal '12? I know you said there's kind of some timing issues there and more of that will be over the last 3 quarters of the year.

Yes, we've continued to invest in what we call Paychex next generation applications, and you'll see some of these things roll out over. We have basically releases over the year and we've continued to invest in this actually for the last number of years. About 2 years ago, we finished our conversion of our entire payroll base over to what we call core advance or an advanced application that we built over the preceding number of years. And now the next generation, Paychex next generation is taking that and building on top of that and we have releases throughout the year around that, that our customers we'll see. We don't release all that information until we're ready to announce that it's coming out, but the first thing would be you'll see an expansion of our reports and the iPad technology. So tablet technology to be able to receive all the reports and so forth in the next few months. So we'll continue these investments. They've been continued investments, but they do fluctuate quarter-to-quarter.

Our next request is from Joseph Foresi, Janney Montgomery Scott.

My first question, I was just wondering maybe you could just talk a little bit about the market size. Is it safe to say that when new sales growth stunted, the market size is basically stagnant?

Well, let me -- Joe, part of the challenge that we have is that the authoritative data is only available on a 9-month lag. And so what we know is that at the end of 2009, the market had dipped to about 700,000 new business formations. This is the Bureau of Labor Statistics data. And then in August they released the 2010 data, which showed a bump up of 3% to 4%. So what we're seeing or what we can infer from that data simply is that there's very, very modest growth. That compares by the way, as many of you know, to traditionally 750,000 to 850,000 new business starts. So we're still below what would be normal business starts in the environment and just sort of gradually inching our way up. We will see with the release of the first quarter data where we're at.

Yes, I guess the point of my question was -- I was wondering, have you seen any changes in the behavior and the competitive environment given sort of the slow incremental increases that you just cited? Any changes on pricing? Any new competitors entering the market, any of your other competitors and yourselves as far as market share gains? Because I know you cited obviously the retention number a little bit.

Yes, not necessarily. We haven't seen much change in the competitive environment. It's been pretty much the same. There's really 2 major players out there, then there's some of the regionals. We've actually, I think, kind of seen a little bit more of a pick up from the regionals and some of our pricing bundles and so forth over the last year. And as far as the other national competitor, it's pretty much the same. We haven't seen a lot of changes and in fact, I think we talked about -- we introduced the price increase in the May time frame and have seen really a very little reaction to that. So we feel the pricing power has been good and the discounting is -- it seems to be well under control.

Okay. And then just a last question for me, maybe could you just talk a little bit about SurePayroll. How -- your judgment, how it's performing? What the integration has looked like and how that's gone? And maybe your expectations for that piece of your business going forward versus more the services side of stuff.

Yes, sure. SurePayroll has, I think, done very well. From a sales standpoint, they have been pretty much right on track with some of the numbers that we had expected. I think they're performing very well from a service perspective as well. And we somewhat left them with their name and their product out there but keeping them very close to as far as any integration that we can do behind the scenes and so forth, and we've made some of those steps already to integrate some of the backroom functions and so forth. But they're doing fine. They're right on track with our expectations and I see that business just continuing to grow double digits as they have been.

Our next request now from Julio Quinteros of Goldman Sachs.

This is actually Roman Lean in for Julio. First thing, can you go over maybe the items that drove the strong margins this quarter and I understand that the ongoing investments are going to be a partial offset in the remainder of the year, but why won't those patterns repeat themselves?

Yes. Well first, Julio, was as we've mentioned checks per client, that was an important factor in the year. While we counted on the price increase, it stuck, and we always expect a little bit of giveback. But that was a positive. The other part is that with respect to the IT spending and project spending, it ramps during the year. It ramped a bit slower in the first quarter. We still remain committed to spending on the projects so we got some favorability on -- in that end. And the other thing I would say is that Marty and I and John really made an emphasis at the beginning of the year, given the uncertainty in the economic environment to make sure, to ensure that spending remained at moderate levels and that we didn't open the floodgates until we had a better sense of how the year was going to perform. And I think that the culture here, the culture of the company is a very disciplined culture when it comes to costs, and I think that people took that advice and were careful. And we were able to get leverage in a number of areas, particularly on the operations side that helped drive favorable margins.

Got it. And then on your guidance, I know you can't speak to specific numbers but just in terms of your expectations for sales, can you tell us maybe directionally whether sales in the first quarter or perhaps in line with expectations above or below and we're kind of in October now, so how that's trended after the first quarter?

Yes, Julio. I would say this; that we won't get into a quarterly sales comparison frankly again because until you've gotten into the sales season, whatever we say about a specific quarter frankly won't mean much until we have those results. We'll update as we go through the year.

Our next request from Gary Bisbee of Barclays Capital.

I guess if I could just probe the cost side a little bit more. The 10-Q had a line in there that there were some costs that were delayed or deferred, is that, that IT and project spending you mentioned earlier, and are there any other areas that you'd expect cost or would you be able to quantify at all sort of how we should think about cost growth trending from here into next quarter and the one after?

Yes, I think the comment was really around the ramp of spending that we didn't delay or defer costs in that sense. What we assumed we would spend on that side we're going to spend for the year.

Okay. And now that you're, I guess, closing in on maybe it is to years since you launched the last upgrade to the core payroll processing platform, how much productivity benefit has the company achieved to date on that? I remember early on after the rollout, there was some commentary for a few quarters there about being very optimistic relative to initial plans. But I don't feel like we've gotten a real follow-up on sort of the magnitude of savings that have been achieved over the last year.

Well, yes, I don't know if we -- I think I specifically asked. I mean, I think if you look at it from a clients-per-payroll specialist, that's how we look at it. If you went before the upgrade to the new platform we were probably, a few years ago, back in the high 180s and are now closer to 220,000 to 225,000. And so pretty significant increase in the productivity of the number of clients we're able to handle. In addition to that, you have more online functionality that the clients have. So they can get the reports much easier. They're much better reports, I think, and easier to use. And they can also input their payroll online in easier fashion with the new platform we've been on for a couple of years now. So but fundamentally, if you look at it from an operational savings perspective, it's that increase in the number of clients that each specialist can handle. And there's others things like training of new specialists that's much easier and so forth. But that would be the big one.

Well, we don't separately disclose that. I think that you can get a good sense that we've been able to offset a lot of increased IT spending from savings on the upside, which is part of why we've been able to maintain the margins that we've been delivering.

And then just one last question for me. I guess Efrain, now that you've been at the company for several months, any thoughts on your end about maybe having different views than what's been -- what's done historically, whether it's thoughts around reinvestment of the substantial excess capital, and maybe how much cash you need to keep on the balance sheet or any other thoughts around maybe investment versus the constant drive to generate margin gains or anything else? Are you pretty much looking at things similarly to how it's been done historically?

Yes. Most of my friends who know me know I'm a pretty independent thinker. So I came in and I looked at what Paychex did. And certainly coming out of the life sciences area, there are many, many differences in the business. So I will say this, one of the things that distinguishes Paychex from other companies that I've been associated with is we literally have opportunities to grow in every single segment of the business, which frankly is what drove a lot of the strong performance in first quarter. I think with respect to our approach on excess capital, I really think that we've done a really good job treating shareholders correctly, and we always need to be looking at a combination of return of capital based on higher dividends and/or applicable. While we are not the sole deciders, we would recommend to the Board. I think that as cash builds up in the past, we have used to that to purchase shares. That's something that certainly warrants a lot of attention. I think the fundamental business model, the point I want to make here is this, this isn't simply a statement about drinking the Kool-Aid. It's that Paychex has a very, very powerful business model. I think we have opportunities for growth literally as you run up and down each of the business segments that we participate in and I think that if we can get the right kind of execution, we'll continue to drive the positive results into the future.

Our next request is from Rod Bourgeois of Bernstein. Rod Bourgeois - Sanford C. Bernstein & Co., Inc., Research Division: All right. So on the margin expansion front, I mean it's nice to see the growth start to the year. But on the margin front, I mean you're not planning to achieve margin expansion in fiscal '12. I guess, I wonder, are you confident in being able to return to margin expansion in the fiscal '13 time frame? And if so, can you mention for investors why the investments you're making in fiscal '12 is seemingly most of this on the technology front, why those investments will not need to be made to the same extent in the future after fiscal 12?

Okay, you got a compound question so I'll start with that, and turn it over to Marty. With respect to the margin expansion question on going forward, a little early to look at what's happening next year. Frankly, a lot of that will depend on what's happening in the business environment, what is happening with sales. I will say this; we have a discipline of leveraging expenses against sales growth so to drive margin expansion. Now how will that look? Frankly, it's a little bit early in the game to quantify that, but we'll be looking to do that in the year. I would remind you, Rod, of one other thing; that while it isn't apparent completely from the guidance that we issued both in June and reaffirmed now, remember that we have cost of acquisition that are masking leveraging that existed in the underlying business. So yes, we expect that we will be able to continue to leverage going forward. With respect to continuing investment on the IT front, I'll turn that over to Marty to talk about how we're looking at that going out into the future.

Yes, I think Efrain makes the first point, Rod, that it's certainly we're always looking to leverage the revenue growth. The focus is very much, for the whole team, on growth and leveraging that to drive additional margins just as we have in the past. We've always focused on also driving productivity in the operations side as we just talked about, to fuel a lot of the investments in IT. The IT spend is up and the operation spend is pretty flat because of the productivity, and we've always tried to drive that into IT investments. Those investments, I feel, will continue for quite a while. I mean you want to continue to stay on the leading edge on the product side as we also continue to look at acquisitions and how they can help add either on products or in more technology to the existing products. So you'll continue to see us adding continued investments there, but we're always looking to leverage the growth that we have in the revenue in the top line.

I think I should probably throw a comment, in fairness to Efrain, he was not here when the budget was done. When we did the budget, we did it without the acquisitions basically originally. We had our normal 2 points of leveraging above revenue growth and then when you lay the acquisitions in, the amortization of intangibles eliminated that. So we are basically flat on that in this year, but we've got some good growth in revenue and I would expect that when you get to '12, unless there's something else like that which we don't know of at the moment, you'll be back to leveraging. So really the year leverages, it's just the 2 new acquisitions that cause the intangibles. Rod Bourgeois - Sanford C. Bernstein & Co., Inc., Research Division: Yes, understood. And then one other question. So on the MMS business, can you give us any update on the MMS business and how it's doing relative to the rest of the business? And if you could specifically comment on whether Paychex is making progress in beginning to win deals with larger-than-normal clients? In other words, are you moving up the food chain?

I would say we're continuing to be pretty steady there. The MMS business, we've added a lot over the last few years time and attendance online and HR administration online, partnered either through those acquisitions or builds or also partnering with expense reimbursement partners and so forth. And then of course BeneTrac, when we purchased BeneTrac to offer full enrollment -- benefit enrollment type engine to client. So our focus has been, over the last couple of years, to then take all of that and integrate it and we're continuing to do that. And I think actually just coming out of the sales conference with our top sales performers and talking to the MMS top 10 performers, very competitive. They feel like they have all the product they need and we're continuing to perform well against competition. I wouldn't necessarily say that we're moving up market. I think we've always had a pretty broad range there. And but certainly with the additional tools we've added, we've done very well competitively, I think. So... Rod Bourgeois - Sanford C. Bernstein & Co., Inc., Research Division: And is MMS continuing to outpace, in terms of growth, the rest of the business and can you give us an order of magnitude of by how much, if so?

It continues to outpace the core payroll business. We won't give an order of magnitude for competitive reasons.

Our next request from Tim McHugh, William Blair & Company. Timothy McHugh - William Blair & Company L.L.C., Research Division: Yes. First I want to ask if you could just give a little more color around HR Essentials, which seems to be ramping up nicely for you guys? Can you talk a little bit about just, I guess I probably don't understand it as well as I'd like to, how that fits into the product suite relative to the ASO model and just how significant is that now? You seem to be talking about it more.

The way I look at it, HRS is a three-legged stool with services solutions and insurance. And then within the solutions business we have a smaller three-legged stool, which is HRE, ASO and PEO. Our salespeople can meet the customer at a number of different price points. One of the things that I thought was a good innovation last year was that we found that there were customers who didn't want the full outsourcing solution either in the PEO form or in the co-employer status or on -- even at the ASO level. And what they wanted was documentation and telephonic access to an HR representative. That is really frankly taking off and it's selling very, very well. And so it basically forms, I would say, one of the 3 legs to that stool and the more value priced option for HR outsourcing.

I think it gives us a chance to offer those clients who don't want the full ASO or PEO a way to kind of get in, get a handbook, an employee handbook, as well as telephonic support. You can actually either go back to them later and sell them the full, if they grow or if they have additional needs that we may see from the telephonic support, we have an opportunity to go back to them as well and say "Would you now like a full HR person that is available to you and is dedicated to your company?" Timothy McHugh - William Blair & Company L.L.C., Research Division: And is there any risk of cannibalizing the prior ASO or PEO sales as people trade down or another debt option is more available?

You don't really see much of -- we haven't seen much trading down. I think there was always the risk when you go in that they buy at a lower price HRE instead of the ASO or PEO. We haven't -- from what we can see, we haven't seen too much of that. Obviously, we're looking for expansion of those business opportunities. And I think what you do find is if there is some people taking the lower price HRE, it's probably because that's where they were going to end up anyway and they would take the full ASO but then after 6 months or so decide, "Geez, this is too much for me. I don't need all of this." The HRE is bidding very well for those clients right off the bat. So they're getting handbook and telephonic support. So we're not seeing cannibalization of prior sales and right now, we're not seeing -- we don't think too much of a loss of folks who really need the full-service ASO versus HRE. Timothy McHugh - William Blair & Company L.L.C., Research Division: Okay and then Efrain, I want to ask about the -- just the, if you can talk a little bit more about the yield on the client funds and in relation to the feds operations that they've announced that kind of try and drag down short-term rates -- I'm so sorry, drive up short-term rates and drive down kind of longer-term rates. We've seen the 5-year treasury move down a fair amount. Can you talk a little bit about how that impacts the portfolio and if it at all changes how you think about the yield and what you might be doing?

Yes. A couple of comments on that. First just as a backdrop, at the end of the year, we were more heavily invested in variable rate demand notes. That was about an 8 bps return on those adds. There was a lot of uncertainty around what was going to happen with current risks and the whole debt issue. We moved into FDIC-insured deposits, which is where we have reasonably good returns. That's more on a net basis up in the 10-bp range. That had a little bit of an impact on the tax rate, by the way, because those are taxable. Our mix of taxable versus nontaxable is changed. Really frankly too early to tell. We're not seeing a dramatic change in any of those factors. And it's a little bit hard to peg, yet, what's going to happen on the real short end of the interest rate curve. We don't expect a significant change, I would say that now. I mean to give you an example we were, at a point, heavily invested in agency discount notes which are yielding 1/10 of 1 basis point. So down on that end where we need to preserve liquidity and safety, I would say the only impact we could have is if we see some lack of availability on investments that have been available to us. And it's a little bit early to call. We were launching with interest the development that the Bank of New York Mellon started. Fortunately, that has not spread to other banks around charging per deposit. So we expect, based on what we see, the environment to stay about where it is now.

Our next request now is from David Togut of Evercore Partners.

Efrain, you mentioned a reduction in discounting within your overall client base in the August quarter. Could you quantify the actual reduction in discounting and how that compares to what you saw in the previous 12 months?

Yes. We don't get that specific around the impact of discounting. I'll just say that we saw more of our units sell closer to the price that we had planned and in some cases, actually slightly above that because we have tightened up the parameters around discounting, we talked about that in prior calls. So there's less ability to discount and I think that field sales now understands that pricing parameters are tight.

Can you us give a sense of what the average level of discounting is versus list price?

I wouldn't do that because it's a competitive issue. We monitor that very closely. We know what our competition is doing and we don't want to give them any more information than they need to have right now.

I see. Just a quick follow-up then. Marty, you highlighted some next-generation applications for the Payroll Services business, particularly an iPad application. How does that iPad application stack up against ADP's RUN product, which also has an iPad app?

Well, we certainly think it'll stack up very well. We feel we've been very competitive with them. I think that as they've introduced some things this fall, I think we'll be very close to -- it's certainly very competitive with what they have.

When you say very competitive, do you mean you have the same functionality at the same price? Can you give a little more insight?

Well from a competitive standpoint I don't think I want to get too much out there, but I certainly feel that we're very price competitive and I think very feature-and-functionality competitive as well.

Our next request from Glenn Greene, Oppenheimer. Glenn Greene - Oppenheimer & Co. Inc., Research Division: Just wanted to drill down a little bit on the 2% growth in checks per client. Obviously it's been pretty steady here, I think you said for 6 quarters. Are you surprised it's kind of held in as well as it has, especially given sort of the deceleration in the broad employment trends we're seeing that seem to have sort of stalled out and flattened? And are you expecting it to sort of flatten out by year end?

I think we have felt that it'll moderate as the comparisons get tougher. And as -- if new sales from new businesses pick up, typically they're smaller and that drives it a little bit flatter as well. But right now, I mean we're seeing that the current client base both from a retention standpoint, meaning fewer going out of business and the checks per client on a year-over-year basis continues to improve. So we think the current client base is still adding employees and we feel pretty good about that, obviously.

Having looked at checks per client for 15 years, my feeling would be that this statistic will stay above where it is unless small business decides to dump employees, which usually happens in a short period of time and we have no indication of that happening at the moment. So I think they're still going to be hiring and as long as new business starts aren't strong, that number could stay positive for longer than we would anticipate, unless the shoe really drops on the economy and small business says, "Hey, we don't have confidence. We're going to start shedding employees" and they're going to want to reaffirm. We have not seen any of that at this point.

Yes. It seems like actually, hopefully we're past that kind of worst point. You never know, but we certainly haven't seen it. Glenn Greene - Oppenheimer & Co. Inc., Research Division: Is there a read through that small business from hiring perspective is somewhat better than the broad economy?

I don't know that. They don't hire and fire people the same way. In the larger companies, they react immediately. It doesn't matter. It's good, bad or indifferent, it's the way it is. They just dump people. They don't -- I'm not saying they don't care about their people, but they do what they've got to do. The small business person knows these people. He doesn't lay them off unless he has to. And once he goes to the issues of laying them off, he doesn't hire them back anytime quick. So I think they just perform slightly different because they're not on a quarterly reporting obviously. And that they're owned by owners who can have longer-term outlooks. They're just not the same types of businesses. Glenn Greene - Oppenheimer & Co. Inc., Research Division: Okay. Helpful, John. Just on the pricing side, and I know you're -- sort of the rate card increase looks like it's stuck, and you've been tightening up the discounting, but maybe you could talk a little bit about the pricing dynamic competitively going after new business both from regionals, from the big national vendor and maybe even from some of the do-it-yourself vendors, what you're sort of seeing competitively in pricing for new business?

I haven't really seen much of a change from the competitive environment there. I think both are still very competitive. We're still running into them about the same number of times. And we have not really seen much of a change. We felt good about the fact that the price increase could go in, in May and be held and the discounting is holding as well. So I guess we haven't seen a lot of change in the competitive environment. Glenn Greene - Oppenheimer & Co. Inc., Research Division: So nothing has gotten irrational?

No.

No. Pricing is in 2 pieces. In the client base, pricing is better. Price increase went in -- well the last 2 or 3 years have still done quite well, but this one probably went better than the rest and the new pricing and new sales remains competitive, but the discounting isn't quite as crazy as it was.

Our next is from Jim MacDonald, First Analysis.

Could we go back to the HR services area? Was there anything special in this quarter that's not expected to repeat throughout the rest of the year?

I don't think -- I think as you look at it we had the new acquisition ePlan come in, so that did give us a pop there. That'll be there until the comparison shows up and moderates that. But we've had good growth in -- we felt in HR solutions, the HR outsourcing, had continued good growth in H&B, the health and benefits, health insurance basically and our workers comp and in our 401(k) as well. Obviously 401(k) was up about 12% with the acquisition and about 4% without. But we're still seeing additional retirement service clients and we're still really #1 in that industry. So we feel very good about starting the most new plans of any other company.

Yes. John, I'd say that we saw strength frankly in all 3 of the businesses. We typically don't come out of the gate charging that way. But we talked about HRE that helped the results, 401(k), Marty just mentioned and insurance was another part of the business that did very strong. Do we expect it to be that strong for the rest of the year? No, more in line with the guidance that we had but frankly, that's pretty strong guidance. So we expect that we'll have a good year on the HRS side.

And specifically on the PEO, anything there? I noticed in the Q that your direct costs were lower actually this year. Does that mean that business is shrinking or...

No, it's not shrinking. In the first quarter, as I mentioned before, you've got 3 options in terms of the sale that you can make on the solutions side. PEO, ASO, HRE. HRE and ASO were strong in the quarter. PEO was relatively weaker. I would say you can't infer anything from that simply because we're going into renewal season. We now know what our rates are for things like health and benefits and we'll get a better read on that as we get into next quarter.

Just a quick follow-up there. Any thoughts on kind of what type of health increase you're going to have to take to the market? Is it like more than or less than the market at this point?

Look, I will just -- I won't quantify, but I'll say it's less than market.

And our next request is from Tien-Tsin Huang of JPMorgan. Tien-Tsin T Huang - JP Morgan Chase & Co, Research Division: I just wanted to ask about the pricing, I guess. How much of that is a function of the new pricing model? I know you talked about competition and whatnot, I wonder how much of it was in response to the new pricing?

Can you clarify the question? I just want to make sure I understand. Tien-Tsin T Huang - JP Morgan Chase & Co, Research Division: Yes, I'm sorry. I guess in the past you guys talked about changing your pricing model a little bit, not the levels but just the way you go about pricing. So I'm just curious of what you're seeing about pricing sticking as a function of that?

Okay, no. I would say it's -- once -- what we did last year, last fall, we reset some of the bundles of products and so forth, some of the pricing with those, and then limited some of the -- and changed some of the parameters of discounting. But the price increase on top of that was fairly normal in the May time frame and I don't think that had a lot to do with it but it did stick, so we felt very good. As John said, for the last 3 years, this was probably the best one. I don't think it had too much to do with that because that pricing -- the new bundles had been set last fall. So we felt pretty good about from a competitive standpoint that the pricing stuck and the discounting has moderated.

Modified our -- pricing changes we made a year ago, we modified some relationship to how ADP reacted. And right now, I think we're not as strong as we would have liked to have been, but we're better than we were. Tien-Tsin T Huang - JP Morgan Chase & Co, Research Division: Good to know. Just on SurePayroll, it sounds like it's performing well versus planned. Has it changed your thinking at all about growing the self-service sales market at all?

No. I guess from our standpoint, there is still a big opportunity that we knew wasn't going to happen overnight. But as these 5 million businesses, the small business that do payroll on their own kind of manually with kind of pen and paper and calculator, we still feel that that's going to be happening over time, and that they'll be perfectly positioned for that. And in the short term, they've been performing very much on what we expected. So we feel very good about that market continuing to grow and be an expansion, not really a cannibalization but more of an expansion. Tien-Tsin T Huang - JP Morgan Chase & Co, Research Division: Got it. Given that, last question just on the acquisition pipeline, I mean, can we see more from Paychex in the way of more on the self-service side or is it more adding to the products with the full service suite?

I think we're -- probably it's more on the product side, but we continue to look at all kinds of opportunities that are out there. I think it's a pretty active environment and it's just always obviously getting the right value for something that's there and if it fits. But it's always typically more on the product side. But when you look at ePlan, when we purchased ePlan for the 401, for the retirement services, that was more of a self-service, but focused on the financial advisor community for 401(k) set up. And so that kind of fit both. It gave us additional product breadth in 401(k) retirement services, but it also targeted an online service alternative for financial advisors. So I think it could be a little bit of both, I think. Both are of interest to us, that's for sure.

They'll be smaller and they will tend to be tuck-in acquisitions.

And our next request from Matthew O'Neill, CLSA. Matthew O'Neill - Credit Agricole Securities (USA) Inc., Research Division: This is Matt O'Neill on the line for Craig Maurer from CLSA. Just had a quick housekeeping question. I noticed in the release, the payroll client number wasn't updated from the 564,000 and I don't know if that's maybe no longer relevant with the SurePayroll acquisition. I was just curious about that or how to think about that?

Matt, I think someone else asked that question earlier. We don't do that every quarter. We'll do that on occasion if we think there's some significant shift in the market that the analyst community should be aware of. Marty mentioned earlier retention looks good, losses from business failures continue to moderate. We're back to a more normalized environment. So we won't be releasing that on a quarterly basis. Matthew O'Neill - Credit Agricole Securities (USA) Inc., Research Division: Okay. I'm sorry about that confusion with just that number. Likewise with SurePayroll, is that being viewed at all internally as a potential market to look to upselling any of those clients you may need -- may change and you're looking for a more comprehensive solution as they might grow? And now you guys have the full Paychex corporation behind SurePayroll clients to look to with that?

Sure. It's always an opportunity. And I think SurePayroll has started to do a pretty good job of adding ancillary products even to those clients on what they had. So offering 401(k) and so forth. And we will certainly add to that. If clients want to move from doing it themselves and more of self-service to the full-service, we certainly have that as well and they're ready and there's a good connection already between the 2 sales teams. So where SurePayroll does everything over the phone, if someone calls in and wants to upgrade, they certainly will pass that lead on to the Paychex sales force to close. And frankly, on the other side of it, it's our sales force who's out selling and see if there's a client that doesn't want full-service but is looking for a self-service alternative to get started, they will refer that over to SurePayroll. So we've kind of nailed that down on both sides. So certainly if there's opportunity there, we're going to capitalize on it.

Our next request from Mark Marcon of RW Baird. Mark S. Marcon - Robert W. Baird & Co. Incorporated, Research Division: I wanted some clarification with regards to the client retention questions. Aside from just the pure decline in terms of the number of companies that are going out of business, are you seeing retention improve aside from that dynamic?

Well, we don't always break all that out, but I think we've seen it continue to improve. I think this is the 7th quarter in a row that the overall numbers continue to improve and it's not just the out-of-business. I would say that, that certainly is a number that continues to improve. But across the board, it's gotten better. Mark S. Marcon - Robert W. Baird & Co. Incorporated, Research Division: Great. And then in terms of the clarification with regards to checks per client in terms of the moderation, certainly understandable why you wouldn't expect it to continue to grow at 2%, but can you give us a little bit more of a framework? Are you thinking 1% or even by the end of the year that it could potentially go flat, assuming that economic conditions don't change?

I would say this. That we're expecting by the end of the year as we lap some tough comparisons that will be down to a more flat environment. Slightly up, but not very much.

But we actually really don't know. Mark S. Marcon - Robert W. Baird & Co. Incorporated, Research Division: Yes, nobody really does, but just wanted to know what the underlying assumption is.

I'm sorry, that's our plan and assumption, Mark.

Obviously, it's been a little stronger than we expected and we continue to think that it will moderate at some point, but we're certainly pleased that it's been better than we thought. Mark S. Marcon - Robert W. Baird & Co. Incorporated, Research Division: Great. And then in terms of the product improvements that are coming out in terms of next generation, it sounds like earlier this -- or early in the fall, we'll see the first iteration of improvements. But it sounds like there's a series of improvements that are coming up. Is that correct?

Yes. We've kind of planned out through this, what we call Paychex next generation application, releases throughout the years and we've got these basically planned out now for the next 2 to 3 years and we monitor them very closely from a development standpoint. So you've got to stay very much competitive and we feel very good about where we are on that. We had, 2 years ago, had to convert the whole base and the core base. And then now as we move forward, you'll see the application, the bases and the software kind of combined across both the MMS and core markets and you'll see improvements come out all throughout the years. Mark S. Marcon - Robert W. Baird & Co. Incorporated, Research Division: It was my impression, and please correct me if I'm wrong, but my impression has been that a lot of the improvements that have occurred thus far were a little bit less transparent to potential new sales candidates, but that the new ones will be a little bit more visible. If that is in fact correct, can you talk a little bit about how you would expect those improvements to impact sales productivity and how you would stack up not only relative to the national player, but also again some of those discounting local players?

Well I think from stacking up against the national players is obviously very important to us and I think we'll be very competitive there and already feeling very competitive, but we're going to stay on top of that with the changes. From a regional player standpoint, obviously it puts you in an even better position because they don't have the resources to continue to modernize as much as we do and increase on the web. The -- really the growth is adding additional functionality. It's adding -- it' making it easier for everyone to access it online. We added W-2s and pay stubs online last year. We've continued to add other things. We don't make a big deal out of it, but we certainly roll them out to current clients as well as new sales. So I think it's going to impact both new sales and it's going to certainly support new sales and current clients because both will have the advantage of using the new application. Mark S. Marcon - Robert W. Baird & Co. Incorporated, Research Division: Great. And then lastly the way that you express things, it sounded like you held back a little bit on the budget, not being sure about how things were going to unfold. Now you're feeling a little bit more confident so we're going to go ahead and spend in terms of these technology initiatives. Can you also describe how you're going to grow or how we should think about the sales force expanding from here?

As far as sales force expansion, it's fairly light. We're watching the market to be sure. Whenever we explain the expenses, it's more about -- I wouldn't say it's going to open the floodgates, it's just we always start out very carefully until we make sure that the base is growing and that the revenue is growing and then we add expenses very carefully. I think as John has said over the years, we're very good about not allowing expense to get in and we continue to do that. So I think that you won't see a major shift in that. We've continued to invest. I think the savings in the first quarter that Efrain talked about from an investment standpoint was some of the projects ran a little bit behind as far as what was hiring and so forth and getting folks in. It hasn't really impacted the delivery of the product. But that'll kind of wash out over the years. So the investments have continued really for the last few years. We get the productivity in operations and we fuel it, we fuel the IT growth with that. Mark S. Marcon - Robert W. Baird & Co. Incorporated, Research Division: Great. Are you going to expand the sales force by say, 2% to 3% over the next 12 months?

I don't know if we've said, but we'll continue to look at doing that as we see a need to. I would say that it's up a little bit less than that right now, and depending on which sales force, actually it probably does average around a couple of percent and we'll continue to look at that. Our standard over the years has been to increase 2% or 3%, and -- but you got to certainly follow where the market is and what the opportunities are.

Our next request from Tim Willi of Wells Fargo.

I think this has been touched on in a couple of answers prior, but I'm just wondering. When you talk about the tablet technology and just thinking about how fast mobile and everything is moving relative to a lot of the smaller mom-and-pops who may not have the scale and margin that you do, do you feel at all that there is actually a technology advantage around delivery and service that you could be in the process of building that would obviously continue to show up in numbers in terms of market share gains and things along those lines as we move forward? Or do you feel like what you're developing and all the tools out there around technology probably enable a lot of your competition to keep pace?

Well certainly over the regional players, the smaller -- we certainly have an advantage from this, the wherewithal of information technology department and the development folks and resources that we have, I think, so we're going to continue to develop those and I think that as more and more folks, client and client employees look to online and look for integration of multiple services from your retirement services to your payroll services to your HR administration, we certainly have advantage over smaller competitors, because of just a big investment that you had to continue to make and stay on top of. And I think it is just very competitive with the national player, the other national players.

On the regionals, what we've noticed over the last 6 to 8 months is we're doing better against them. I think one of the reasons is one thing that hurts them, as this product becomes more spread geographically because of the Internet, you don't -- it's harder to focus on a region to do your client. Small locals and regionals generally don't do payroll across the whole U.S. They can't do it across the whole U.S. because the local, they have tax regulations. So I think there are some things going on tied to technology that are going to help us against the lower end, people that aren't disqualified as some of the others.

[Operator Instructions] My last request presently is from Nicole Conway of Stifel Nicolaus. Nicole Conway - Stifel, Nicolaus & Co., Inc., Research Division: This is Nicole Conway on for David Grossman at Stifel. So I was curious if the current economy stays the way it is and new business starts to continue to be weak, do you still expect to have positive new client growth for fiscal '12? Can you get there without having that metric, be it other drivers such as new products?

Let me answer that in 2 ways. The first one, a very direct one, is that we assume that if the environment continues currently without a change, that we are aiming at getting positive client growth. So we expect that we can grow. Now, obviously the magnitude of that growth is going to depend on what the growth in new business starts ends up being. But I'd say one other thing that's important; that I think this quarter demonstrates that we've got a model that can produce revenue growth and income growth, even when conditions aren't necessarily favorable economically. And we will simply adjust based on the conditions that we see. We're not pegging our results in the future solely on what's happening with new businesses.

I have no further requests at this time, so I would like to turn the conference back to Mr. Martin Mucci for any closing remarks.

Thank you. At this point, we will close the meeting. If you're interested in replaying the webcast for this conference, it will be archived until October 28. I do thank everyone for joining us. We're very proud of our first quarter, and we look forward to the rest of the year's results. Take care.

Thank you everyone for your participation. The conference has concluded. All lines may please disconnect.