Paychex Q4 Earnings Call Transcript

123jump.com Staff
06 Jul, 2009
New York City

Payroll and related service provider fourth quarter revenue fell 4% to $495.5 million and net income declined 16% to $113.8 million reflecting weak economic scenario. Earnings per share were 32 cents as against 38 cents in the prior year quarter.

Paychex, Inc. ((PAYX))
Q4 2009 Earnings Call Transcript
June 25, 2009 5:00 p.m. ET

Executives

Jonathan J. Judge - President, Chief Executive Officer, Director
John M. Morphy - Chief Financial Officer, Senior Vice President, Secretary

Analysts

David Grossman - Thomas Weisel Partners
Christopher Mammone - Deutsche Bank
Julio Quinteros - Goldman Sachs
Kartik Mehta - Northcoast Research
Jason Kupferberg - UBS
Rod Bourgeois - Sanford C. Bernstein
Jim McDonald - First Analysis
Gary Bisbee - Barclays Capital
Mark Marcon - Robert W. Baird
Giri Krishnan for Kelly Flynn - Credit Suisse
Tien-Tsin Huang - J.P. Morgan
James Kasim (ph) - Banc of America

Presentation

Operator

Good day, ladies and gentlemen and thank you for standing by. (Operator Instructions) At this time all participants are in a listen-only mode. After the presentation we’ll have a question-and-answer session and to ask a question at that time please press “*1”. Today’s conference is being recorded. If anyone has any objections you may disconnect at this time. Now I would like to turn the meeting over to Mr. John Morphy, Senior Vice President and Chief Financial Officer. Sir, you may begin.

John M. Morphy – Chief Financial Officer

Thank you for joining us for our fiscal 2009 year-end earnings release. We will begin today with a review of our fiscal 2009 financial results, including guidance for fiscal 2010. Then John Judge, our President and CEO, will provide you with an overview and we will end with a Q&A session. Yesterday afternoon, after the market closed, we released our financial results for the year ended May 31, 2009 and filed our Form 8-K, which provides additional discussion and analysis of the results for the year. These are available by accessing our investor relations page at www.paychex.com. We expect to file our Form 10-K by the end of July. In addition, this teleconference is being broadcast over the Internet and will be archived and available on our website for approximately one month.

Overview of fiscal 2009: Fiscal 2009 was one of the most challenging years in Paychex''s history. We were faced with the weakest economic conditions we have ever experienced. These included a severe credit crisis which inhibited new business formation and made it more difficult for existing businesses to survive, and extremely low interest rates of return on our funds held for clients. Despite this, our team responded well to the challenge by delivering a record level of operating income net of certain items. Our operating income net of certain items was $730 million, an increase of 5% over the prior year. We leveraged our resources generating operating income net of certain items as a percentage of service revenue of 36.4%. Our served payroll client base declined 3.1% to just over 554,000 clients. It was difficult to watch our client losses due to companies going out of business or having no employees rise by 17% over the prior year. At the same time, our new client sales from new business formation declined by 19%. We believe both conditions were the worst in Paychex''s history, which explains our experiencing negative client growth for the first time in our history.

While pricing conditions were more competitive, they did not have any significant impact on client share as we believe we increased our market share in comparison to our significant competitors. On the new sales front, we added over 111,000 clients during the worst business environment most of us can remember. Our client base, CPA, and bank channels continue to be excellent sources of business. On the bright side, we met our major market services, new sales targets, which reflected year-over-year growth of 20%. In total, we sold slightly less new annual business revenue than we did in fiscal 2008.

Operationally, again we received high client satisfaction results. We find this to be encouraging considering the economic pressures our clients are facing. Our client retention was 77% of our beginning-of-the-year client base. Our range of client retention over the past 10 years has been from 76% to 81% of our beginning-of-the-year client base. There’s been unprecedented volatility in the global financial markets resulting in many companies experiencing investment or credit losses. We have maintained our conservative investment strategy and not recognized or realized any impairment losses for our investments. As of June 19, 2009, the total investment portfolio contained net unrealized gains of approximately $56.3 million. We invest on average approximately $4 billion of our clients’ money and our own cash with daily balance changes frequently in the $1 billion to $2 billion range. In these turbulent markets, we have managed these sizable investments with no losses of principal and have met all of our clients’ daily needs related to the payment of wages, taxes, and other benefits to their employees. We regularly monitor credit worthiness and are able to react quickly to changes that would impact the flow of client funds for our cash flows.

We continue to generate significant cash flow even after paying dividends to our shareholders. In fiscal 2009, our cash and total investments increased by approximately $140 million after paying $448 million in dividends. This translates to a dividend payout to our shareholders of 84% of net income. Our cash flows historically slightly exceed net income, which allows us to be comfortable with and committed to maintaining our current dividend level even though the pay-out is increasing as a percent of net income.

We strengthened our software-as-a-service solution for our MMS clients and in fiscal 2009 we enhanced the Paychex time and labor online, an Internet based integrated time and attendance system. We also introduced Paychex expense manager and integrated payroll and expense management solution. We continue to head down the path towards becoming a significant provider of health and benefit services. Fiscal 2009 revenues were $20.9 million, up 70% over the prior year, and we expect significant growth from health and benefit services to continue in future years as we look to pass the $30 million mark in fiscal 2010. We continue to be the premier supplier of 401K record-keeping services as we sold 11,000 plans. Total assets in the plan is near $9 billion and our 50,000 clients means we are serving one in every 10 401K record-keeping plans in the U.S. We enhanced our 401K product through the addition of auto enrolment as an optional plan feature that allows employers to automatically enroll their employees in the company 401K and increase overall plan participation.

We’ll now take a few minutes and talk about economic conditions. We will share some of the key indicators that should provide insight into how the small-to-medium-sized economy has been behaving during fiscal 2009. Again, we have added some additional information that we believe will be beneficial to our current shareholders, prospective shareholders, and the Wall Street community, and also enhance your understanding of Paychex. Our checks per client decreased throughout the year with the largest sequential decline occurring as we move from the second to the third quarter. The calculation of checks per client for a quarter is based upon the number of payroll checks issued divided by average client base for the quarter. Checks per client declined 2.9% for the year with the quarterly breakout in quarterly sequence of 1.2%, 2.1%, 4.3%, and 5.2%. Looking forward and assuming checks per client to have bottomed out, we would expect the year-over-year comparisons to improve throughout the year with the decline in fiscal 2010 approximating 3%.

Our new client sales through new business starts decreased 27% for the fourth quarter at 19% for the fiscal year. Clients lost due to companies going out of business or no longer having any employees, increased 19% for the fourth quarter and 17% for the fiscal year. We earned an average rate of return on our combined investment portfolios of 2.1% for fiscal 2009 compared to 3.7% for fiscal 2008. And short-term taxable average interest rate earned was 1.2% for fiscal 2009 compared to 4.2% for fiscal 2008. Note that in fiscal 2009, our short-term portfolio became heavily invested in taxable securities as our current primary short-term investment vehicle is U.S. agency discount notes. Lower interest on funds held for clients contributed to lower results of operations as it declined $56 million, or 43% in 2009. In addition to the lower interest rates previously discussed, average investment balances were down 3% in fiscal 2009 compared to fiscal 2008. Overall economic factors which negatively impacted our client base were the main cause of this. Average invested balances for the fourth quarter of fiscal 2009 decreased 9%. The greater deterioration in the fourth quarter was due to weakening economic factors, fewer clients on tax pay and employee pay, and the 2009 economic stimulus package generating lower tax withholdings for client employees. Of the 9% deterioration, approximately half related to the stimulus package.

Although we’ve been operating in an unprecedented economic environment during fiscal 2009, we maintain stability in our employee base, no jobs lost, allowing us to continue to focus on providing excellent customer service and investing in our future.

We will now move to a discussion of our results on the income statement. Payroll service revenue increased 1% to $1.5 billion. The growth was driven primarily by our annual price increase and growth on the utilization of ancillary services. The weakening economic conditions in fiscal 2009 negatively impacted payroll service revenue. As of May 31, 2009, 93% of our clients utilized our payroll tax administration services. Employee payment service utilization was 75% with over 80% of our new clients selecting these services, which include direct deposit, access card, and ready checks. The human resource services revenue increased 11% for the fiscal year to $524 million. The following factors contributed to this growth. Comprehensive human resource outsourcing services client employees increased 3% to 453,000 client employees served as of the end of May. Comprehensive human resource outsourcing client base increased 10% to 18,000 clients. We continue to add clients at a higher rate than client employees due to lower levels of employees per client, especially in Florida. Workers’ compensation insurance client base increased 6% to 77,000 clients. Retirement services client base increased 2% to 50,000 clients.

Our growth in health and benefit services continues to be strong and grew 70% to $20.9 million for fiscal 2009. And we earned $12.4 million of retirement services billings for client plan restatements in fiscal 2009 that are required by law approximately every 10 years. The following factors adversely affected growth rates. Volatility in the financial markets caused the asset value of retirement services, client employees’ funds to decline 12% from May 31, 2008 to $8.5 billion. The decline in the asset value accompanied by a shift in client employees’ retirement portfolio to investments earning lower fees from external money managers reduced retirement services revenue growth by $8.9 million for fiscal 2009. The lower levels of employees per client in our comprehensive human resource outsourcing services resulted in a reduction to revenue growth of $8.7 million for fiscal 2009.

Interest on funds held for clients decreased 43% for fiscal 2009 due to lower average interest rates earned, lower average investment balances, and lower realized gains on sales of available-for-sale securities. The average interest rate earned on funds held for client has decreased to 2.2% from 3.7% a year ago. As previously discussed, our average invested balances were negatively impacted by the economic conditions and lower tax withholdings as a result of the 2009 economic stimulus package. Consolidated operating, selling, general and administrative expenses increased 3% for fiscal 2009. Fiscal 2009 expense growth benefited from continued leveraging in response to the weakening economic conditions. As of May 31, 2009 we had approximately 12,500 employees compared with approximately 12,200 a year ago. Our philosophy on expense management is to continually look for more efficient ways to conduct our business while not impacting the level of service our clients expect when they add our services and to invest in the future. In these turbulent times, our employees are doing an excellent job of cost management, ensuring we continue to provide our best service levels ever.

Investment income net decreased 74% to $6.9 million for fiscal 2009. The changes in investment income reflect lower average interest rates earned and lower average investment balances from the funding of the stock repurchase program completed in December of 2007. Our effective income tax rate was 34.3% for fiscal 2009 compared with 32.6% in fiscal 2008. The increase in the effective income tax rate was primarily the result of lower levels of tax exempt income derived from municipal debt securities held in the investment portfolios.

We’ll now take a look at the balance sheet. Our liquidity position is strong with cash and total corporate investments of $575 million as of May 31, 2009 and no debt. Our cash flows from operations were $689 million for fiscal 2009. We continue to maintain a conservative investment strategy emphasizing maximum liquidity and principal protection first, and then investment yield. See our preliminary MD&A filed with the SEC on June 24, 2009 for detailed information related to our investment portfolios. Our priority towards liquidity is to ensure we can meet all of our cash commitments to clients that take place as we transfer cash balances from their accounts. Our funds held for clients routinely fluctuate daily by $1 billion to $2 billion, meaning we must be positive our investments can meet our daily liquidity needs without failure.

For additional liquidity, we currently have $400 million in a credit facility and $900 million in lines of credit available to us. Our total available-for-sale investments, including corporate investments and funds held for clients reflecting net realized unrealized gains of $66.7 million as of May 31, 2009, compared with net unrealized gains of $24.8 million a year ago. Client funds, deposit balances grew at a slower rate than historical in fiscal 2009 as expected, with client fund deposits as of May 31, 2009 at $3.5 billion. Total stockholders’ equity was $1.3 billion as of May 31, 2009, reflecting $448 million in dividends paid during fiscal 2009. Our return on equity for the past 12 months was an exceptional 41%.

We’ll now talk about guidance. Our guidance philosophy has been in place for a long time and that has been to provide guidance based upon what we are experiencing in financial terms and quantifying our expectations for the current fiscal year. While we do not change the steepness of the trend line, we do project current trends into future periods of time. We believe it is extremely difficult, if not impossible, to accurately predict significant up-turns, downturns in the economy and even more difficult to forecast increases, decreases to short-term interest rates. We believe our guidance philosophy assists the many people developing and evaluating expectations for our future financial results. They know what it is based upon and they can, if they choose to do so, make their assumptions on what they believe are realistic assumptions of the future, whether it be changes to interest rates, employment levels, et cetera. That said, our current outlook for the fiscal year ending May 31, 2010, is based upon current economic and interest rate conditions continuing with no significant changes. Consistent with our policy regarding guidance, our projections do not anticipate or speculate on future changes to interest rates.

Comparisons to the fiscal 2009 quarters are expected to improve as fiscal 2010 progress. That is primarily because the comparisons will become slightly easier since some of the significant deterioration occurred subsequent to the first quarter a year ago. Projected revenue and net income growth for fiscal 2010 are as follows. The payroll service revenue growth, 3% to 5%; human resource services growth, 3% to 6% -- I’m sorry, the payroll service revenue is a decrease of 3% to 5%; total service revenue is projected to decrease in the range of 1% to 4%; interest on funds held for clients is expected to decrease by 25% to 30%; total revenue is projected to decrease in the range of 1% to 4%; investment income is projected to decrease by 30% to 35%; and net income is projected to decrease in the range of 10% to 12%.

Operating income net of certain items as a percentage of service revenue is expected to range between 34% and 35% for fiscal 2010. This will be the first time in some time that margins have not expanded on a year-over-year basis. The primary reason are the reductions in checks per client, as the last check issued to a client or by a client is the lowest revenue check but at the same time is the highest margin check. In addition, we have increased our selling expenditures to increase sales coverage in order to take advantage of opportunities when the economy improves. We are also continuing our investments to aggressively grow our healthcare business. When more normal conditions return, we expect to return to expanding margins on a year-over-year basis.

The effective income tax rate is expected to approximate 35% throughout fiscal 2010. The higher rate for fiscal 2010 is driven by higher state income tax rates resulting from state legislative changes. Interest on funds held for clients and investment income are expected to be impacted by interest rate volatility. Interest on funds held for clients will further be impacted by a projected 5% decline in average invested balances, with most of the effect in the first half of fiscal 2010. Comparisons to fiscal 2009 are challenged by both the weak economic conditions and the 2009 economic stimulus package generating lower tax withholdings for client employees. As of May 31, 2009, the long-term investment portfolio had an average yield to maturity of 3.3% and an average duration of 2.5 years. In the next 12 months, slightly less than 20% of the portfolio will mature and it is currently anticipated that these proceeds will be reinvested at a lower average interest rate of approximately 1.4%. Please refer to our press release filed yesterday afternoon for our fiscal 2010 projected changes by quarter in interest on funds held for clients and investment income.

Under normal financial market conditions, the impact of earnings from a 25 basis point decline in short-term interest rates would be approximately $3.5 million after taxes for a 12-month period. Such a basis point change may or may not be tied to the federal funds rate. It is not possible to quantify the after tax effect of the 25 basis point change in the current investment environment. Purchases of property and equipment in fiscal 2010 are expected to be in the range of $55 million to $60 million. Fiscal 2010 depreciation expense is projected to be in the range of $65 million to $70 million, and amortization of intangible assets for fiscal 2010 is expected to be in the range of $20 million to $25 million.

At this time, I will turn the meeting over to John Judge, our CEO.

Jonathan J. Judge – Chief Executive Officer

Thanks, John. Good morning, all. I want to add some comments on our fiscal 2009 performance and then reflect on 2010 and beyond. Let’s start with 2009. There are very few companies I suspect that are satisfied with their financial results of the past year. That’s certainly true of us. 2009 was not a normal Paychex year. Instead of setting yet again more records, we watched our streak of 18 consecutive record-setting performances end due to the weakest economic conditions in the history of our company.

John took you through the details of our financial performance and we would all agree those were not normal Paychex numbers. We are clearly not satisfied with them but with that said, we are proud of how our team fought through the adversities of 2009’s economic crisis and produced results that while not up to Paychex standards, were better than most if not all players in our industry and most public companies in the United States. We did increase our revenues. We did expand our margins and achieve the highest expense-to-revenue ratio in our history. We did create over $800 million of profit in the worst economy in 75 years. We did create almost $700 million of cash flow and paid out almost $450 million in dividends to our shareholders. There are also some important non-financial accomplishments that will benefit our future. Despite very difficult selling conditions, we were able to sell almost the same new annualized revenue as last year. Our major markets division had a very strong year with a 20% increase in sales year-over-year, in some respects, almost a normal year for our MMS team.

We continued to invest in our future, in areas such as sales reps in our healthcare business, as well as new product enhancements. And we implemented a price increase in May of between 3% and 4%. We maintained industry-leading client satisfaction, which is extremely important in this industry and in our business model. When we look to the future, we remain very confident and very optimistic. 2009 was tough year for everyone but when we look back at our results, nearly all of our short-fall to a normal Paychex year was directly attributable to four things. First was, the fed fund rates at or near zero that caused our float income to decline by $56 million, or 43% year-on-year. Second was, increased losses due to business failures or clients in such bad shape that they stop processing payroll. Third was the significant decrease in new business formation caused by the credit crisis. This alone was responsible for 90% of our sales shortfall versus a normal year, and fourth was the impact of unemployment on our check volume.

Those four areas were directly impacted by the economic crisis and took us off a normal Paychex year but more importantly, all four will improve with the return of a more normal economic environment. That’s why we are confident about the future. If we were being disintermediated by a company, providing better products or services, we’d be more concerned. But that’s not the case. In fact, everything we know says we are doing better than our competitors and taking share. We can’t predict when the turn for the better will occur for our economy but we know that when it does, we’ll be in a very good position. In the meantime, we’ll continue to invest in our business while watching our non-essential spending and protecting our margins. In 2010, for example, we’ll add more sales reps, invest more in telesales reps, continue to invest in healthcare and product enhancements, and tweak our comp plans to ensure that we get the best possible performance from all of our employees for our company.

We don’t expect 2010 will be an easy year but the combination of our financial stability, our extraordinary business model, and our incredibly dedicated employees will make it as good a year as it possibly can be.

John and I would be happy now to take any questions or comments.

Question-and-Answer Session

Operator

(Operator Instructions) Thank you. We will now begin the question-and-answer session. If anyone would like to ask a question please press “*1”. You’ll be prompted to record your name and you will be required to introduce your question. Once again to ask a question please press “*1”, one moment please for our first question. Our first question comes from David Grossman of Thomas Weisel. You may ask your question.

David Grossman - Thomas Weisel Partners

Good morning. Thanks very much. You talk about the margin outlook being impacted by both cyclical factors as well as the investments you are making in the sales force and healthcare. Can you provide a little more color around the incremental investments that you are making? And maybe give us a sense of just how much you are actually spending on these initiatives?

John M. Morphy

Well, I don’t know we would give defined numbers but obviously the checks per client affects the margins because of the fact that last check is the most profitable check. We’ve talked before about the fact that when checks per client get much over 4%, it really starts to inhibit our ability to increase margins. The client decline affects it somewhat too, but we’ve been able to offset most of that. When you talk about the other investments though, the healthcare thing initiative, we’re processing the sales force growth, which you saw in the thing. We’re increasing sales force in both the core and the MMS and some of that is really to take advantage when hopefully this economy turns around because the other thing is we don’t want to cut our sales force because to do that would allow us to have a short-term earnings pick-up but in the long run, it would hurt us in the future.

David Grossman - Thomas Weisel Partners

Okay. And just in terms of the client growth, I know that it’s a bad year to compare this, your guidance as well as kind of what’s happened in the last 12 months. I mean, I think client growth has been trending around a 3% to 4% range prior to the economic downturn. Is that a number that we should think about going forward in terms of what’s a realistic target?

Jonathan J. Judge

Well, the thing I would tell you is, this is Jon Judge, on the client, the new client growth, the biggest single issue that we had in that was the lack of new business formation due to the credit crisis. So to the extent that the credit crisis abates and new business formation returns to a normal rate, there is nothing that we see in any of our numbers that would tell us that anything other than going back to normal would happen. In other words, we don’t see any losses that are due to a better mousetrap or somebody providing better services. Our issues on the new client growth really come from the new business formation, which as I mentioned in my comments was about 90% of the miss that we had to a normal sales year, even though we still had pretty decent year going flat versus most people down 10% to 20%. And then the second thing would be losses, an increase in client losses that are, that have been directly caused by the economy, things like businesses going out of business or getting down to either so few clients or so troubled a business economic scenario that they stop processing. Those two things were the ones that affected us, and so when you think about when we go back to normal, there’s nothing that we can see that would tell us that we would not go completely back to normal as soon as the economy changes. To the extent that the credit crisis remains, to the extent that the economy stays bad and business failures continue at these unprecedented rates, it will be a slower return than normal. To the extent that the economy turns, we’ll turn with it.

David Grossman - Thomas Weisel Partners

Thanks, John, so does that 3% to 4% sound like a more normalized number to think about in normal economic times?

Jonathan J. Judge

Yes.

David Grossman - Thomas Weisel Partners

Okay. And one last question, just really on the skew of EPS. I know you don’t really talk about that in your guidance but given the current, kind of where we are economically, does it make sense to think about the EPS skew kind of building momentum throughout the year as opposed to kind of your typical year, which would see kind of flattish sequential growth in EPS?

John M. Morphy

Normally, you’re right, it would be almost flat. Actually the four quarters are almost always identical, or there might be a penny difference. So there will be some skewing. It won’t be staggering and the best way for you to calculate the skewing is really look at the investment income difference which we disclosed in the press release and the filing with the SEC by quarter. If you run that through it would also recognize the checks per client will come back. As comparisons get easier, you can pretty much figure out what the skewing would be and I think you can come up with a pretty good estimate of it.

David Grossman - Thomas Weisel Partners

Okay and just one other thing in terms of your guidance. I think if I heard you guys right, that you talked about checks per client being down 3% and that you’ve got your price increase of 3% to 4% in for the new fiscal year. Did I hear that right?

John M. Morphy

Yes. Now, the checks per client for the year is down 2.9% and when you go next year, and we’re hoping it’s going to stabilize right where it is, when you do that, you kind of get the, you get 2.9% to 3% again, but it just happens in different places, meaning that the decrease is toward the end of the year and the bigger hurt is in the beginning.

David Grossman - Thomas Weisel Partners

All right got it. All right, thanks very much and good luck.

John M. Morphy

Thanks.

Operator

Our next question comes from Chris Mammone from Deutsche Bank. You may ask your question.

Christopher Mammone - Deutsche Bank

Hi thanks guys. I appreciate your comments about the guidance and the growth rates improving throughout the year in fiscal ’10. Do you expect though on a quarterly basis that payroll will remain in negative territory for all four quarters, or is there a possibility it could return positive by the latter part of the year?

John M. Morphy

Well, it’s certainly going to start off negative it the beginning and I think where it will wind up at the end is going to depend what the economy does. I can’t remember if we were negative in the fourth quarter but for it to get positive where it would be meaningful, you’d have to see some improvement.

Christopher Mammone - Deutsche Bank

Okay, some improvement in the economy?

John M. Morphy

Now, a lot of that, you get to a constant environment, I would not expect payroll revenue growth to be negative the following year. If checks per client were to hang in there and client growth stays around flat, we would get the positive revenue growth.

Christopher Mammone - Deutsche Bank

Okay. And then could you give us anymore granularity on the more recent I guess trends in checks? I know you did a good job in the last quarter of sort of talking about the past six weeks. Any color like that I guess to…

John M. Morphy

Well, basically I was hoping it wouldn’t have gotten to 5, but things aren’t dropping off as significantly as they were. We are seeing some stabilization. We look at the June numbers, which are really early to look at them but we think we are going to make our revenue number for the first time in our forecast in quite a while, so that’s hopeful but two or three weeks isn’t enough to indicate what’s really going to happen. So right now we are hoping it’s going to stay there. Things were deteriorating in the fourth quarter but at a much slower rate than they were and my belief, it’s a personal belief, is that if we could get the world to be a little more optimistic, which sometimes you can be so pessimistic you create your own problem, not that we don’t have a few but that could be just enough to get this thing maybe from slightly negative to slightly positive, but only time will tell.

Christopher Mammone - Deutsche Bank

Okay. Great, I guess a final question, as far as the sales force additions, if you were to, I guess instead of a scenario where we’re going to add sort of 5% to the core payroll sales headcount. If you were to keep that sales force flat, would that change what your, I guess payroll revenue growth expectation would be for 2010?

John M. Morphy

It wouldn’t affect 2010 too much but it would definitely affect 2011, because as we’ve talked before, in the year the sales force makes the sales, that’s not the biggest impact on revenue but the following year it sure is.

Christopher Mammone - Deutsche Bank

Great, that’s helpful. All right, thanks, guys.

Operator

Our next question comes from Julio Quinteros from Goldman Sachs.

Julio Quinteros - Goldman Sachs

Great, thanks, guys. Real quickly, John, if you were to go back to the comments I think you made one or two quarters ago about the drivers of the SMB segment, in particular credit card usage and things like mortgage equity withdrawals, just your sense on what your clients are doing to drive growth from here? Assuming that those two sort of sources of funding aren’t there, what are the alternatives for some of your SMB clients at this point in terms of being able to drive both sort of growth and expansion and obviously payrolls to feed their growth at this point?

John M. Morphy

Well, basically we know, we have to guess how they are getting their money. They don’t tell us how they are getting the money but I think what you’ve got to realize is how much difficulties in the world, everything doesn’t stop and people are going to find ways to move forward. And it isn’t like everybody lost all the money they had. It might feel that way sometimes. Sometimes I think the world lost more than it had but that’s not really what happens and they have got to find ways. Now, there’s pressure in America, that big is moving towards small, so eventually these people know they have to find a job, they have to do something and I think what happened is that some of these jobs, or some of this business formation doesn’t require a lot of capital. So the thing that I feel good about, I don’t maybe like the number exactly but we did sell over 110,000 new clients. That’s a staggering number in an environment like this one, so granted you are down maybe 5% to 10% but the other 90%, they find a way to do something and hopefully that will continue and hopefully it will move more towards the 100% level.

Julio Quinteros - Goldman Sachs

Got it, that’s great. And then just on the trade-offs between the investments to drive future growth versus continued pressure on the top line, at what point, and I know you guys are trying to balance longer term growth opportunities, et cetera, but at what point do you look at the plans to invest incrementally, et cetera, and say we really shouldn’t be doing this, or is this just something that you guys are going to do no matter what because it’s important for longer term growth anyway?

Jonathan J. Judge

We aren’t going to stop for investments in healthcare, the ones that matter. We made two big things we’ve been doing over the last six months and then John will add some things. One, we continued our investment in our core platform, which has now been put in service and we are in great shape on that, and the other one is healthcare. And we believe that we have a great future in front of us and we believe to curtail those investments means we will have to accept lower results in the future. Right now, everybody has got results they don’t like. We want to make sure when things are good, we get ones we do like.

John M. Morphy

I guess I would add is that we have got, we are sort of blessed with a financial stability that very few companies have. We don’t have any debt, we don’t use debt. We’ve got a rock solid balance sheet and we clearly understand where we are in our business relative to the economy and what part of our issues that we’re dealing with are caused by competitive pressures versus what part are caused by the economy. And since the majority of our issues are caused by the economy, then the wise course to take is to make sure that you stay positioned for the future. Now, relative to your question, I’m not sure exactly what you are trying to get at, but the point that I would hold up as sort of the poster child of the conservative nature with which we manage this business is you look at 2009, one of the toughest economies in the history of the United States, and we expanded our margins. So we have sort of a history in this company of we are going to make the investments but to a certain extent, we are going to self-fund those investments by stopping non-critical or non-essential things to be able to fund the things that we needed to make our business stronger in the future.

Julio Quinteros - Goldman Sachs

Got it, okay. And then just lastly, on the market share gains, are there any percentages or any ranges that you guys could think about in terms of sizing how much market share gains you guys you think have made in the marketplace? And then on new sales, what’s the pricing environment there? I think the plus 3% was on existing clients, or is that also on new clients?

Jonathan J. Judge

Well, I’ll start with the first question you have on market share. Market share is a difficult thing in this industry because there aren’t a lot of numbers published but the part that makes it a little easier is the fact that it’s an industry dominated by two big players and then it fragments down to a bunch of smaller players. And so if you kind of get a feel for what’s happening with the two big players, and we know what’s happening with the smaller regional players, it makes it easier for us to see. But things that we look at that tell us, kind of give us a clue as to where we are relative to share gain is the number of clients that we take from our biggest competitor versus the number that they take from us. We’ve been positive on that journey for a very long time and we were positive again last year. And then we look at things like what kind of discounting is being done, particularly as it relates to newer clients and we can see very clearly where they are and where we are and so for example, you know that we’ve just told you that on a year-to-year comparison, that we sold roughly the same amount of annualized revenue in 2009 as we did in 2008. I don’t think there’s anybody else in the industry that can say that. Most of them, as I mentioned, were down 10% to 20% on a year-to-year basis. So those are two pretty significant indicators that would tell you where the share thing is moving. There are other things that we look at but they are proprietary, things that we don’t talk about publicly.

Julio Quinteros - Goldman Sachs

Great, thanks, guys.

Operator

Our next question comes from Kartik Mehta of Northcoast Research. Your line is open.

Kartik Mehta - Northcoast Research

Thank you. John, you talked a little bit about your flowed income and I was wondering, what’s the best thing to look at as to when you think you might be able to invest some short-term funds in other securities that get a little bit of a higher yield? I know you’ve always wanted to stay conservative but is there anything we could look at that says you feel comfortable moving a little bit up into other securities?

John M. Morphy

I think basically it’s when the federal funds rate starts to move up, and this would happen inside a quarter, and I think we would disclose it pretty quickly when it would happen because we do it in the next press release. I don’t think we’d make a special press release for this factor but when the federal funds rate starts to move and the bank starts to work a little better, we’ll move back towards variable rate demand notes.

Kartik Mehta - Northcoast Research

If you look at fiscal 2010, are checks per client the biggest impact to revenue, either up or down as we move through the year?

John M. Morphy

No, it’s one factor. There’s, the other factor is obviously negative client growth, so the biggest three things you have going is pricing, negative client growth, and checks and then losses, both losses and sales. So those are the factors but one that’s tough on revenue per check is not that it has any bigger revenue impact. It’s just that the one that wreaks the most havoc on what you are trying to do with your margins. It’s just the most profitable check that peels off and you can’t take much cost out because that check is handled pretty easily.

Kartik Mehta - Northcoast Research

And then both of you gentlemen talked about dividends and safety and your desire to continue to pay or the board’s desire to continue to pay it. John, is there some kind of a stress where you say gosh, it might be time to look at the dividend again, or are you in a situation where the dividend, at least for the foreseeable future, is in pretty good shape?

Jonathan J. Judge

I would say more the latter but we always tell you that this is a board decision, not a management decision. We obviously have an opinion on it. We make recommendations to the board but the board makes those decisions. What I would tell you from the conversations that we’ve had over dividends on the board is that we believe that it’s one of the hallmarks of our financial stability and our financial model and it’s something that we definitely want to maintain, so I’ll start with that. From the standpoint of stress, I mean, if we ever got ourselves into a position where our financial model was stressed and we needed to make a change to the dividend, I’m sure there would be a lot of discussion about that. But if you think about our capital structure, I mean, the fact that we have no debt, that we have a fairly large amount of cash on our balance sheet, that we are cash flow positive and we’ll remain cash flow positive, it’s sort of hard for me to see a time anytime soon where we’d even be having that discussion. So I don’t, there’s nothing in the near-term that would tell me that we are going to be stressed to the point where we would have to start considering things such as decreasing our dividend. So that’s sort of where we are but again, it’s a decision that’s always one that’s held to the purview of the board, but I think I’ve given you some insight in terms of where they are, about how they feel about the dividend and certainly how the management team feels about it.

Kartik Mehta - Northcoast Research

And then a last question was I think last quarter we talked a little bit about discounting and what was happening in terms of new sales. Has the environment changed at all, or has it remained about the same for new sales?

Jonathan J. Judge

Over what time period?

Kartik Mehta - Northcoast Research

I guess in the last three, four months, have you seen a change in how your competitors are discounting their product? Have they gotten more aggressive? Has it been relatively the same or do you think it’s gotten a little bit better?

Jonathan J. Judge

It’s gotten a little bit better but I mean, part of that you have to be careful with because in our business, particularly as it relates to core, the majority, not the majority but 25% roughly of a year is in a couple of months, November/December, December/January, and so during that period is when you tend to, if you are going to see any kind of significant moves in discounting from competitors, you tend to see in that period. We did see it this year. We’ve talked about that already. Whether that’s in just hard discounts on the dollar basis or whether it’s in giveaways in terms of free service for three months in the front-end and three months in the back-end of the year, or commitments over long-term price freezes or price movements that are restricted and all of that stuff we saw during the selling season, there’s still some of it that we’ll see from time to time but it’s nowhere near as severe as it was during the selling season but that would also be normal. This year was not normal. There was more of it than we’ve ever seen before and it was more national than we’ve ever seen it before. But that’s when we typically would see it, and so it’s natural that it would taper down once you walk out of those important months.

Kartik Mehta - Northcoast Research

Thank you very much.

Operator

Our next question comes from Jason Kupferberg of UBS. Your line is open.

Jason Kupferberg – UBS

Thanks guys. I wanted to ask a little bit of a longer term question, I guess. Do you think you get back to your traditional financial target model of 12% and 15% kind of thing, with 15% being the operating income excluding float? I mean, can you get back to that on any kind of sustainable basis? I mean, once the whole cyclical downturn is over, what are your thoughts there?

Jonathan J. Judge

Well, I will give you mine and I’ll let John give you his. If you listen to what we told you about what drove us off of our normal environment and our normal environment is a 12, 15 environment. They were all issues that were around impacts from the economy. So if the economy goes back to where it was then there’s nothing that I could see that would tell us that we wouldn’t go back to where we were. Now there’s always, each year it gets a little bit harder, right? We’re not a baby company. We’re a pretty large company and so each year as you get more penetration, it gets a little bit harder but we’ve gone a lot longer than I think anybody thought was possible for a company of our size that has got a top line of 12 and a bottom line of 15, and the model that we have that gets us there is still a realistic model. So from my vantage point, if we were back in a normal economy, we wouldn’t be having the tone of this conversation that we are having nor would you be having it with all the other companies in the United States. It would be a much different environment versus, you know, if there was a major shift in buying patterns in the United States or somebody created a better mousetrap and they were stealing share from us, then you would have a different scenario.

John M. Morphy

Yeah, I would add I don’t think the economic conditions we are experiencing today are what puts that model in jeopardy, and the biggest issue on the model I think as we get larger, it gets harder but I think people have to recognize 12, and it really isn’t the 12 to 15 that’s the hard part. The hard part is getting the 12. If you get the 12, the 15 will happen and you can probably get to the 15 a little less than the 12 but the real question is going to be as we cross over this $2 billion mark and you get a little better idea on what’s going to happen in some of these other areas, you know, as revenue growth somewhere between 10 and 12 and right now, I think we feel pretty good that it can be definitely double-digits and how high you go, who knows.

Jason Kupferberg – UBS

So the key really becomes to expand your whole set of ancillary offerings and things like insurance, et cetera? I mean, it sounds like that is what you would need to do because arguably in core payroll, things are a lot more mature than they were years ago and there is still some incremental growth with new business creation, right? But not a huge secular trend, arguably. Would you agree with that?

Jonathan J. Judge

That’s right but it’s also been our model for a fairly long period of time now. I mean, core payroll has been growing in single digits for a fairly long time and our model at the 12 and 15 assumes that a part of our business will grow at one level and then we’ll get other parts of our business that will grow at much greater levels than that, albeit they are smaller businesses and we’ll continue to add things. So for example, in the last two or three years, we’ve decided to get into the health insurance business and that business is now a $20 million business on its way to a $100 million business. What we have to do is keep finding those types of things that will help keep moving the needle, the combination of the different revenue mixes to keep us at the double-digit level and that’s what we work on every day. So you can call it ancillary because I guess in some respects, it is ancillary but when you have a business as large and as successful as our core payroll business, the only thing that keeps the whole company from growing at that level is that we continue to push other services and put new products in place and continue to grab share and so on and that’s essentially our model.

Jason Kupferberg – UBS

And just two questions on fiscal ’10 assumptions, one what are you assuming in terms of new sales growth? And two, are you assuming that the full 3% to 4% price increase, if all of that actually sticks throughout the year?

John M. Morphy

Well, the price increase, most of it will stick. I mean, basically you get some resistance in some areas but once the price increase goes in and it pretty much sticks on existing client base and as the discount that took place and new sales comes up, we recover a fair amount of discounting each year, so I don’t see that as an issue. What was the other assumption?

Jason Kupferberg – UBS

In terms of new sales growth, I guess you were down slightly year over year.

John M. Morphy

New sales growth, we think will be slightly better but that’s because we added sales reps. We are not looking for anything dramatic to change.

Jason Kupferberg – UBS

Okay. And just last question, MMS, I mean, over time, I mean, how big could that get as a percent of your revenue?

John M. Morphy

Well, it’s going to keep growing faster than core, simply because this is an opportunity that we’ve probably only been able to take full advantage of for five years. We are growing well before that but the part of the market that we weren’t in until the late 90s and today we have products that compete very well and we are aggressively pursuing on making them better. If you noticed, most of the acquisitions we have made either relate to the human resource side or improving MMS and we are seeing some really great results as the result of adding these full service elements, whether its expense things or health things, et cetera. So we are very viable, a very good competitor and fortunately our share of the market isn’t as, it’s getting bigger but it’s not that big.

Jason Kupferberg – UBS

Okay. I’ll leave it there. Thanks, guys.

Operator

Our next question comes from Rod Bourgeois of Bernstein. Your line is open.

Rod Bourgeois - Sanford C. Bernstein

Yeah, Rod Bourgeois here. I hope this is more than semantic question, or maybe it’s a semantic question that should really matter but I think you noted that the deterioration in your key metrics in the May quarter was a slower amount of deterioration than what you were seeing earlier. But when I look at the payroll revenue growth, it looks like it went from plus 1.9% in February down to negative 4.8% in May, which is a pretty big turn in that core business, so is there, how do we think about the key metrics are declining at a less rapid rate but the payroll revenue growth kind of dropped off at an unprecedented sort of pace?

John M. Morphy

Because the selling season is so big in the February quarter, so the real impact of that selling season and losses became full force in the fourth quarter.

Rod Bourgeois - Sanford C. Bernstein

Got it all right, so that explains it, and so what that would imply is that there’s no way you are going to see a similar amount of sort of fallout in payroll revenue growth in the next couple of quarters because you’ve already digested the impact of the weak selling season?

John M. Morphy

Yes, I don’t think it gets significantly worse than it was. I can’t remember by quarter but a lot of the quarterly impact relates to investment income in checks, with investment income getting a good chunk.

Rod Bourgeois - Sanford C. Bernstein

Okay, great. And it looks like one of the metrics that’s been troubling of late is client churn going up and I assume that the increase in client churn is mostly because of bankruptcies but can you quantify how much of the increase in churn is due to bankruptcies and kind of out-of-business activity versus competitive factors that might also be playing a role?

John M. Morphy

Well basically, 60% to 70% of our churn is in this bankruptcy out of business and that hasn’t changed too much. You see a little bit more on price but that’s, sometimes that’s somebody not wanting to tell you they just can’t afford it anymore. The competitive factor though is one that we think we are gaining share. So when people want to look at this and think are we giving up share to hold price, that’s not the circumstance and Jon can talk a little bit here about how we work with the sales people and what they are doing but we know we’re the price leader but it isn’t like we will never bend. We do what we need to do but we think we’re okay.

Rod Bourgeois - Sanford C. Bernstein

Okay. Are you in some cases giving up price to sort of gain share or is that not necessary because your product set is sufficient to drive the share gains?

Jonathan J. Judge

No, we’re not, we don’t lead with price. I’ll use core as an example. Core price position to market, we are comfortable selling normally somewhere in the 20% to 25% higher than competition, mainly because our offering is that much better than competition and gaining share as we do that. So we don’t lead with price. What we will do though is if we are confronted with price, then in most cases unless it’s just a crazy eddy kind of a thing, in most cases we’ll meet competition but we don’t lead with trying to drive the price down. So we won’t allow share to be taken from us with price as the issue but we won’t use price to gain share, or we haven’t used price to gain share. We use our service and our feature functionality and our people to be the thing that differentiates us in the market and it’s been pretty successful for a pretty long period of time.

Rod Bourgeois - Sanford C. Bernstein

All right, that’s helpful. And if you think about pricing with existing clients, just to ask a scenario here, if your client retention were to struggle further with your existing clients, would you consider more aggressive pricing as a way to counteract the impact of the weaker client retention?

John M. Morphy

Okay, first off, what’s unique in this business is very few clients switch over price. They usually switch because they are dissatisfied with the service. A price differential on what this costs doesn’t drive that much switching. Now, when a client gets in a situation where they may talk to us about this, we are responsive. It doesn’t mean when an existing client calls up with a pricing concern, we ignore them. We listen to them. We do what we need to do. We do what is right for us and them, and we work it out but it’s not as conflictive as you might think.

Rod Bourgeois - Sanford C. Bernstein

Got it, it makes sense because a lot of the clients aren’t really looking for price because it’s not a big item.

Jonathan J. Judge

Well, remember the numbers, the thing that people often forget. I’m not suggesting you are, Rod, but what people often forget when you are dealing with small and medium-sized clients and in our case the majority of our clients are small clients, is that if you look at percentages, it tells you one story. If you look at the actual number itself, it tells you another. So for example, if we are selling at $2,500 and a competitor is selling at $2,000, you might say that’s a 20% difference but $500 spread over 26 pay periods becomes, spread over X 14 employees per pay period, it becomes a very small number. It’s not typically the thing that will drive a client one way or another. It’s much more about the service they are receiving, the experience that they are getting and quite frankly, the peace of mind and the guarantees that come from a company like ours which if there ever was a mistake made that generated any type of penalty, we pay it flat out, no discussion. So it’s really, it doesn’t get to be that big a deal.

Rod Bourgeois - Sanford C. Bernstein

All right, that makes sense. But that said, I mean, it’s pretty clear that discounting activity with existing clients has increased in the last year. Is there a way to quantify how much discounting has actually changed in the last year with existing clients?

Jonathan J. Judge

I’ll let John answer that if he chooses to but before he does, there’s an important notion that I want to make sure you understand. The increase in discounting was not originated in Rochester.

Rod Bourgeois - Sanford C. Bernstein

I understand that too.

Jonathan J. Judge

We react to it.

John M. Morphy

Now, you also have to realize that the discounting pressure is like 95% on new business as opposed to existing.

Jonathan J. Judge

It’s probably higher than 95.

Rod Bourgeois - Sanford C. Bernstein

Okay. In terms of the economic consequences, or in terms of the percentage of the --

Jonathan J. Judge

No, the activity.

Rod Bourgeois - Sanford C. Bernstein

Okay.

Jonathan J. Judge

The activity is almost exclusively on the point of sale of new clients. It’s not existing clients.

Rod Bourgeois - Sanford C. Bernstein

Okay.

John M. Morphy

To give you a better perspective, and we talked about this before so I’m not saying anything we haven’t talked about, we know who the other big guy is. We know how many clients we lose to them a year and we know how many we get from them. And there isn’t appreciable change in those numbers.

Jonathan J. Judge

Well, more importantly the number that we take is larger than the number we lose.

Rod Bourgeois - Sanford C. Bernstein

Got it, and that is also true in the mid-market segment? I mean --

John M. Morphy

No, in the mid-market, we take, we don’t even, I think we track that. I haven’t looked at it. We get way more from them than they get from us.

Rod Bourgeois - Sanford C. Bernstein

Right.

John M. Morphy

And we add more.

Rod Bourgeois - Sanford C. Bernstein

All right, guys, thank you for your help on that.

Jonathan J. Judge

You’re welcome.

Operator

Our next question comes from Jim McDonald of First Analysis. Your line is open.

Jim McDonald - First Analysis

Morning guys. Can we talk about what seems to be more of a bright spot, the HR area, where it looks like your employee growth bounced back a bit this quarter and could you talk about where that came from, that re-increase and maybe why there was a decrease last quarter?

John M. Morphy

Well, the last quarter was just small business really reacting in that January timeframe. Now you get back to where there’s a little more seasonal employment as you head into the summer, so we’ll see if it continues but it was a bit of a bright spot but we are cautious on bright spots right now but we’ll take what we can get.

Jim McDonald - First Analysis

But was it, since this could cover a lot of different areas, was this all in Florida or was it in…?

John M. Morphy

No, it probably was spread everywhere.

Jim McDonald - First Analysis

And was it in the comprehensive and PEO business or was it in other kind of ancillary services that are in the HR sector?

John M. Morphy

No, it would be pretty much in the premier, I think.

Jim McDonald - First Analysis

Pretty much in the premier, and what about, could you talk about COBRA outsourcing impact in the quarter?

John M. Morphy

Too small for us to matter.

Jim McDonald - First Analysis

Okay. Thanks very much.

Operator

Our next question is from Gary Bisbee of Barclays. Your line is open.

Gary Bisbee - Barclays Capital

Good morning. I guess the first question I just want to be clear on what’s baked into your guidance in terms of the economy. When you made a comment that checks per client seemed like it was maybe stabilizing or bottomed, I guess is the word you said, so does the guidance assume that it stays at the current level and does the year-over-year comparisons ease as you get through the rest of the year, or do you have some sense baked in there that we’ll continue to see job losses on a monthly basis?

John M. Morphy

No, basically what we bake in is we look at where we are and we take the trends that are happening. We don’t make trends get better and we probably don’t make them get worse, so we take checks per client, it’s a very good one. We forecast the next year based upon the fact that checks per client are bottomed out around five. Now, could it be slightly worse? Maybe, but it wouldn’t have made it much better either. Now, if we continue to get further deterioration from this point, obviously it affects us. If we get what we hope is improvement, it will affect us positively. And the reason we do that is we have no way of totally forecasting what’s going to happen, so if I make a guess, then you’ve got to try and guess what my guess is before you put your guess on it because you are going to probably spin it somewhat, which is okay. So basically we are trying to give you a basis of where we are so you can determine what you think is the right or wrong answer? Now, you also have to recognize that a slight change in this stuff doesn’t affect us too much. So basically we’ve got a plan and we work around our expense controls and if we missed a little bit of revenue, we’ll find it but sometimes the water coming over the dam is just too much that you can’t do much about it. But that’s kind of what happened this year eventually but we’re hopeful next year that things will stay stable enough that we’ll manage the business and we’ll be right on the guidance we gave you.

Gary Bisbee - Barclays Capital

Okay, and then the guidance seems to indicate that the interest rate you earn on the float is going to continue to ease somewhat sequentially as we move into the second half of the year. Is that just the…?

John M. Morphy

It only eases because my interest rates dropped like a rock after basically September and they kept dropping. So while that’s not any easing, that improvement in interest, on our interest thing is baked in. It will happen unless rates go lower, and I don’t know how they can go any lower. I mean, zero is zero.

Gary Bisbee - Barclays Capital

And I know it’s not big deal in the grand scheme of the revenue guidance but you mentioned a quarter ago that $60 million was likely the floor, the float income. It looks like the guidance is at least $5 million below that.

John M. Morphy

Rates got a little lower. I didn’t think they could go lower but they did.

Gary Bisbee - Barclays Capital

Okay. And then just two clean-up questions, if I could, the $20.9 million in health insurance revenue that was the full-year number, right? Or was that just the --

John M. Morphy

Yeah, full-year.

Gary Bisbee - Barclays Capital

So a quarter ago, yeah, so a quarter ago when you said $14.8 million, that would have been the year-to-date through nine months?

John M. Morphy

Yes.

Gary Bisbee - Barclays Capital

Okay, and then the last one, the $12.4 million of revenue in HRS from the plan restatements, retirement plan restatements, is this more of a one-time thing? Is that why you pointed that out or was there some the prior year and is there going to be some of that this coming year too?

John M. Morphy

Totally one-time.

Gary Bisbee - Barclays Capital

Okay, so that’s a big reason why the guidance for revenue growth there would be much lower. You had a benefit the last couple of quarters from that, that’s pretty much it?

John M. Morphy

Absolutely.

Gary Bisbee - Barclays Capital

Okay, thanks a lot.

Operator

Our next question comes from Mark Marcon of Robert W. Baird. Your line is open.

Mark Marcon - Robert W. Baird

Good morning. I just wanted to follow-up on the HRS side. Can you talk a little bit more about the guidance in terms of the 3% to 6% growth? And also what your plans are for the sales force there and is there anything that’s happening aside from the macro environment that might lead you to believe that things are going to slow down relative to the growth that you’ve experienced all along the HRS side?

John M. Morphy

I’ll take the guidance and Jon can talk about the sales force. Basically the guidance is our best estimate right now of what we think is going to happen. We have not put out aggressive goals. When you look at the sales targets, we’ve not made this belief that all of a sudden this is all going to bounce back. You know, obviously in the 401K market where we are the leader that market is under some duress now because people aren’t quite sure what’s going on but we still do sell 401K plans. So the HRS revenue guidelines