Paychex F3Q07 (Qtr End 2/28/07) Earnings Call Transcript

Mar.29.07 | About: Paychex, Inc. (PAYX)
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Paychex Inc. (NASDAQ:PAYX)

F3Q07 Earnings Call

March 29, 2007 10:30 am ET

Executives

John Morphy – SVP and CFO

Jon Judge - President and CEO

Analysts

Craig Peckham - Jefferies

Brandt Sakakeeny - Deutsche Bank

Adam Frisch - UBS

Brian Keane - Prudential

Tim Morly - A.G. Edwards

Charlie Murphy - Morgan Stanley

David Grossman - Thomas Weisel Partners

T.C. Robillard - Bank of America

Gary Bisbee - Lehman Brothers

Mark Marcon - Robert Baird

Greg Smith - Merrill Lynch

Jeremy Davis - Credit Suisse

Sanil Daptardar - Sentinel Asset Management

Liz Grausam - Goldman Sachs

Franco Turrinelli - William Blair

Rod Bourgeois - Sanford Bernstein

Presentation

Operator

Welcome and thank you all for standing by. (Operator Instructions) I would now like to turn the call over to Mr. John Morphy, Senior Vice President and Chief Financial Officer. Sir, you may begin.

John Morphy

Thank you for joining us today on our third quarter earnings release. Also with us is Jon Judge, our President and CEO. The teleconference call will be comprised of three sections: a review of third quarter 2007 financial results, including comments and guidance for full year 2007; an overview from Jon; and lastly, a Q&A session.

Yesterday afternoon after the market closed, we released our financial results for the third quarter ended February 28, 2007. This press release can be obtained by accessing our website at the Investor Relations page. We have also filed our Form 10-Q with the SEC, which provides additional discussion and analysis of the results of the quarter. This filing is also available on our website.

In addition, this teleconference is being broadcast over the Internet and it will be archived and available on our website until April 30, 2007. Please refer to our website for access to all recent news releases, current financial information, SEC filings, and our Investor Relations presentation that will be updated next week or so.

Third quarter was another excellent record setting quarter for Paychex. Total revenue was up 13%. Payroll service revenue grew 8%. Payroll revenue growth was slightly lower than normal, primarily due to year-over-year growth on year end type revenue, such as year end reports and W-2's not being quite as strong as last year when payroll revenue growth was very strong at 10%. We anticipate the fourth quarter will be in the slightly over 9% range. As mentioned before, quarter-over-quarter revenue growth can bounce around. It is not always indicative of full year results.

Human resource services revenue increased 25% to $102.2 million as we crossed the $100 million in a quarter threshold for the first time ever. We continued to leverage our revenue growth with operating income growing faster than revenues; operating income excluding interest on funds held for clients; stock-based compensation costs; and the increase to our litigation reserve, increased a strong 18% to $155.3 million for the three months ended February 28, 2007. On a year-to-date basis, the same calculation is at 15% year-over-year growth and accompanied by our 12% growth in total service revenue puts us right on our stated long-term growth formula.

During the third quarter, we made significant progress in finalizing the rapid payroll litigation as we received court approval to discontinue all licensing operations and reached a settlement agreement that reduced the number of open cases to two. The litigation is related to our acquisition of Rapid Payroll in the mid 90's.

At that time, we inherited licensee contacts that provided for no price increases nor expiration dates. In 2001, we sought to end these contracts and wound up in litigation. Other than the cost of settlement, this litigation had little or no affect on the past or future operations of Paychex. Diluted earnings per share of $0.33 reflects a reduction of $0.02 per share related to our increasing our litigation reserve by $13 million in the third quarter of fiscal 2007.

We will now refer to the consolidated income statements. Again, payroll service revenue increased 8% and 9% for the three and nine months ended February 28, 2007 to $345 million and just over $1 billion. This growth was again driven primarily by growth in clients, pricing, check volume and increased utilization of our ancillary services. Our key indicators on payroll growth, including checks, continued to be at stable levels and strong.

As of February 28, 2007 92% of all clients utilized our payroll tax administration services and 70% utilized the employee payment services. More than 75% of new clients utilized our employee payment services, including direct deposit, access cards and Readychex. Human resource services revenue increased 25% and 24% for the three and nine months ended February 28, 2007 to $102 million and $290 million.

The growth was generated from the following: retirement services client base increased 15% to 43,000 clients. Comprehensive human resource outsourcing services increased our base of served client employees 30% to 350,000 client employees, and our workers compensation client base increased 16% to 59,000 clients. Additionally, the asset value of retirement services client employee funds increased 24% to $7.6 billion.

Interest on funds held for clients increased 31% and 41% during the three and nine months ended February 28, 2007 to $38 million and $97 million. The increases in interest on funds held for clients were due to higher average interest rates earned and higher average investment balances. The average interest rate earned on funds held for clients has increased to 4.0% from 3.1% a year ago. The effective increasing average interest rates is expected to end in the first quarter of fiscal 2008 as the federal funds rate has remained unchanged since June 29, 2006. Please refer to our Form 10-Q for further information on the effective interest rates on interest on funds held for clients.

Consolidated operating and selling, general and administrative expenses increased 16% for the three months and 14% for the nine months ended February 28, 2007.

Our stock-based compensation costs, including compensation-related expenses, were $7 million and $19 million for the three and nine months ended February 28, 2007. Excluding stock-based compensation costs and the $13 million to increase the litigation reserve, total expense growth would have been 8% and 10% for the three and nine months ended February 28, 2007.

The growth was the result of our continued investment in personnel and other costs related to retaining clients, promoting new services, and creating more efficient systems for selling and servicing through new and enhanced technology.

At the end of the quarter, our employees increased 7% from 10,700 employees a year ago to 11,500 employees.

Investment income, net increased to 65% and 78% for the three and nine months ended February 28, 2007 to $10 million and $30 million. This was due to higher average interest rates earned and growth in the average portfolio balances resulting from investment of cash generated from our ongoing operations.

Our effective income tax rate was 31.0% for both the three and nine months ended February 28, 2007, compared with 31.4% for both the prior year periods. The decrease in our effective tax rate is attributable to higher levels of tax exempt income derived from municipal debt securities held in our funds held for clients and corporate investment portfolios, and a lower effective state income tax rate partially offset by the non-deductible compensation related to incentive stock option grants.

We'll now move to the balance sheet. Cash and total corporate investments were $1.2 billion as of February 28, 2007. Our cash flows from operations were again strong at $532 million for the nine months ended February 28, 2007, an increase of 16% or approximately $74 million from the same period a year ago. Last October, we increased our dividend by 31% and we'll continue to evaluate the best means for Paychex and its shareholders to benefit from our exceptional abilities to generate cash.

Our total available for sale investments, including corporate investments and funds held for clients, reflected net unrealized losses of $6 million at February 28, 2007, compared with net unrealized losses of $22 million at May 31, 2006. The change in the unrealized loss position is due to decreasing yields that increase the fair value of the company's investment portfolio. The three-year AAA municipal securities yield decreased to 3.60% at February 28, 2007 from 3.65% at May 31, 2006.

Activity in our net property and equipment balance during the first nine months of fiscal 2007 reflected capital expenditures of approximately $61 million and depreciation expense of approximately $42 million. Client fund deposits as of February 28, 2007 were $3.5 billion, as compared to $3.6 billion on May 31, 2006. Client fund deposits vary widely on a day-to-day basis, with the average balance increasing approximately 7% for the three and nine months ended February 28, 2007.

The growth in client fund deposits of 7% is less than the 12% we experienced a year ago due to several factors: fiscal 2006 benefited from a more favorable calendar related to the day of the week the tax due dates occurred. For example, the 15th or 30th of the month falling on a Wednesday produces four more float days than when falling on a Tuesday.

The $100,000 of federal tax withholdings in a single pay periods require a next day deposit of the withholdings and $50,000 of federal tax withholdings in the prior 12 months requiring weekly deposits has not been revised since 1994. Inflation has taken its toll as the average sized client still on a monthly deposit frequency has reduced to approximately 13 employees. In summary, more of our clients are becoming weekly payroll tax filers.

The fund balances benefit Readychex was not as great as in prior years, as the growth of this product is now much closer to that of direct deposit. Readychex is a service whereby we pay client employees with checks drawn on Paychex's bank accounts. So basically, when we look at the float balances being seven versus 12, we have looked very hard at this and have found three very good reasons for the change and we believe that the fund balances growth level of about 8% is probably more realistic on an ongoing basis.

Total stockholders equity increased to $1.9 billion at February 28, 2007 with $221 million in dividends paid in the first nine months of fiscal 2007. Our return on equity for the past 12 months was 29%.

Our current outlook for fiscal 2007 remains virtually unchanged from the guidance provided on June 28, 2006, except for revised guidance reflecting the last increase in the federal funds rate on June 29, 2006. Payroll service revenue growth is projected to be in the range of 9% to 11%. Human resource services revenue growth is expected to be in the range of 20% to 23%. Total service revenue growth is projected to be in the range of 11% to 13%.

Interest on funds held for clients is expected to increase approximately 30% to 35%. Total revenue growth is estimated to be in the range of 12% to 14%. Corporate investment income is anticipated to increase to approximately 55% to 60%. Stock-based compensation costs will be primarily included in selling, general and administrative expenses and are expected to be in the range of $25 million to $30 million.

The effective income tax rate is expected to approximate 31.0% and net income growth is expected to be in the range of 13% to 15%.

I will now turn the meeting over to Jon Judge, who will provide his comments on the third quarter before we open the meeting for questions.

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Jon Judge

Thanks, John. I'll just add a few comments and then open up for Q&A. As John pointed out, we were pleased with how the quarter played out. It was another record quarter for the key financial drivers. Revenue performance was solid, with payroll services revenue at 8% growth against a pretty tough compare. HRS revenue at 25% growth. Operating income growth at 18%, excluding the normal items of interest in client funds and stock compensation litigation reserve, was very strong there. Diluted earnings per share of 35%, less the 2% that John mentioned for the unusual charge for the litigation reserve, was right on target. Our expense management was excellent as was margin protection. So, we were pleased with our financial performance.

But there were other reasons for our positive feelings about how our nearly 12,000 people performed. The third quarter is a very important quarter for us and one where it's imperative that we perform well if we're to have a good year. It's our clients' year end, so there's lots of important processing and service delivery work to be performed. It's the most important quarter from a sales volume standpoint, especially December and January. It's the quarter where we put on the most number of new clients because of January and the new calendar year. From a P&L standpoint, it'll usually determine whether or not we can deliver the full year performance at our stated guidance. So in short, while it might seem like just another quarter, it's not. We actually have a lot riding on how we perform in the third quarter.

With all that said, let me comment on why we feel so positive about the results our team put forward. We had one of the most successful and least eventful client year end closings that we've ever experienced. Year end processing was near flawless. We delivered almost 11 million W-2's and both the core and MMS customer bases we delivered those W-2's a week or more early.

Year end payroll processing, year end bonus payments, tax withholding, tax filings and so on all went incredibly well. We have a very rigorous and a very formal set of year-end processes that get us and our clients through the year end processes, including a few weeks of daily national conference calls that hook up our 100 plus offices to a national project office that monitors all key milestones and deadlines, as well as capturing and resolving any and all issues or problems. In anyone's recent memory, it has never run more smoothly.

We are really proud of the work and the results that our operations team accomplished. And by the way, they did this in addition to having a terrific year end close, the operations team also continues to perform extremely well against their normal business metrics.

Client retention is at an all time high and we project it will finish at record levels once again. Client satisfaction continues to defy gravity and rise even higher. Payroll specialists turnover is much improved and the number of senior payroll specialists is up very nicely, which impacts both our productivity and our client satisfaction, not to mention our employee satisfaction.

On the sales front, our team performed well. December and January are critical months for us. We can do as much as 25% of the full year sales volume in a single month. All three of our sales divisions -- core, MMS and HRS -- came through the quarter in good shape and are definitely in the hunt for another good year. And just as we've done in prior years, we've released early new hires to the sales team management so they can be assured of starting the year at full strength. So hopefully, that gives you a flavor for why we're proud of the efforts and results our employees achieved in the third quarter.

Looking forward, we remain bullish on our prospects. The economy looks fine to us, our offerings portfolio is strong and we work every day to make it stronger, and our execution remains at very high levels. As John pointed out earlier, we're reconfirming our full year guidance.

Let me close my comments on a high note for the Paychex team. We were recently honored by Business Week magazine when they selected us as one of the 50 Best Managed Companies in the United States. Our ranking was number 40 and we were obviously pleased with that, especially since we had nothing to do with it other than generate pretty good results. This is not an award one applies for.

I think you know that our Company was cited for some other important awards this year. Fortune picked us one of the Top 100 Companies to Work For. Our rank was number 70. Computer World picked us as one of the best 100 Companies to Work for in the Information Technology Sector. Training Magazine picked us as one of the Top 125 Companies for our training organization's results and that's a global recognition, so, Top 125 in the world. Fortune picked us as one of the Most Admired Companies, in fact we were picked in the top five in the financial services industry.

So, the recognition is something that we're honored to receive, not for the sake of the recognition, but rather because it reinforces to our managers and our employees and our shareholders that the things that we're working on are the right things and that the results that we're achieving are in some small measure being appreciated.

With that, I'll end my comments and open it up to any questions you might have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Craig Peckham – Jeffries.

Craig Peckham – Jeffries

Hi, John Morphy, thanks for some of the explanation on the rate of growth in the payroll services line. I wondered if you could elaborate a bit, is there any correlation between the rate of growth in payroll service revenue in this quarter and your comments on what's happening with balances?

John Morphy

No, because the float income basically is not in payroll service revenue and the balances in filing frequencies don't really affect our revenue or profitability other than the floating coming back.

Craig Peckham - Jefferies

Could you give us an update in terms of what's happening on the health care front?

John Morphy

The health care front is going pretty much exactly as we planned it to be. We're in the process of building out our sales teams and building out the back office support systems for it. It's going extremely well. I would say that our early experiences would absolutely reconfirm that this is one of the brightest opportunities that we have in front of us and one that we are going to pursue extremely vigorously.

Craig Peckham - Jefferies

I suppose it's too early to give us any revenue statistics there though?

John Morphy

That would be correct.

Operator

Your next question comes from Brandt Sakakeeny - Deutsche Bank.

Brandt Sakakeeny - Deutsche Bank

Just in terms of the 8% payroll growth, maybe John or Jon, if you could just highlight again a couple issues that maybe resulted in that this quarter? Also, your confidence that you'll achieve the 9% to 11% target in the payroll growth for the full year? Thanks.

Jon Judge

First, you've got the guidance 9% to 11%, that says something. I just mentioned we believe the fourth quarter is going to be slightly over 9%. Basically, the third quarter is an unusual quarter for us because it's kind of our year end. Not the accounting year end but the client year end and year-over-year reporting can vary different. And we have to make accruals going into the quarter based on W-2's and other things. It doesn't take much year-over-year on some of that unusual to be different to drive the number down.

So, a year ago we got strong 10% growth because those year-end things more went our way and this year a couple didn't go quite as strong as they did in the prior year so, it's affected the growth number a little bit in the quarter. But we've looked at our forecast and we believe it's going to be right back to a little above nine in the fourth quarter. I think it's just a one quarter thing.

Brandt Sakakeeny - Deutsche Bank

Right. And I guess number two is, clearly Ceridian is having some issues, more on the stock front. Have you seen in your major market segment any fallout from the noise around that or is it sort of business as usual there?

Jon Judge

Ceridian is an interesting company, one we rarely see in the marketplace. They tend to focus much more on the high end customers, in many cases the customers that we don't go after. They have obviously a much larger international operation. So, there is a bit of a soap opera going on in the boardroom over right now but in terms of the impact in the marketplace, we really rarely see Ceridian and that hasn't changed with the recent problems that they've had.

Brandt Sakakeeny - Deutsche Bank

Great. And finally, just in terms of the cash flow, it is continuing to build nicely on the free cash flow. I know you have historically liked or had a preference for dividends. Any new thoughts on buy backs or is dividends still the preferred way of returning cash?

Jon Judge

We still have a definite preference for dividends. The thing I think we will look at aggressively, and I can't speak for the Board because the Board approves the dividend but last October we put a healthy increase on there of 31%. I wouldn't say we have any limit on a percentage of earnings we will pay out. So, we'll continue to look at that. Also, we did the bigger dividend to see what reaction we got. And when they asked me what reaction did we get I'm going to say a very, very positive one. Most shareholders like the fact we upped the dividend and they appreciate what we did. And they really recognize we have great cash flow producing abilities and we've got to look for ways to really get more benefit from that. So, I think we're in good shape.

Operator

Your next question comes from Adam Frisch - UBS.

Adam Frisch - UBS

John Morphy, just a quick clarity on the payroll growth. The 9% that you're calling for the fourth quarter, is that the total line item or does that exclude major market and other payroll?

John Morphy

Payroll service revenue. That's the only revenue number we give you.

Adam Frisch - UBS

On the three main components of revenue growth -- pricing, ancillary and clients -- have there been any changes there that you've seen? Jon Judge spoke to a strong market and you're really pleased with the quarter but were there any kind of changes in those three main drivers of the top line?

Jon Judge

We stay within our parameters. And you have to recognize, when we look at that growth formula, the client growth really can range from 3.5% to a beautiful 5%, though it wouldn't be in the imminent future, although we'd like to keep pushing for it. Pricing is generally around 4% and probably the more consistent and ancillaries are the same thing. They really can range from 3.5% to as many as much as 6%.

Lately, the client growth has been the one that's been not quite as strong in that formula, but the ancillary has been more than making up for it. So far, I think we're still pretty close on the revenue model.

Adam Frisch - UBS

John, you answered a question about the healthcare initiative from Craig's question. But anything substantial on the 401-K side, any new initiative you have going on over there?

John Morphy

401-K is playing out very well. We talk to you about the investments that we made to create what we were calling multifund at the time, which is a capability in-house to essentially be able to take on any 401-K recordkeeping from any new clients that we bring on or existing clients in the install base. We have been very pleased with the reaction that the markets had to that, particularly in things like the guided choice offering.

We've essentially gone from a pretty, not to offend any of our partners before we went to multifund, but a pretty plain vanilla set of offerings with a handful of management firms that we are working with to essentially a wide open space. The reaction from the client base and particularly the new clients has been very good. I think that this is going to be another winner for us over time. It takes a while to build these things up but the reaction has been very strong and we were happy with that obviously.

Adam Frisch - UBS

Timing on the dividend, you seem to be giving a good indication that maybe you guys can increase it. Would that be another October decision?

John Morphy

Usually it's October and that's kind of been our tradition, whether that would change, that would be really up to them.

Adam Frisch - UBS

Finally, just on the client growth, you said it's a little bit at the lower end of where you kind of model it.

John Morphy

It varies inside the range of where we model it.

Adam Frisch - UBS

Right. But you said it was a little bit on the weaker side but being held by ancillaries for the overall. Hiring and sales, what's your timeframe there and expectations in terms of quantity?

John Morphy

Basically, the new hires, we released those a little while ago so, we'll be at the full force when we go there. But the actual number of people, the finalized number for sales force, hasn't been decided yet and we will give you that when we do the June disclosure. It also varies on where we are. If we have some areas that are at full strength and they're going to open the year at full strength with all territories covered, then they obviously don't need new hires. Others where we project that we might have some openings would. So, that part will vary.

The main part of the message, though is we'll continue to do the work that we do to determine what we want to do with the territories, where we're going to add new territories and so on. But the release of the new hires is just to make sure that when we start the year that we're at full strength and ready to go.

Adam Frisch - UBS

Maybe a better way to ask the question is do you guys feel you need to over invest a little bit more so than you have in the past years to re-energize that space or are you guys okay with where you are currently?

Jon Judge

We're okay. What happened with the sales force is, if you look at our traditional businesses, we've learned over the years that if we add much more than 7% new salespeople into the traditional spaces, we actually get a diminished return.

We've got a pretty good formula in terms of how much additional salespeople we can absorb and still improve our productivity. That probably will not be changed going into this year. We're sort of in the middle of our budgeting process for next year. So, we're kind of far along but we haven't got everything finalized. My anticipation would be that that won't change. And then obviously, when we get in the new business, In this case, the example would be to health benefits, that sort of distorts the hire numbers. Because we get pretty aggressive in the hires for the new businesses.

If your question is; Do we think that we're sluggish and we're going to go throw some more salespeople at the sluggishness? The answer to that is no. We'll continue, particularly in our traditional businesses, we'll continue to make the investments in sales that we've made in the past.

What I would say is the good news there is as long as you continue to see us adding salespeople into the fray, it's a reaffirmation that the market remains underpenetrated and there's still lots of demand there that needs to be picked up and we need more salespeople to go pick it up.

Adam Frisch - UBS

That explains it. Because people might look at the payroll services revenue growth being a little bit lighter to say maybe the business isn't doing but well. But I wanted to just clarify that. So thanks.

Jon Judge

We clearly don't feel that way. I am, actually, where John is on that. Number one we don't get even flows from quarter to quarter in all cases. And we have a pretty tough compare in this quarter from quarter to quarter, so I don't see any long term issues at all.

Operator

Our next question comes from Brian Keane - Prudential.

Brian Keane - Prudential

You said December and January are the big key sales months. It sounds like new client growth for the year will probably fall out 3% to 4%. I was just hoping, Jon Judge, you could give us a little bit of color on the sales this year? Did there tend to be more bankruptcies, more start-ups, less start-ups, just kind of on the environment there?

Jon Judge

I don't really have anything to report you on those particular metrics. On the bankruptcies, there's no dramatic change in that that would cause us to even go in to do a detailed analysis on it. On the new business starts, there's nothing dramatically different there.

I will remind you, though that one of the interesting things about our business is that even when we have a bankruptcy, if we've done the right job in terms of client satisfaction, when these companies go bankrupt, the people end up either starting a new company or going into an existing company next door. So, they actually continue to be referrals for us and help generate new business for us even in the case of a bankruptcy.

But on the points that you brought out, there's really nothing that I'm aware of; John can comment if he sees something differently. There's nothing I'm aware of that would suggest that there's anything different going on, on bankruptcies, if there's anything different going on in terms of the rate of client growth inside of our clients. That seems to be pretty stable at somewhere between 1% and 2%. We don't see a lot going on new in terms of new business starts. Either slowing down or speeding up. So, I really don't see anything in that arena that would suggest that there's a big change.

John Morphy

We see the business in a good place and stuck. But it's nice where it's stuck.

Brian Keane - Prudential

Right, and that's where you get the 3.5% to 5% client growth. There's nothing really that moves the needle much one way or the other.

John Morphy

One of the things that we're working on, it doesn't move it dramatically, but it moves it, one of the reasons that we work so hard on client retention and customer satisfaction is there's two parts of that equation. There's the net guys you brings on and then there's the clients you lose. Some large number of the clients we lose we can't do anything about because they've either gone out of business or lost the ability to pay for the service or gotten down to one person in the firm and they're not paying payrolls anymore. That would amount to, in a normal year, about 12% of our losses. That still leaves us 7% or 8% that we can work on. Every point that we save there it's a pretty important point. So, that's one part where we can impact and of course the other part is the net new sales.

Brian Keane - Prudential

But the range this year of 3.5% to 5%, it's probably closer to 3.5% to 4%, for the full year, is probably a better safe number to expect?

John Morphy

You're trying to narrow the range to the one that we use that I could play with but yes, you would be accurate.

Brian Keane - Prudential

I'm just trying to figure it out to get to the total number. And then just my last question, on utilization of the ancillary services, 92% of tax base and then 70% of employee base. It looks like tax pay we're probably not going to get any extra points of penetration. I'd just like to hear your comment on that. And then employee pay at 70%, where's your latest thoughts on where you think the penetration level is on that?

Jon Judge

I'll start on that one and I'll turn it over to John. I'll start just from a historical perspective and granted it's not a very long history. I've only been here two-and-a-half years. But I would tell you that both of those numbers look to me like they were near saturation when I got here and they just keep going up.

John Morphy

The tax pay number actually would have maxed at 85, but I'll give some kudos to our risk organization over at HRS at University Park. By them becoming very aggressive at watching risk, we were able to allow this to go up 92. You say, what do you mean allow it to go up? When we get to this number, the reason it's not higher is because we don't let everybody be on tax pay because of the risk of losing payroll tax dollars to bankruptcy or whatever reason there might be. And that risk is I don't like to lose any money, but if I lose some revenue billing, it's not too bad. But if I lose my hard earned cash by paying their tax liabilities, that's a big hit. So they've done a great job to help on that.

Direct deposits I think will continue to move up. I don't think we've seen the peak on that. That would go right to the level of tax pay if the government would allow you to just force somebody to pay on a direct deposit. Now, what we've also done that's helping us there is the Readychex product, whereby basically it's actually better than direct deposit because we pay the clients' employees on checks drawn on our bank accounts, so we actually get a little more float than the one day on direct deposit.

So, I agree tax pay is kind of pretty close to the top. I think direct deposit will still keep making some growth for some time but it won't be as great as it has been.

Brian Keane - Prudential

Tax pay is a little bigger of the revenue of the two components, I assume.

John Morphy

It is bigger, primarily because it's got more flow.

Jon Judge

The other piece to remember when you're looking at ancillaries is the penetration of ancillaries on our new accounts. We bring in, in an average year, about 120,000 new accounts. The numbers of ancillary penetration on the new accounts is astoundingly high. So, it's not just the installed base. Remember that there's also a fairly significant amount of that comes with every new account we bring in.

Operator

Your next question comes from Tim Morly - A.G. Edwards.

Tim Morly - A.G. Edwards

Just on the 401-K business in terms of additional utilization by employees at existing customers, have you seen any changes on that that you might attribute to the auto enrollment kinds of features from legislation several months ago?

John Morphy

We're not seeing that and the reason is that if you go back and you ask the clients that you have do you want to flip in auto enrollment?, which is probably more to our benefit than theirs, they probably don't do too much of it. But if you can try to get it squeezed into new plans, then you're going to see more of it.

Auto enrollment is going to be a little more controlled by the company because while you want people in the 401-K plans, auto enrollment may cost you more in matches etc., but then there's Safe Harbor rules. So, I think all the stuff in the end is going to help but it's going to take a while.

Tim Morly - A.G. Edwards

And then my follow-up question goes back to the issue of the cash on the balance sheet. But just thinking about the M&A environment, I am just curious any thoughts you have about the realistic amount of money you think you may commit to M&A? I'm sure you look at stuff all the time, like you said. But thinking about the things you look at and would consider, do you think you really only need to earmark $500 million for M&A or $600 million over the foreseeable future or is it too hard to even put a tag on that amount?

Jon Judge

We don't think of it as specifically in those terms as you think about it. Let me make a couple comments, one reinforce what John was saying and then get specifically at your point. The part about the comment that was made earlier about dividends, it's not that we have a religious commitment to dividends versus anything else, stock repurchases, or other. When we look at the financials on it, it's just far more attractive, we believe to the Company and to the shareholders for us to keep pushing this money back through dividends.

Every time we do the analysis on the stock repurchase, it actually has negative consequences for us. Until that formula changes, if that formula were different, then we would have very positive feelings about stock repurchase. But right now, because of our multiple, it's not something that makes sense to us.

On the M&A piece, the way I'd answer that is just a general statement about cash on the balance sheet. We need a certain amount of cash on the balance sheet for things like M&A. If you look at our history, what you'll see is that we almost exclusively do purchases, whether they're small purchases, small payroll companies that we're buying, small solution providers that we're buying the company because we want to get at the solutions, Stromberg would be an example of that.

Our tradition has been to use cash. Looking forward, that's in all likelihood what we would do. But I would remind you that we have no debt on our balance sheet and we have a very strong currency in our stocks, should we choose to want to go after those two alternatives, as well.

When we think about it, we think about M&A in general. We don't specifically earmark money for M&A. We've got $1 billion on our balance sheet. Most people, I'm one of them, would say that's enough money to hold on your balance sheet.

As we start, as we continue to generate more cash through operations, it creates an interesting conversation at the Board. The current feeling of the Board has been to continue to push that money back out through the dividend process in through our shareholders' pockets. That will change as soon as we have an alternative that looks better. But for right now, the best alternative that we have at our disposal, given the fact that we're going to continue to generate a lot of cash and probably have enough money on the balance sheet, is to continue looking at pushing it out through dividends.

Operator

Our next question comes from Charlie Murphy - Morgan Stanley.

Charlie Murphy - Morgan Stanley

John Morphy, could you talk a little about CapEx? I think you provided the guidance down two times this year, if I'm not mistaken? What's driving that?

John Morphy

The down happens because our people don't spend the money.

Charlie Murphy - Morgan Stanley

So if you look out to next year, how much is maintenance CapEx versus growth, what should we expect there?

John Morphy

I don't think CapEx next year will be any different from this year. If anything, it'll be lower. We had some big stuff in there but again, I'm not the whole way through the budget. But our people, generally we get aggressive sometimes in what we approve and our limiting factor on CapEx is not cash, it's what can we implement and get the returns on.

Operator

David Grossman with Thomas Weisel Partners, you may ask your question.

David Grossman - Thomas Weisel Partners

We talked a lot about the payroll business. Maybe I missed it, but could you give maybe at least some qualitative views on how the checks per client have tracked in the quarter versus let's say the first half of the year?

John Morphy

Checks per client are relatively flat right now. There's been times in the year where we've seen some improvement, but I wouldn't say anything consistent, which is why your hear us continually use the kind of discussion of stuck in a good place. The last time we saw check acceleration that was meaningful was in the first quarter of fiscal 2006.

David Grossman - Thomas Weisel Partners

Is that consistent with prior business cycles that you've experienced in terms of the trend in checks per client?

John Morphy

Checks per client actually doesn't usually change very much except when the cycles really change. It's amazing how it just stays kind of right where it is. But it can move fast both ways when you get either real good expansion or the other one. That's what we saw the first quarter last year. Something moved it and that's when we changed the guidance up a little bit for the operating year. But since then, we've really seen pretty good check activity, maybe slightly up but not a lot.

David Grossman - Thomas Weisel Partners

John, your comments about the float balances. I think you talked about 8% is a good number to use going forward. So, are we at a point now, I think you said your anniversary of the rate increases is in the first quarter of fiscal '08. Is that to imply then that we should look for just maybe a little modest uptick, but somewhere just above 8% in terms of float income growth?

John Morphy

Float income growth from my perspective will be somewhere between 7% and 10% in the following year.

We haven't modeled the whole thing but if I'm sitting here knowing what I know, the same thing you can get from reading our 10-Q and as we discussed this, I think that's what a reasonable person would assume.

Operator

Your next question comes from T.C. Robillard - Bank of America.

T.C. Robillard - Bank of America

Jon, forgive my ignorance here, but can you give just some examples as to what can be unusual, some specific examples around what varies in the third quarter? You said last year it caused you guys 10% growth, this year it was 8%. Can you just give me some examples of what happens with your clients at year end that can cause some fluctuation?

Jon Judge

There's a bunch of things. The third quarter, in a way we don't have a seasonal business but in a way we do. It seems like it's so predictable but to give you an example, float is seasonal. The best quarter for us on float is the third. The next best is the fourth, and the next best is the first, and the worst is the second. That's because the money pile-ups at the front end and the bonuses where they are and the federal deposit withholdings and the FICA.

Now you take the business, though, you've got year end, which is the big thing that causes change. So, what's involved in a year end is you've got obviously W-2s. Now, in W-2's, our philosophy and policy is that we basically earn that revenue all year, there's very little W-2 that we prepare that we don't get paid for. It's minuscule. So, we basically accrue W-2 revenue across the whole year based upon a year end basis. So, basically it's a March accrual until the end of February. We accrue it and we basically break the accrual into 13 periods booking two periods in January because a little more work gets done in January than the rest of the year. So, you've got some swings on that year-over-year.

The other thing that happens in this quarter is you've got all the year end reports. You got the year end bonus checks. So, you've got a lot of transactions that tie to activity that's not normal to the whole year. So at the end of the day, that's why the revenue generally goes up and it's why we also sometimes don't get sequentially higher revenue from the third quarter to the fourth.

So, you've just got all those unusual items. You don't get as much of it on the human resource side, but you do get some of it there because you have 401-K filings and other things, but it doesn't seem to be as built up. But you get transactional things and you get the W-2's, you get the float moving and then you've got the year end report. So, it does move around. And there's really no way to estimate that stuff as closely as we can estimate some other things.

Operator

Our next question comes from Gary Bisbee - Lehman Brothers.

Gary Bisbee - Lehman Brothers

You mentioned a minute ago that what you're seeing in terms of penetration on the ancillary products with new clients is very high. Can you give us a sense what that's trended like in the last few quarters for the sale of the HR products into the new payroll customers because penetration is substantially higher than overall?

Jon Judge

Penetration levels don't bounce around too much. The payroll ones have been high for quite a while on tax pay and direct deposit. HRS, obviously we've got pieces that grow, the ones we're pushing like Paychex Premiere, if you call that an ancillary, that growth obviously is continuing to be excellent. Now, the year-over-year growth on that might be less only because we're getting to more critical mass. When something is at 0%, getting it to increase a big percent is easier than when finally it gets up to tens of millions of dollars.

So, we looked at each one of these and we pushed the sales forces. But while in terms of being ancillaries, I don't think the penetration of the take rate changes dramatically as much as maybe our emphasis on where the product is on a maturity cycle. Like workers' comp, I think about 10% of the base has workers' comp. Hopefully, that's going to get up to about as 30%. So these growth rates just kind of move along as time goes on but it isn't like all of a sudden we see more people taking something.

John Morphy

Well, in reference your specific question I think if I heard right, the difference would be in a new client, tax pay penetration might be at 98% or 99% whereas in our installed basis, it's at 92%.

Gary Bisbee - Lehman Brothers

I was wondering with that example John just gave, workers' comp is 10% overall, but are 30% of new clients taking it?

John Morphy

No, more new clients are taking it. I don't know the exact percentage. Because what happens is, on some of those products the existing base has already made the decision they want or don't want it. The easiest sale is always to the new account.

Now, one thing we like about the health care and this exact thing you're talking about is on the workers' comp decision, we are actually just a little bit late to the party. In other words, once the client's going to go in with employees, he probably already has workers' comp. Fortunately, on healthcare it's the opposite. He probably isn't going to do anything on health care until he has employees.

Gary Bisbee - Lehman Brothers

In terms of the litigation reserve, can you just give us a little more background? How many outstanding suits remain? In raising the reserves today, how many more are you sort of accruing for?

Jon Judge

Well, basically, started off with about 75 licensees, about 30 suits. We've been on a long road trying to get those resolved. We've been on a long road trying to get the operations turned off in a way that's fair to them and fair to us. Basically in this quarter we made some great progress in view of the fact that we've got the number of lawsuits now down to only two. One is very small, the other one we'll wait and see.

But we booked the reserve, which I believe as I sit here is adequate and I probably guess it's a little bit on the high side, but not much. That's a big number, but obviously when you go in front of a judge, you can get a different answer.

Now, do I think the risk of this litigation compared to what it was before this quarter, I think we diminished the risk significantly. So we had to book $13 million more. Obviously, it's something I would have rather not have done, but we decided to put this thing and get most of it behind us.

The other great event in the quarter was we finally got approval from the court to fully liquidate this and discontinue all these operations. Rapid Pay was a fantastic acquisition. Unfortunately, it had one thing in it that wasn't quite so fantastic. We inherited a contract that you could not raise prices on nor could you ever have it expire. We serviced those contracts for quite awhile and then we sought ways to basically move on and today, we're successfully moving on.

Gary Bisbee - Lehman Brothers

In terms of the cash balance here, I'll go back to that maybe with a different tack. Has there ever been any thought to accelerating R&D and product development in some more of these HRS areas or for example, enter another country internationally? Or are you really tied to this goal of the 15% growth in operating earnings and would not considering accelerating investments?

John Morphy

There's a thought given to that every year, especially around budgeting time. But we are absolutely committed to the 12% and 15%. We're also very committed to making the proper investments in our business and striking the balance between those two. We believe that we can do both. We believe we can produce good financial results, that inside of those financial results that we can create enough additional cash through our operations to do the proper amount of investing in our business to ensure that going forward we can continue to stoke this engine at 12% revenue growth and 15% operating income growth.

Gary Bisbee - Lehman Brothers

I didn't hear any real comment on the level of the year end bonuses this year. I think in past years you've talked about that as sort of a barometer of how the small business economy is doing.

Jon Judge

It's good. To me it was a little more meaningful indicator this time because sometimes because sometimes it's a real, what I would call, not a lead indicator, but if there was weakness in the economy we would have seen it in the bonus activity. So, if the economy was slowing down in the fourth quarter, that would have been a good indicator. But the bonus activity was real good year over year.

Operator

Your next question comes from Mark Marcon - R.W. Baird.

Mark Marcon - Robert W. Baird

Good morning. Could you -- did you mention specifically how the retention for clients payroll shaped up for this quarter? Was it at a new record level?

Jon Judge

Yes. I did, although, I maybe went over it quickly. The new client retention or the inverse would be client loss, those numbers are running at record levels. We broke the record last year and we've been running this year at levels beyond last year's performance and we're at a point now through the third quarter with one quarter to play, I don't like to go and make too many projections or point to the center field wall too many times, but I feel very strongly that our ops team is going to probably bring us in this year at a new record, which would be hopefully below 20% on losses.

Mark Marcon - Robert W. Baird

John Morphy, your comment with regards to the average check per clients not changing. When you're saying that, are you saying that in terms of the overall pool, which you have the normal dynamic where you're bringing in new clients that are smaller than the average client and so that balances out? Or are you saying that in terms of if you looked at the same client a year ago, they have an increased hiring?

John Morphy

We don't look at the same client a year ago because it's almost impossible to do with our level of detail and payouts in the client base. Not that there's a bad cast, it's just a lot of coming and going. No, that's the average for the whole base.

Mark Marcon - Robert W. Baird

That's what I thought. And so, the dynamic is you're bringing in new clients who are smaller and therefore, even if your existing clients are increasing the number of employees per client, the new clients are going to offset that.

John Morphy

Flat means you probably got a little bit up in the existing base.

Mark Marcon - Robert W. Baird

With regards to your sales force productivity levels, the 3.5% to 4% new client additions, would that indicate that sales force productivity has increased or has remained the same?

John Morphy

We look at sales force productivity today more on a revenue basis. We've been forced to go to that because we have so many of these new revenues channels. So, when you've got a salesman out there, a unit isn't quite as important as it used to be. It's still important so you've got a salesperson out there that's really going to take time to make sure he's got his MMS partner if he needs him. He's got his HRS partner if he needs him. So, the unit production is not as good as it used to be but that's been true for a while. The revenue production is better than it used to be.

Mark Marcon - Robert W. Baird

With regards to the Paychex Premier, obviously that continues to be on fire. What percentage of those clients that you're adding or the work site employees that you're adding is actually coming from your existing base?

John Morphy

About 50/50.

Mark Marcon - Robert W. Baird

So, it's 50/50? It doesn't look like from a sequential basis, at least sequential/absolute basis, that there's any signs of any slow down there at all.

John Morphy

We hope not.

Mark Marcon - Robert W. Baird

Any reason to believe that it might slow down?

Jon Judge

It's still pretty early. We're still pretty early in the creation of that offering and in the staffing of the team deliver that offering. So, our view is it's not an offering for sure that it's going to be for everyone. Remember, we still have a lot of clients that have one or two or three employees. It's not an offering for everyone. But we're still so early in the go to market plans on that that I, quite frankly, would be disappointed if it slowed down at this point at this stage of it. We've still got a lot of ways to go before we even think about hitting the first level of penetration or saturation.

John Morphy

But size will ultimately affect that percentage growth.

Mark Marcon - Robert W. Baird

Did health insurance have any impact at all on the HRS year over year revenue growth?

John Morphy

Not enough yet to be a factor.

Operator

Our next question comes from Greg Smith - Merrill Lynch.

Greg Smith - Merrill Lynch

Intuit's payroll business looked like it might have been a good fit. Any reason you guys didn't do that deal?

Jon Judge

Well, I'm thinking about how to answer this question. We were very much aware of that deal. We have very good insight into that client base, and we have a reasonably good understanding of how that business was performing inside Intuit and we did not have any interest in buying that client base.

John Morphy

I am sure ADP was very happy when we bought Advantage and InterPay and we weren't too disturbed when they bought Intuit.

Greg Smith - Merrill Lynch

Got it. Okay very helpful. There was a lot of talk about the balance sheet and the cash. Just curious if the idea of taking on debt and paying out a big one-time dividend, is that something that's ever been considered or are you just philosophically against something like that?

John Morphy

We've looked at it but that gives the person sitting there a nice Christmas present but it doesn't do much for the ongoing situation.

Jon Judge

I would say that we're philosophically against both of those ideas but we're more philosophically against one-time distributions than we are about taking on debt.

Operator

Your next question comes from Jeremy Davis - Credit Suisse.

Jeremy Davis - Credit Suisse

Good morning, guys. I know it's a small component of overall profitability, but wondering if you've seen any trends on workers' comp or health care costs within the PEO business or claims activity that may have changed?

Jon Judge

No, we haven't seen anything, but we're probably not the best ones to ask on that and that's because we are just brutal at making sure we're minimizing risk on our PEO. We have a great group of people down that run the PEO organization. We have clearly told them that while we want growth, we don't want increased risk. We continue to do very well in our worker's comp claims in that business and our healthcare is under control. So, we're in a little bit different spot than the rest of them.

ADP is probably a little more closer to us but I think Adminstaff, they look at this differently. They're trying to make money in areas where we aren't. It doesn't mean it's good, bad or indifferent, it's just different posturing and different ways of looking at the base.

We also have the Paychex Premier product push in kind of the PEO type of environment and actually we're seeing more Premier in Florida. We're still seeing PEO but we are seeing some Premier business that's very good down there too, which keeps us out of those situations.

Jeremy Davis - Credit Suisse

Good. Well keep being brutal.

Jon Judge

We will.

Jeremy Davis - Credit Suisse

Any commentary on time and labor? I don't think anybody's commented on that one yet and whether or not you're getting up to the high teens or maybe a $20 million run rate in that business yet?

Jon Judge

Well, we're definitely, if I take all of it, the Stromberg piece plus Paychex piece, we're definitely over $20 million. I don't know that we're over $30 million but we're clearly over $20 million. It's a good business for us and it helps us sell other stuff, it really helped us sell other stuff. This isn't a business we went into so much to just get margins off it. In enables us in the MMS marketplace to get clients and significant MMS revenue where we wouldn't get them without these products. So, we're pretty happy with them.

Operator

Our next question comes from Sanil Daptardar - Sentinel Asset Management.

Sanil Daptardar - Sentinel Asset Management

On the operating expenses, if you look at the operating margins, they were down sequentially, you did mention about litigation reserves of $13 million. If you exclude those reserves, there was a sequential drop of more than 100 basis points, was it solely due to the hiring of additional employees or something else has gone into that?

John Morphy

First off, you should not look at our operating margin sequentially quarter by quarter ever because it doesn't work. I talked about the seasonality earlier in the call, we don't look at it that way and they can bounce all over the place. Actually, the better one to look at -- and I also don't look at too much of the gross margin without the selling and G&A expenses because we have a tough time categorizing clearly there.

The best statistic, and we disclosed it, is operating income without float. Now, here you've got to take out stock-based comp because there wasn't any of that a year ago. Next year you'll leave that in. Obviously, we take out the $13 million in the lawsuit, what you'll see is that the quarter generated almost 18% increase in operating income year over year in that quarter. That is 3 points above our stated objective and the quarter also got us to the fact that we're at 15% our stated objective year-to-date. So basically, when I look at margins and things going on, we felt very favorable about them in the quarter. But when you do sequential and some other things, it doesn't always work.

Now, one of the reasons it doesn't, is our margins generally jump the most in the first quarter. The price increase goes in May 1, our operating people kind of hold back on their money, and then margins tend to stay about the same and sometimes go down a little bit based on where expenditures are and investments. But we are real happy with where margins went this quarter.

Sanil Daptardar - Sentinel Asset Management

You did mention about the payroll revenue to clarify things but I think it was not clear. You are targeting for about 9% to 11% growth for the whole year in terms of payroll revenues. If we look at the three quarters and the next quarter, assuming about 9% growth, you're not even going to come at the midpoint of the range. It's going to be at the lower end of the range that you're targeting. Is something is going on in the business? Would you be able to clarify what's going on there because in terms of your client growth, it's clearly not up to the mark? I think it's somewhere around 3.5% or 4%.

Pricing is clearly helping but check volume is not growing. Probably the use of ancillary services it may not be growing as you want it to grow. So is it possible to clarify what is going on there in that business?

John Morphy

First off, the range on the guidance was 9% to 11%, partially because last year we were very strong at 10.2% or 10.3%. Are we going to get 11% in payroll growth? Probably not. I would look at the guidance and people who have been following us for a long time would see that, for me, very good payroll revenue is anything between 8.5% and 9.25%. Above 9.25%, you need a little help from the economy. Below.8.5% on a year to date basis, that's less than you would want it to be.

I think we're well within the ranges of what we'd expect payroll to normally do. We know the revenue acceleration that we get in total comes off of HRS. The payroll continues to be a very good business. So, I think when you look at the range and say we're at the low end, we give ranges, we're very accurate on where we are. And as long as I'm inside the range, I feel pretty comfortable.

Operator

Your next question comes from Liz Grausam - Goldman Sachs.

Liz Grausam - Goldman Sachs

Thank you. I'm actually going to ask the margin question from the opposite side. You guys outperformed my margin expectations by quite a bit in the quarter. So what contributed, in your mind, to some of that outperformance? Was it just better expense control, was there some spending that you ratcheted back, related really to sales productivity that delivered that margin?

John Morphy

Well, basically, we are tough on expenses. The second thing is a very clean year-end helps expenses because you don't have overtime on your payroll specialists. And I don't know how much we had but I know we had less than we had in the past. We've had year-ends where the burden on a branch is just overwhelming. So, we're running it better and better and we also knew that we did some investing a little bit earlier in the year than we normally do, which is why we were below our 15% goal. But we've been after our managers and they've done a great of responding; ideally we want to be back to the 15% threshold through the nine months and we were able to do that.

Liz Grausam - Goldman Sachs

On the multifund product, I know last quarter you said that it was taking a little bit longer to ramp customers onto that just due to the newness of the products. How is that initiative going in terms of getting clients up and running on the product?

Jon Judge

It's going well, as I mentioned earlier. I'm not going to give you the specific numbers but I will tell you that I've had some concern expressed to me from our operations team because we're putting on somewhere in the neighborhood of almost three times the number of people that we've put into the plan. So, we're kind of working the back room over time right now and they're running as fast as they can to keep up. We're pretty pleased with where it is.

Operator

Your next question comes from Franco Turrinelli - William Blair.

Franco Turrinelli - William Blair

A question for you on the 401-K front. I noticed the growth in retirement services client up 15% and the employee fund up 24%. Can you give us a little bit more insight into these numbers? Clearly, you're getting more penetration of the base, is that really penetrating the existing base or is it really what you've been talking about in terms of new customers taking this on a lot?

I'm assuming the funds are up because the average plan size, so to speak, is bigger. Is that because different types of customers are coming on board? What's been going on that explains these numbers?

John Morphy

The funds are up because the stock market is up.

Franco Turrinelli - William Blair

It's as simple as that?

John Morphy

Our client base hasn't changed materially. When the multifund thing gets a little more down the road, hopefully we'll get more conversions. We've had good acceptance of that product. But that's why that's up. So, I don't look at those two to ever move in sync. In the 401-K, 15% is doing well.

Franco Turrinelli - William Blair

Jon Judge, can you give us an update on international?

Jon Judge

Not a significant change from the last time that we talked. The international continues, Germany continues to go well. The expansion there is as we've discussed in the past, it's one where we're running that as fast as the expense world will allow us to run it; and really not a whole lot more to report. It's going well. It continues to rise at levels faster than opening up a new operation in the U.S. would run. All in all, it seems to be going quite well.

Franco Turrinelli - William Blair

Can you remind us how many markets you're in now Germany?

Jon Judge

We're in four cities. We opened up in the first city. We went to the second city a year later. We opened up two more cities the following year. So, we're in four cities now.

Franco Turrinelli - William Blair

Jon, can you help me understand what your decision-making process would be in terms of continuing to focus on building out Germany or thinking about new markets? Just what would the thought process be?

Jon Judge

Well, it goes something like this. It starts off with when we look at all of the investments that we're making in our future growth, we have a certain amount of money that we have targeted for investing in these types of things. We've split that against those investments. So Germany, is in the same pot as building out the insurance business and so on.

Then as we look at how we drive those investments, when we think about Germany, as an example, it makes more sense to us currently for us to go to the next city in Germany than the first city in another country for where we are in our international expansion. It costs us a lot more money to open up a new country than it does to open up another city. So, until we get the Germany experience to the point where we feel like we've captured the flag, if you will, and are the market share leader in our space in Germany, it would be the likely guess for you to make that we will continue to pour the money that we're going to put into the international expansion into Germany rather than open up another country for the time being.

Operator

Our final question comes from Rod Bourgeois - Sanford Bernstein.

Rod Bourgeois - Sanford Bernstein

The 18% operating income growth, that float at 18% is very nice to see. Congrats on the margin expansion there. The question that I have relates to the float and earnings growth outlook, which is what we've kind of been focused on here lately.

John, you made it pretty clear that the balance growth is probably going to be in the 8% range. I also take it that you're expecting the yield to potentially peak here in the not too distant future. Can you talk about that dynamic?

John Morphy

I think it's going to get stuck, hopefully, in the safe peak. I think it's going to be stuck until they do something. You're not going to see much rate change.

Rod Bourgeois - Sanford Bernstein

Right. So, but does that happen about mid calendar year?

John Morphy

I think you're going to see that dynamic happen right in the first quarter.

Rod Bourgeois - Sanford Bernstein

Okay. And therefore, you get 7% to 8% float earnings growth because the yield maxes out and gets stuck and then the balance just grows at 8%?

John Morphy

Correct. It's going to go equal to the balance curve. We've done some planning on it. I don't know the exact number, but that's why I said somewhere between 7% and 10% and probably somewhere right in the middle of that. Until I really run all the cash flows, I don't know exactly. But we know that float income growth does diminish quickly and you've seen it diminish lately. But the last increased anniversary is the one that was on June 29, which was the day after our guidance in the beginning of the year.

Rod Bourgeois - Sanford Bernstein

John, at this point with the structure of the interest rate world, do you have pretty good visibility into how the yield will play out over the next year? Are there any wild cards with respect to the shape of the yield curve or anything?

John Morphy

I don't think so because the long-term portfolio; well it's not a super long-term, those rates do not change very much. In the short-term they almost go with rate with the federal funds rate.

Rod Bourgeois - Sanford Bernstein

Thanks very much, guys.

John Morphy

Again, we thank you for your great interest in Paychex. Jon and I are looking out at one of those unbelievable March days. It's actually sunny and warm here and hopefully the rest of the year will be like that. So anyway, thanks a lot and you all have a great start to spring.

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