Paychex (PAYX) Earnings Report: Q Conference Call Transcript

Transcription

1 Paychex (PAYX) Earnings Report: Q Conference Transcript The following Paychex conference call took place on December 19, 2014, 09:30 AM ET. This is a transcript of that earnings call: Company Participants Martin Mucci; Paychex; CEO, President Efrain Rivera; Paychex; CFO Other Participants David Togut; Evercore ISI; Analyst Jason Kupferberg; Jefferies; Analyst George Halas; Credit Suisse; Analyst Joseph Foresi; Janney Montgomery Scott; Analyst Kartik Mehta; NorthCoast Research; Analyst Gary Bisbee; RBC Capital Markets; Analyst Tim McHugh; William Blair; Analyst Smitty Srethapramote; Morgan Stanley; Analyst Sarah Gubins; BofA Merrill Lynch; Analyst Brian Keen; Deutsche Bank; Analyst Jim Macdonald; First Analysis; Analyst David Grossman; Stifel; Analyst Jeff Silber; BMO Capital Markets; Analyst S.K. Prasad Borra; Goldman Sachs; Analyst Mark Marcon; Robert W. Baird; Analyst Lisa Ellis; Sanford Bernstein; Analyst Tien-tsin Huang; JP Morgan; Analyst Matt O'Neill; Autonomous Research; Analyst MANAGEMENT DISCUSSION SECTION Welcome and thank you for standing by. By. At this time, all participants lines are placed on mute until the question answer of today's conference. (Operator Instructions). Today's session is being recorded. If you have any objections, you may disconnect at this moment. Now, I'll turn the meeting to President Chief Executive Officer, Mr. Martin Mucci. Sir, you may begin. Thank you and thank you for joining us on that discussion of the Paychex second-quarter FY15 earnings release. Joining me today is Efrain Rivera, our chief financial officer. This morning before the market opened we 2014 TheStreet, Inc. All Rights Reserved Page 1 of 29

2 released our financial results for the second quarter ended November 30, We will file our form 10-Q which provides additional discussion and analysis of our results for the quarter within the next few days. Our earnings release and form 10-Q will be available on our Investor Relations page at paycheck.com. This teleconference is being broadcast over the Internet and will be archived and available on our web that for approximately one month. On today's call I will review highlights from the second quarter and our operation sales and product development areas, Efrain will review second-quarter financial results and discussion our full-year guidance and then we'll open it up for your questions. We were pleased with the second-quarter results we continue to see growth have good progress in our key initiative. Payroll revenue continue to advance as a result of increases in revenue per check and client base growth. HRS revenue grew at double-digit rates in the second quarter led by our success in selling HR outsourcing solutions to our client -- solutions to our clients. Total service revenue increased 10%. From a sales perspective we saw continued progress during the second quarter, particularly in our Paychex HR services and retirement services. We're fully staffed, Rep retention and development is on track and we continue to be successful in adding new bank and franchise referral arrangements as well as increasing our web leads in addition to our CPA referral channel. Our partnership between our selling organizations has never been more efficient, as they help our clients realize the full value of the breadth of services that Paychex has to offer including our newest offering, (Stratus Time) the leading cloud-based time and attendance solution in the market from the addition of our nettime solutions company acquired last June. We're also seeing an increase in the sales of our health care reform related product. We are in a unique position with both payroll data and insurance agency, to offer our clients assistance and value in understanding the impact and requirements of the Affordable Care Act and it's impact on their business and their employee. We can bring clients great value by helping them navigate the complexities of the act as stay in compliance with their requirements. From a technology perspective we continue to focus on bringing industry-leading products and enhancements to the market to meet the growing needs of our clients. Our innovative leading-edge technology coupled with our exceptional client service, we believe, that that's a part of the market. During the second quarter we introduced Paychex Flex, a product offering which integrates a leading-edge software as a service platform with our newly expanded service offerings. Paychex Flex offers powerful capabilities in a simple user experience that responds to the needs of our clients across the human capital management sector end. Our new service initiatives offers clients the flexibility of choice for their service needs. This approach gives clients access to a variety of customer service options based on their size and complexity including our new 24X7 customer service center. Paychex Flex offers a unique blend of both software and service and we believe, again, it differentiates us, Paychex, in the marketplace. In Q2 we also enhance our mobile app with the introduction of Paychex time, a mobile time punch app that offers a quickest mobile punch possible. This app enables client employees to securely record their hours and avoid time consuming log in. In summary, we are pleased with continued execution of our sales and service teams, our product strength and the financial performance and I appreciate the great work of our Paychex employee team across the country and in Germany and Brazil TheStreet, Inc. All Rights Reserved Page 2 of 29

3 I will now turn the call over to Efrain Rivera to review our financial results in more detail. Efrain? Thanks, Marty and good morning. I would like to remind everyone that today's conference call -- during today's conference we'll make some forward-looking statement that refer to future events and as such involve some risk. Refer to the press release for a discussion of forward-looking statements and related risk factors. You also may recall that during the latter part of last year, we introduced a new health insurance offering within the Web PEO. For PEO clients and work site employees, due to the self insurance provisions within the new offering, we began classifying certain PEO direct costs as operating expenses rather than a reduction in service revenue. This change had no impact on operating incomes, this new product offering had an impact on our FY15 second quarter and six months result as it was not initiated until the second half of FY14. As Marty indicated our second-quarter FY15 represented continued progress from the solid start we had for the year. Here's some of the key highlights. I will provide greater detail in certain areas and wrap with a review of our 2015 outlook. Total service revenue grew 10% for the second quarter, to $666 million and 9% to $1.3 billion for the six months. Interest on funds held for clients increased 4% for the second quarter and 3% for the six months, to $10 million and $21 million respectively. These fluctuations were driven by an increase in average investment balances. Expenses increased 10% for the second quarter and 11% for the six months, primarily in compensation related costs and PEO direct costs. The increase in the portion of PEO direct costs is the result of the new health insurance offering which accounted for approximately 4% of total expenses for both the quarter and the year-to-date period. The increase in compensation related costs was driven by higher employee benefit related costs mostly medical costs along with our sales headcount and performance-based comp costs. We also continued our investment in our product development and supporting technology. Operating income net of certain items increased 9% for the second quarter and 7% for the six months, $260 million $517 million respectively. We maintained strong operating margins and anticipate that are full year will remain within our guidance range which I will discuss shortly. Diluted earnings per share increased 9% to $0.47 per share for the second quarter and 7% to $0.94 for the six months. Net income increased 9% to $173 million for the second quarter and 7% to $344 million for the six months. Payroll services revenue increased 4% for both the second quarter and six months. We benefited from an increase in revenue per check and client base. Revenue per check grew as a result of price increases net of discounting along with the impact of increased product penetration. We saw a moderation in the growth in checks per payroll into Q2 and expect that we'll continue through the new year. HRS revenue grew 21% for the second quarter and 19% for the six months. The increase reflects an increase in PEO revenue as a result of the new minimum premium plan that I refer to earlier. This represented approximately 7% of total HRS service revenue for the quarter and the six month periods. In addition, we experience from growth in both clients and work site employees of Paychex HR. All of the 2014 TheStreet, Inc. All Rights Reserved Page 3 of 29

4 metrics -- operational metrics on the HRS side our trending very positively. Retirement services revenue benefited from pricing together with increase in the number of plans and average asset value of participant funds. Our online HR administration products contributed to the growth through sales success of (SAT) solutions. Turning to our investment portfolio, our goal is to protect principal and optimize liquidity. We invest in highquality, low risk instruments primarily variable rate demand notes and bank deposits for short-term funds of mutual bond for the longer-term. Our long-term portfolio has an average yield of 1.6% and an average duration of 3.2 years. A combined portfolios have earned an average rate of return of 1.1% for the second quarter and six months consistent with the same period last year. Average balance for interest on funds held for clients increased during the second quarter and six months primarily driven by wage inflation together with growth in the client base. I'll now walk you through the highlights of our financial position. It remains strong with cash and total corporate investments at $928 million, as of the end of November and no debt. Fund held for clients as of November 30th were $4 compared to $4.2 billion as billion dollars as of May 31, Funds held for clients very widely on a day-to-day basis and averaged $3.6 billion for both the quarter and six months. This reflects growth of 4% for both period. Total stockholder's equity was $1.8 million reflecting $270 million in dividends paid during the six month and 1.3 million shares repurchased. Our return on equity for the past 12 months was 35%. Cash flows from operations were $405 million for the first six months, a slight increase from the prior year. This trend is the result of higher net income on cash flow from operations offset by fluctuations of working capital. The fluctuations in operating assets and liabilities between periods were primarily related to timing of collections from clients, payments for compensation, PEO payroll, income tax and other liabilities, all of these were affected by cut off in the a given month. It is common for working capital to what sweet between quarters. Now, let me turn to guidance for the remainder of the year. I would like to remind you that our outlook is based on current view of economic and interest rate conditions continuing with no significant changes and that is our expectations. And, our guidance is unchanged for the year. Total service revenue is anticipated to be in the range of 8% to 10%,%, but the ranges for payroll and HRS consist with previous guidance. Let me provide additional color on the second half of the year. You expect that payroll services will be at the very low-end of the full-year guidance range in the third quarter. But in the fourth quarter, we expect revenue to be above the midpoint of the range and this really just has to do with some timing of revenue shift from third into fourth quarter. It doesn't affect the year as a whole. So, let me just repeat that again, we expect payroll services revenue to be at the very low-end of the range in the third quarter but above midpoint of the range in the fourth quarter for the region that I just mentioned. We've also updated the supplemental guidance schedule to reflect HRS revenue expect patience in the third and fourth quarter and you'll see that those ranges have been tightened somewhat. These changes, which are modest changes to update the ranges a little bit more precisely, so you can update your model, have no impact whatsoever on full-year guidance. Net income growth is anticipated to be in the range of 6% to 8%. Our operating margin and tax rate for the year are expected to be consistent with prior guidance. Now, I'll turn it back to Marty TheStreet, Inc. All Rights Reserved Page 4 of 29

5 Great. Now, Derek, we'll open it up for any questions. QUESTIONS & ANSWERS (Operator Instructions). David Togut of Evercore ISI. David Togut (Analyst - Evercore ISI): Do you have any early read on the calendar year-end selling season and client retention? Yes, client retention continues to be very strong, so, we feel very good, very consistent with that. The early look, obviously you don't know until we're through January, but it looks good to us and selling continue to progress well. It is early, particularly in the small market side, to know for sure. But, I think we're off to a good start through November and December, from what we are seeing we've got full rep headcount, we've got turnover pretty consistent to where we want it to be and we are feeling, at this point, pretty good about it. David Togut (Analyst - Evercore ISI): What client retention running currently? I'd say we are still very consistent, still around 82%, which is basically our all-time best. David Togut (Analyst - Evercore ISI): Can you quantify for us bookings growth in the November quarter? No. We don't give that out. We certainly what wait until we get through the selling season before we talk about how it was. We feel pretty good about it though. We mentioned in the first quarter that we felt good about Q1, Q2 is very consistent from a revenue part growth, you know, annualized revenue sold. David Togut (Analyst - Evercore ISI): Can you quantify growth in checks per client? Yes. Checks per client were under 1% in the quarter. I had mentioned in previous call that once we started dipping under 1% we wouldn't call out the exact tenths of a point. We saw some moderation in checks per client. We are looking at it. It seems to be consistent with what we are seeing, what seems to be happening in the under 50 space, which is around 1%, a little bit under, in terms of employment growth TheStreet, Inc. All Rights Reserved Page 5 of 29

6 But, we'll have to see. It can vary, sometimes, from quarter to quarter. This wasn't a particularly strong quarter from a check for payroll and point. David Togut (Analyst - Evercore ISI): Understood. And pricing, can you quantify what the net price increases running after discounting? David, I wouldn't go any farther than to say that we are still in the 2% to 4% range. Feel pretty comfortable it holding. Don't see any significant issues, there. David Togut (Analyst - Evercore ISI): Understood. Just a quick final question. ADP completes their transition of the small business client base to run, they say, by the end of fiscal 15 ending June. What impact will that have in your view, in terms of direct head to head competition versus ADP? And if you could frame that in terms of any new products you have in the small business base. David, as far as we can understand their strategy, they appear to be, obviously, moving a lot of people on to their run platform. Also, moving a lot of people to an online service model. That has some strength and some weaknesses associated with it. We think there are challenges in the lower end 12 operate with that model and we think we have differentiated service that will compete very well from a platform perspective, from technology. What they offer versus what we offer in the small-market, we feel pretty comfortable we can compute pretty effectively. And, we think we've got the better service model. Just to add to that, they been going through this platform change for a while. I think we've competed very well. In fact, if you look at the gain, the net gain from our numbers, we are gaining slightly from them. We always lose them and take some. I think we're still doing very well, so I don't really anticipate much change there. As well, as Efrain said, I think we compete very effectively from a product standpoint. Our SaaS-based product our online interface and mobility apps are the best out there right now. And we discontinued to keep adding to them. David Togut (Analyst - Evercore ISI): Understood. Happy holidays. Jason Kupferberg of Jefferies. Jaso n Kupf erberg (Analyst - Jefferies): Wanted to start with the follow-up question on the checks per client. I know you said that you expect the slowdown to continue in the second half. What's your sense of where it will actually bottom-up? I know you are still trying to get to the root cause, here. Do you think it could even go negative? Anything you can give us in terms of revenue sensitivity when this metric moves by 50 basis points or 100 basis points? 2014 TheStreet, Inc. All Rights Reserved Page 6 of 29

7 So checks per payroll, when you start getting down below 1%, there's a lot of variability in that number and it's affected by the mix of what's happening with new clients compared to other clients that are trading out of the base. I think we're reaching some sort of steady-state, here, where that number will oscillate between flat and 1%. That seems to be consistent with what we're seeing in terms of our small business index numbers and seems to be implying -- you have to be careful, because this is one quarter of data. It seems to be implying that your reaching some sort of more moderate state of employment in the small-market space. We had two or three years of really strong checks per payroll and employment growth in the small business base, it seems like that starting to moderate. The impact on revenue -- so, what I like to say -- if you have about a point growth in checks, that's typically going to give you anywhere from 25 basis points to 50 basis points, depending on the mix in revenue. So, it should be relatively modest. And, we should settle in somewhere in that range. Jaso n Kupf erberg (Analyst - Jefferies): That would be specifically for the core payroll? Yes. It mostly impacts payroll service revenue, yes. Jaso n Kupf erberg (Analyst - Jefferies): But the 25 to 50 bits is specific to that line, not your total revenue? Yes. That's correct. Sorry. (CROSSTALK) Go ahead. Finish. Jaso n Kupf erberg (Analyst - Jefferies): No, I had another question. You want to finish your answer? So, just on the CPA referral channel, I know you mentioned last quarter you were penetrating some newer CPAs. But just wanted to see if there's any update in terms of latest data on percent of your new sales coming from the CPA network, or what percent of them are exclusive to paycheck or payroll referral and is there any uptick on competition for the channel? Been pretty consistent competition in the channel. What we've done is kind of change the sales force around a bit to have some CPA centric reps. So where we have a lot of concentration of CPAs in the past we hadn't done that. We've been pretty clean on the territory of who owned the territory and everything in it. So, we've added more dedicated reps just to that CPA channel. I think it's early in that process. We continue to get a majority of our referrals, not a majority, a large sense of 2014 TheStreet, Inc. All Rights Reserved Page 7 of 29

8 our referrals from CPAs. That's been fairly consistent at times. I think it's competitive. I think it's picked up maybe a little bit from a competitive standpoint, meaning from one competitor. There is not many that come after that channel. There is really two of us and I think there's a little bit more competition from an incentive to the CPA, I guess I'd say. But we still feel good about that, and I think we'll have the best sense of that after third quarter. Jaso n Kupf erberg (Analyst - Jefferies): That fair. One question on the margins, income obviously running around 39% through the first half of the year. You got the typical seasonal headwind in the second half. I know you are still endorsing the full-year range of 37 to 38. But should we think about the upper part of that range being more likely? Or does that feel more like right down the middle sort of year? It feels right on the middle sort of your right now, Jason. Jaso n Kupf erberg (Analyst - Jefferies): Okay. Thank you, guys. Happy holidays. George Halas of Credit Suisse. Geo rge Halas (Analyst - Credit Suisse): Efrain, I know you don't want to get to specific as it relates to pricing, but I think on the first quarter call, you had mentioned that pricing trends were, kind of trending toward the midpoint of your 2% to 4% range. Would you care to update that at all? I care to reiterate what I say. Geo rge Halas (Analyst - Credit Suisse): Perfect. What we see, George, is very consistent, there. We feel like we're holding the price and the price increase and nothing really changed in Q2 from Q1. Geo rge Halas (Analyst - Credit Suisse): Okay. I know it's early days in the selling season, but would you categorize what you're seeing so far as ahead of expectations in line with your patient? It's hard to say. I'd say certainly in line if not a little positive, a little above. But, it's early. You never know, especially in the small business market. Because so much of it is done at the last minute and we got a lot of 2014 TheStreet, Inc. All Rights Reserved Page 8 of 29

9 sales in at the last minute. Right now, I say certainly at expectations or a little above. Geo rge Halas (Analyst - Credit Suisse): Okay pick last question for me. I want to make sure I understand it. The deferment of some payroll revenue from the third quarter to the fourth quarter, can you remind us again what's driving that? Have we seen that before? Is something going on here that little -- Let me explain that in two ways. If you look at last year's -- last year's results, payroll services revenue, we started the year relatively low, 2.4 accelerated in Q2 and Q3 end of the year at 3. That had to do with days. This really doesn't have anything to do with days compare. It is simply that cut off in the given quarter may affect we are revenue falls the edge of one quarter or another. We look at -- there's 14 revenue stream that comprise payroll service revenue. We looked at it our best estimate is that some revenue that we would otherwise see in Q3, because of timing, is falling in Q4 this quarter. (multiple speakers) it doesn't always happen, but if you look at the payroll service revenue line over the last couple of years, you see it bouncing up and down. Not because it's that variable, because timing can affect it, days can affect it. That's why I caution that you really need to look at the year, as a whole. Geo rge Halas (Analyst - Credit Suisse): Okay. Thanks guys. Happy holidays. Joseph Foresi of Janney Montgomery Scott. Jo seph Fo resi (Analyst - Janney Montgomery Scott): I guess my first question here is, could you give us some sense of what the client growth was like this quarter? I know you talked about the checks per payroll. Was wondering how that's been trending? Joe, what we said, we had a goal of growing clients 1% to 3%. We certainly feel pretty comfortable about where we are in that range. We got off to a good start through the first six months, feel like we're on track in terms of where we expect to be in the year in that range. Jo seph Fo resi (Analyst - Janney Montgomery Scott): Got it. The year-over-year revenue growth has ticked up over the last couple of quarters. Can you give us a sense of how much that is associated with this, I guess either new business or penetrating your own business's versus the general macro backdrop? I think it's probably a little bit of all. When I'm asked that question, I say we could egotistically say it's 95% execution. The reality of, we need a better environment. The environment is better. Our execution is better. Pricing is a little bit better. And, the opportunity in the under 50 space, overall, is better and we're executing better against it. I think it's the mix of all of those issues TheStreet, Inc. All Rights Reserved Page 9 of 29

10 I would say that our execution on the sales side has been really strong and it's been strong for a number of quarters, now. We feel pretty comfortable about where we are positioned competitively. Jo seph Fo resi (Analyst - Janney Montgomery Scott): Are there any -- I guess two parts to the last question trigonometric you can provide that you'd like to share with us about the execution on the sales front? The second part of that question, it more of a competitive one. A lot of potential competitors have gone public. Are you seeing them in the general arena or any change in the competitive environment? I'll take the last question and turn it over to Efrain. I think we've seen, certainly, some more of the competitors showing up in that midmarket space, in particular. But, I think we're doing well against them. In fact, they are going to pick up some client that some point, because they are new in the market and the got something new to show. What we've done is started to win back some already, which we think is a very positive thing. Overall, it is not having any sizable different to us. So, I think, while there out there, I think we've invested very well in the past, particularly the past three or four years and it rolled out a lot of product out that I think have positioned of well against competitors. While there out there, we still have the widest breadth of services to offer and certainly, the best service and service options along with the mobility and when you think about the interconnection, it depends on the client - but when you think about all the service offering that we have that connect you into a platform of 401(k~), payroll, HR administration, time and attendant, et cetera, it makes us a much better from a competitive standpoint. Efrain? I think the other thing, we called it out in the press release, while we don't give specific, when we get year-end you can calculate the number. We talk about revenue per check. Revenue per check is a combination number thing that obviously include pricing. But I think what you are seeing, there, is sales to a little bit bigger client on the core payroll side and more sales of precisely the kinds of products that Marty just mentioned to that sales force. Our cross-selling abilities have never been better and our team selling has never been better. So I think it's all of those working in combination and while it's easy to look at just what's happening in payroll service revenue and ignore what's happening in HRS, the reality, is that you have to look at both. Our growth rate is a combination of ability to do both of those things well. Jo seph Fo resi (Analyst - Janney Montgomery Scott): Thanks. Happy holidays. Kartik Mehta of NorthCoast Research. Kart ik Meht a (Analyst - NorthCoast Research): I know both of you talked about the selling season being good and I think you've given some thought behind why. I was wondering, if you look at the fundamentals, at least the fundamental you look at to determine if it 2014 TheStreet, Inc. All Rights Reserved Page 10 of 29

11 will be a good selling season or not, how have those trended? What are some of the fundamentals that you would look at to, kind of, predict how the selling season of owing to go? I think, at this early stage, obviously you look at submitted, we don't get into that amount of detail, but you look at what kind of sales have been submitted already and as Efrain mentioned, that's not only payroll, but that's the PEO business, the 401(k~) business, et cetera. You get a sense of those a little bit earlier, even in small business payroll and things look pretty solid to us. The other thing you look at, it's a little more subjective, what the pulse of the sales force and the sales leadership. It's pretty strong right now. As Efrain mentioned, we got great team selling going on, we got retention in a good place. We have full reps all out their all positions are filled. In fact, we are a little slightly over so all the positions are up and running. Leads are coming in very well. So, I think all those early signs, you know, we hate to talk about it until the third quarter kind of over and you get a sense of it. But it's a pretty good sense right now, of what we are seeing. Again, you really got the January to know. But it is a good sense. And competitively, we feel very good. There's not a lot of things that things that are popping up competitively that are saying, hey there is someone out there with a real aggressive pricing like we've had that was really taking some share at a very low price or high, high discounting or something. We are not thing anything like that. So we feel we are competing very well and the products are going over really well. The retention also looks good at this point, so we don't know, again. But, retention, we are at our best ever and that feels good. Kart ik Meht a (Analyst - NorthCoast Research): Marty, in the press release you talked about the minimum premium health plan that doing really well. Is that strictly a reflection of ACA and what your customers are trying to do? Or are there other drivers helping that business grow? Talking about that planned specifically to the PEO and we introduced it in the last half of last year, I think what that really implies is the PEO is doing well. So right now, in the marketplace, PEO's' have come on very strong and we certainly have felt that kind of from the end of last year through this year. A little slow at the beginning of the year, starting, but we seem to be picking up great momentum. I think some of it, Kartik, is definitely health care reform, looking for the strength of coming in to a co-employment position. But I also think we having great sales execution on the PEO side. We also expanded it so we're selling -- while you still sell the majority in PEO kind of quote-unquote PEO states, we are selling it nationwide and getting very good sales execution on the PEO side. Something we've been in a long time but we think the product the sales team are really hitting at their peak right now. Kart ik Meht a (Analyst - NorthCoast Research): One last question, Efrain, on the portfolio, any thoughts about changing invest strategy or any other at that aspects of it considering the rate environment? 2014 TheStreet, Inc. All Rights Reserved Page 11 of 29

12 You know, Kartik, that's a good question. So, our duration now is 3.2 and our yield is about 1.6% on the long end of the portfolio. You can see, if you look at that line, we are ticking up gradually. We obviously invest differently than ADP does. We don't push everything out longer-term. Look, we have a conversation about that in the spring. We'll take a look at it. I don't anticipate any major changes. We were very, very positive about rate changes three to four weeks ago. And now I'm thinking that while will see some rate changes there, they are going to be moderate. So, you're going to have to think about how you position the portfolio in that environment and we may be there for a longer period of time. Yes. We will give some thought to that, as we get into the -- into the back half of the year. I don't anticipate any significant shift. But, it looks like we've got low interest rates here for some more time, given the collapse in oil prices. Kart ik Meht a (Analyst - NorthCoast Research): Thank you very much. I hope you guys have a great holiday. Gary Bisbee of RBC Capital Markets. Gary Bisbee (Analyst - RBC Capital Markets): On the HRS revenue growth, you'd given, and I guess you updated this morning, this chart of how adding in the new health plan changes the growth rates. That chart sort of implied 4% acceleration Q1 to Q2 in HRS revenue. Is that really why we see the acceleration? Or is the underlying momentum in the business, adjusting out the impact of the revenue recognition change is having -- is it really picked up momentum? We saw some improvement in the second quarter. So, we had versus course quarter, Gary. We have strong performance, literally, against every single product line. Insurance, which started a little soft in the first quarter for us, had a good quarter and the second quarter we expect that to continue. So, we anticipate that we'll continue to have strong performance in the balance of the year. Gary Bisbee (Analyst - RBC Capital Markets): The deceleration implied in the back half is more just how it flows through and then starting to lapse some of that revenue being last year, not anything about underlying? No. Sorry, Gary. I probably misunderstood a question pick correct pick in the back half, you anniversaried the changes in the minimum premium plan. By the time you get to the third-quarter, you are getting roughly about half of the impact on by the time you are in fourth quarter, you anniversaried it completely. Gary Bisbee (Analyst - RBC Capital Markets): Great. Then on the PEO and more broadly HRS strength, there's several competitors that are public now that we PEO seems to be doing terrific everywhere. Do you have any -- and obviously, there seems to be some benefit from help perform. Do you have any fears that sort of demand is being pulled forward with everyone 2014 TheStreet, Inc. All Rights Reserved Page 12 of 29

13 doing well? Or it sets up really difficult comparison once we get into calendar 2015 and more of the midmarket customer -- they have to be in compliance, so then you sort of done that? Or, has this got people really more willing to consider the benefits of this model and you think that it will remain for awhile? At some point, the growth, itself in PEO will slow down a bit. It's early to talk about where we are in terms of But, we've had a strong year and a half with respect EEO. We'll be where we end the year. Marty was mentioning about sales season. Sales season in Q3 is important for the PEO, so where we end up there will give us a good indication where we are for We will let Marty talk specifically about employer shared responsibility, which is also an important component of our thought process. But, certainly get the conversation about PEO going in a way that probably was different than two or three years ago. I think, as Efrain said, obviously, when you look at year-over-year and get into 2015 their will be become a comparison on the PEO side. But I think we are very early date on health care reform. As Efrain mentioned our health care reform product just starting to pick up steam now. And we had it in place before anybody a year ago. But with all the delays in the changes in regulations, I think it took awhile while to get going. We are seeing a nice pick up, now, from health care reform whether it's PEO or not. I think this would just add to it. I think it's still pretty early and I think this will give us growth, certainly for the rest of this year and Internet year. Gary Bisbee (Analyst - RBC Capital Markets): One last one. On the strong HRS growth, if we look today versus two or three years ago, has the mix of what's coming up sell to existing customers who may have already been a payroll client versus new customers that just want the services and you sell them because they are interested in the HRS. Maybe more than legacy payroll. Has that changed at all? Or, is it really the same mix and sales process that you've been executing for -- It similar, although a couple of things have picked up. One, Efrain mentioned insurance. Health insurance has ticked up, particularly, recently picked that's in there and that started to pick up again. I think 401(k) was very strong a few years ago, and that has kind of leveled out, it's got nice growth but the fastest-growing is HR outsourcing, whether the PEO model or the ASO model or our phone support model. All of those, I think, the HR support has been the fastest growth in the last two years, anyway. That's picked up a little bit faster in the mix of things. I think that's just the fact that the HR outsourcing and the complexity of HR come down in the client base. So, where it used to be that was 50+ are at least 30 or 40+, that's coming down more and more into where we have a lot of clients. So I think we've done very good at selling the value of HR support at various levels to smaller clients and Efrain mentioned earlier that the team selling approach we've gone to, which is that the client is of a certain as we go in with multiple sales together on the front-end instead of coming at them after they have payroll, I 2014 TheStreet, Inc. All Rights Reserved Page 13 of 29

14 think is also helped get that growth going higher. Gary Bisbee (Analyst - RBC Capital Markets): Okay. Great. Thank you. Tim McHugh of William Blair. T im McHugh (Analyst - William Blair): Can you update us at this point in terms of how much of the sales force, your sales resources up year-overyear as we go into the telling season? And is that a fair bogey for how you think about -- I think you said 1% to 3% client growth for this is the your but a lot of it was dictated by last selling season. So I'm trying to get a sense for how we should ballpark but the potential is for this up coming season in terms of client growth. I think, from a sales headcount perspective, I would say it's up around 4%, maybe 4% plus, a little bit. So a little stronger. We were holding constant for a few year, last year up a bit. We were up a bit and this year we went up again across the various sales organizations around four plus, a little bit over 4%. I didn't catch the second question, back half - T im McHugh (Analyst - William Blair): Is it fair to think about the target I guess for client growth, it would be around that number? I know you said 1% to 3% for this is fiscal year. I would assume most of that was driven by last year's selling season. I would just start by saying, remember, that sales team is across all divisions. It's not so much on the payroll growth as we probably seen more increases in the HRS teams, as well and also we've moved up some of the virtual sales teams on some of the product like time and attendance and merchant services and so forth. So it's a mix across that Tim. I wouldn't say that necessarily has given you anything on the client growth for the client growth, we still think we are on that 1% to 3%. T im McHugh (Analyst - William Blair): Okay. Then the new PEO, the new health insurance product, I get a lot of the of the focus - I mean there is an accounting impact of adding that in there. But how has the client reaction, as we look back at this point? It feels like it's been adopted a little more broadly even then you would have thought. I think follow-up is what does that imply? I think you only started doing this in the eighth you market, initially. Do you get more aggressive with rolling this out? (multiple speakers) TheStreet, Inc. All Rights Reserved Page 14 of 29

15 I want -- I don't want to mix up two different things that the healthcare plan, where we took on more in the PEO and that was primarily in Florida. That's the market that we're trying at there. So your right there, we're doing it in Florida and getting good feedback on that. It gives us more flexibility on the rates and the process of how we sell it. We've gotten good feedback on that and that part of our PEO growth, I believe, that you will see continued. On the health care reform, specifically, we've increased the product across the country and that's not just PEO, that's to all clients and it various products on helping them. Primarily, helping them understand and give them reporting on the number of clients that they have as full-time equivalents, whether health applies to them. If it doesn't apply to the impact of the have all the right things in place and how are they going to file the requirements of the Affordable Care Act? So, I would say they are a little bit different. I don't know if you are combining them are not. The PEO is going well, there, in Florida, in particular. And then the health care reform product as we talk about is really the reporting and the compliance and that's across the country. That's really -- this second quarter just started to really are to pick up some steam, the we are anxious to see how Q3 growth. T im McHugh (Analyst - William Blair): I was talking more the Florida product. What would you want to see to take that more broadly across the rest of the country? It's just a matter of, can you get the right plans in place and is the risk reasonable for us to take on? This is where we take on more of the risk ourselves then we felt it was, certainly, a very big PEO market when you think of to really two or three key states for PEO, at least, right now. That was about one to take on. It was worth it because of the size of the market, the number of sales we have there and, of course, the plan we are able to get and work out through the Florida blue. So, we continue to look at those all the time and we're looking that them around the country, as to whether that the right move are not. It combination of all those things. T im McHugh (Analyst - William Blair): If I could slip in one more. Just this week, news of a new legislation around that PEO sector in terms of having some certification and clarifying some of the tax implications of adopting a PEO, I believe that can you give us your thoughts? Is that meaningful as you think about the growth of that business? We're talking about, I think it is called SPEA? Another great government acronym. At the margin, it's positive for PEO. It recognizes them as an important solution within the marketplace. There was some ambiguity about how the government was going to look at PEO's and we think that it's just going to make the attractiveness of that offering greater in the marketplace. We're digesting all of the provisions of the legislation and we think at this point, our compliance group, legal group think it's going to be a positive for PEO. T im McHugh (Analyst - William Blair): Great. Thank you TheStreet, Inc. All Rights Reserved Page 15 of 29

16 Smitty Srethapramote of Morgan Stanley. Smitty Srethapramote (Analyst - Morgan Stanley): There's been a lot of attention on the growth in the FSA and HSA accounts in the U.S. Can you talk about role you would expect PayChex to play going forward, whether working and partners or becoming more directly involved? How big an opportunity could this market the? Yes. I think FSA, has come under some pressure because of the changes on it and so forth in legislation. And, the deductibility of it and everything. I think that's going to slow down a little bit. I think HSAs will become stronger. I think what you'll be there, you give us more health plans, and this could be through the agency as well, through our insurance agency, you'll see more health plans go toward HSAs. They are going more toward, obviously, the high deductibles and giving HSA money to employees. I think it's an opportunity for us. I don't know if it point to be a major impact at this point. And I think you'll see us do a combination of -- probably always partnering to some degree with it because of the back room requirements of it, just makes more sense them time to partner than to build. But, we've been and FSA for a long time, I think will be able to render it very well and it will be continue to be a part of our package. Smitty Srethapramote (Analyst - Morgan Stanley): Great. Maybe just follow-up partnership that you have developed with companies like (Elophon)), can you talk about how the partnership and payment processing is going and if there's any other type of similar types of partnership in the pipeline? Yes. I think the (Elophon) partnership has gone well. We were a little slow out of the gate on the selling and merchant services. Think we felt that the field sales would be able to sell that well and they were first in for some new businesses and so they be able to sell it. It turns out we learned a lot of different trials on that, but it's a complicated pricing structure based on your type of business and so forth and very competitive. The, what we found, was they now have the field sales team refer back to an internal team, which we increased the size this year. They are doing very well, so we've got some real traction this year on the inside team that sells virtually. The field sales refers it back to an inside team who then talks to the client and sells the credit card, card, the merchant processing and that started to pick up some real steam. Now, takes a lot of clients, given the commission structure there to have the substantial revenue given our revenue side. But, we do think it got great momentum and we are continuing to the that. So, it's been a nice partnership and I think it's starting to take off. Under partnerships like that, can think of to many other than Paychex accounting online. We've invested with (Kashoo) in the Paychex accounting online. Again, a little slow getting going. I think we are learning lot about the marketing of the product and how to integrated or into the marketing. Our client still view us very much as the human resource, human capital management, payroll and HR and time and attendance, and getting them to view us as an accounting offering as well with the (Kashoo) product has been lower than we thought. So, we're learning on that. We are always open to that. Of course, Brazil is a 50/50 partnership with (Semco) down there to help us get 2014 TheStreet, Inc. All Rights Reserved Page 16 of 29

17 started and I think the starting in January, we're off to a pretty good start. I wouldn't give a client code at this point. But, it starting to pick up traction, as well, and we feel very good about that decision. Smitty Srethapramote (Analyst - Morgan Stanley): Thank you. Sarah Gubins of BofA Merrill Lynch. Sarah Gubins (Analyst - BofA Merrill Lynch): I had a question about the new platform. I had a chance to take a look at it at the recent HR Tech conference. I was particularly interested by the flex enterprise platform for larger clients. I know it's really early, but I'm wondering what the feedback has been from the sales force in early demo's and if you think that is now fully competitive with some of the more recent entrance, at least to the public market. Thanks. Obviously, we've been able to show it at some of the shows and the sales force is really picking up steam on it, now. I think we've sold another platform for long time, so there was a lot of learning there and we've been enhancing it very quickly. The thing that changes so quickly today, is when you release something, almost every month there's a new release that's adding something to it. So, that's probably been the biggest challenge for the sales force is all the changes with that we've been adding. That's a good thing because it's adding enhancements. Good feedback on it. I think the clients really like the way it shows the user interface, very simple and very direct for them. We're working on integrating more and more of the other products that we have into that. So, there is a full suite of products and combined with that great user interface and the mobility platform in multiple products that are going anywhere from recruiting, onboarding proved payroll, HR administration, time and attendance. All of that's bundled in and we are giving more service options now between user interface, mobility and 7 by 24 client services. The differentiator will be technology to some did be but also the great service we can provide that I don't think anybody else is focused on. So it's getting good traction with the sales force and we're anxious to see the January result. Sarah Gubins (Analyst - BofA Merrill Lynch): Great. Thanks. Following up on that theme of being able to do payroll in a lot of different forms, given all of the updates that you've been making to mobile and your platform, are you starting to see - or are you continuing to see a shift towards more online entry as opposed to phone and fax? Is there anything appreciable really happening there? If there is, you think that we might see in operating margin benefit over time from that? I think we are seeing some shift towards that. It's interesting. It is particularly, we just saw a big shift on mobility for the holiday, for Thanksgiving. You are seeing it around certain times, which is exactly what we'd like, with a client has a choice every week or every other week, whenever they do payroll, they can go mobility this week. They can go online next week, they always have the dedicated personal life services to fall back on whatever they need it. And they can just call up and give their payroll over the phone, as well TheStreet, Inc. All Rights Reserved Page 17 of 29

18 So, we are seeing some shift, but the thing that we are thing that's very positive to us is that clients are using a multitude of options available to them, which is what we wanted to give. We don't want to force them to online. We don't want to force them away from a payroll specialist who give that a great retention numbers that we have. So, I think certainly has some opportunities there. And you'll see us with our industry leading margins, you'll see us continue to find ways those. You may find us reinvesting, as we have the last four years, right back into technology because it's going to be the combination of service and technology that makes us successful. Sarah Gubins (Analyst - BofA Merrill Lynch): Great. And then just last quick question. Last quarter you talked about an up pick to sales to new startups. You mentioned your continued strength in the under 50 and I'm wondering if that sales to start ups continued this quarter? Yes, it did. We continue to see a positive uptick compared to last year and so, were still seeing -- the new business startups, as you know, I'm sure still are not back to what they were prerecession levels, but they certainly have ticked up over 700,000, just not quite back from what everything we see, backup over that 800,000 level, countrywide. So, we are we encourage that were seeing more sales from new businesses and that's always been a big part of our business. So, yes, that has continued in Q2. Back great. Sarah Gubins (Analyst - BofA Merrill Lynch): Thanks very much. Brian Keen of Deutsche Bank. Brian Keen (Analyst - Deutsche Bank): Most of my questions have been asked and answered. But just want to look at the big picture, maybe Marty, when you look at payroll services growth and HR services growth, look at the guide, is that the right model for growth rate or are you leaving some growth on the table? How do you think about the big picture as go out next couple of years? well, is of the right model? I think will always be the HR services model growth growing faster and I think that the good thing, Brian, is we've got a lot of opportunity -- when you think of the penetration rate that we are at. So even as long as we've been in this business and successful selling into that base, we still have low penetrations rates and a lot of services from 401(k) to insurance's and so forth. So, I think you'll always see that that growth is higher. I think the interesting thing approaching $1 billion in revenue in HRS, is really exciting to us and going well beyond that. Payroll service revenue growth is always going to be somewhat tied to the economy. But, we like we're executing well and everything that we can control. I think you'll see, frankly, a blending more of that. It won't be so much about how much of payroll services 2014 TheStreet, Inc. All Rights Reserved Page 18 of 29