• changes in demand for our services and products, ability to develop and market new services and products effectively, pricing changes and the impact of competition;

• changes in the availability of skilled workers;

• changes in the laws regulating collection and payment of payroll taxes, professional employer organizations, and employee benefits, including retirement plans, workers' compensation, health insurance, state unemployment, and section 125 plans;

• changes in health insurance and workers' compensation rates and underlying claims trends;

• changes in technology that adversely affect our products and services and impact our ability to provide timely enhancements to services and products;

• the possibility of a security breach that disrupts operations or exposes client confidential data;

• the possibility of failure of our operating facilities, computer systems, and communication systems during a catastrophic event;

• the possibility of third-party service providers failing to perform their functions;

• the possibility of a failure of internal controls or our inability to implement business processing improvements;

• the possibility that we may be subject to liability for violations of employment or discrimination laws by our clients and acts or omissions of client employees who may be deemed to be our agents, even if we do not participate in any such acts or violations; and

• potentially unfavorable outcomes related to pending legal matters.

Any of these factors, as well as such other factors as discussed in our periodic filings with the Securities and Exchange Commission ("SEC"), could cause our actual results to differ materially from our anticipated results. The information provided in this document is based upon the facts and circumstances known at this time, and any forward-looking statement made by us in this document speaks only as of the date on which it is made. We undertake no obligation to update these forward-looking statements after the date of filing of this Form 10-Q to reflect events or circumstances after such date, or to reflect the occurrence of unanticipated events. Business
We are a leading provider of payroll, human resource, and benefits outsourcing solutions for small- to medium-sized businesses. Our business strategy is focused on achieving strong long-term financial performance by providing high quality, timely, accurate, and affordable services; growing our client base; continually improving client service to maximize client retention; increasing utilization of our ancillary services; leveraging our technology and operating infrastructure; and expanding our service and product offerings to continually add value for our clients. We also supplement our growth through strategic acquisitions when appropriate opportunities arise.
We offer a comprehensive portfolio of services and products that allow our clients to meet their diverse payroll and human resource needs. Our payroll services are the foundation of our service portfolio. They are provided through either our core payroll or Major Market Services ("MMS"), which are utilized by clients that have more sophisticated payroll and benefit needs. In addition to the services described below, our software-as-a-service solution ("SaaS") through the MMS platform provides human resource management, employee benefits management, time and attendance systems, online expense reporting, and applicant tracking.
Our services and products are as follows:

Service                                                   Description

Payroll processing                           Includes the calculation,
                                             preparation, and delivery of employee
                                             payroll checks; production of
                                             internal accounting records and
                                             management reports; preparation of
                                             federal, state, and local payroll tax
                                             returns; and collection and
                                             remittance of clients' payroll
                                             obligations.

Payroll tax administration services          Provides accurate preparation and
                                             timely filing of quarterly and
                                             year-end tax returns, as well as the
                                             electronic transfer of funds to the
                                             applicable federal, state, and local
                                             tax or regulatory agencies.

Employee payment services                    Provides the employer the option of
                                             paying their employees by direct
                                             deposit, payroll debit card, a check
                                             drawn on a Paychex, Inc. account
                                             (Readychexฎ), or a check drawn on the
                                             employer's account and electronically
                                             signed by us.

Regulatory compliance services               Includes new-hire reporting and
                                             garnishment processing, which allow
                                             employers to comply with legal
                                             requirements and reduce the risk of
                                             penalties.

Service                                        Description

Human Resource Services:

Paychex HR Solutions                           Available through an administrative
                                               services organization ("ASO") and a
                                               professional employer organization
                                               ("PEO"). Both options offer
                                               businesses a combined package that
                                               includes payroll, employer
                                               compliance, human resource and
                                               employee benefits administration,
                                               risk management outsourcing, and
                                               on-site availability of a
                                               professionally trained human
                                               resource representative, among other
                                               services. Our PEO differs from the
                                               ASO in that we serve as a
                                               co-employer of the clients'
                                               employees, assume the risks and
                                               rewards of workers' compensation
                                               insurance, and offer health care
                                               coverage to PEO client employees.
                                               Paychex HR Essentials is an ASO
                                               product that provides support to our
                                               clients over the phone or online to
                                               help manage employee-related topics.

Retirement services administration             Offers a variety of retirement plan
                                               options to clients, as well as
                                               recordkeeping services, which
                                               include plan implementation, ongoing
                                               compliance with government
                                               regulations, employee and employer
                                               reporting, participant and employer
                                               online access, electronic funds
                                               transfer, and other administrative
                                               services.

Insurance services                             Our licensed insurance agency,
                                               Paychex Insurance Agency, Inc.,
                                               provides insurance through a variety
                                               of carriers. Insurance offerings
                                               include property and casualty
                                               coverage, such as workers'
                                               compensation; business-owner
                                               policies; commercial auto; and
                                               health and benefits coverage,
                                               including health, dental, vision,
                                               and life.

eServices                                      Offers online human resource
                                               administration software products for
                                               employee benefits management and
                                               administration and time and
                                               attendance solutions.

Other human resource services and products     Includes section 125 plans, state
                                               unemployment insurance services,
                                               employee handbooks, management
                                               manuals, and personnel and required
                                               regulatory forms.

Overview
Our financial results for the three months ended November 30, 2012 (the "second quarter") of the fiscal year ending May 31, 2013 ("fiscal 2013") continued to show growth. Payroll service revenue grew modestly at 1.4%, impacted by client disruptions from Hurricane Sandy. Human Resource Services ("HRS") revenue grew at a double-digit rate as we continue to experience success in selling value-added solutions to clients. Our key business indicators of checks per payroll and revenue per check continued to show modest improvement and client retention levels remain near historic highs. Growth in checks per payroll was 1.2% for the second quarter, compared to 1.8% for the prior year second quarter. This has moderated somewhat from growth of 2.0% for the first quarter of fiscal 2013, and this moderation is anticipated to continue for the remainder of fiscal 2013. We are seeing good results from our selling efforts in the small-business market.
Our financial results continue to be adversely impacted by the interest rate environment, as interest rates available on high-quality instruments remain low. The Federal Funds rate has been at a range of zero to 0.25% since December 2008. Our combined funds held for clients and corporate investment portfolios earned an average rate of return of 1.2% for the second quarter of fiscal 2013 compared to 1.3% for the same period last year. The decline in average interest rates earned was partially due to a change in the mix within our short-term portfolio to a higher percentage of tax-exempt securities. While tax-exempt securities typically earn a lower rate of return, they are expected to lower income tax on interest earned.
We continue to focus on driving growth in clients, revenue, and profits, while providing industry-leading service and technology solutions to our clients and their employees. We are managing our personnel costs and expenses while continuing to invest in our business, particularly in areas related to product development and supporting technology. During the second quarter, we continued to deliver on our commitment to innovation as we introduced the following enhancements to our services to provide added value for our clients:

• Launched a new industry-leading Report Center, a one-stop shop for standard, on-demand, and ad-hoc reporting; data extract templates; and more.

• Launched a newly redesigned Paychex Accountant Knowledge Center, a free online resource available through www.paychex.com that brings valuable information and time-saving online tools to accounting professionals.

• Launched a new and improved BuildMyBiz.com, that includes a number of new features that provide enhanced resources for entrepreneurs and small business owners.

We also recently acquired ExpenseWire, a leading expense management solution for small- to medium-sized businesses. Prior to this acquisition, we utilized ExpenseWire, through a partnership arrangement, to power our Paychex Expense Management, a web-based solution that provides clients with tools to manage and control the expense reporting process. The acquisition of ExpenseWire gives us the ability to further enhance our Paychex One-Source solutions for major markets, and provide even greater value to our clients.
We continue to invest in our Paychex Next Generation innovative suite of products and services. We believe these investments in the next generation of technology and products are key building blocks to our future success. This new platform allows us to leverage efficiencies in our processes and to continue to provide world-class customer service to our clients.
Highlights of the financial results for the second quarter as compared to the same period last year are as follows:
• Payroll service revenue increased 1% to $377.0 million.

• HRS revenue increased 12% to $182.4 million.

• Interest on funds held for clients decreased 8% to $10.0 million.

• Total revenue increased 4% to $569.4 million.

• Operating income increased 6% to $230.0 million and operating income, net of certain items, increased 6% to $220.0 million. Refer to the "Non-GAAP Financial Measure" section, which follows, for further information on this non-GAAP measure.

• Net income and diluted earnings per share both increased 5% to $147.9 million and $0.41 per share, respectively.

Non-GAAP Financial Measure
In addition to reporting operating income, a U.S. generally accepted accounting principle ("GAAP") measure, we present operating income, net of certain items, which is a non-GAAP measure. We believe operating income, net of certain items, is an appropriate additional measure, as it is an indicator of our core business operations performance period over period. It is also the basis of the measure used internally for establishing the following year's targets and measuring management's performance in connection with certain performance-based compensation payments and awards. Operating income, net of certain items, excludes interest on funds held for clients. Interest on funds held for clients is an adjustment to operating income due to the volatility of interest rates which are not within the control of management. Operating income, net of certain items, is not calculated through the application of GAAP and is not the required form of disclosure by the SEC. As such, it should not be considered as a substitute for the GAAP measure of operating income and, therefore, should not be used in isolation, but in conjunction with the GAAP measure. The use of any non-GAAP measure may produce results that vary from the GAAP measure and may not be comparable to a similarly defined non-GAAP measure used by other companies. Refer to the reconciliation of operating income to operating income, net of certain items, in the "Results of Operations" section of this Form 10-Q. Financial Position and Liquidity
The supply of high credit quality securities has been limited with the continued volatility in the global financial markets, thereby limiting our investment choices. Despite this challenging macroeconomic environment, as of November 30, 2012, our financial position remained strong with cash and total corporate investments of $805.5 million and no debt.
Our investment strategy focuses on protecting principal and optimizing liquidity. Yields on high credit quality financial instruments remain low, negatively impacting our income earned on funds held for clients and corporate investments. We invest predominately in municipal bonds - general obligation bonds; pre-refunded bonds, which are secured by a U.S. government escrow; and essential services revenue bonds. During the six months ended November 30, 2012 ("six months"), our primary short-term investment vehicles were high quality variable rate demand notes ("VRDN"s) and Federal Deposit Insurance Corporation ("FDIC")-insured deposit accounts.

A substantial portion of our portfolio is invested in high credit quality securities with AAA and AA ratings and A-1/P-1 ratings on short-term securities. We limit the amounts that can be invested in any single issuer and invest in short- to intermediate-term instruments whose fair values are less sensitive to interest rate changes. We believe that our investments as of November 30, 2012 were not other-than-temporarily impaired, nor has any event occurred subsequent to that date that would indicate any other-than-temporary impairment. Our primary source of cash is generated from our ongoing operations. Cash flow from operations was $326.0 million for the first six months of fiscal 2013. Historically, we have funded our operations, capital purchases, business acquisitions, and dividend payments from our operating activities. Our positive cash flows have allowed us to support our business and to pay substantial dividends to our stockholders. It is anticipated that cash and total corporate investments as of November 30, 2012, along with projected operating cash flows, will support our normal business operations, capital purchases, and dividend payments for the foreseeable future.
For further analysis of our results of operations for the second quarter and six months and our financial position as of November 30, 2012, refer to the analysis and discussion in the "Results of Operations" and "Liquidity and Capital Resources" sections of this Form 10-Q.
Outlook
Our outlook for fiscal 2013 is based upon current market, economic, and interest rate conditions continuing with no significant changes. Our expected full year fiscal 2013 payroll revenue growth rate is based upon anticipated client base growth, offset by an expected lower rate of growth in checks per payroll, and modest increases in revenue per check. HRS revenue growth is expected to remain in line with our historical organic experience. Prior acquisitions are expected to have minimal impact on projected revenue growth rates for fiscal 2013. Our revised guidance is as follows:

                                   Low      High
Payroll service revenue              2  % -  3  %
HRS revenue                          9  % - 11  %
Total service revenue                5  % -  6  %
Interest on funds held for clients  (8 )% - (6 )%
Investment income, net               -  % -  5  %
Net income                           5  % -  7  %

Operating income, net of certain items, as a percentage of total service revenue is expected to be approximately 37% to for fiscal 2013. The effective income tax rate for fiscal 2013 is expected to approximate the tax rate for the first six months.
Interest on funds held for clients and investment income for fiscal 2013 are expected to continue to be impacted by the low interest rate environment. The average rate of return on our combined funds held for clients and corporate investment portfolios is expected to be approximately 1.1% for fiscal 2013. The average rate of return is anticipated to be impacted by a change in the mix within our short-term investment portfolio to a greater percentage invested in tax-exempt securities. While tax-exempt securities typically earn a lower rate of return, they are expected to lower income tax on interest earned. As of November 30, 2012, the long-term investment portfolio, which excludes VRDNs, had an average yield-to-maturity of 1.9% and an average duration of 3.1 years. In the next twelve months, approximately 15% of this portfolio will mature, and it is currently anticipated that these proceeds will be reinvested at a lower average interest rate of approximately 1.1%. Investment income growth reflects the impact of anticipated lower average investment balances during the second half of the fiscal year.
Purchases of property and equipment for fiscal 2013, are expected to be in the range of $95 million to $100 million. This will include costs for internally developed software, as we continue to invest in our product development. Fiscal 2013 depreciation expense is projected to be in the range of $80 million to $85 million, and we project amortization of intangible assets for fiscal 2013 to be slightly less than $20 million.

RESULTS OF OPERATIONS
Summary of Results of Operations:
                               For the three months ended                      For the six months ended
                                      November 30,                                   November 30,
$ in millions                    2012               2011         Change          2012             2011         Change
Revenue:
Payroll service revenue     $      377.0       $      371.7         1  %    $     762.9       $     754.0         1  %
Human Resource Services
revenue                            182.4              163.3        12  %          364.6             333.0        10  %
Total service revenue              559.4              535.0         5  %        1,127.5           1,087.0         4  %
Interest on funds held for
clients                             10.0               10.7        (8 )%           20.1              21.8        (8 )%
Total revenue                      569.4              545.7         4  %        1,147.6           1,108.8         3  %
Combined operating and SG&A
expenses                           339.4              327.8         4  %          679.6             661.2         3  %
Operating income                   230.0              217.9         6  %          468.0             447.6         5  %
Investment income, net               1.9                1.5        22  %            3.8               3.0        26  %
Income before income taxes         231.9              219.4         6  %          471.8             450.6         5  %
Income taxes                        84.0               79.0         6  %          170.8             161.3         6  %
Effective income tax rate           36.2 %             36.0 %                      36.2 %            35.8 %
Net income                         147.9       $      140.4         5  %    $     301.0       $     289.3         4  %
Diluted earnings per share  $       0.41       $       0.39         5  %    $      0.83       $      0.80         4  %

                                    For the three months ended                    For the six months ended
                                           November 30,                                 November 30,
$ in millions                          2012              2011        Change         2012             2011        Change
Average investment balances:
Funds held for clients           $     3,231.2       $  3,107.1         4 %    $    3,266.6       $ 3,182.8         3 %
. . .