John Gibson :

Thank you for joining us for our review of the Paychex Fourth Quarter and Fiscal Year 2024 Fiscal Results. Joining me today is Bob Schrader, our Chief Financial Officer. This morning before the market opened, we released our financial results for the fourth quarter and fiscal year ending May 31, 2024. You can access our earnings release and investor presentation on our Investors Relations website. Our Form 10-K will be filed with the SEC before the end of July. This teleconference is being broadcast over the internet and will be archived and available on our website for approximately 90 days. I'll start the call today with an update on the business highlights for the fourth quarter and fiscal year. Bob will review our financial results for fiscal year 2024 and outlook for fiscal year 2025. We'll then open it up for your questions. As we close out the fiscal year, I am pleased to report that Paychex delivered solid financial results, reflecting our ability to navigate changing market conditions by providing both innovative HR technology and advisory solutions that continue to deliver value for our clients and their employees. And as the best operators in the business, we are continually finding ways to run our business more efficiently. For fiscal 2024, we achieved 5% growth in total revenue and 11% growth in adjusted diluted earnings per share. These results are a testament to the hard work and dedication of our more than 16,000 employees and the investments we have made in our technology and advisory solutions. Revenue retention remains near record levels, and HR outsourcing work site employee retention continue to improve and hit new record levels. We believe our sustained high revenue retention demonstrates that our value proposition is resonating in a competitive marketplace. Our client retention for fiscal year 2024 was in-line with last year and pre-pandemic levels without a business losses back to pre-pandemic levels but stable. We continue to see demand for our HR technology and advisory solutions. Our activity and pipelines remain strong and in fact increased year-over-year in the fourth quarter. But close rates were softer than historical norms and our expectations. Sales results in some market segments faced headwinds in the quarter. In SMB, we made some adjustments to our go-to-market strategy and in our digital technology stack in the micro segment, which impacted our lead and sales volumes. We believe these are one-time issues which we have addressed. In the mid-market, we have seen some of the same pressures our competitors have mentioned with delays in decision-making and increased focus on cost. Our HR outsourcing, both ASO and PEO, and our retirement business continue to perform well and we believe the value proposition for those solutions remains strong. The breadth of our solutions, both technology and complete outsourcing advisory solutions, along with the market segments we serve, provides us with the ability to pivot our sales and marketing investments as market conditions change to maximize the opportunity. Small and mid-sized businesses continue to face a challenging operating environment due to complex regulations, a historically tight labor market, and persistent inflationary pressures. Our Small Business Employment Watch has shown stabilization in job growth and continued downward pressure in hourly wages in the recent months. In fact, our May index posted the biggest one-month increase in job growth this year. We also saw improvements in hiring within our client base with both better checks for clients and worksite employee growth in the quarter after a few quarters of declines. As we mentioned last quarter, our data and conversations with clients, reveal they are having a tough time finding qualified candidates. As an innovative leader in our industry, we took this as an opportunity to find a way to help these businesses by launching a new program starting in our PEO called the Employer of Choice Playbook. This program combines our digital HR technology and analytics, with our dedicated HR professionals dedicated HR professionals to work directly with our clients to find, attract, hire, and retain qualified employees. It starts with our digital recruiting and hiring technology which provides both seamless integrations with the top job boards. This solution streamlines and automates the hiring process for the employer and provides a better candidate experience. Our PEO clients are able to attract top talent by offering a Fortune 500 suite of employee wellness benefits as well. To help them retain employees, our HR professionals proactively work with our clients to leverage our HR data analytics and our retention insights to identify at-risk employees, determine the top drivers of turnover, and implement strategies to engage and develop their people. We are excited to offer a comprehensive solution to help our clients solve one of their biggest problems, hiring and retaining talented employees. We are planning more innovations in this area for all our market segments in the coming fiscal year. Our PEO business has continued to gain momentum with excellent performance in fiscal year 2024. We finished the year with strong results in sales, retention, and insurance enrollment. We have continued to see a shift back towards the PEO offering, both inside and outside our client base. This mix shift has a long-term positive impact on lifetime value in our model, particularly as clients attach insurance benefits. Our retirement services business was another strong contributor in the fourth quarter with double-digit revenue growth. As the industry leader in 401(k) plan record-keeping in the US, with approximately $52 billion in assets under management and over 120,000 clients. We are dedicated to helping small and mid-sized business owners, offer an affordable retirement solution for their employees. According to our own data less than half of US Employers currently offer a retirement plan. We are committed to providing affordable solutions to these companies that will help them offer their employees the opportunity for a secure retirement. Legislation like the Secure Act and Secure Act 2.0, the introduction of pooled employer plans and state mandates are helping to address the growing retirement crisis in the US, but there is still more to be done. We are committed to educating business owners and industry professionals on available programs, potential tax benefits, and the cost-effective plans available to them and their employees by Paychex. As you know, AI has been a hot topic in our industry and is something we have focused on for many years. Our AI initiatives and investments have been centered around enhancing our customer service model and identifying clients that are at risk, optimizing our pricing and discounting strategies, and driving higher sales productivity through improved marketing and targeting efforts. Additionally, we are focused on harnessing the power of our vast data to drive more value for our customers and continue to drive greater operational efficiencies across the company. We continue to gain recognition for the strength of our technology. For the fifth consecutive year, Paychex Flex, the company's cloud-based SaaS solution, earned an HR Tech Award for Best Small Business Focused Solution in the Core HR and Workforce category from White House Research and Advisory. For the tenth time, Paychex was named among the best employers in excellence in health and well-being, which affirms our long-standing commitment to our own employees. Paychex was also recently recognized by Forbes as One of the America's best employers for diversity. These recognitions and the many product and service awards that we have received in the last year and over the decades are a testament to the strength of our business model, our culture, and our commitment to invest in our business to deliver long-term value for our customers and our investors. In this post-pandemic era, Paychex is uniquely positioned to help small and mid-sized businesses navigate the challenges they face in a ever-evolving world. And we believe our value proposition to these businesses remains compelling based upon the breadth and quality of the solutions we can provide. We remain committed to our purpose to help businesses succeed, while making a positive impact on our clients, employees, communities, and shareholders. I'll now turn it over to Bob to give us a brief update on our financial results for the fourth quarter and fiscal year. Bob?

John Gibson :

Thank you, Bob. We will now open the call to questions.

Bryan Bergin:

Hi, guys. Good morning. Thank you. Maybe we'll just kick off with the demand and the go-to-market commentary that you had there, John. Can you just give more color on your comments on the lower close rates and the go-to-market changes you need to make? I'm curious if that was required because of something in your strategy and sales practices or reactions to just how clients are spending it and their changing behaviour.

Operator:

Thank you. And we will take our next question from Kevin McVeigh with UBS.

John Gibson:

Look, I think on the macro area, what we continue to see is growth and moderate growth. We continue to see wage inflation cool. I would tell you, in May in our report, we had the biggest one month increase there. As we said in our comments, we actually saw growth in checks and worksite employee in the fourth quarter, and that was a positive trend. We started engaging because, again when you got the economy growing at the rate it is growing, our models would suggest that you'd see more hiring. So to your point, what's going on here. And what we did is we went out and started looking at our analytics and data and to point retaining clients is a challenge for small business owners. Second, attracting qualified. And so we started engaging them. We did a lot of surveys. And what we found was they have open positions, they are just struggling to find them with qualified individuals. And I think, another thing they learned during the pandemic when everyone was just trying to hire just anybody that hiring just anybody doesn't help your culture or your workforce. And so I think, they are being a little more selective. So we rolled out a series of products we'll have more on the way. We started it in the PEO because that's an area where we have a lot of direct contact with the client and their employees and started doing a lot of comprehensive work both on retention and helping them directly attract using both our technology capabilities, as well as our AI capabilities and then directly building recruit strategies, and we saw success in that program, and we are going to look to continue to move that forward as we go forward. But I'm not -- we're not seeing any side of a recession or hearing from our clients are seeing payoffs or those type of things that we would typically see in a recessionary period.

James Faucette:

Great. Thank you very much. I want to go back a little bit on the changes you were making in the micro segment. And just to be clear, was that something that you felt like you needed to do for your own product? Or are you seeing some market pressures, et cetera, on that segment? And when you say onetime, how quickly should we start to see some of those sales conversions, et cetera come back to more normalized levels?

Operator:

Thank you. And we will take our next one from Samad Samana with Jefferies.

Bob Schrader:

Yes. Sure, Samad. Thanks for the question. Yes. I mean it absolutely was factored in. I'd say -- the only thing that surprised us about the end of ERTC was that -- it happened probably a quarter earlier than what we expected. But we've been -- we knew that it was going to come to an end this year. So we've been really focused all year on preparing for that. John has actually been talking to the team about it for two years, telling us that it was going to come to an end. So we've been focused on our cost savings initiatives, really trying to find ways to continue to enhance our digital capabilities, find ways to be more productive, more efficient while making investments in the business to prepare for this, really focused on not letting new costs in the business. And so we've been working on a plan for 12 months. What you saw as it relates to the cost actions that's been underway for some time. Obviously, I wasn't going to communicate it, but I had a high degree of confidence on the execution of those plans which enabled me to provide the preliminary color around margin expansion that I did on the last call.

John Gibson:

Yes. So a couple of things. We disclosed round numbers there. So the client base growth was closer to 1% when you kind of do have the full numbers and not the round numbers Samad. And I'm not sure on the worksite employee because our worksite employee growth was upper single digits. It was strong both in ASO and PEO and it was close to double digits, I'd say on the PEO, we've had a lot of strength there. So I'd have to look at those numbers again, but the worksite employee growth across both solutions has been extremely strong this year in particular, in that PEO business.

John Gibson:

You did this last time, Samad I remember. You're on my [indiscernible] side. [technical difficulty] I'm sorry, was your follow-up question on what the assumption is for next year related to those metrics?

Bob Schrader:

Yes Samad. I would say, it's -- our growth formula, which has proven in the 5% -- or the 4% to 5.5%, you take the midpoint of that, you got to factor in the 200 basis point headwind from ERTC. I would say, very similar. We're always putting together plans. We're trying to find ways to be more productive from a sales standpoint, trying to sell more and lose less and drive client-based growth. I'd say we are not as maybe dependent on that as others because we have lots of different solutions that we can sell. And we want to get client base growth. And then the big part of the formula is really going back into that base. And getting a larger share of wallet over time, we've driven a lot of growth historically and our ability to do that when you look at the kind of the penetration rates in those key solutions. And John really mentioned them, ASO, PEO, retirement. We have a lot of momentum in those businesses, and there is still a lot of runway within the existing client base. Pricing, we've talked a little bit this year about maybe pricing being a little bit of a headwind or a little bit less than our expectations, I will tell you the price realization in our model is still strong. Maybe our expectations. This year, we're a bit high, but pricing in our model is still strong and that would be a contributor to growth next year, maybe not at the same level as the last couple of years. But when you kind of put those things together, that gets you close to that growth rate ex-ERTC that's implied in the guide.

Operator:

Thank you. And our next question comes from Jason Kupferberg with Bank of America.

John Gibson:

I would tell you this that our growth formula that we historically have is well intact. I think that -- particularly when you even look -- I look at these numbers ex-ERTC, there are so many headwinds -- things that are difficult to look at over the last three years because you have the PPP, you have ERTC. You had a lot of onetime programs that we were engaging our clients with -- which was critical for their success. And that certainly gave us a lot of opportunities to talk to our clients about the provide. What Bob said is exactly what we would say. We continue to have good value pricing opportunities in our base and we have a demonstrated track record that as we bring clients in, we can move them up the value chain, demonstrate value and get price realization. So I think, the historical pricing capabilities that we have in the market, we continue to see and we continue to believe those are sustainable into the future.

Operator:

Thank you. And we will take our next question from Andrew Nicholas with William Blair.

Bob Schrader:

Yes, Andrew, it is a very strong number. And the thing to remember is we did not reach our expectations in terms of work site growth inside the client base. If the economy growing at the rate it's growing, we expected to see a lot more worksite employee hires in the PEO. That's part of the reason why we put this hiring program in place in the PEO because what we heard from our clients there was they were -- they had a lot of openings, but they were struggled to find them. So these numbers are very impressive, and they're volume-driven. I think we do have a very competitive offering. We did a lot of things on our insurance program. We had strong medical attachment exceeding our expectation. And then the enrollment based upon the breadth of the offerings that we're providing to the employees, the participation rates actually increased as well. So really pretty much across the board when I look at it, I think there is increasing demand for HR advisory and HR outsourcing solutions. And again, I remind everybody that's one of the things that I think is going to end up differentiating Paychex, is we can go all the way from a pure-tech play, which maybe there was a little more choppiness it. All the way up to a full outsourcing play. And when you have inflationary and you're trying to do more with less and you're trying to look at cutting costs, the old play of outsourcing moves in there. So now do I need to add another person to my HR department. Do I even need to add an HR person. Or can I outsource that? I think there is growing demand, and I think in an inflationary and where people are being very cost conscious. Outsourcing is one of the key tools. Everyone goes to an [e-CFO] (ph) knows as you go to outsourcing when you want to cut your cost and we've got the offering to do that. And I think we've positioned our value proposition very strongly against the competitive set that we're going up against.

Bob Schrader:

Better late than never.

Ashish Sabadra:

Thanks for taking my questions. I just had two quick questions on the first quarter guidance. First one on that if I understood correctly, 2% revenue growth, that's a material slowdown compared to 5% we saw in the fourth quarter. I understand the one less processing day but the ERTC headwinds were in the fourth quarter as well. So just trying to bridge that gap on what's causing that slowdown? And then on the margins, the margins at the midpoint of 41% to 42% would suggest a modest decline in margins in the first quarter, and so just wanted to better understand the puts and takes weighing on margins in the first quarter and then the improvement as we go through the year. Thanks.

Ashish Sabadra :

That’s very helpful color. Thanks Bob.

Peter Christiansen:

Thank you. Good morning. John, I was just hoping you could go a little bit into your middle market commentary on decision delay that you are seeing there. Is that a function of tech issues? Or is it high switching costs? Just your thoughts on perhaps now switching costs have kind of trended competitive landscape, what have you. Just it would be great to hear you expand on that dynamic just a bit more. Thank you.

Peter Christiansen:

Absolutely, it does. That is a fantastic color. But back on the discounts, I guess on an overall level, promotions discounts, all that would you say that -- that's rising?

Peter Christiansen:

All right. That’s super helpful. Thank you John. Appreciate it.

Ramsey El-Assal:

Hi, thanks for taking my question. Given the slower growth in Q1, can you help us think through the Q2 through Q4 cadence in terms of our models for management solutions. And also, if I could just tack on how much M&A contribution are you assuming in the full year guidance? Thank you.

Ramsey El-Assal:

Fair enough. Thank you so much.

Bryan Keane:

Hi, good morning guys. And Bob just a follow-up on that. On the one less processing day in the quarter, does that just automatically like there is a catch-up in the second quarter, so you'll see the boost that the processing day ends up adding to the second quarter. Is that how it works?

Bryan Keane:

Okay. And then just on the operating margin component in itself, it starts lower in the first quarter and then it ramps pretty significantly. Is there cost actions that are doing that? Or is that part of the processing, the less processing day that comes back? Or just trying to think about the take up in operating margin?

Bryan Keane:

Got it. Thanks for the color.

David Togut:

Thank you very much. Could you quantify the 2025 revenue or cost benefits from implementing Gen AI? You called out use of Gen AI in prospecting, and I'm curious, if you could go a little deeper into how you implement that in the business and what the financial benefits are?

Bob Schrader:

Yes, I'd say another example and it kind of takes long to a question that was asked earlier about the PEO performance. Another example where we leverage these technologies is in the PEO business. I mean, we talked to you guys about this in the beginning of the year that was one of our strategies to reaccelerate growth in the business. We had a really strong year last year with ASO and we knew that we were going to be able to leverage our data in AI models to really go back into that customer base, identify those prospects that were good clients for the PEO model and really go back in and upgrade them to PEO and be able to do that in a productive and efficient way with low customer acquisition costs. And that is one of many things that we did to really improve the PEO performance this year. But I think that is a great example on the real benefit, it’s having in our business model.

David Togut:

Just following up on your points around service, are you able to use Gen AI a lot to create more automated chat and reduce the labor intensity of servicing the client?

David Togut:

Understood. Thanks so much.

Kartik Mehta:

Yes, good morning John and Bob. If we took a step back at FY '25 and looked at the growth model for the company, I always used to think about net client growth, pace for control, price and the ancillary sales. And on those factors, would you say price is more historical, are we still at a point where you're getting a little bit better price? And then on the [semi or control] (ph), since they’ve been so strong or likely flat. So if you kind of look at that growth model, how would you say things have -- are different than historical?

Bob Schrader:

Yes, Kartik, I think we talk a lot about what you realize from client base growth. What do you realize from price? Remember, we got a pretty broad growth formula. And when you look at product penetration, that's been an area that's been historically very strong. And I would say that accelerated during the pandemic. So if I look pre-pandemic to post-pandemic and say what changed. We're exiting the pandemic and entering the post-pandemic era in a stronger position as a company. And we are more profitable, I think we are more agile. We have a stronger value proposition and set of solutions. I think we've established ourselves as a trusted adviser with our clients. I mean we got over -- we had over $90 billion of money in our clients' hands from ERTC and PPP. And so that built up a lot of goodwill. So when I look at what we can do from an insurance penetration of what we're seeing in the PEO. Remember, we sell the PEO both inside the base and outside the base, and we are seeing both of those accelerate. We are seeing our HR outsourcing inside the base. We are seeing 401(k) inside the base accelerating. So that product penetration is something -- sometimes gets left out, and that's also a key part of our growth formula as a company and has been for, as you know, for 50 years.

John Gibson:

Well, let me talk about M&A in general. I’d say, another part of our growth formula has been historically M&A as well, and that would be one that we continually looked at. I would tell you that I do find the market getting back to more rational valuation, both directly in our space and then that the adjacencies that we have been looking at historically where I think there was a lot of inflation as I see this go back. We're going to continue to be very active in that market. Specifically, in the area you're asking the question, we are more interested in expanding our partnerships with Fintechs and other companies digitally, so that as the client comes into run their pay. Remember for most small business owners, the biggest check they're going to write every month is their payroll. And so that's a source that if we can provide them alternatives to float some of that or get a loan if they need to repair a truck or something like that in their business. So what we are trying to do is build more partnerships there so that we can actually give them access to capital at the point of funding their payroll.

Operator:

Thank you. And we will take our last question from Scott Wurtzel with Wolfe Research.

John Gibson:

Yes. So to answer to the second question is no Scott, I think we have all that behind us. It is $30 million, I'd say roughly 20% of that is probably head count related, and then the balance from there is probably split roughly half between the real estate assets and the technology assets. There'll be some more disclosures when you see our 10-K in a couple of weeks around that. But that's the rough breakdown of those costs.

John Gibson:

Okay, Madison, let’s wraps it up.

John Gibson:

Okay. Thank you, Madison. At this point, as we close the call, if you're interested in a replay of the webcast, it will be archived for approximately 90 days. Again, I want to continue to thank each and every one of you for your interest in Paychex. And I hope everybody has a great day and a great fourth of July. Take care.

John Gibson:

Thank you, Mike. Thank you, everyone for joining our discussion today on the Paychex third quarter fiscal year 2024 earnings release. Joining me today is Bob Schrader, our Chief Financial Officer. This morning before the market opened, we released our financial results for the third quarter. You can access our earnings release on our Investor Relations website. Our Form 10-Q will be filed with the SEC within the next day. This teleconference is being broadcast over the Internet and will be archived and available on our website for approximately 90 days. I'm going to start the call today with an update on the business highlights for the third quarter and then turn it over to Bob for a financial update and then of course, we'll be happy to take your questions. We delivered solid results in the third quarter and the first nine months of the current fiscal year. Total revenue growth of 4% in the third quarter reflected a lower contribution for our employee retention tax credit or ERTC service as compared with the prior year period. This is consistent with our previously communicated expectations that ERTC revenue would become a headwind in the second half of the current fiscal year. Excluding this impact, our total revenue growth accelerated to 7% in the quarter, while our new client volumes remained solid and in line, and both client and revenue retentions were in line with our expectations. Several factors including our decision to wind down the ERTC program based upon the recent legislative developments on Capitol Hill, continued moderation of employment growth within our client bases and slightly lower realized rates all combined to create headwind, a larger headwind than what we had anticipated in the quarter. With the end of the ERTC program, we are now officially in the post pandemic era at Paychex, and I will tell you I am very pleased with how our teams have performed during these past several years. We put nearly $90 billion of financial aid into the hands of our clients, and based upon an analysis by MIT, we estimate that we save over 300,000 small business jobs. While these pandemic error programs are not part of our normal reoccurring revenue product strategy or our business model at Paychex, they were certainly consistent with our purpose. And that's simply to help businesses succeed. And I believe that we are a better company today than when we entered the pandemic four years ago. We are winning in the marketplace, and our long proven a recurring revenue growth formula still holds true. And this post pandemic and digitally driven era for the company, focused client growth, value-based price realization, increased product penetration, and opportunistic acquisitions are still the key pillars of the Paychex growth strategy. We are exiting the pandemic era with an even greater focus on our purpose, more opportunities to impact our clients and their employees, and with an even stronger reputation as a trusted advisor to small and mid-sized business owners. Despite the headwinds in the quarter, we delivered 7% growth in diluted earnings per share, and expanded operating margins, due to our longstanding tradition of expense discipline. As one of the best operators in the business, we continue to demonstrate our ability to deliver on earnings in uncertain times, and still make the necessary strategic investments to drive long-term profitable growth. Our culture of expense management along with investments we've made the past several years in digitization and enhanced sales and operational excellence capabilities have positioned us well for future profitable growth as well. The macroeconomic and labor market remains challenging for small mid-size businesses, a tight job market for qualified workers reduce access to affordable growth capital and inflationary pressures continue to be headwinds for small businesses. Our small business employment watch continues to show moderation in both job growth and wage inflation. But however, a relatively stable macro environment, the softening in hiring we started to see in the second quarter continued in the third quarter. There is more choppiness in hiring across all customer segments and industries now. Our clients tell us they still can't find qualified employees and are not willing to hire just anyone at higher wage rates, especially in areas with recent minimum wage increases and aggressive legislative changes. The demand for our HR technology and advisory solutions remains robust and the volumes of new clients added in the quarter were strong. We continue to deliver value for our customers as seen on our revenue retention results, which remain above pre-pandemic levels. Client retention for the third quarter was also in line with pre-pandemic levels and both revenue and HR outsourcing work site employee retention remains at record levels. As we continue to focus our resources on acquiring and retaining high value clients. Our sustained high revenue retention demonstrates that our value proposition and our market leadership remain intact. The fundamentals of Paychex are same. I'd like to highlight the success in our PEO business specifically, which has continued to gain momentum with strong results during the first nine months of the fiscal year. We finished the quarter with strong results in sales, retention and insurance enrollment. We have continued to see a shift back towards the PEO offerings both outside and inside our client base. This shift mix has a long-term positive impact on the customer lifetime value in our model, particularly as clients attach insurance benefits. AI and related technology investments are also key areas of focus in our industry and something that, as many of you know, we've been focused on for many years. We are proud to announce that we successfully implemented in the quarter several additional innovative AI models that significantly improved results for Paychex and our clients. Leveraging innovative technology and advanced analytics has allowed us to gain deeper insights into prospects and client behavior, their preferences, and their growing needs. Last month, we announced that Beaumont Vance has joined the company as our Senior Vice President of Data Analytics and AI. In this newly created role, he will be responsible for refining and executing the company's data strategy, including the use of business intelligence, advanced analytics, and AI driven automation to drive both improved business performance and enhanced customer value. We are excited to have Beaumont on Board to help us capture the full value of our vast data assets. I want to thanks to the hard work of our more than 16,000 employees and their focus on our company's values. Paychex continues to be recognized for both what we do and more importantly in my opinion, how we do it? We are proud to be recognized for the 16th time by Ethisphere, as one of the world's Most Ethical Companies in their recent annual list. Paychex was also recently recognized by Fortune Magazine as one of the Most Innovative Companies for the second consecutive year. These recognitions and the many product and service awards that we have received in the past year and over the decades is a testament to the strength of our business model, culture and the commitment to invest in our business and our employees to deliver long-term value for our customers and investors. I'm very proud of how our employees have delivered for our customers, for each other, for our communities, and for our shareholders throughout the pandemic area. We exit at this period in Paychex history, more focused and determined to be the digitally driven HR leader in our industry, and we are even better positioned to capture the opportunities in the markets we serve. I'll now turn it over to Bob to give you a brief update on our financial results for the quarter.

John Gibson:

Okay. Thank you, Bob. Mike, we'll now open it up for questions.

Mark Marcon:

So ERTC, just one thing just to clarify, Bob. When you talked about that you sold it in February, but because of the legislation you're going to end. It's basically bipartisan and it's basically going to end retroactively in January 1. So you then stopped recognizing the revenue. Did you -- is any ERTC revenue from -- that you sold from January 1 through February actually included in the third quarter number that you just reported?

Mark Marcon:

I mean, just related to the guide that you were providing, I was -- obviously, for the third quarter within Management Solutions because of the ERTC headwind, things were tougher and it seems like you actually did see some acceleration ex ERTC on total revenue. So I was just wondering like is there any way to quantify the impact in terms of not recognizing that revenue in February just because obviously you were anticipating that coming in. So any thoughts there?

Mark Marcon:

Okay. Great. And then with regards to the margin expansion, obviously, that's very encouraging, especially when you're not getting that benefit from ERTC. What are the key drivers in terms of that? Is it the AI initiatives? Is it efficiency on the sales side? What's driving the margin expansion? And how do you think -- to what extent do you think you're going to be able to continue that strong progress?

Operator:

And we have our next question from Kevin McVeigh with UBS.

Bob Schrader:

Yes, Kevin, I mean, we're still going through and finalizing all of our assumptions. But I would say at this point in time, we would assume a fairly stable, steady macro environment. Obviously, there's an expectation that the Fed is going to start cutting rates later this year. We do have some of that factored in at this point in time. But I would say, overall, the assumption is a fairly steady-state macro environment with some expectation that there'll be rate cuts as we move into the fiscal year.

Kevin McVeigh:

Lot of sense. And then, John, just to follow up on that point. Is that -- is kind of that tight labor what's driving kind of the reenrollment on the Insurance side of the PEO? Or just anything to call out in terms of what's been driving that?

Operator:

And we have our next question from Tien-Tsin Huang with JPMorgan.

John Gibson :

Yes, go ahead.

Tien-Tsin Huang:

Got it. Okay. Very clear. So it's just really the employment side that's out of your control. Perfect. So my quick follow-up, just on the pricing front among the 3 factors, you mentioned pricing last. Any more color on the pricing? Is it more discounting that you're seeing? And I'm curious if that informs your typical price action that you would take in the May or the spring time frame. And if that's baked into your look-ahead or preliminary '25 outlook?

Operator:

And we have our next question from Bryan Bergin with TD Cowen.

John Gibson:

Yes. Bryan, I would just probably reiterate what I've kind of already said. We had solid demand for our solutions really across the board. Volumes were in line with our expectations. What I said before is across each one of those sectors, I would say that the average size of the deal that we landed was smaller than what we anticipated than typical. So -- and I'm talking small, small amounts of differences. But as you all know, in a business of our scale, a small change going from average 1 or 2 employees or 3 or 4 employees or worksite employees per deal, it can have an impact on the revenue you expect.

John Gibson:

Yes. Bryan, I would say this, our sales head count has been at our expectations through the year. When we went into the selling season, we were at head count, that's what we reported. I think to your point, what was interesting in the third quarter, when I look holistically across the business, the amount of business we drove digitally across each of the platforms was impressive. And that's approaching some of our other channels that have historically been Paychex's bedrock of where we've gotten business. And so what we're seeing is and what we're doing with digital, I think, will continue to be something, and we're looking at a lot of different go-to-market strategies that we think will drive more productivity in our sales reps. And I think what we're trying to do right now is make sure we're doing the proper territory management so that we can have even more reps more productive. So I'm not prepared -- we're still working through our final budget planning process. What I can tell you is that we're driving a lot of productivity on a per rep basis. And we're going to make sure that we're covering every nook and cranny of the market. So making sure how many salespeople do we actually need to go after the market opportunity we have in each of the segments? And I think getting more specific about segment sizes and product type is what we're focused on as part of our new go-to-market strategy going into this post-pandemic era.

Samad Samana:

So maybe, first, we've heard about maybe pricing increases going into effect, let's call it, either towards the end of the year or earlier this year. I was just curious if there is a change in the timing of when you push through price increases for customers this year? And then I have a follow-up question as well.

Samad Samana:

Okay. Great. And then I guess just as you think about segmenting by customer size, I know what you just said about the average deal size, comparing it being smaller, but are you seeing any trends within if you stratified it by your smallest customers versus maybe slightly more like mid-market? And then same question between Management Solutions and PEO, if we're seeing anything that's different by the type of customer that you're seeing in terms of behavior or deal size or deal closing times.

Samad Samana:

I'm going to break it -- it does. I'm going to squeeze one more in. I know 2 are normally the limit. But just is there -- I know you're not guiding by segment for next year, but is there any reason, Bob, to assume that the trend line that you've guided for, for next quarter for Management Solutions ex ERTC and PEO, like what's implied in the guide that, that wouldn't be the trend line heading into next year? I guess, is there anything that would materially get you off of those trend lines?

Samad Samana:

Great. Thank you so much. Have a great day.

Operator:

We have our next question from Jason Kupferberg with Bank of America.

John Gibson :

Bob, you want start with the M&A?

John Gibson:

And Caroline, I mean the only thing I would add to that, just overall as it relates to capital allocation, really no change in our approach there. We're going to continue to invest in the business. Dividends are -- we're going to continue to grow the dividend, and that will continue to be our primary use of cash. You mentioned share repurchases, really no change in our philosophy there. We do that to offset dilution from executive comp. You saw recently, a month or so ago, we did do a new share reauthorization so we can continue to do that. The old authorization had expired. And then to John's point, we certainly are interested in M&A opportunistically, and we'll continue to use M&A to drive growth in the business. So our strategy and philosophy around capital allocation is very consistent with what you are all used to in the past.

James Faucette:

I wanted to go back on just a quick couple macro points that you're making. If I rewind back in December, you talked a little bit about some concerns you had about potential for increases in out-of-business rates, et cetera. I'm just wondering, like how that's evolved and what your current outlook is there? And it seems like you feel better about it, but I just want to make sure I'm interpreting your comments correctly.

James Faucette:

Yes, it does make sense. I appreciate that. And then we've talked about kind of labor scarcity pretty consistently for the last few years. And I think your incremental comments in terms of the quality of labor and specifically employers being more discerning now, it's interesting. Any specific areas or whether it be industries or geographic regions that that's important too. And I'm asking the question because I'm trying to think about what the path to resolution there is or if this is just something we're perpetually going to be grappling with?

Operator:

And we have our next question from Ramsey El-Assal with Barclays.

Bob Schrader:

Yes. Ramsey, I mean, M&A, we didn't do any new M&A. The only M&A that we've done this year was the small Alterna acquisition that we did at the end of Q1. Obviously, it contributes something. It's a small number, it doesn't even round to 1%. So it's really not a big contributor at all. In the guide, we typically don't -- although we're always active in looking for opportunities, we're not going to put anything into a forecast until the deal is closed. So that does not assume any -- the preliminary guide does not assume any level of M&A next year.

John Gibson:

Yes. I think, Ramsey, replacing ERTC is a very difficult thing to do, both in terms of the revenue nature of it and the profitability of it. And I would say that helping -- and basically, we're doing filing, as you know. We were doing tax filings, which is something that's core to our business and there was a lot of hype around ERTC. So there was a lot of education going on by others that was helping that. What I see in secured the SECURE Act is I think it's a great thing. I mean, our retirement business had a solid quarter and it's had solid year-to-date, and that continues to be a strong growth driver. I think you've still got to talk to business owners and educate them on it. It's still a sales process. We've had states that have made it mandatory. Those kind of come and go in the area. The other thing on the SECURE Act 2.0, which we've been pushing on is there is a little bit of a loophole that kind of disadvantages businesses with under 10 employees. I won't get into the nuances of it. And there's pretty bipartisan support in both the House and Senate to try to close that loophole and we keep pushing for that because I do think that would particularly help in our micro segment, really accelerate some adoption there. But right now, that will pull is still there.

David Paige:

This is David Paige on for Ashish. I just had a question on your AI initiatives. Maybe can you provide some of the customer feedback, what -- I guess, what parts of your tools or your AI models that they're liking and maybe some of the benefits you're seeing internally in terms of greater sales teams, productivity, et cetera?

Operator:

And we have our next question from Bryan Keane with Deutsche Bank.

Bob Schrader:

That's right, Bryan. So it's roughly -- there's 3 big drivers -- 3 drivers that we've talked about. They're all small, but there's 3 drivers that we've talked about. Certainly, the continued moderation of employment -- we definitely saw lower checks per client, lower change in base relative to what our assumptions were. That started in Q2. We updated our forecast in Q2 for some of the trends that we are seeing. But I would say employment came in a little bit softer than even our revised assumptions in the forecast. And then John mentioned a little bit on the rate. We saw smaller client sizes maybe a little bit higher discounting than what we assumed. I mean, we're still getting really good price realization overall and strong growth in revenue per client. But I would say it was a little bit softer relative to what our forecast assumptions were. And then the bigger piece there was the ERTC that I mentioned. So when you look at those 3 things, they're roughly 1/3 of piece is how I would characterize it.

Bob Schrader:

Yes. So I'd say there's a few things to call out there, Bryan. One, I mentioned the ERTC headwind being similar to Q3. It's a little bit less than it was in Q3, so that has a little bit of an impact. You have less of a headwind from ERTC in Q4. We're still getting a strong client base, price realization, product penetration that carries into Q4. And then I would say on the PEO side, we came out of selling season in a stronger position from a worksite employee standpoint in medical enrollment and so we're going to get the full quarter benefit of that in Q4 relative to where we were in Q3. So we got positive momentum, I would say, heading into Q4 in both businesses. And then we are getting a little bit of a lift in interest on funds in Q4. You've seen a little bit stronger growth there versus Q3. Some of that is the compare we did some repositioning of the portfolio. I think we had some -- or some realized losses that we took in Q4 to better position the portfolio going forward. And so you get a little bit of a tailwind in growth from that as well. And I'd say when you put those together, that's what accounts for a little bit stronger growth in Q4 relative to Q3.

Scott Wurtzel:

Just one for me. I wanted to go back to the margin side. I mean the outperformance, I think was notable despite the ERTC revenue going away. And I just wanted to clarify. I know you talked about some of the efficiencies off of the investments over the last few years. But were there any specific actions on the expense side that you took during the quarter as the ERTC revenue sort of wound down?

John Gibson:

Yes. I don't want to shortchange the tremendous job that each and every employee does in the company in terms of managing expenses. And we have it built into our DNA when we say, hey, we're seeing signs it's time to go. People know what to do and they do it. Because again, as Bob pointed out, some of that PEO and Insurance revenue is direct revenue pass-through. So when you look at our margins, you think some of that revenue into ERTC. I just want to come in how good a job we've done and I think have done historically as part of our just DNA as being the best operators. And so it's every little bit, every little thing matters. And so there's no one big thing. I would say that the insights that we're gaining and the opportunity for digitalization, the investment we've made in enabling our clients and their employees to engage our systems and the rate in which they're adopting that opportunity is tremendous. And we've invested over the last several years into building out both our AI robotics capabilities and our global footprint. And I think all of those investments we've made over the last 3 years during the pandemic era, when we had ERTC are going to serve us well as we move forward. So I just look at it and say, as we exit this era of the pandemic from a Paychex perspective, I think we're entering the new era of just fundamentally a better positioned company. I think we're a more positioned, trusted adviser to small businesses. We're delivering more value to our customers. They're rewarding that with retention and with better pricing in a market where there's a lot of cheaper alternatives out there. We're more digitally enabled in all aspects of our business than we've ever been. And I think we're more agile and focused and also more profitable, quite honestly. So hats off to the team for all the things we've done to get ourselves in this position that when the tide turned, we had leverage we could pull to make sure that we're delivering for our shareholders.

John Gibson:

Okay. Well, listen, everyone, at this point, we'll close the call. If you're interested in a replay of the webcast of the conference call, it will be archived for approximately 90 days. And I want to thank you for your interest in Paychex and hope all of you have a great day. Thank you.

John Gibson:

Thanks, Chelsea. Thank you, everyone, for joining us for our discussion of the Paychex second quarter fiscal 2024 earnings release. Joining me today is Bob Schrader, our Chief Financial Officer. This morning, before the market opened, we released our financial results for the second quarter. You can access our earnings release on our Investor Relations website, and our Form 10-Q will be filed with the SEC within the next day. This teleconference is being broadcast over the Internet and will be archived and available on our website for approximately 90 days. I'm going to start today with a brief update on the business highlights for the second quarter, and then I'll turn it over to Bob for a financial update, and then, of course, we'll take your questions. We had solid results in the second quarter and for the first half of the fiscal year with particularly strong performance in the PEO, mid-market HCM, and retirement. Revenue for the first half was up 6% year-over-year and our adjusted diluted earnings per share was up 10%, double digits. The demand for our HR technology and advisory solutions remained strong as business leaders continue to face a very challenging small and mid-sized business environment. The tight labor market and rising healthcare and benefits costs are forcing many to rethink their HR and benefit strategies, and they can turn to Paychex as a trusted business partner in these times. As we sit here today, the selling season for our mid-market HCM and our PEO teams are in their final phases, and our insurance open enrollment is underway. All are going well and in-line with our expectations. Our pipelines for these solutions are strong and up from this time last year. In the small business market, selling season is just ramping up. We still have a critical third quarter to go both in terms of selling and delivering for our clients during year-end, but we are fully staffed and well positioned at this critical time of year. Our revenue retention remains above pre-pandemic levels as we continue to focus our resources on acquiring and retaining high value clients. Client retention has improved over last year and retention in our HR outsourcing solutions remains at record levels. I'd like to highlight the success specifically in our PEO business, which we've talked about on prior calls. It has continued to gain momentum with strong results during the first half of the fiscal year. We have seen a back -- a shift back towards the PEO offering, both outside and inside our client base. This shift in mix has a long-term positive impact on customer lifetime value in our business model, particularly as clients attach insurance benefits. We previously discussed actions we took to help the PEO recover after last year's challenges including

John Gibson:

Okay. Thank you, Bob. We will now open it up -- the call for questions. Chelsea?

Kevin McVeigh:

Thanks you so much, and congratulations as you close out the year, John, Bob, and I want to thank Efrain, because I think this is the last quarter Efrain will be on the call too. So, John or Bob, I think you talked about revenue retention at record levels and client retention improving. Can you maybe dimensionalize that a little bit? And -- because it feels like that's getting a little bit better, but the revenue maybe more the middle of the range. So, what's driving the improvement, and then, kind of maybe just the tweak on the revenue expectations overall?

Bob Schrader:

Yeah, Kevin, I'll just add on the guide. As you guys remember, at the end of Q1, I think where we ended the quarter, we had said we expected to be towards the high end of the range. I think there were a couple of reasons at that time why we felt confident in saying that. I would say, one, the positive trends that we were seeing in the PEO business. I think we wanted to wait another quarter before we raised the PEO guidance. But we definitely saw some positive trends really going back to the end of last year. That continued into Q1. I'd say that gave us a little bit of confidence. And as you guys know, we did do a small acquisition at the end of Q1, not a big contributor to growth. But I think those two things combined really gave us a bit of confidence that we thought we might be towards the upper end of the range, I'd say, as we got through Q2. The one thing that I'll highlight, I think John made reference to it, although we didn't have big growth assumptions in the plan related to employment growth, particularly in our larger employee sizes across both Management Solutions and the PEO. We typically get some seasonal hiring. We expected to see some growth there that didn't materialize to the level that we expected and certainly what we've seen in the past. And so that's given us a little bit of pause. And as I mentioned, that was across both categories, Management Solutions and PEO and Insurance. The PEO and Insurance, for the most part, they've been able to outrun that I would say, just given the strength of the business. John talked about the strong demand there. And some of the action plans that we've taken have really paid off there. But on the Management Solutions side, it's been a little bit of a headwind. And that is kind of what you see in the quarter as well as kind of the fine-tuning of the guidance ranges that I just provided.

Operator:

Thank you. Our next question will come from Andrew Nicholas with William Blair.

John Gibson:

Yeah. So, thanks for the question, Andrew. I'll say this, the PEO, you can tell by the growth numbers, continued to improve as the year has gone on. And I would tell you that our pipeline is very strong in comparison to last year. So, whatever the competitors are doing, our value proposition is resonating. I can assure you that we're not using cheap health as that part of the value proposition. So, we go at it more as a comprehensive HR outsourcing value proposition. And if clients are looking for cheap health, they're probably -- we're probably not engaging in that conversation very long. We have the capability, as you know, to also leverage our insurance agency within our PEO as well. But very pleased with where we are on -- with the PEO right now, very strong performance. The pipeline is solid. We are in the final stages. As you can imagine. That in the mid-market, as you know, typically the selling season is much earlier, it's pretty much in the final innings. And both pipelines, I would say, for the PEO are very, very strong, both in terms of insurance attachment and in terms of sales.

Bob Schrader:

I'll start on just kind of the financials. I'd say for the most part, ERTC, we finally got it right from a forecasting standpoint after three years. It's bit been a little challenging to forecast that. But for the most part, it has lined up with our expectations. Most of that was assumed to be in the front half of the year. That's behind us. There still is a little bit in the back half of the year. But for the most part, it has lined up. I've gotten this question a lot. I promise to provide an update on ERTC. So, I'm going to stick to my word, which was essentially we had said prior that we expected it to be a slight tailwind in the front half of the year. That's where the front half landed, it was a slight tailwind. We expected it to be a headwind in the back half of the year. It will be a headwind in the back half of the year. But I wanted to provide a little bit more color and you guys can kind of do the math and back into it. But on a full-year basis, with the tailwind in the front half and the headwind in the back half, we would expect it to be about a 1% headwind on a full-year basis to growth. And then, I don't know if, John, you want to address the PEO?

Andrew Nicholas:

Perfect. Thanks so much.

Ramsey El-Assal:

Hi, thanks so much for taking my question. I had a follow-up on ERTC. It strikes me that there is a kind of a backlog building, right, as they've paused processing. So, is this the type of thing that we should think about, yes, it's a headwind in the back half of the year, but eventually as the IRS begins processing again that revenue might start to flow again in the future? Is it sort of more of a shift of revenue into the future? And I know it's complicated and they're rolling in some deadlines in '24 -- calendar '24. So, I'm just curious how we should -- how you're thinking about that ERTC revenue, not just for the following quarters, but maybe a little bit beyond that.

Ramsey El-Assal:

Great. That's very helpful. And a quick follow-up. SECURE Act 2.0, is that in any of your conversations in the selling season? Give us kind of your latest view about how that opportunity is framing up for Paychex?

Ramsey El-Assal:

Got it. All right, thank you so much. Happy holidays, by the way.

Bob Schrader:

Same to you.

Bryan Bergin:

Hi, guys. Good morning. Thank you. So, I wanted to start on Management Solutions. The late seasonal hiring that you've called out here that drives the weaker view, can you just dig in more on that client profile? And is this more so a pullback in demand for employees or issues in hiring? So, I'm curious what you might be seeing as it relates to clients' talent acquisition funnels, job openings, background checks, things like that.

Bob Schrader:

Hey, Bryan. I just want to add a little bit. You didn't specifically ask this, but just as your comment as it relates to the weaker Management Solutions. The other part of that -- beyond the softer hiring versus what we expected, the other part of part of that has to do with the strong performance in PEO as well. We talked to you guys about the PEO business. We've had a lot of questions on that and our ability to kind of reaccelerate growth there. And one of the strategies there was that we knew the ASO was really strong last year. We had put a plan together to really go back inside of the base, leverage our data, leverage our AI models, really look at the clients that we thought would be good PEO fits, and we've been executing on that plan over the last six months and that has actually been a little bit better than what we anticipated. So, now the pendulum has swung back a little bit the other way. We probably should just put these two businesses together in one category. It would make mine and John's job much easier. But we've had a lot of success with PEO. I think that's why you see the raise there. And that is impacting to some extent, to use your word, the little bit weaker performance in Management Solutions.

John Gibson:

Well, let me take the last one first. Yes, I would tell you that we talked about the PEO in the fourth quarter of the last fiscal year. We told you about many of the changes we were making across that business. We began to see acceleration there. It accelerated further in the first quarter, and it continued in the second quarter. And it continued both outside the base as well as inside the base. So, as Bob pointed out, this ASO to PEO conversion. So, we've seen a very healthy pipeline. And I would say not only in the PEO, also in our mid-market. So, when you look at the two businesses, that are -- in summary, if you -- if we're sitting here today in the selling season in our mid-market HCM and PEO, they're well underway. They're really in the final stages. Our pipeline was very strong. And then, the enrollment of the insurance, it was very strong as well. I would tell you that we're getting back in line to where we've been historically. If you remember, we had a little degradation. And actually, what we saw inside the existing customer base was an increase, I would say, maybe single-digit increase in penetration. If you remember, last year, we had some employees in it sign up for plans. We did some things on changing our plan lineup. We did some things in the way we're doing education and open enrollment there. And the team has done a great job of improving our attach rate within the existing client base as well during this enrollment.

John Gibson:

Happy holidays.

Operator:

Thank you. Our next question comes from Jason Kupferberg with Bank of America.

Bob Schrader:

Yeah. I mean, I can start and then John can add on. I mean, obviously, there is the headwind there with ERTC, but there's other areas of the business. And although ASO, we had some of the hiring challenges that John referenced as well as better PEO performance, ASO still continues to be a strong contributor to growth, and we expect that to continue to be the case in the back half of the year. We talked about retirement. That has been a really strong driver of growth for us and just really increased product penetration. We expect that to continue into the back half of the year, Jason. That will offset, to some extent, some of the ERTC headwind. And again, we did do a small acquisition. It's not a huge contributor to growth on a full-year basis. But again, that will help mitigate some of that headwind as we move into the back half of the year. And when we kind of put all those things together, we would expect Management Solutions to be in a similar growth rate in the back half of the year than the first half -- or same as the first half.

Jason Kupferberg:

Okay. That's good color. I know you talked about how you're thinking about overall revenue growth for Q3 versus Q4, but can you just parse out maybe your segment level growth expectations for Q3 versus Q4, just so we get our models tuned properly? Thank you, guys. Have a great holiday.

Bob Schrader:

Yeah, I'm just -- I'm taking a look at that, Jason. Obviously, the Management Solutions will probably be a bit lower in Q3 than Q4 because of the headwinds that we talked about being greater with ERTC in Q3. And then, the PEO and Insurance, those growth rates are going to be similar to where they were in Q2. And hopefully, when you look at the full-year guidance, the guide that I gave you on Q3, you can kind of do the math and should get you close.

Jason Kupferberg:

Okay. Thanks again.

Peter Christiansen:

Good morning. Thanks for the question. Nice execution here. John, Bob, I was just hoping if you could talk a little bit about balance of trade. Any trends that you're noticing, particularly in the Management Solutions area? And then -- and John, you also mentioned AI playing a part in the sales role. Just wondering if you could dig a little bit into that and give us a sense of where you're making headway on that front? Appreciate the commentary. Happy holidays.

Peter Christiansen:

On the AI front, I think you mentioned it...

Peter Christiansen:

Thank you.

Kartik Mehta:

Hey, good morning, John and Bob.

Kartik Mehta:

Thanks. John, you talked about -- a little bit about the key selling season, obviously, in the SMB. And I'm wondering if you've seen any kind of change in price competition or if you're seeing anything that is a little different this time than last year?

Kartik Mehta:

And then, Bob, just on the Management Solutions and you're talking about the seasonal employees, is that just -- if we kind of consolidate all that, is it just a matter of your pays per control expectations were X, but they came in a little bit less because of what you're seeing?

Kartik Mehta:

Thank you both. Appreciate it.

Operator:

Thank you. Our next question comes from Samad Samana with Jefferies.

Bob Schrader:

Yeah -- oh, you want me to take it?

Bob Schrader:

Yeah. Samad, I've gotten this question a lot. I think if you look back at -- and we've talked about this area. I've talked about it with many of you on this question specifically. But if you look at what we've done from a revenue growth, whether it's over the last five years or 10 years, it's well within the range of that midterm guidance that we gave. I would also say the guidance that we're providing this year, at least the way I think about it, is well within that range as well. And as you know better than anyone, we have a way we go about delivering that growth. It's a mix of client-based growth, and then, I would say that we would assume that to be similar with past performance. One thing that we're really good at is getting a larger share of wallet out of our client base, particularly with our higher value solutions, ASO, PEO, retirement. We still think there's a lot of opportunity inside the base. When you look at a lot of those key solutions, the penetration rates are fairly low. And so, we believe we have a lot of opportunity to continue to drive growth there. As John mentioned, we have pricing power, right? We deliver a strong value proposition and our expectation is that, hey, we might not be capturing price to the level that we did over the last couple of years where inflation was, but we believe we have a strong value proposition that is going to enable us to continue to capture price in the future. And I think when you put all that together -- I'd say the other component of it, when you look back historically, is we have used M&A as a way to drive growth in the business, and that has been part of our growth formula. It's part of what we've delivered over the last five and 10 years, and we expect that we'll continue to look for opportunities, and that will be part of our growth in the future. So, when you kind of put that all together, that gives us confidence that we can continue to deliver in that upper single digit level. It's not going to be -- it'll vary year by year, but for the most part, we expect it to be in that range.

John Gibson:

No. We're fully staffed, and our intent is to continue to grow sales. Look, the business starts are up. We feel like the opportunity in the marketplace is strong. Now, I will tell you, the thing we are trying to balance is the productivity gains that we can get out of some of the go-to-market strategies. As I said, we did some testing learns in the PEO that showed some really good lift. And so, quite frankly, I think we're going to apply those in the mid-market and upper end of the SMB market. And I think those could also be a lift as well, but we have no plans of pulling back on investing in growth.

John Gibson:

Thank you.

Bryan Keane:

Hi, guys. Good morning. Just a couple of clarifications from me. When you talked about SMBs investing for growth, hesitation -- some hesitation there. Does that impact their willingness to buy ancillary services and maybe has impacted the management services growth as well?

Bryan Keane:

Got it. And then, the other clarification I had is, the shift to ASO the PEO, did that surprise you guys or was that all part of the plan and pretty typical?

Bryan Keane:

Got it. That's helpful. And then, just a quick one for Bob. Just to quantify the small acquisition, does that add about 1 point to 2 points of revenue for third quarter or how do we think about that?

Bryan Keane:

Yeah, I was just thinking maybe it could offset some of the ETRC...

Bryan Keane:

Great. Happy holidays.

John Gibson:

Happy holidays.

James Faucette:

Great. Good morning, guys. Just a couple of quick follow-up questions. In terms of back to this point on seasonal hiring, maybe being a little bit weaker, I'm just wondering from your perspective if there's been any impact or truth even before now to this narrative that we've heard a lot around labor hoarding and that smaller businesses in particular were keeping people on payroll or employed that they maybe otherwise wouldn't have just because they were concerned about shortages. And just wondering if you'd seen any evidence of that actually in your customers and if that could be impacting the seasonal hiring at all.

James Faucette:

Okay, got it. I just wanted to make sure that I was interpreting that correctly. Thank you. And then, you mentioned that we still are in a period of strong business starts. What about on the other end? I think there had been this view over -- in the economy generally that we weren't seeing failure rates or out of business rates get back to pre-pandemic levels yet. But can you just give us an update on what kind of out of business levels we're seeing? And how much -- and particularly in the context of continued strong business stores, I'm just wondering on that component of the customer set.

James Faucette:

It does. Yeah, I just -- on that point, so clearly bankruptcies have been rising, but have they -- in your customer sets, have they surpassed pre-COVID levels or not yet? Or -- and it sounds like, given that large number of bursts, we probably should expect them to surpass pre-COVID levels at some point if they haven't, right?

James Faucette:

Got it.

James Faucette:

Okay. Fantastic. Thank you so much for that.

Operator:

Thank you. Our next question will come from Mark Marcon with Baird.

Bob Schrader:

Yeah, I mean, as John mentioned, I think we've seen a lot of strength in the mid-market. And from a sales performance standpoint, our unit performance that we had in Q2, I think you mentioned in the prepared remarks, John, was above where we were at this time last year. We continue to see strong penetration within the existing client base, upsells into the base, whether that's ASO, PEO, retirement, but I would say, Mark, there's strength across the board, both from a new logo standpoint, particularly in the mid-market as well as upsells into the base.

John Gibson:

Yeah, Mark, I would say what we're seeing is what we've typically seen, again, SurePayroll more in the micro set. So, if I look at the micro set, continuing to see similar type of -- there's a lot of new business starts. So, there's a lot of opportunity there for growth. And then, in the small business, we're just so early in the key selling season. Really as you know, the next 60 days are really going to tell us how that's going to shake out. Back to I think what your original question was as well on Management Solutions is, remember, you have the geography issue occurring at the same time. So, while we're selling a lot more inside our human capital management base and into our ASO base, some of what we're upselling is PEO. And so, they're moving over to the other geography on the P&L, which is a good thing from a long-term perspective. And then, as we said, this issue relative to the seasonal hiring, which happened in the upper end of the market, that impacted both the PEO on the PEO and Insurance side and the ASO market on the Management Solution side.

John Gibson:

Yeah, look, you're pointing to an item which I think is a tailwind that I think will continue to evolve, and that is healthcare inflation. And really, I think you'll see that evolve in the future post-pandemic. Pushing costs through the health system is a slow process. It starts with more expenses at the hospital. They have to negotiate with carriers. They have contracts that takes years to do. In our local community, there's unionization and strikes going on at the local hospital for more pay. Then that has to get approved by state legislature. So, the cost increase that we saw inflationary in healthcare last two years is going to start making its way to health plan costs in the future. We're certainly aware of that, and we're doing things to prepare for that. And when we talked about that last year, we did a lot of changes in our healthcare lineups to give more choices to people, making sure that we have the right plans. And I would say that our apples-to-apples was actually highly competitive to what the general inflation was, and we're keeping our MLRs in-line to where they've historically been at the same time. And so, through some plan designs and some other ways in which our teams have been creative in coming up with some creative health solutions, I think we've got a good portfolio of products and services that our clients are finding very competitive to alternatives that they have. I don't know if that helps.

John Gibson:

Well, I would say given the results and the pipeline that I see, that's made us more successful. That's the results I look at. We're not in a -- we're in a very competitive environment. So, most of the deals that we're involved in, someone else is involved in. And I think our lineup is very comparable. I think what you would -- what I would say is that we manage our plans in such a way that we tend to beat the standard health inflation and we've broadened our portfolio of offerings such that I think there is something for every client. They can find something that they want in our plans. And I think that breadth of services and breadth of options is one of the things that differentiates us from others.

John Gibson:

Happy holidays.

Scott Wurtzel:

Hey, good morning, guys. Just one from me quickly. Can you remind us of what your top end market exposures are by vertical, maybe in the PEO segment? We have heard from one of your peers who is seeing some challenges sort of on the pays per control worksite employee side in PEO mostly due to some certain end market exposures. So, it would be very helpful if you guys can just remind us of where you guys have some of your larger exposures in the PEO. Thanks.

Scott Wurtzel:

Great. That's super helpful. Thanks, guys.

Operator:

Thank you. Our next question will come from Ashish Sabadra with RBC Capital Markets.

Bob Schrader:

Yeah, I mean, that was a very small contributor, David, to growth in the quarter. And the other thing you need to keep in mind, we kind of gave you color on ERTC being a slight tailwind in the first half. It was actually a headwind in Q2, so most of that came in Q1. So, you kind of -- you have the headwind of ERTC. You have a slight tailwind from the acquisition. But the organic growth rate is not going to be too far different from what you see as reported.

Bob Schrader:

Yeah, same to you.

Tien-Tsin Huang:

Hey, thanks. Yeah, just to close out the call, John, you mentioned the LTV for the PEO business being attractive. I don't think I've heard that from Paychex all these years. So, can you elaborate on that relative to the ASO or HRO or even if you can't size it, just the ratio there? Just love to learn more on that.

Tien-Tsin Huang:

Got it. Yeah. I know the notionals are high, but in my mind, the payroll [indiscernible] payroll business, the retention, [indiscernible] margins are so high, I figured that was also tough competition...

Tien-Tsin Huang:

Thank you for that.

Tien-Tsin Huang:

And the CAC is also low because a good chunk of it is still selling into exist. I know you said it's coming [indiscernible]...

John Gibson:

Good point.

John Gibson:

Thank you. You too. Okay, I think that was it. At this point, we'll close the call. If you're interested in a replay of the Webex of this conference call, it will be archived approximately 90 days on our website. We would certainly want to wish all of you and your families a very safe and happy holiday season. I want to continue to thank you for your interest in Paychex and hope everyone has a great day. Take care.

John Gibson:

Thank you, Shelby. Thank you, everyone, for joining us for our discussion of the Paychex first quarter fiscal year '24 earnings release. Joining me today is Efrain Rivera, our Chief Financial Officer; and Bob Schrader, Vice President of Finance and Investor Relations. This morning before the market opened, we released our financial results for the first quarter. You can access our earnings release on our Investor Relations website. Our Form 10-Q will be filed with the SEC within the next day. The teleconference is being broadcast online and will be archived and available on our website for approximately 90 days. I will start the call with an update on the business highlights for the first quarter. I'll then turn it over to Efrain and Bob for a financial update, and then, we'll open it up for your questions. But before getting into the discussion of our earnings results, I want to take a brief moment here to make a few brief comments to acknowledge Efrain Rivera, who announced his intention to retire as CFO effective October 12, 2023; though he will remain as a Senior Advisor at least through the end of the calendar year. Efrain has been a valuable member of this senior leadership team at Paychex for the past 12 years. He has provided strong financial stewardship, but more importantly, great strategic leadership as well. During his time with Paychex, the company has transformed into a technology-enabled services company and we significantly expanded our HR Solutions and capabilities. Efrain has been a key strategic advisor and a catalyst for this transformation. Efrain, I think you know how truly I appreciate your intellectual wisdom, your integrity, the guidance you've given me personally over my decade here and to the company. And we are all in great gratitude for what you've done for each one of us personally and for the company. Our customers, our employees and our shareholders are better off because you were here. So, thank you. Joining us today is Bob Schrader, who will succeed Efrain as CFO. Bob joined Paychex back in 2014 and is taking on progressive leadership roles over the past nine years, including over the last year and a half since I was named President and subsequent CEO of being co-lead of many of our strategic review efforts and strategic initiatives. Bob's promotion is a part of a strategic succession plan to bring in an innovative leader who will continue to guide the company going forward. I want to congratulate Bob and, Bob, I look forward to continuing to work with you as I have in the last 10 years, I mean, as we continue to -- continue our track record of delivering strong financial results and continuing to position Paychex as a leader and innovator and a company that you can count on for predictable and sustainable results. Now, moving on to the first quarter results, speaking of predictability and sustainability. We have begun the fiscal year '24 with solid growth of 7% in total revenue and 11% in adjusted diluted earnings per share. We've seen operating margin expansion approximately 60 basis points year-over-year, while still investing in our business to drive future growth. Our first quarter reflected solid execution by our sales, service and all of our teams across Paychex. The demand for our HR technology and advisory solutions continued, resulting in strong quarter new sales, revenue growth, we saw positive trends in client, revenue and HR outsourcing worksite employee retention during the quarter, and we continue to focus our resources on acquiring and retaining high-value clients. We are starting to see improvements in some of our key PEO and insurance metrics during the quarter, with good results across sales activity, insurance attachment and retention. We will know more after our open enrollment season is completed, which primarily runs from October through January, but at this time, we believe that the actions we have taken in response to the headwinds we faced in 2023 are beginning to gain traction. Employment levels within our client base have remained stable. Small businesses, which are central to the U.S. economy, continue to show the resiliency. Our Small Business Employment Watch has shown that small businesses continue to add workers at sustained, but modest rates, also the trend in wages is showing some cooling in wage growth consistent with overall inflation. Our data indicate a continued stable macro-environment for small and mid-sized businesses. We continue to monitor our leading indicators and are prepared to take appropriate actions to navigate any changes. But again, at this time, we don't see any material change to the macro-environment. Small businesses have faced challenges getting access to capital and managing cash flows in this environment. This has continued to drive demand for our full-service Employee Retention Tax Credit Service. I know there's been some recent news of the IRS pause in ERTC processing in order for them to perform increased audits. This is not expected to have an impact on our ability to provide the service, though it may take longer for our clients to receive their funds. We continue to communicate this opportunity to existing clients and prospects and we continue to file amended returns with the IRS on their behalf. We anticipate that ERTC revenue will be a slight tailwind for the first half of the fiscal year and then turn to a headwind in the back half as the program ends. We are seeing greater adoption of HR software as businesses look to digitize their HR efforts to support the complexities of managing today's workforce in a more efficient manner. We also continue to see strong demand for our HR advisory solutions as businesses deal with the continued challenges of being an employer in today's challenging employment world. Paychex is uniquely positioned to offer a continuum of HR products, technology and services from do-it-yourself payroll all the way to full-service PEO HR outsourcing. All of these products deliver a strong return on investment for our clients. For the 13th year in a row, we were named the leading retirement record-keeper by number of plans by PLANSPONSOR Magazine. Our leadership position in retirement makes us an excellent resource for small businesses and we continue to educate and execute on this opportunity. There have -- there has certainly been a lot of excitement about AI and related technology and advancement around the monetization of large datasets. At Paychex, as we've talked on prior calls, this isn't anything new or it's not a fact. We have been using artificial intelligence to transform our business for over a decade. We have over 200 AI models that are actively working on our business today, designed to provide valuable insights, fueled by our vast data assets. Our award-winning Retention Insights tool uses AI-based predictive analytics to provide HR leaders with early insights into potential employee retention issues. Our Flex Intelligence Engine is an embedded AI chat capability within our Flex platform that allows the customer to get quick answers to over 900 of the most common questions and access over 1,200 instructional resources. Companies like Paychex with large amounts of data will clearly be the winner with AI, and we will continue to harness the power of AI and leverage our extensive data to drive internal efficiencies and provide actionable insights and solutions to our clients. This quarter, we continued to be recognized for our innovation, service and the positive impact we are having on our customers, our industry and the world. For the third time, Paychex has been recognized by TrustRadius with a 2023 Tech Cares Award for the company's Corporate Social Responsibility programs and our community impact. We also received an award from Selling Power for our commitment to fostering a diverse and inclusive workforce, and from Forbes as one of the Best Employers for Women in 2023. On the product and service side, NelsonHall, once again, identified Paychex as the leader in its 2023 Next Generation HCM Technology Market Report. We also earned at silver Brandon Hall Group 2023 HR Excellence Award for breadth and depth of training that we provide our HR advisors to keep them up to speed on the ever-changing complexities of the employer-employee relationship. Paychex was also named the 2023 Constellation Research on their ShortList for best payroll for North American small and mid-sized businesses. The depth and breadth of our product suite provide American businesses the freedom to succeed with the technology and advice that they desperately need to remain competitive in a very complicated world. I want to thank our over 16,000 global employees who consistently deliver for our clients and our shareholders. It's because of them that we are off to such a good start this fiscal year. I'll now turn it over to Bob Schrader to give you a brief update on our financial results for the first quarter. Bob?

Efrain Rivera:

Thanks, Bob, and good morning to everyone on the call. Before I start, just wanted to say thank you, John, for the generous words. It's been an absolute professional privilege and honor to have been with Paychex during all this time. As you all know, we maintain a strong financial position with high quality cash and earnings. Our balance for cash, restricted cash, and total corporate investments with more than $1.7 billion. Total borrowings were approximately $812 million as of August 21, 2023. Cash flows from operations were $656 million for the first quarter, was driven by net income and changes in working capital. There was some influence of timing there. It wasn't quite as strong as the percentages would indicate, but nonetheless, it was a very solid quarter. As you know, our earnings quality, which many -- some of you have pointed out, is among the best candidly in the entirety of the S&P 500. In the first quarter, we acquired a small company that purchases outstanding accounts receivable of their customers under non-recourse arrangements. This acquisition is a good strategic fit with another business that we have called Paychex Advance, and that business purchases accounts receivable for temporary staffing clients. This acquisition will provide an opportunity for our small business clients to manage working capital challenges. As John alluded to earlier, we've seen over the last several years that access to financing is very important for small and medium-sized businesses. We think this plays well into our -- in our portfolio of businesses that we have. I'm very excited to have it. The acquisition, at this stage, is not anticipated to have a material impact on our financial results this year. We paid a total of $322 million in dividends during the first quarter. Our 12-month rolling return on equity was a stellar, superb, amazing 47%. Now, let me turn to guidance for the fiscal year ending May 31, 2024. I'm going to give you color on not only the full year, the first half and the second half, and we typically do that at this stage. As you noted, we have raised guidance for interest on funds held for clients and for adjusted EPS, but I want to go through a little bit of color as we go through to give you a sense of what our thinking is. Our current outlook is as follows

Operator:

[Operator Instructions] And we'll take our first question from Ramsey El-Assal with Barclays. Your line is open.

Efrain Rivera:

Thank you.

Efrain Rivera:

Yeah. So, Ramsey, there's a couple of things that go into that line beyond just -- so for everyone who isn't focusing on that line that much. So that's a combination of our interest expense, our interest income from corporate portfolios primarily, and also some gains and losses on investments that we have in small investment fund that we have. Those things can swing a bit during the year and are subject to whatever we think the balance is going to be on corporate funds during the year. We made an acquisition, so we expect that. During the year, our average corporate balances will be lower. So that will generate lower interest income. And then, the other part of that, Ramsey, is gains and losses on that other investments as the mark-to-market can change from quarter-to-quarter. So, there could be a little bit of lumpiness in that number, but it might be a little bit different. I would say one other thing just by way of color on that line. We ended up with a fairly high cash balance that was influenced by timing. I think, I called that out,, or if I didn't, let me call it out now. It just really had to do with the day on which we closed the quarter so our cash balances were higher. They are likely to be a bit lower -- not a bit lower, but lower as we progress through the year. So, you might see that number change a bit.

John Gibson:

Yeah, look, SECURE Act 2.0, I think is a great action and great step that the government has taken is encouraging and helping small and mid-sized businesses, provide for the retirement of their employees. We are certainly out there educating the market on the opportunity. It really provides an opportunity for them to add a 401(k) plan or get a tax credit back for the implementation fees or the set-up fees of the plan. And then allows them to actually do a match for their employees and get that back into a tax credit as well. So, we are very happy our 401(k) business has continued -- has very, very strong growth, that has continued. The thing I continue to remind people, we have some experience in this in other state mandates and what we realized is that there's a lot of education that has to go on to get the market educated about the cost of a 401(k) plan, the benefits of a 401(k) plan. And certainly, we are out actively in the market, educating the market, educating our strategic partners on that, and we believe that the SECURE Act 2.0 is going to allow us to continue to sustain the double-digit growth rates that we've seen in the retirement business over the last several years.

Operator:

And we'll take our next question from Andrew Nicholas with William Blair. Your line is open.

John Gibson:

Yeah. So, I would say this, we continue to see strong demand for our HR outsourcing solutions across the board. And I would say that the balance is probably more back to prior to '23, where we saw a little shift to ASO. We've seen more of what -- more traditional balance of ASO to the PEO. As we mentioned on our last call, we've made some changes I think to our product portfolio in the PEO that I think is balanced that out a little bit. The other thing that I would point to that we mentioned on the prior call is that when we over-index with ASO in the prior year, we always look at that as a great opportunity for us to go back to those customers and then upgrade them or selective them into our PEOs product. And we started doing that. We actually -- that's a good example of AI, where we are actually using AI tools to be able to go into the ASO base and find clients that we believe there's going to be a valuable value proposition to be in the PEO relationship for multitude of different reasons, and that program actually has shown results in the first quarter. It's early in the process, but I would tell you that our transition of ASO to PEO customers, the number of customers that we transitioned this first quarter versus last first quarter was nearly 2x the number of clients. So, exactly what we thought could happen, which was we over-indexed when ASO in the prior fiscal year. We continue to sell outside to new logos and that was also double-digit strong in PEO in the first quarter. So, we have both benefits. We had strong outside the base growth in PEO in the first quarter, and we had good migration or upgrades ASO to PEO, which was a good start to the first quarter. We still got three quarters to go and we are in the middle of our open enrollment, which is critical there. But good early signs. We had good signs in the PEO in the fourth quarter, and we've talked about that on the last call, and that just accelerated in the first quarter. So, now we just got to see if that can continue into the core selling season.

Bob Schrader:

Yeah. This is Bob here. I mean, we, obviously, take risk in the PEO business on workers' comp. Obviously, we are very prudent in managing that risk in which -- and picking on which risk we are willing to take. I'd say there is growth in the quarter, primarily driven by, we have growth in worksite employees, that is going to drive higher workers' compensation costs. We go through every quarter and do true-ups of our reserves and so forth, but nothing specific to call out other than growth in the business that would drive growth in direct costs.

Daniel Maxwell:

All right. Thanks a lot, guys, and congrats again to Efrain on your retirement and Bob on your promotion.

Operator:

And we'll take our next question from Bryan Bergin with TD Cowen. Your line is open.

Efrain Rivera:

Thank you.

John Gibson:

Listen, Bryan, appreciate the question. Look, ERTC was in line with our expectations in the first quarter. We continue to submit. No one is wanting to delay. The program is going to end. And, I -- again, the IRS announcement is not stopping anyone's efforts -- our efforts in approaching clients who are assisting and then filing the tax credits. And in fact, the IRS specifically commented to clients and small business owners that they should seek trusted partners to complete their filings. The IRS pause in processing that, and accepting. So they're accepting filings. It's really due to some just really bad actors out there that are providing bad advice to small businesses and putting them at risk. I talked about this probably a year ago when this started when these little pop-up companies started to show up. And again, I think the IRS is trying to do a prudent thing to tamp down on fraud and also to make sure these small businesses are not getting bad advice from these pop-up firms. So, we actually are continuing to accept and encouraging our clients and prospects to file, and we provide a service where we are confident that the advice we are giving them is adequate and we'll continue to try to get their processing done before the filing deadline early next calendar year. The delay impact for the client is really going to be in the processing, which is really going to be when they get the refund.

Efrain Rivera:

Organic offsets, which...

Efrain Rivera:

Not really, Bryan. I mean, it will contribute a modest amount of revenue, we'll call it out as we go through the year. But it's not masking something or additive in that respect. I think there's a number of different vectors of growth within the company that are working pretty well. So, no, not really.

Efrain Rivera:

Yeah, you're welcome.

Ashish Sabadra:

Thanks for taking my question. And Bob and Efrain, congrats to both of you. Just on my question, I wanted to better understand the raising of the guidance and confidence in the back half. Is that both on Management Solution as well as PEO? Any color on that front? Thanks.

John Gibson:

Yeah, just to add on to that, I think, again, every business has -- we have a rhythm and the third quarter is a critical -- that's our selling season. And so, what the macroenvironment will be in the third quarter, fourth quarter, those are all the things we are trying to guess. I think what I would characterize it at this point in time is when we left the fourth quarter, I talked about the second half of our last fiscal year, we actually saw new sales bookings, both in Management Solutions and the PEO and Insurance accelerating. We continue to see that double-digit momentum in the first quarter, HR outsourcing, ASO and PEO, strong mid-market in the quarter, retirement is strong, digital payroll is strong. So, when we look at the demand environment, then we look at the employment environment with our index and what we are seeing the first quarter set-up to be kind of a repeat and continuation of what we saw in the second half and particularly the fourth quarter. Now as it relates to the PEO business as we talked about the insurance is a portion of that, insurance attachment is part of the reason why we have a little bit of a wider range. What you have to determine there is, how many companies continue to offer benefits to their employees? That's the first choice. The second choice is, how many of those employees sign up for Health Insurance, and what plans do they sign up for? Now, we are only a quarter way through that decision process, which really is already started, about 25% of the way through. What I would say at this 25% away, we are running a little bit on par, where we expected. I mean if that continues, I think that's what gives us confidence in the back half. But again, I still got three quarters of that process left and again, I want to be predictable relative to what we should expect. And so, we are being, I think prudently cautious in making sure that we are executing both Management Solutions, we are taking advantage of the opportunities in the marketplace, and then in the POE and Insurance, making sure we are doing what we need to do to make sure we have a successful open enrollment and drive insurance attachment.

John Gibson:

Yeah. So, I would say that there is a multitude of things that we probably tweaked every aspect of how we approach the insurance, both in terms of analytics of what we are doing relative to targeting customers that we think can drive -- we can drive value proposition there. We've changed the technology. We've changed our advisory approach, and we've expanded the products -- choices that both employers and employees can have. We've improved our educational tools in that process. We got a lot more engagement with our HR advisors, with clients around that. So, I would say, across the board after what we experienced a year ago in the first quarter, we've looked at every aspect of it and the team has really done a great job there and just re-imagining how we need to approach this. And again, we are only 25% of the way through, but we are seeing results from those activities. And, I do think demand for insurance, and I think it's going to be interesting. We were very pleased with our renewals. I mean, if you read in the general press right now, you will see that there is a degree of health inflation, and when that occurs, we do typically see more customers shopping for alternatives that we think we have a good value proposition there.

Operator:

And we'll take our next question from Scott Wurtzel with Wolfe Research. Your line is open.

Efrain Rivera:

Well, I'll bracket it in three ways. The first thing is that, as John alluded to or said earlier, the ability for small businesses to access funding -- in small and medium size, I should say, access funding is important. So, we had our eyes on looking to build our capability in that area. The second thing is, acquisitions are, as you would know, they don't always present themselves with exactly the timing which you would expect them to, and when an opportunity arises and you do what you need to do to take advantage of it. We saw an opportunity for high-quality asset and decided that it was the right time. And I would say the third is that, it's an interesting environment for small businesses, so where access to funding opportunities is becoming more tricky given what has happened with banks and with rising interest rates. So, we think the timing seemed to fit pretty well. And again, I don't spend too much time. It's a relatively modest acquisition based on our revenue side, but we think we've had a lot of success with our Paychex Advance acquisition, and it's a very profitable corner of the market. And we think we can do the same thing with the company that we bought, called the [indiscernible] by the way.

Scott Wurtzel:

Got it. That's super helpful. Thank you. And then, just as a follow-up. I mean, just one quickly on the float portfolio. When we think about the recent Fed commentary and dot plot showing maybe a sustained higher rate trajectory than maybe we were expecting a few months ago. I'm afraid, I know you've talked about in the past wanting to position the portfolio more on longer duration securities. I was just wondering if this -- the recent Fed commentary sort of gears you even more towards sort of the longer duration securities in the portfolio rather than shorter duration? Thanks.

Scott Wurtzel:

Great. Thank you, and congrats, Efrain.

Operator:

And we'll take our next question from Tien-Tsin Huang with JPMorgan. Your line is open.

Tien-Tsin Huang:

Hey, good morning. Thanks. I just wanted to follow-up on the acquisition, the $200 million acquisition here, and the strategic fit with Paychex Advance. I remember when that deal was announced and there was a lot about payroll funding and factoring and whatnot. Is this now more about early wage access and some of the more modern funding opportunities for employees? Just want to make sure I understand what you're adding specifically here.

Tien-Tsin Huang:

Okay, very clear. So, this is an AR opportunity?

Tien-Tsin Huang:

Understood, okay. No follow-up for me. Just want to wish you, Efrain, all the best, of course, for the next chapter. And I've said it before, you've been really helpful for us for a long time. So, thanks for that. I definitely going to miss talking to you.

Operator:

And we'll take our next question from Peter Christiansen with Citigroup. Your line is open.

John Gibson:

No, well look, I think what we are trying to do is make sure that we are focused on what do we need to do to help our clients succeed. And as I said, whether that's through partnership or if there's opportunities for us to participate in that process integrating that with our technology, those are really the things that we are interested in. And when we hear our clients, and we are engaging those clients through our advisors on a constant basis, say, this is an issue for them, we go and search for answers, and partnerships are part of that. And as I said, we have several partnerships with fintechs that we are doing and relationships with large banks. I can go deeper on that if you want to know about banking and banks and payroll. We do -- we have businesses that do that. But I think, in general, you should not read anything more into this than the fact there is a need out there that we had an adjacent business that has been very successfully managed and has been a good return for our shareholders. And there was a natural relationship and opportunity that we thought by us coming in with our balance sheet, with our expertise, with our client base, that we could potentially make something of this. And so, I don't think you should read anything more into it than opportunistic acquisition that matches a need that we are seeing today from our customers, and one that based upon the macroenvironment, we think we are going to grow. And I don't think this is competition with any of the major banks. Most of these clients are just not getting access to the funds. It's just not available. And if there's more tightening at the regional bank, which is generally the go-to place for small and medium-sized businesses, that's not good for small business owners. And so, we are going to try to figure out how we can build partnerships to do that.

John Gibson:

Well, I'll just say this, as we've talked about our sales momentum continues in the first quarter that we saw in the second quarter, on the macro side, when I'm looking at it, I'm not seeing any major shifts at all relative to balancing trade in the competitive environment. I commented on the fourth quarter. When I do look under it, again, these things go back and forth. I would say, it's raining a little more in our favor on the competitive front in several key areas that we monitor. We had a good first quarter in the mid-market. That was -- there were several good signs there as well, but it's not monumental. It's the same market, very stable competitive environment. Same set of competitors, low-end, mid, high-end PEO. It's the same cast of characters, same kind of pricing environment, competitive environment. It's a competitive marketplace. We'll leave it at that, and I think we are winning more than our fair share.

Efrain Rivera:

Thank you.

Efrain Rivera:

Hey, Bryan.

Bob Schrader:

Yeah, Bryan, this is Bob. I mean I think that's a fair way to think about it. I think as you guys know, we typically don't have big swings in our working capital. And as Efrain mentioned, we had a little bit of a timing there at the end of quarter. The quarter ended on a big collection day, so we had a big influx of cash that would go out the next day. So, the way to really think about our operating cash flows and then, obviously, free cash flow gets impacted by M&A. So, there was a little bit of an impact there in Q1 to free cash flows. But typically, our operating cash flows growth is going to trend in line with our net income growth. And so, you'll see that moderate as we move through the year and that's what you should expect from a growth standpoint.

John Gibson:

Yeah, no -- so, when we say elevated, I think that they are elevated over what we saw during the COVID period that's two, two-and-a-half years. Actually, bankruptcies are still slightly below where they were pre-pandemic and kind of trending toward a normalized rate. We have seen that. I would say, particularly in the start-up businesses when we had the big start-up boom, we've seen a lot more out of businesses on the very small -- I think we called that out in our press release. Revenue retention at near-record levels, and when you look at our HR outsourcing businesses at record levels. So that's what we've kind of seen on the bankruptcy side. The other interesting stat related to bankruptcy that kind of surprised me in the first quarter is we actually saw an uptick in new business starts. And again, we had this big elevated area and then we kind of gravitated back down towards kind of normal levels. And we actually saw in the first quarter new business starts click up, which was interesting.

Efrain Rivera:

Thank you, Bryan. Appreciate it.

Samad Samana:

Great. Thank you. Efrain, I'll echo, missing working with you and enjoy a well-deserved retirement, sir. Appreciate all the help over the years.

Samad Samana:

Maybe just a quick one for me. A lot of the questions have been asked. But just how are you guys seeing the top of the funnel in terms of inbound leads, the digital channel? Any change in maybe interest levels, registrations for webinars, just anything that we can look look at as a leading indicator of bookings? And how has that trended maybe in first quarter?

Samad Samana:

Great. And then maybe just on your own hiring plans with the quarter doing better than expected and maybe some trends you're seeing, any change to your own sales hiring plans or should we expect maybe the original game plan to be here?

Samad Samana:

Great. Appreciate you taking my questions. Thank you.

Operator:

And we'll take our next question from Eugene Simuni with Moffettnathanson. Your line is open.

Efrain Rivera:

Thank you, Eugene.

Efrain Rivera:

Hey, Eugene, I'll start, then John [can make a comment] (ph). It really -- if I were to give you a number, it would give you some sort of false sense of what reality is. It's almost impossible to draw a conclusion on that where you are in first quarter. In some ways, some trends are positive and you can draw conclusions on project out through the year, but client base is really a tricky one. And the reason is you just lose so many and gain so many in the selling season that it's almost difficult to predict and we expect to be a bit better than we were last year, but it's still early innings.

John Gibson:

Yeah, I would say it's probably consistent. We definitely see employees in our PEO -- clients in our PEO business adding employees. I wouldn't say it's a huge tailwind, but it's positive and probably in-line with what we are seeing in other areas of the business.

Efrain Rivera:

Thank you.

Mark Marcon:

Hey, good morning. Hey, Efrain, we go back a long way as it's been an absolute pleasure working with you.

Mark Marcon:

I want to thank you for the relationship. And Bob, looking forward to working with you, but Efrain, it's been an absolute pleasure.

Mark Marcon:

A lot of questions have been on the short term. John, one big-picture question. A quarter ago everybody was asking about AI. Obviously, you've been -- Paychex has been doing a lot with AI for a long period of time. I'm wondering if you can just talk a little bit about -- now that some of these LLMs have been around for a couple of quarters and permeated the consciousness, how are you thinking about further evolution of your journey with AI? And what are the longer-term implications from a margin perspective or a scope of business perspective?

Mark Marcon:

Well, everybody is asking about the quarter...

Mark Marcon:

And then for my follow-up, just a quick question. Just in terms of the margin uplift from the first half to the second half, aside from normal seasonality and obviously float balances, certain forms of processing, is there anything to call out above and beyond that? Is it just pace of investments in the first half being a little bit front-end loaded?

Mark Marcon:

Terrific. Thanks again, Efrain. I'll miss working with you.

Operator:

And we'll take our last question from James Faucette with Morgan Stanley. Your line is open.

Efrain Rivera:

So, James, you mean, what are we looking at...

Efrain Rivera:

Well, let me start, and then John and maybe Bob can weigh in. So, I just want to make sure that I'm answering the question correctly. I think the key thing in -- if you step back on the PEO is, we saw that attachment last year where we expected it to be. And also we saw an opportunity to tilt the balance a bit between what was an ASO sale versus a PEO sale. So, what we are looking at, at least to start the year is, first, are we positioned appropriately on the insurance side to be able to take advantage of that, and create momentum as we go into some key points in the year which occur in the fall and then at the beginning of the year on insurance and attachment. But one thing, James, that's important to point out, last year, when we were talking at this point, we were seeing actually something unusual where we are seeing clients dropping insurance and actually lowering their attachment -- I'm sorry, not their attachment, their enrollment. So, we haven't seen that start of the year. So, the absence of a negative is a positive. So, I think -- that's one piece. And John called out something, I think, that is important, also that balance between what we are seeing on ASO and PEO that seems to kind of come into a little bit more in balance. So, I think those two things bode -- or have started the year well. And...

James Faucette:

That's actually really helpful. And I guess just as -- so it sounds like for most of your employers in terms of their behavior on particularly some of those offerings is that they're kind of reverting back to what you would expect to be in a normalized environment, and really it was last year that was really atypical.

James Faucette:

Got it. That's really helpful. Thank you, guys.

John Gibson:

Okay. Shelby, I think that wraps it up. At this point, we will close the call. If you're interested in replaying the webcast of this conference call that will be archived for approximately 90 days. Again, that's on the Paychex Investor website, where we also have all these fabulous reports for you to read. And again, we want to thank you for your interest in Paychex and hope everyone has a great day.

John Gibson:

Thank you, Stephanie. Thank you, everyone, for joining us for our discussion of the Paychex fourth quarter and fiscal year '23 earnings release. Joining me today is Efrain Rivera, our Chief Financial Officer. This morning, before the market opened, we released our financial results for the fourth quarter and full fiscal year ended May 31. You can access our earnings release on our Investor Relations website. Our Form 10-K will be filed with the SEC before the end of July. This teleconference is being broadcast over the Internet and will be archived and available on our website for approximately 90 days. I will start with -- the call today with an update on the business highlights for the fourth quarter and fiscal year. Efrain will review our financial results for fiscal '23 and our outlook for '24. We'll then open it up for your questions. We finished fiscal year '23 with solid financial results and momentum heading into fiscal year 2024. Total revenue grew 9% for the full year and we hit a major milestone for the company with over $5 billion in total revenue. I was personally reflecting on this last night when I joined the company, we were just over $2 billion. It took us 6 years to go from $2 billion to $3 billion, 3 years to go to $3 billion to $4 billion, and it took us 3 years to go to $4 billion to $5 billion, but I remind everybody that was during the global pandemic. So certainly very proud of those results. In addition to the revenue growth at 9%, adjusted diluted earnings per share grew 13% to $4.27 and operating margins finished at 41% as we continue to benefit from our continued investments in technology, our focus on driving digitalization in all aspects of our business, and our long standing tradition of operating excellence. These results are due to the hard work and dedication of our more than 16,000 employees. I'm very proud of what we've achieved this fiscal year. Our industry leading technology and advisory solutions have made a positive impact on our clients and their employees. And in return, they continue to reward us with additional business and their continued loyalty. Momentum in sales has continued with solid growth in new annualized revenue for both the fourth quarter and the full fiscal year. HR solutions and retirement were areas of particular strength with double-digit growth. We are well-positioned in terms of our staffing levels and rep tenure heading into the new year. Revenue retention finished the year near record levels as we continue to focus on retaining and increasing our share of wallet with our high value customer segments. Client retention was impacted by higher losses due to out of business, concentrate mainly in newly formed businesses in the last 2 years and financial distress in the lower revenue small clients. We continue to see strong demand for our HR outsourcing solutions with worksite employee growth over 10% year-over-year. For the year we achieved record level worksite employee retention due to our strong and unique value proposition of our leading HR technology and advisory capabilities. Businesses of all sizes continue to navigate the challenges of a very complicated regulatory environment, a competitive labor market and now tightening credit. Demand for our solutions remains strong due to the depth and breadth of our integrated offerings, including HR technology, designed to deliver efficiency for both the employer and the employee, our comprehensive HR outsourcing which leverages the strength of our technology and the experience of a trained HR professional and our outstanding compliance organization and the need for businesses to offer quality benefits including retirement to compete for talent. Our retirement solutions are benefiting from the growing expectations of a retirement plan as a core benefit offering for small and midsize businesses. Recent passages -- passage of the SECURE Act 2.0 legislation and various state mandates requiring employers to provide retirement services to the employees or making 401(k) the key benefit for small and midsized businesses. With more state mandates expected to take effect in the future, we expect a strong market for retirement to continue for the foreseeable future, and we are well-positioned as a leader to take advantage of this opportunity. The SMB credit environment has continued to feel demand for our employee retention tax credit service. Our full service ERTC offerings has helped tens of thousands of businesses obtain tax credits, and gaining access to funds they need to keep their businesses running and growing. We continue to communicate this opportunity to existing clients and prospects. Industry recognition continues to reinforce the competitive strength of our technology solutions. For the fourth consecutive year, Paychex Flex earned an HR Tech Award for Best Small and Midsized Business focused Solutions in the Core HR category. Our consistency and winning these awards and being placed repeatedly in the leadership quadrant of respected technology analysts rankings, speaks to our market leadership in HR technology. I’m not only very proud of these results in the performance of the team, but I'm also equally proud of how we achieved these results. We have been consistently recognized as one of the world's most admired, most ethical and most innovative companies. In addition, we've been ranked as one of the best place -- places to work for people in sales, for women, for diversity, and for our outstanding training and investment in our employees development. These awards are a testament to how our employees not only get the job done, but do it the right way and we are constantly looking for new ways we can make ourselves and our communities better. As we move into fiscal year '24, we will continue our focus on developing leading customer experiences that combine our technology, our advisory capabilities and our partnerships to deliver superior value to our customers. Paychex is uniquely positioned to help small and midsize businesses navigate the challenges they face in a complex and ever changing and evolving world. We remain committed to our purpose, and that is to help businesses succeed. And we'll continually strive to have a positive impact on our clients, our employees, our communities and our shareholders. Now I'll turn it over to Efrain, who will take you through our financial results for the fourth quarter and the fiscal year as well as our guidance for fiscal year '24. Efrain?

John Gibson:

Okay. Now with all the conditions and restrictions that Efrain has laid out for you, we will now open the call for questions.

Ramsey El-Assal:

Hi. Thanks so much for taking my question this morning. Can you comment on the pricing environment? You called it out a little bit in the press release. And I guess the question is, are you seeing sort of a window right now for more aggressive pricing adjustments just given the inflationary environment? Or is this sort of -- are you feeling now that you're in sort of a steady state, kind of continual trajectory when it comes to pricing?

Ramsey El-Assal:

Okay. And I wanted to ask also about retention. Obviously, retentions at healthy record levels. At the same time, you called out a little bit of where you were seeing a little bit of headwind, I think it was from out of business, from newly formed businesses, and I think there was some other color that Efrain provided. If you could just elaborate on that a little bit, I'd appreciate it.

Ramsey El-Assal:

Got it. Thanks so much.

Eric Dray:

Hi. This is Eric Dray on for Jason. Thanks for taking the question. I had a question just kind of high-level. We've seen small businesses be really resilient kind of seems like the macro may avoid a hard landing. But curious about kind of trends you're seeing among different client groups. Anything to call out maybe blue collar versus white collar, any color you can add there?

Eric Dray:

Okay, great. Thanks. And then on the -- this one is for Efrain. On the float guidance, kind of two parts. What are you thinking about burn interest rates? And then, what are your thoughts on kind of managing duration. I know the question comes up every call, but thought I'd ask. Thanks.

John Gibson:

Stephanie?

Rayna Kumar:

Good morning. Thanks for taking my question. Can you talk about what booking was?

Rayna Kumar:

Hello. Can you talk a little bit about bookings in the quarter, anything that call out on different customer sizes and products where you're seeing strengths or weaknesses?

Rayna Kumar:

That is very helpful. And then just a quick, really quick follow-up to stay within Efrain's guidelines here. Can you call up the ERTC contribution just for the fourth quarter?

Rayna Kumar:

Got it. Okay. Thank you.

Operator:

Thank you. Our next question will come from Andrew Nicholas with William Blair.

John Gibson:

Yes, Andrew, thanks for the question. Our ambitions remain the same. We're trying to find opportunities to meet our strategic objectives and at the same time, make sense financially. The latter has been more challenging in the environment, I'd say over the past few years. But I think we certainly began to see some change in the market dynamics and our pipeline is beginning to expand with opportunities that I think are more realistic for us to consider. I don't think our focus has really changed. We're going to continue to look for tuck-ins. That help us kind of add scale in the markets or expand our product suite. We are looking for capability enhancements, particularly in the digital areas, digital capabilities, data, data analytics, HR, HR analytics. And then again, we're constantly looking at numerous adjacencies as the market continues to evolve, and looking for new growth platforms that are adjacent to our current suite of solutions and really help us continue to deliver that, that value proposition with small, medium sized businesses to help them succeed. So again, smart tuck-ins, capability enhancements in the growth platforms. That's our areas of focus. And we're going to continue to be mindful of making sure we're getting good deals [indiscernible].

Efrain Rivera:

Yes, I guess I'd answer that in a couple of ways. Look, March is preliminary, mean that we haven't gone through a plan. I think that John's continued a tradition that that we've had in the company, which is to say, where we can find sources of leverage in the P&L. So obviously, mix has an impact on that, Andrew, as you're aware. As you get more opportunity and more management solutions, that gives you more opportunity. But I would say we went through pretty disciplined process in the planning process to see where there were opportunities to leverage uncover them. And that that's what you're seeing in the guidance. I'd say one other thing that's really important. The process of planning a year is a 365 days activity. If we get through the first quarter, because we see opportunities both on the investment side, and also on the cost side, we go for it. And we challenge ourselves to find those opportunities. So I think that in addition to the fact that that was a byproduct [indiscernible] byproduct, but a theme of the planning process. We think in those terms, and so because you'd have to go into the year with multiple levers to find leverage if you need it. So we're, as we speak, thinking about okay, how can we even do better or offset any potential issues that might come up in the year. So it means that there's a little bit around -- a little bit of planning and a little bit of DNA.

Efrain Rivera:

Yes.

Kevin McVeigh:

Great, thanks.

Kevin McVeigh:

I'll just have one to make up some time. Hey, Efrain -- hey, pardon me, you talked a little bit about I think, kind of revenue retention versus client retention and revenue retention being an all-time high despite kind of, I think, a little shift in client. Can you help us frame what the delta is there kind of what it is today, and kind of where that's been historically, and I would imagined, probably narrowed over time. But is there any way to frame that a little bit more?

John Gibson:

Yes, Kevin, the thing I would add to that, I will remind everybody I go back and -- we go back and look at this over the last 4 to 5 years, when we say pre-pandemic levels, you go back to '19, you got our transcript, what you would also hear in '19 is that on a client retention, we were aligned, we actually had historical high client retention back in '19 as well. So we're returning on the client side to levels that historically, for Paychex would have been historical highs into client retention and then as Efrain pointed out, we've had a lot of focus on what we need to do to drive better retention in our high value segments and we've been very successful to do that. And I think coming out of the pandemic, the value that we've demonstrated to those clients in terms of both our technology enhancements as well as the advisory support that we've given them through very challenging times, I think they rewarded us -- they rewarded by buying more from us. They rewarded us by giving us the opportunity to have a better pricing for those products and services because they see the value and they reward this with the loyalty.

Operator:

Thank you. Our next question will come from Bryan Bergin with TD Cowen.

Efrain Rivera:

Yes, yes, I would say, Bryan, two things is that we have said that typical client growth in the year is going to be in the 1% to 3% range. We're on the low end of that range, we expect to be middle or higher next year. So that's part of the equation on the pricing side. We're typically in the 2% to 4% range, although on recent years higher than that. We’re on the mid to maybe perhaps a little bit higher than mid-level on the pricing on site. Those are sort of the basic elements, and then you got mix and additional product penetration driving the remainder of that. Now if you start reconciling me, I got to take the negatives too. And the negative is, I'm going to get some headwinds from ERTC, which you will see in -- on the management solution side. So that when you triangulate all those pieces, that's where you get to our 5% to 6% growth.

Efrain Rivera:

Sorry, I started talking over [indiscernible]. You were saying 3Q and Q4, what were you saying then?

Efrain Rivera:

Yes, yes, that played out and going into next year, we expect to be flattish. I will say that, I mean, you always have to have an element of caution on the impact of higher rates. I mean, they share the level of their -- that would cause me to get a little bit [indiscernible] concern that I have right now. So we'll have to play that out. And that definitely would have an impact on worksite employee growth. I think it's manageable and we've taken that into account in our plan. But at this point, we're not expecting that is going to change [indiscernible] sure.

Efrain Rivera:

Thanks.

Bryan Keane:

Hi, guys. Good morning. Hi, how you doing?

Bryan Keane:

I just want to -- yes, I just wanted to follow-up on the client growth question. It sounds like you expect it to go up a little bit, higher than it was on the low end of the range, and then it will go up. Is that a function of what you're seeing in the sales channel or is that a little bit of retention just given that maybe some of the smaller clients that turned off during the pandemic, you won't have that same issue as you go into this year?

Bryan Keane:

Got it. And the guidance looks pretty consistent. As you look at the revenue and the margins, you're not wildly off from the first half, the second half and sometimes there's bigger changes there. Any kind of key macro factors that you watch that we should be watching that could move it up or down, that could change at least maybe as we get into the second half as we think about the macro?

John Gibson:

Yes. No, I think the other thing that, I think to keep in mind a little bit about the macro, again, we'll get back to the macro side, I look at our small business index, I look at the start of this calendar year, we went the first 3 months, the index actually went up every month. So went up for three consecutive months, and then it sort of stabilized. So we continue to see that. As Efrain said, we probably expected in the fourth quarter, and we're always kind of sitting there waiting for employment to go down and [indiscernible]. So actually, I would say I was actually a little pleasantly surprised at where we were on checks and where we were on worksite employee growth inside the base of clients that we had. So continuing to see that hiring is also an issue. And staffing, it continues to be an issue of our HR concern. So we look at what are the questions and issues that are coming in to our HR consultants, we continue to see that to be an issue. And I do think you're going to see something [indiscernible] we probably not seeing. Small midsize business owners are scarred by their experience of employment over the last several years and they fought to get back to staffing levels. I think what's going to be interesting is they're going to be very hesitant to let go, because I think they remember what it was like trying to find talent and just simply not enough labor supply here. So I think it's going to be very interesting, who kind of wins this tug of war, back and forth relative to employment. The other thing that we see is we're seeing a lot of nontraditional labor being tapped by a business as gig workers, contract workers, maybe a little bit more part time. And what I -- what I'm curious about to see are will those be the first things to go. With that [indiscernible] a small business owner is going to let go permanent staffing that they've got, that they're paying every week, are they going to try to write it out by tightening in other areas such as this nontraditional gig employment that's kind of sprung up. So the labor market is a very, very interesting thing I think for us to look at and study right now. And I don't think it sets up for traditional recessionary models that people have built. So that's just my pontification based upon my conversations with what we're hearing from clients and what we see in our data.

Operator:

Thank you. Our next question will come from Scott Wurtzel with Wolfe Research.

John Gibson:

Yes, so the investments are in growth and growth those are probably the top two. And then you mentioned digital, I mean, we've been making a lot of investments in the digital area, both in terms of our sales and what we're doing from a go-to-market perspective, which we're very happy with and how we're leveraging technology AI in the back office. And I'm very pleased with several things that we've got going on. So we've been actively leveraging AI for several years across every area of the business, driving efficiency, delivering a lot of our large clients. And one of the things I keep telling people was, we're one of the few players in this industry to have the size of data set that we have. And I do think in these types of AI, you've got to have a large data set. We're using it in customer service, we're using it in risk, we're using it in finance, we're using it in our HR outsourcing advisory capacity, we're building it into our products, and our retention insights products. So there's a lot of investment that we're making and a lot of learnings that we have in terms of how we can digitize the front office and the front of house and kind of the back office of our business. And so those are -- that's going to be an area that we continue to invest and continue to explore.

John Gibson:

Client balanced growth, roughly in line with wage inflation, which is to say low single-digit.

Operator:

Thank you. Our next question will come from Kartik Mehta with Northcoast Research.

Efrain Rivera:

Hey, Kartik. Are you battling with smoke there in Cleveland too?

John Gibson:

You [indiscernible] Kartik.

Efrain Rivera:

Yes, two good questions. So flattish, I guess is the short answer to what we expect for '24. Don't expect too much in terms of inclined base growth and that's a mix. I think our larger clients are doing fine. And in some cases, adding employees, we look at it. Smaller clients less so and then you got to factor in what your anticipated losses are. So you always tend to lose a little bit higher than what you gain in a given year. And then you expect your incline, your decline from the base to grow the worksite employees. But this is an environment where I don't think it's going to be robust in terms of hiring, in part because of what John said earlier, which is that that many businesses would like to hire that just simply aren't the people who were there -- were available and also figured out how to do it without people, but probably won't be, as John mentioned, less inclined to perhaps get rid of them. On the PEO, and I'd say also the ASO side, our worksite employee, we have worksite employee growth this year. We expect that to continue into next year. You could see solid works and [indiscernible] growth as the key or rebound going into next year. But overall, and I think that Bryan asked this question, it's not going to be a significant driver of revenue growth, perhaps in PEO, but not on the HCM side.

John Gibson:

Yes, I go back to what I said before, we continue to have clients that are wanting to fill open positions. And I don't -- I have not seen that change. I would say that they're being more successful in filling and filling those positions. So we've certainly seen that and we've seen some recovery. I mentioned, leisure and hospitality, in particular, which was well behind and had good recovery in the back half of our fiscal year here. I do think relative to [indiscernible] maybe opening up as many positions, I would also tell you that one of the things that I think did happen is when we were in the great resignation, which was probably a few months ago, seems like forever now, but really only 18 months ago, pretty much a lot of business owners were thinking every position I have needs to be posted, because I've got to assume that I'm going to potentially lose those positions. So I think there was a lot of postings for jobs that people were passively looking for. And I think some of the contraction that we've seen in the postings are more of business owners being a little more disciplined about what am I actually going to hire and being out in the market and focus on that. I don't know if that makes sense or helps you.

John Gibson:

Yes, you’re welcome.

Operator:

Thank you. Our next question will come from Eugene Simuni with Masset Makinson.

Efrain Rivera:

Hey, Eugene. Let me start and John will provide additional comments. With us, it's less about verticals, although I'll caveat that in a second. It's really more about where we derive revenue on the health care side that flows through the P&L. And that's in state of Florida. So for us on the PEO health care, as it relates to revenue, really, it's a Florida game primarily, and the anomaly and when you talk about Florida, you know immediately that you're going to over index [indiscernible] hospitality. So a bit of what's going on is it depends on new clients coming into the base and whether customers in leisure and hospitality are really interested in offering health care to clients. [Indiscernible] and that's not all clients in Florida to be fair, that's probably too much of a generalization. But it was more of a regional issue than it was I would say, as an effected revenue than it was something else. So why do we feel more comfortable? Because we have put a tremendous amount of focus on it. And that's not to say that guarantee success. But I would say as we saw what was going on, we took a lot of measures to improve that that aren't going to necessarily again be evident in first quarter but should be evident beyond that. And there were things in which we talked about in prior calls, I won't repeat that. We are somewhat anomalous that we saw people actually in the PEO decided they didn't want health care insurance. We thought our hypothesis was they were feeling some pressure from a wage perspective and perhaps decided that from a total compensation perspective, they were not going to offer health care. But we've taken a number of actions that we think will create better momentum going next year. I'll let John talk about that issue.

Eugene Simuni:

Got it. Super helpful. And then quick follow-up on some of the comments you made earlier on retention bookings, and client growth tied altogether. So when we're thinking about your guidance for next fiscal year, and Efrain you mentioned that you expect client growth to pick up from the kind of 1.5% level with so this year. Would that be a result of both improved retention and improved sales? Or is it primarily one or the other that will drive improvement in client growth?

John Gibson:

Yes, And I'll add on to that. Again, I would say the second half was stronger than the first half from a sales unit perspective. And if you dig under our retention numbers first half to second half, our controllable losses improved in the second half. So, again, what we can control and I do believe that there's a degree of what I call flushing out of the bankruptcies from 2 years ago in terms of us looking at clients that are kind of on the financial edge, and whether or not we want to continue to or feel confident we can continue to do business with them, those type of things are kind of flushed out of the system. We've been investing a lot in what we can do to control, what we can control, regardless of the environment. It talks about AI. We've been deploying a lot of very sophisticated AI models inside our service organization, and inside our client base that are giving us very strong indications of where we may have a client at risk. And we're demonstrating success and demonstrate success in the back half of the year of being able to intercept those and turn those situations in the positive retention story. So, when I look at the retention story and the sales story, first half back half of last fiscal year, I feel good about the progress we're making there.

Efrain Rivera:

Welcome.

Peter Christiansen:

Thank you. Good morning.

Peter Christiansen:

Good. Efrain, I was curious about the portfolio repositioning and not [indiscernible] large, but should we expect I guess future maybe operating outperformance to be reinvested for portfolio repositioning, maybe layering to rates faster. And then as a follow-up to that may be looking at prior cycles, is there a relationship between interest rates and competitive pricing? I would imagine this float income becomes more a bigger part of the business model that gives more leeway for competitors to be more aggressive on the pricing side. Any comment there would be helpful. Thank you.

Peter Christiansen:

Yes, certainly it does, the balance. That's certainly a challenge. I would imagine, I don't envy you. But thanks for the insight. Very helpful.

Operator:

Thank you. Our next question comes from Tien-Tsin Huang with J.P. Morgan.

Efrain Rivera:

Well, I will take that Tien-Tsin. So, look, I want to kind of clarify something to start, which is that we have worksite employee growth in the PEO. It's not as though we contracted in that area. We think we're off to a pretty strong start actually in terms of at least our bookings activity. But we expect relative to last year, for health care attachment to be higher than it was. The contribution from health care attachment will be higher than it was last year. We just couldn't hit the numbers that we hit last year. We had also seen simultaneously that the base business [indiscernible] was going down [indiscernible] in very difficult challenging. So we expect growth in the business, growth in clients, we expect growth in attachment that's what's really kind of driving the [indiscernible] less so Tien-Tsin, I think that's less of an issue. Typically, just to remind everyone, our PEO clients are typically upper 20s and low 30s. In terms of clients, we're not trying to go down [indiscernible] necessarily. But it's really going to come from more clients that are [indiscernible].

Tien-Tsin Huang:

And that's the beauty of Paychex having both ASO and PEO. So I guess as my follow-up, any change in your appetite on the whole self insured versus the fully guaranteed PEO model to the extent that you can better maybe control the insurance packages. And I know Efrain [indiscernible] try to trick you guys answer the consolidation question, but I'll ask it to. So right appetite to do acquisitions on the PEO side? I know it's been, what 5 years since you did [indiscernible]. You said tuck-ins, but I know there's been some news in the market around consolidation, I know that probably is a multi part question. So I'm on the bad guys.

Tien-Tsin Huang:

Just get anyway, thank you.

John Gibson:

Yes, just to add to that, I don't think that our current approach to insurance in the PEO was a driver to what we saw last year. And so I don't think taking more risk is necessarily the solution. I think that our current approach has demonstrated that we can grow at industry rates without exposing ourselves to additional risk. And so to Efrain's point, I don't see that as a magic [indiscernible]. I don't think you need that to grow the PEO value proposition to Efrain's point to the degree in which we thought it could accelerate growth in some way and the risk could be balanced. It's something to consider, but not something that we're looking at. I mean, I think in terms of the PEO M&A front, we haven't done much in 5 years. It's obviously a very attractive industry for private equity to pay very high multiples for which -- for in my opinion, not much capability. When we made the acquisition of Oasis, we were looking at those getting significant scale on the PEO and capability. We got that with Oasis. We were typically a smaller kind of regional PEO and we [indiscernible] national scale to get there, we're now top player in the industry. So I think what we would be looking forward is tuck-ins in markets. Would that make sense? If we were going to add a capability, right, but a capability in terms of something different in the PEO that's interesting. But, again, when I continue to see as we're involved in and know about almost every deal in the industry, I still think the multiples are a little high for what they would bring value and we have enough organic and inside the base opportunity for us to continue to invest our dollars.

Operator:

Thank you. Our next question comes from James Faucette with Morgan Stanley.

John Gibson:

It's back to normal. And again, I go back to say, it's back to normal pre-pandemic '19, which again were at reasonably, historically low levels for us, if you went back historically before that. So, look, there was a big surge in new business starts, right at the start of the pandemic. And we knew in our models, whether or not there was recession, whether or not interest rates were 1% or 6%, those businesses, a fair number of them were not going to survive after 2 years. And so we didn't know whenever it's going to come, but I think we knew what was going to come, I think we've seen that begin to flush through, we've kind of returned back to what I would say are more normal business start levels. And again, business starter is still reasonably solid. We're not seeing a dip in business starts. Again, the big spike, we're now back to where we were kind of pre-pandemic, which again were very, very solid and conducive numbers for growth in our business before the pandemic.

Efrain Rivera:

Yes, I'd say -- so you got two points of comparison, kind of what happened in 2007, and '08 and then what happened during the pandemic. What we saw during the pandemic was that on the PEO side, PEO was our base, at least, a PEO client shed employees more quickly. I was surprised by the speed with which they did it. I think you'd see more of an impact there on the PEO, if you saw more of a sharp downturn. And a garden variety of softness, probably not. And then second, James, it will see but it would go back certainly due to pandemic you saw employers start to shed clients and shed employers, I should say, shed employees. Interestingly enough, what was a little bit anomalous during the pandemic, we didn't see huge client losses. But what we did see them drop employees. And so when -- then you'd see an impact, I'd remind everyone that our model is not a pure people model, subscription plus people. And so we have some insulation in the event that there's a downturn and overall unemployment levels fall. And finally, last caveat, we do have the ability to pivot in the base, which we did during the pandemic, which helped to mitigate the impact of what was going on in the economy as a whole.

James Faucette:

That's great. Appreciate it.

Unidentified Analyst:

Its [indiscernible] on for Mark. Thank you for taking our questions. So I'll just leave it at one. Retirement solutions continues to see strong growth and clearly has some nice tailwinds. Can you talk about some of the measures you're taking to capitalize on the opportunity provided by both the SECURE Act as well as state mandates?

Unidentified Analyst:

Great. Thank you for the color.

Samad Samana:

Hi. Great. Thanks for -- hey, good morning, guys. Thanks for squeezing me in. So I just wanted to ask on maybe your own sales organization. Can you help us think through just between the last couple of years being strong and then us entering, let's say, a slightly different environment, maybe looking forward. How maybe the sales organization performing versus quota [ph] in fiscal '23? And maybe what assumptions around quota you're thinking for fiscal '24 in terms of that quota increases for your sales organization?

Samad Samana:

Appreciate that. Efrain, I'd love to ask you another PEO follow-up question, but I'll [indiscernible].

Samad Samana:

I’m joking. I’m going to [indiscernible] question. You guys have a great day. [Indiscernible]. Thanks, guys.

Operator:

Thank you. There are no additional questions at this time. We'd like to now turn it back to our presenters for any closing remarks.

Operator:

Thank you, ladies and gentlemen. That conclude today’s presentation. You may now disconnect.

John Gibson:

Thank you, Todd. Thank you, everyone, for joining us for our discussion of the paychex third quarter fiscal year '23 earnings release. Joining me today is Efrain Rivera, our Chief Financial Officer. This morning, before the market opened, we released our financial results for the third quarter ending February 28. You can access our earnings release on our Investor Relations website. Our Form 10-Q will be filed with the SEC within the next day. This teleconference is being broadcast over the Internet and will be archived and available on our website for approximately 90 days. I'm going to start the call today with an update on the business highlights and then Efrain will review our financial results and outlook for fiscal year '23. We'll then open it up for any of your questions. As you saw in our press release, we delivered solid financial results for the third quarter with total revenue of 8% and adjusted diluted earnings per share growth of 12%. Thanks to the outstanding efforts of our employees we completed a successful selling and calendar year-end season with strong sales volumes and revenue retention for the quarter. We continue to see a stable macro environment and demand for our solutions. Our unique value proposition is clearly resonating in the market. Small and midsized businesses continue to show remarkable resilience as seen in our job at index in the last two months as they contend with a constantly changing labor market, inflation, increasing regulations and rising interest rates. Before we get into the third quarter results, I want to take a minute to address the recent volatility in the U.S. banking market as a result of two highly publicized bank closings. We have no cash, restricted cash and investments deposited within Silicon Valley Bank or Signature Bank, and we've met all client fund obligations related to employee payment services and remittances to applicable tax or regulatory agencies. We continue to monitor this situation and believe that our existing client funds held cash, cash equivalents and investment balances are more than sufficient to meet all client fund obligations. We remain ready as we were when the crisis was unfolding to help businesses and their employees whose payroll processing or direct deposits may have been impacted by these bank closures. Paychex has a long-standing track record for being a stable place for customers, employees and investors during all types of macroeconomic situations and crisis, and we demonstrated that once again. The selling season was positive in terms of both revenue and volumes in a very highly competitive environment. In particular, demand has remained strong for our HR outsourcing solutions though as we've reported in prior quarters, we continue to see a trend of client shifting preferences for our ASO model over the PEO model. In the third quarter, we saw revenue retention remaining near record levels and normalization of uncontrollable losses at the very low end of the market. The focus and investment we continue to put in our high-value clients is making the difference in the customer experience. In addition, the advisory assistance we provide our clients is critical in these challenging times. Our retention for our HR outsourcing businesses, both ASO and PEO stand at an all-time record high year-to-date. PEO and Insurance Solutions continue to show lower health insurance attachment and enrollment inside those clients that are attaching. This is specifically impacting our PEO in the Florida market and the softer rates for workers' compensation insurance continue to impact the property and casualty part of our insurance agency. We expect these trends to continue early into the next fiscal year and normalize as the year progresses. Paychex is uniquely positioned with a continuum of solutions designed to help businesses in any macro environment. We help them recruit and train employees gain access to capital and provide valuable benefit packages such as insurance and retirement. Through our innovative technology, compliance and HR expertise, we are here to help businesses drive efficiency within their HR processes, which therefore frees a valuable time for them to focus on growing the business. Competing for and retaining employees remain a challenge for today's workforce. And I want to commend Congress and the President for signing the recent SECURE Act 2.0, which will introduce a range of new opportunities for businesses looking to introduce a retirement benefit and make their employee value proposition more competitive. We have begun to launch campaigns to educate the market on the SECURE Act 2.0 and continue to position Paychex as the industry leader in retirement plans that we are. We are working on strategies to leverage our strength in this market and capitalize on this opportunity in the years ahead. As higher interest rates and disruptions in the banking system have both impacted the cost and access of capital for many small and midsized businesses, we have fully embraced this challenge to help them out by proactively assisting our clients and prospects with obtaining financial assistance available to them through non-traditional financial partnerships and through government programs such as PPP and the ERTC program. We continue to see strong demand for our full-service ERTC solution. Many of the businesses we've helped are leveraging their new financial flexibility to reinvest in new solutions, such as a retirement plan, or one of our integrated HCM technologies. Recently, our ERTC service was recognized with a Stevie Award for helping businesses obtain critical financial support. In uncertain times, people look for stable, trusted advisers to help them succeed. I am proud that we have recently been recognized as one of the most admired, one of the most ethical and one of the most innovative companies by several prominent and respected brands. We remain one of Fortune's most Admired Companies in 2023. And for the 15th time, we were named among one of the most ethical companies in the world by Ethisphere. This is a select group of companies that show exceptional commitment to ethical operations, compliance performance and governance and risk practices, including strong commitments to ESG and diversity, equity and inclusion. And today, we are announcing that we have been named to Fortune's list of America's most innovative companies for 2023 due to the innovation we've shown in our products, processes and culture. These awards are the result of the dedication of our 16,000-plus employees who daily are supporting our clients and helping them succeed and doing business the right way every day. Very proud of the team, and I'm very proud of Paychex. There's no question that we are a well-managed and stable market leader that people can depend on. We have a long-standing track record of being there for our customers when they need us most, and we continue to be well positioned to help them through the HR challenges they are facing and whatever comes their way in the future. Now, I'll turn it over to Efrain who will take you through our financial results for the third quarter.

John Gibson:

Thank you, Efrain. With that now being complete, Todd, we'll open up the call for any questions people have.

Kevin McVeigh:

Congratulations. Just really, really strong results here. I don't know, John or Efrain, maybe -- and I know it's preliminary Efrain, but the 2024 looks pretty similar to '23, and there's a lot of crosscurrents from a macro perspective. And you folks tend to be pretty conservative. Maybe help us understand some of the puts and takes? Is it maybe there's a little bit more pricing and just any base underlying assumptions around unemployment because, again, just really, really outcome. I'm just trying to understand maybe that a little bit more.

John Gibson:

Yes. Yes. Kevin, keep in mind that we've certainly seen a reference and really expected to see some moderation. I mean, we don't expect another 4.5 basis points increase in interest rates that we don't expect the type of hiring that we saw from the HCM. It's hard to believe that the great resignation was just last year, a year away. So certainly, we've had the benefit of staffing up. But we're not seeing any contraction moderation. And in fact, if you look at our job index, which has been a great indicator of kind of small business health and what we've seen in both January and February that we've reported, it's actually an increase in the index. And we have not seen that through all of this fiscal year. So these are the really first two months where we've seen an increase in the index and also saw some moderation in wage inflation as well. So, we're certainly not seeing it. We haven't reported March yet, but I can tell you we continue not to see anything there. Demand for our products, the HR products, the online products that we're offering HCM products of the 401(k) effort is really, really strong. I mean, we had a strong sales quarter in the second quarter and the third quarter was actually better than that even on a relative basis quarter-to-quarter from prior periods. So, we're seeing good demand in what I would say, moderation stabilization. We're certainly closely watching all of the indicators, but we're not seeing things. We've got a very -- the other thing I would point out on a macro basis, there's a lot of noise in the system. And I think it's important to say, we have a very diverse client base. And I think it's fair to say, Paychex, we're one of the main street small and midsized business company. We're not that still Silicon Valley. We're not focused on one particular vertical or we're not heavily weighted here or there. And so we tend to represent what's going on in Main Street. And I don't think Main Street small business owners have been reckless in hiring or requisite spending or able to spend more than they make. And so again, they struggle through this and we've been helping them get through it. So, our retention has been strong as well and particularly where accounts in our HR advisory products, both PEO and ASO again at record levels. So, we have a good degree of confidence that our value proposition is resonating with our current clients. We still think there's a ton of opportunity inside our client base to provide them further assistance. And while we've seen until towards ASO versus PEO this year, I always look at it this way. Those are ASO clients are Paychex clients and we'll be talking to them again next year about whether or not it's the right time and whether or not you've got the right benefits offering that now meets their needs, and we're certainly doing a lot of work there to try to make sure we've got the right continuum of insurance products to meet the market conditions for small businesses today. So I feel like, look, this labor challenge that we have is not going to go away. And I don't think the complexities of hiring people is going to go away. And I think that bodes well for how we've positioned ourselves, both from an HCM perspective, our technology is driving efficiencies and it's helping people manage remote workers. It's helping them attract workers and quite frankly, our HR advisory services are paying big dividends. So I hope that gives you some color on what we're seeing.

David Togut:

Just to dig into fiscal '24 guidance a bit more. Could you walk through some of the underlying drivers of Management Solutions revenue growth for next year and a little greater depth? And in particular, if you could let's say, start with the critical year-end selling season, which you've just gone through, you've indicated it was strong. If you could kind of walk through kind of what parts of the bookings were particularly strong within your client base, small end like sure payroll versus kind of more of the core payroll processing business, and then in addition to that, if you could comment on your expectations for client revenue retention next year and also for pricing?

John Gibson:

Yes. No, I think, David, the key point was is we had both strong revenue production -- new revenue production and good volume production across the core business and then really just continue to see this accelerated level. I mean, we were growing our HR businesses. We're growing a good healthy clip before the pandemic and when the pandemic hit, we started to come out and they accelerate. And we're really seeing strong growth there, strong growth in retirement services, our online services, time and attendance, the other bundles that we're offering retention insights. We're just seeing a lot of traction in our products and services and we saw it in the third quarter. And I said the third quarter was a step-up from the second quarter, we felt pretty good about the second quarter. So -- and it was a very highly competitive environment. I would say there's a lot of aggressive competitors out there, and I think our products and our sales team did a great job on executing. Also, the other thing I feel good about in that quarter is we sell a lot of our business, only 50% of our new clients come to us from strategic partnerships, and we had a good year-over-year increase there. And again, I think what's going on there, not only as our products and services resonating, but I think people that are advising clients are beginning to put a preference on, hey, if I'm going to advise my clients were to go, maybe they need to be in a nice safe place where I don't have to have worries about whether or not their employees are going to get paid. So, I think that's also helped us in the third quarter as well.

Efrain Rivera:

So, that's an interesting point, David. I wonder whether they're almost been raising short interest rates. I tend to agree with you, but I'm not so certain about it. But the levers you have there is what percentage you have long term versus what percentage you have short term? And where do you lock -- where you lock long-term rates and over a period of time, so you can manage what happens on the downside of the cycle. So, we're starting to extend duration now because we're of the conviction that interest rates seem to be getting close to some sort of peak. Having said that, my prognostication skills on this or not anything anyone should take to the bank, but I do think from a portfolio management perspective, it's probably better to start going longer now for us. We were shorter earlier in the year.

Ramsey El-Assal:

Efrain, can I ask you control down a little bit in terms of the factors that are giving you confidence that the insurance side of PEO will improve next year. Just curious about the drivers or sort of reasoning behind that expectation.

John Gibson:

Yes. I would add to that, I think it's important to understand that particularly on the insurance attachment side in the PEO, remember, that's a lot of pass-through revenue, not a lot of margin. But it's a big dollar number. So a small percentage change in any direction has probably an over-weighted impact on the revenue in the PEO, right? And so extra 1% or 2% and then another 1% or 2% participation within the base, I think, is critical. And to Efrain's point, you have this opportunity to reset your insurance portfolio every open enrollment, and you're hoping that you have the right portfolio of cost and the type of plans that people can afford and they want to gravitate to and what they're going to do. And that cycle comes up every fall and into the winter. So certainly, we're taking a lot of data. We're doing a review of every market for the PEO and looking at our health insurance line up, making sure it's competitive. We're taking an affordable for clients. We're talking to our clients. We're already in the process beginning to reset that and talk about that reset. So, we're confident that we'll have the right lineup and the right opportunity, and then as Efrain said, historically, most of Paychex PEO sales really prior to our acquisition of Oasis was coming from upgrading ASO clients into the PEO business, a lot of inside the base. Now it's far more outside the base, but we still have that capability inside the base. So, we think there's additional opportunity inside our client base to upgrade them to PEO and that not only increases the revenue, but it also increases the lifetime value of the customer to us, it's the right thing to do for the business, and we'll be looking at plans to do that as we go into next year as well.

Efrain Rivera:

No. For sure, I mean, if you look at -- if you parse all the data, I'm not sure you get it from all of the public fiscal you get pretty close. You've seen persistent growth in revenue per client. So I think we've been very skillful at finding new opportunities, both with product attachment, but also the ability to create new products and services within our client base to drive that revenue higher. So yes, we can talk about an algorithm that's about units and price, or we can talk about an algorithm that's really around revenue per client and revenue per client has become more important, certainly in the last five years.

Operator:

Thank you. Our next question comes from Andrew Nicholas with William Blair.

Efrain Rivera:

Yes, Daniel. So, we've seen healthy growth in WSEs across ASO and PEO. We don't separately break them out, but both have been growing. So, we're seeing positive results on that side of the equation, splitting it out between new adds versus existing base. The reality is that because the existing base is so large, it dwarfs the impact of new adds from a WFE perspective, especially when you consider loss. And so, we've seen good growth on WSE that makes us, as John said, more positive about the general value of our HR advisory services like both cross ASO and PEO. I'll let John talk through shifting preferences in a given year between ASO and PEO.

Daniel Maxwell:

Yes, that's helpful. And then just generally on capital allocation, anything on the attractiveness of buybacks going forward or any M&A opportunities that have become more attractive in the last few months in the pipeline?

John Gibson:

Yes. I think Daniel, I think, our position has changed on this. I think the market conditions are changing and have changed and I think we're going to continually be on the lookout for opportunities that accelerate our position from an HR leader and the technology leader and continue to position us as the leading digital HR human capital management provider. So I would say some -- we've seen some valuations starting to come down. I'm sure the recent disruptions in the financial markets may create additional opportunities. And as Efrain said, we stand ready if the right opportunity comes around to pull the trigger. It's not that we haven't wanted to do something but we also are not going to overpay for something. So we're going to be -- you're going to see the same financial discipline you've continued to see from Paychex. What we believe that the market conditions are more conducive to us moving forward on the M&A front, but we'll see if that actually transpires.

Samad Samana:

Maybe one, just as I think about that comment about the number of new customers coming through strategic partnerships, how should we think about maybe how that impacts kind of customer acquisition costs those tend to be slightly larger, smaller, more profitable, less profitable? How should we think about where you're acquiring the customers from and what the impact of that is to the financials?

Samad Samana:

Okay. Great. And then as we think about the bookings in the quarter, anything to call out between the different kind of customer sizes so think about it as very down market and maybe more micro customers versus your average customer size. Just any trends or pockets of strength or weakness?

Operator:

Thank you. Our next question comes from Bryan Bergin with TD Cowen.

Efrain Rivera:

Yes. Jared, I won't get into that level of granularity at this point. And -- so we will report as we get through the quarter and year-end, I'm not ready to dive into specific operational metrics for the PEO at this point. We called out that revenue was going to be lower in Q4. That's a function of the topics that we've been talking about relative to insurance. But yes, I won't go any further than that. We'll have more to say as we get to Q4.

Efrain Rivera:

Yes. I mean it's a -- it's an emphasis that the Company has had. We're going through the budget process, frankly, after this call, we've done, we'll start the process of putting our budget together. But -- we just have a mantra to get more efficient where we can get more efficient. And some of it comes from operations. Some of it comes from sales. Some of it comes from G&A. It's really across the business and where we see an opportunity to become more efficient. Not simply massivley just cut costs, obviously, that's important, but also deploy technology where appropriate, to become better at doing what we're doing. We do it. I would say that many of the technologies that you read about in that here, we don't trump it, but we use. And we think that advances in things like AI can be of tremendous help to tech angle services businesses. So we're excited about the potential, to understand the risk and are actively looking at how we can deploy those technologies to get more efficient, get better at serving the clients.

Jason Kupferberg:

So I guess there's a school of thought out there that just one of the byproducts of the banking crisis could be some tightening of credit, small businesses find it harder to get loans. They tend to bank with a lot of the regionals, et cetera. I'm just wondering what your take is on that as we start to look into fiscal '24. It doesn't sound like you guys are really assuming a recession per se in this preliminary outlook for next year. So, I just want to get a reaction to that to start.

Jason Kupferberg:

Okay. Understood. As a follow-up, I just wanted to ask on the float side of things, maybe a two-parter there. the first part just being, obviously, the unrealized losses have increased with the rates going up, but just wanted to confirm, you guys can comfortably meet all the float obligations just short-term component? I know you said so far to date, obviously, that's been the case. But I just wanted to make sure we shouldn't expect any material amount of realized losses? And then just any thoughts on Fed -- now coming this summer, do you see any potential impacts on float if it's adopted by enough banks? And maybe just talk about how your float income breaks down between payroll and tax pieces.

Jason Kupferberg:

Yes, sorry, I was just asking about Fed now with those real-time rails coming out this summer. Just any thoughts on how that could, if it all impact float balances, float income obviously like we'll see how many banks adopt it, right, but -- and then anything just on your float income, how it breaks down between the payroll and the tax pieces? Because I know, obviously, some of the float you hold a lot longer. So...

Operator:

Thank you. Our next question comes from Kartik Mehta with Northcoast Research.

Efrain Rivera:

So, I'll turn it over to for John some comments on pricing because I think that I think we need to distinguish between pure pricing and value delivered to customers. So -- but let me answer your question. So as you know, Kartik and everyone on the call knows, we typically have said that pricing is in the 2% to 4% range on a realized basis. So maybe it could be a little bit higher for some clients, but frequently or sometimes it's discounted. I don't want to talk too much to the specifics around pricing next year. I think the pricing environment will not be quite the same as it was this year. I think it was somewhat of an unusual situation given inflation. Having said that, I just want to limit that comment to the issue of pricing and not include value. I do think there's always an opportunity to think about how to add more value to a customer and then charge them for that because they're willing to accept that. I'll let John comment on some of the things that we think about in that respect.

Kartik Mehta:

Fair. And then just -- we've talked a lot about, obviously, PEO and ASO. And I'm just wondering if you could give a little bit of context as to revenue per client PEO versus ASO?

Operator:

Thank you. Our next question comes from Bryan Keane with Deutsche Bank.

Efrain Rivera:

Yes. So Bryan, a good point, and obviously, we all hear the same chatter everyone is hearing. So let me just move to the answer to that. That's a little bit more new. At this point, I can only tell you what we see right now. And I can say, as we said we've repeated earlier, we see signs of moderation that we've been seeing progress since the fall after Q1, but we don't see any significant signs of slowing. So we just got through the last three months, John gave an overview of kind of what was happening from the selling season, that would have been to a signal that, hey, maybe something going on here that we needed to pay attention to and incorporate. At this point, through the selling season, we haven't seen signs of a slowdown. Again, I've seen signs of moderation and we've incorporated that in our thinking. To the extent that we saw a slowdown, obviously, we'd see it by July, and we've incorporated that in our thinking, we come back and say, guess what, things are slowing down. I don't think that things will occur that way, but it could. The way we think about the year is really -- and I've said this probably for the last three or four years, it's in two halves. So I think that are confident in terms of what we expect to see in the first half is at this stage, decent win by thesis. I mean, we've got enough trending to say something should not fall off the cliff in the first half of the year. The Fed is tight. And John said, our clients are going to be much more impacted by rate increases in the prime rate than anything else. And at this point, they seem to be absorbing where we're at and seems to be absorbing a higher rate environment. And the other thing that I would say is that our thought process is that we're getting close to peak short-term rates. So if we put that all of those factors into the gumbo and then stir it up a bit and see what our view is of first half and look at the micro factors in the business, strength in retirement services, strength in HR, we're seeing good progress on HCM and then a rebound in PEO or it produces the results we have. Now the nuance that I would provide to that is that, that takes us through, as you know, the end of November. That's the first half. We'll come up for air and see is that the trends that we expected to occur in the back half of the year actually materialized. At this point, it's a little tough to call that nine months out, but that's why we labeled with preliminary. Right now, the point out, Bryan, after I get all of those words is simply to say at this point, we don't have anything in our data that's suggesting that a slowdown is occurring or is it imminent. Now if the Fed were to decide that it needs to go back to a cycle of 50 basis points increased rates, we're going to have a different conversation really quick. Don't see that happening. And one final point. All of us on the call we're wondering two or three weeks ago when we're going to have a systemic banking prices on our hand, but we certainly were looking at that and seems like the economy was resilient enough and the Fed did I should say, treasury did the right things in terms of shoring up the banking system. So we're -- we have the environment we have. We understand what factors are moderating. We think that what this outlook incorporates is our best thinking on the environment. And I think that -- having said that, our confidence in the second half, obviously, will be something that we'll talk about -- talk more about as we go through the year.

Operator:

Thank you. Our next question comes from Peter Christiansen with Citi.

John Gibson:

Yes. Peter, again, I'll go back. What we see is on business applications, business starts, again, they're back to pre-pandemic levels. So I was always trying to explain to people that when you look -- when I look at it because we're doing our budget points, I'm looking back almost five fiscal years now and fiscal year '19 stands out because then you see all this entity going on in the other fiscal years. Business starts are down from where they were historically. And that's why when I even look at some of our retention in the small end, that doesn't surprise me because even in good times or bad times, a small business that starts two years later, most of them aren't in business. So when I look at it, there's a good new business starts. When I looked at our sales from the third quarter, they were strong across the board, not just in ERTC but across the board. And so I really -- again, I'll go back. I'm not seeing anything on a macro level that would indicate to me that there are macro issues or there are demand issues relative to the products and services that we're offering.

Mark Marcon:

A couple of questions. One is basically in terms of the margin guide or the preliminary thoughts with regards to margins for next year. To what extent would you expect to see any sort of improvement in terms of the margins ex the impact of float income? And how are you thinking about that?

Mark Marcon:

Do you think there will or will not be?

Mark Marcon:

But ex quote, we should see some margin improvement. And then -- and then with regards to -- I know you're in the budget process now, but are you anticipating an increase in terms of the sales force and in terms of the overall headcount within the business? Or are the technological innovations that you're making sufficient to basically continue to drive the business with the same headcount?

John Gibson:

Yes. I don't tell adding expense to the business very frequently. So I think that we're constantly looking to make sure that we have the right go-to-market strategies and the right go-to-market coverage. We are certainly focused on using our vast data sets and analytics and digital engagement as much as we can. As Efrain said, I went back five years ago, our digital, if you think about just in the U.S., I mean, including international paychex.com and surepayroll.com, probably a 20-point improvement in the percent -- 20 percentage point improvement. And what we're getting there. We're driving analytics to make our sales force more productive instead of just cold calling across the market or inside and client base, we're using data analytics and models and triggers of behaviors of people engaging our systems to give them active risk. So, I think there's opportunity for productivity. And we're doing a lot more digital engagement inside our applications and actually creating digital experiences to drive more attachment of ancillary products and services. So, I think when we're sitting down for the budget, we're certainly going to add sales reps engaging our strategic partners, doing things that we need to do to cover the market and the market opportunity we have, but we're equally balanced on making sure we're making the investments in digital engagement and driving productivity and using the data analytics we have to make sure we're making every rep as productive as they can be.

Efrain Rivera:

So, we didn't talk about it, but I will say that through the year. We have seen increases in pay per control or we would say, checks, and it's moderated as we've gone through the year. So that -- in some ways, it's been a tale of two cities, the first half is port end up being different than the second half of the year.

Operator:

Thank you. Our next question comes from Eugene Simuni with Masset Makinson.

John Gibson:

Yes. Yes. So as we said, we're in our budget and we're really in our planning stages to figure out how we want to approach the SECURE Act 2.0. We started some education, certainly within our base and we're trying to figure out in scope the size of the opportunity across the market and determine what investment we're going to do that. And that's something I think we'll talk about more in the next call. We're doing a lot of surveys trying to get where people are in their understanding of what it means. There's a huge education effort that I think has to go on, but I think it's a pretty powerful value proposition. Like I said, I think the secular labor problem is going to continue. I don't -- even we get to a recession, we just simply don't have enough people working. The labor participation rate is just not big enough to meet even a lower demand were at 3.4%, 3.5% unemployment. And so, I think the simple fact is small and midsized businesses needing to compete against large employers, we typically have richer benefit plan. It's going to be a secular trend that's going to continue, and I think we're well positioned to do that. And I say that because that's going to create the opportunity for a 401(k) plan. And the SECURE Act 2.0, just to give you an idea, pretty much if you're an importer with between 20 and 50 employees, we could provide you and start up a 401(k) plan, and you would pay Paychex literally nothing because you pay us for a startup fee. You pay us for the other fees that we would have there. But you'd get all that back through tax credit. So it's -- basically, you can add the plan. And then if you want to contribute up to $1,000 to each employee, you can get that $1,000 as a tax credit as well in many circumstances. So I think there's not a lot of awareness. Look, we found the same thing with the ERTC. They're just a lot of small and midsized business owners not even where these programs exist and then they have reluctance to participate because whether we want to like it or not, they have some skepticism about government programs and being on some government list. And we're really positioning ourselves as kind of this trusted adviser to help them and help facilitate that. And so we're doing a lot of studies on it. We're trying to figure out how big the opportunity is and certainly, we think it's a great thing for small, midsize businesses. And again, I applaud the Congress and all the partisanship that goes on in Washington. It's great to see them have a program like this, and I hope there's more programs like this in the years to come to support Main Street small business owners.

James Faucette:

Just a couple of questions from me. First and I know we've talked a little bit about this both in previous quarters, but now, but can you recap for us a little bit why you think ERTC outperformed what you thought it would do during the course of this fiscal year? And then kind of how that contributes to you thinking that it could slow a little bit in next?

John Gibson:

Yes. No, again, I would just reiterate, I think this is a good example of how we're trying to approach helping our clients. I think when the program was first announced, we did a lot with the PPP loan program. I talked about that 9% of all of them paired with fintech companies to be able to facilitate that. And we've really developed a muscle there to build an automated simple solution and an educational package and program for both our strategic partner CPAs and for our clients to go through. When the ERTC program came out, I think, we thought they kind of knew about it and were just trying to do general education. I think what we learned early on is that was just not resonating. And a lot of people either thought they didn't qualify or weren't sure, or quite frankly, by some of the just hassles and other challenges of participating in to some other government programs, they felt like, Hey, I don't need this right now, and I just can't tolerate. I think we had two things kind of happen. One is our data science team began to look at actual data models and we started to be able to pinpoint accuracy, be able to go to a client and say, we actually know from our data that you qualify and this is how much we're talking about. So now you're saying, hey, I can get you a check for $180,000 and what you had to do with education. There was some more information and then we made it a very simple process. So one was we were now instead of broadcasting to all of our clients, we were going with a specific database analysis to a specific client and saying, we have a high degree of confidence that you spend 10 minutes with us and we get a few pieces of information. We're going to be able to get you a check that would be meaningful and worth your time. That's one. Then we had to overcome all the obstacles, I think, simultaneously to that, interest rates started to go up, and the cost of capital started to go up. And I think a lot of small business owners who said it, hey, I don't need it. It's not worth my time. I don't want to be associated with the government program. I may get audited. And most business owners, small business owners are concerned. An audit would put them out of business worse than anything else. So they -- I think they were avoiding it. I think as we saw that happening now, the receptivity and the demand that said, hey, I really need that $180,000to bridge inflation to be able to bridge the cost of capital to grow my business. And so I think we had those two things us being more precise in terms of our messaging and getting our sales and our education teams out there. And then second, I think there were some macro pressures on small business owners that created that tailwind that exceed what we expected.

Efrain Rivera:

That's a good question, James. So -- and that's the benefit of listening to what I've said over a period of time. If you would have said to me persistently, we could be above 40%. And I would have urged caution because I didn't know whether we had all of the set of initiatives that could drive us there. The short answer to that is I don't have a great answer. I have a sense of when we're probably getting closer to the ceiling, I do think that you're right in saying that it's been reset a bit, and it's been reset a bit because of technology. So technology keeps giving us opportunities to automate things that we -- if you would have said seven years ago, is that a chatbot could be as good or better than in answering 275 questions that are 90% of what clients want to know, I would have said -- I don't know about that. And short answer now is -- that number is not 275, it's probably 375 or 400 question. So short answer is technology is going to set the limit especially in the tech services business. And so I think we probably have developed some more headroom with some of the actions that we have taken. And it's not just pure technology, but I think we wanted to become more automated efficiently. A lot of the initiatives that John started years ago have paid these dividends.

Andrew Polkowitz:

just wanted to -- just wanted to ask, you mentioned earlier that it was a fairly competitive selling season. So I just wanted to ask if you could share where that competition is coming from, whether it's new or entrance usual suspects like the regional and if there is anything to call out different from history regarding balance of trade?

Andrew Polkowitz:

Got it. And I just had one follow-up on op margins. I mean for the quarter, this quarter, it came out a little bit ahead of the 40%, 43% you laid out three months ago. Just wanted to ask if there is anything that came out better than you expected three months ago relating to the expense line?

Operator:

At this time, I have no further questions in queue. I'll turn the call back over to John Gibson for any additional or closing remarks.

Operator:

This concludes today's call. Thank you for your participation. You may disconnect at any time.

John Gibson:

Thanks, Tadd. Good morning, everyone. Thank you for joining us for our discussion of the Paychex second quarter fiscal year '23 earnings release. Joining me today is Efrain Rivera, our Chief Financial Officer. This morning, before the market opened, we released our financial results for the second quarter ended November 30. You can access our earnings release on our Investor Relations website. Our Form 10-Q will be filed with the SEC within the next day. This teleconference is being broadcast over the Internet and will be archived and available on our website for approximately 90 days. We'll start the call with an update on the business for the second quarter and then Efrain will review our financial results and outlook for fiscal year '23. We'll then open it up to your questions. We delivered solid financial results for the second quarter with total revenue of 7% and adjusted diluted earnings per share growth of 9%. Demand for our comprehensive solution suite remains strong and we are well positioned to help our clients succeed. Our unique combination of leading HR technology, HR expertise and the wide breadth of solutions we have to address the many needs in the marketplace continue to help small and midsized businesses navigate this very dynamic and challenging environment. We continue to closely monitor the macroeconomic environment and our internal leading indicators. The latest findings from our Paychex IHS Small Business Employment Watch revealed moderating growth in jobs and steady growth in wages. Our clients continue to be challenged by the continuing impacts of the pandemic, inflationary pressures and the challenges of this labor market. However, small and midsized businesses continue to show their resilience. Our revenue retention remained solid as we focus on retaining clients and driving increased value and penetration of our HR outsourcing, HCM software and retirement solutions. Our overall HR outsourcing business continues to perform well with strong growth in worksite employees and record revenue retention. We achieved a major milestone this quarter. We now serve over 2 million worksite employees across our ASO and PEO business, clearly establishing us as an HR leader. Our industry-leading HR advisory services sets us apart and our certified HR professionals are truly a unique asset as they are advising our clients on HR issues as well as leveraging our HR technology and the analytics from our vast SMB data set to help our clients achieve greater operational efficiency, increase employee engagement and reduce turnover. While demand for our technology and HR outsourcing solutions remain strong, we continue to see shifts in what offerings clients find are the best fit for their current situation. Both early and during the pandemic, we saw lower demand for adding employer health benefits. We continue to see this trend and also high demand for our ASO solutions, driven by businesses seeking immediate assistance with HR issues and filing for tax credits, but delaying decisions on adding or changing their insurance offering to their employees. In addition, the lower medical plan sales and participant volumes in our health and benefits area of our insurance agency that we discussed last quarter continued in the second quarter, and we saw some similar trends in our Florida at-risk insurance program in the PEO, impacting revenue growth in that area of the business. Awareness and demand of our employee retention tax credit or ERTC service, which helps clients maximize eligible tax credits, continues to grow. To date, we've helped more than 50,000 clients secure billions in ERTC. A recent survey actually showed just 63% of business -- that 63% of business owners didn't even know that they were eligible for these credits. We continue to educate existing clients of the benefits as well as leverage this service to attract new clients. We continue to invest and enhance our product suite and customer experiences. In November, we released our enhancements to Paychex Flex, focused on further streamlining the recruiting, onboarding, time and attendance, and benefits administration experiences. Through our HR technology, three out of four Paychex clients surveyed have shortened the time required from recruiting, screening, tracking and onboarding new employees. Those clients reported an average time savings of 26%, indicating that the typical two-month recruiting cycle has now been reduced to just six. I'm very excited about our Retention Insights offering, which continues to deliver strong results for our clients at a time when businesses remain committed to retaining their existing staff. This feature uses predictive analytics, coupled with our vast data sets, to provide insights on potential employee flight risk. Clients leveraging the Retention Insights offering are showing a 15% reduction in turnover when compared against their industry peers. We're very pleased we received the Bronze Brandon Hall Group Excellence Award for Best Advance in HR Predictive Analytics Technology for this solution. This is the 10th consecutive year they've recognized us. During the quarter, we also were recognized with the IDC 2022 SaaS Customer Service Satisfaction Award for Core HR and we are honored to have received this award as another confirmation of the power of our HR technology and the quality of our advisory services. These awards continue to validate that Paychex is a technology leader and that our focus on HR is delivering real impact for our clients and their employees. At this time, we're heading into our critical year-end season. We are fully staffed in both sales and service, and we have good momentum. I want to thank all the employees in advance for all their hard work and dedication in making this the best year-end ever. Now I'll turn it over to Efrain who will take you through our financial results for the second quarter. Efrain?

John Gibson:

Thank you, Efrain. Tadd, we will now open the call for questions.

Ramsey El-Assal :

Thanks for taking my question this morning and happy holidays to you. I had a question on the insurance business. I'm just curious, you mentioned lower medical plan attachment and the mix shift to ASO. What do you think is the underlying driver there? Is there any other color or insight that you have in terms of why that sort of those dynamics are kind of kicking in right now?

Ramsey El-Assal:

One follow-up for me. You also talked about Management Solutions higher product attachment cross-sell. Can you kind of update us on your strategy there? What levers you're using to execute on cross-sell and what inning we're in, in terms of that broader opportunity?

Operator:

Our next question comes from Bryan Bergin with Cowen.

John Gibson :

Yes. Again, what I would tell you is, even though the -- it's a challenging and kind of a mixed macro environment, everything you read about the resiliency that we're seeing in the small and midsized businesses continues to be strong. So when we look at the leading indicators that we would be looking at of kind of the first signs of a downturn, we're simply not seeing those in our indicators at this time, and that's what we've reported here. I think there's certainly been a rare coaster effect from the COVID perspective. Certainly, when you look under the covers, I think our mid-market customers and larger customers seem to be doing better than our small customers and small customers seem to be doing better than the micro customers in terms of dealing with inflation and the recruiting scene. But when you look at the overall macro perspective, we're not seeing anything at this time in our indicators that would indicate any kind of downturn for small businesses.

Efrain Rivera :

I think pretty -- at this point, I think we're assuming an environment that's similar to what we saw in the first half. And with this caveat, Bryan, that as we've looked at quarter-over-quarter, you continue to see a pace that is moderating versus the previous quarter. I think that's the trend we think continues into through the end of the fiscal. So while it doesn't represent a sharp departure, we still see continuing signs of moderation as we go through the year. Now that assumed that the impact of the Fed's rate raising continues to have the same incremental impact it's had in the first couple of quarters. What do I mean by that? I mean, right now, what we see is it's having the effect of starting to tamp wage pressures. It's not having a dramatic impact on hiring especially in the SME firms that we serve. If that started to change, it would change our assumptions. Right now, we don't see that occurring. But right now, we're not at 5% short-term rates. We're going to have to monitor that. And there is just a note of caution that we have as we approach what they would consider their peak short-term interest. So no dramatic departure from the first half.

Jason Kupferberg :

I wanted to start just on Management Solutions with the raise of the revenue guidance there. Just which of the key operating metrics are you now bullish on? I mean is it pricing, retention, bookings, checks per client?

John Gibson :

Yes. And Jason, I would probably add to that. I mean we continue to see the demand for our HR solutions, both ASO and PEO. We like the demand. What we're seeing an increase in worksite employees and the retention in those has been very I mean historic record high when you look at our HR outsourcing businesses, both of them at record highs. So we've had solid revenue retention across -- at the macro level. And then when you look at what's going on in the HR area, very, very positive results, and that's certainly helping us as well.

John Gibson :

Yes. Well, Jason, let's talk a little bit because we've talked about the agency a little bit. I mean P&C has been a continued product. Again, remember, most of our P&C business is workers' comp, the vast majority of it to new start-up businesses. And that's been a very soft market for a period of time. So certainly, that has continued to be a drag and that has not turned around. I think when you look at the H&B side, which has been a little bit more impacted up and down as you went through this pandemic. It's what I kind of say, you have a little slower new business starts, so people less people we're talking to, and then you have the economic pressure of adding a benefit at that cost both from an employer and employee side. So I don't think there's anything terribly structurally. Now one of the things we're certainly doing is we're trying to make adjustments to our approach both in terms of driving more digital engagement on the P&C side. We're also doing a lot more going back to current clients on the H&B side, where we think we may have more success in converting them from existing benefit programs. And we're going to continue to look at expanding our insurance product portfolio to meet the demands of the marketplace with some things that may be more economical. But again, this is really a continued sluggishness with P&C and then this kind of lack of attachment and backup participation in H&B.

Kevin McVeigh :

Happy holidays, and John, congratulations on the first call. I wanted to drill into the puts and takes on the guidance a little bit. I mean, there's been a pretty sizable step-up in float, which is pretty profitable. And then the swing factor on the other income is pretty profitable, too. But we're kind of holding the EBITDA and I know the other income is below the line, but the floats above, is there anything offsetting that, Efrain? Or is that a little conservatism? Just -- because it seems like your overperforming in some of the more profitable parts of the business as opposed to not and it doesn't seem like that's flowing through. So is there anything I'm missing there or just not thinking about that right?