Paychex Q2 2022 Earnings Call Transcript

Quartr
Provided by Quartr
December 21, 2021

There are 16 speakers on the call.

Operator

Good day, everyone, and welcome to Paychex Q2 FY 2022 Earnings Conference Call. At this time, all participants are in a listen only mode. Later, you will have an opportunity to ask questions during the question and answer session. Please note this call may be recorded. It is now my pleasure to turn today's program over to Martin Mucci, Chairman and Chief Executive Officer of Paychex.

Speaker 1

Thank you, Emmet, and thank you for joining us for our discussion of the Paychex Q2 fiscal year 2022 earnings release. Joining me today is Efrain Rivera, our Chief Financial Officer. And this morning, before the market opened, we released our financial results for the Q2 ended November 30, 2021. 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, will be archived and available on our website for approximately 90 days.

Speaker 1

I will start today with an update on the business highlights for the Q2, then Efrain will review our financial results for the quarter and provide an update on fiscal 'twenty two. We will then open it up for your questions. Today, we reported strong financial results for the Q2 of fiscal 20 2 as both management solutions and PEO and insurance revenues increased double digits year over year and adjusted diluted earnings per share increased 25%. We continued to have strong momentum from the Q1 with positive trends across the entire business. Client bases across all major solutions have continued to grow.

Speaker 1

Sales performance for the Q2 was strong across the board, resulting in our highest year over year growth in new annualized revenue in over 5 years, and in fact, a record high level of annualized revenue sold For the Q2 and the first half of the year, the investments we've made in our technology, product, sales and digital marketing have positioned us well for success in today's environment. Our client retention remains near record levels. This is reflective of both the resilience of small businesses in the U. S. And the value provided by our unique blend of software solutions and HR expertise.

Speaker 1

Macroeconomic tailwinds persisted And resulting in strong growth in checks per payroll and increases in worksite employees in our HR outsourcing clients. The tight labor market and war for talent has been very challenging for all businesses. In response, Paychex ourselves, we've taken proactive steps implementing incentives and programs to compete for talent, And we've made significant progress in hiring over the past quarter, and we're well prepared heading into the calendar year end and selling season. COVID-nineteen and its variance continue to pressure businesses of all sizes, and we constantly enhance our robust set Of COVID-nineteen related solutions, most recently within 10 days of the legislation surrounding COVID-nineteen vaccination and testing, We introduced a digital solution that businesses can leverage to confidentially capture and store employee vaccination status and request testing results for the unvaccinated. To help our clients stay up to date on all federal and state regulatory changes, We continue to introduce new methods of communication to proactively keep them informed and educated through white papers, webinars, videos and our podcast series On the Mark.

Speaker 1

We closely monitor topics that may have a significant impact on our clients, such as vaccine management, updated guidance on employee retention tax credit or ERTC and the return of mask mandates in specific states. And the acceleration of digital technology solutions to support a distributed workforce and tools to help businesses maximize available stimulus from the government. We've seen the benefits of these trends and strong demand for our HR solutions. Another business that is benefiting from strong demand is our retirement business, where we have reached the 100,000 Client milestone. As a leader in this space, we are uniquely positioned to help businesses meet the growing number of state mandates for retirement plans and provide a critical benefit offering to drive employee retention and satisfaction.

Speaker 1

In fact, in January, We were one of the first to release a PEP plan or pooled employer plan and 11 months later, not even a year later, we now have over 10,000 The access to stimulus funding has been a powerful retention tool for Paychex. We're proud that we've been able to help clients Obtained 1,000,000,000 in Paycheck Protection Program loans and approximately 90% of our clients have leveraged our award winning PPP forgiveness tool to gain some or all level of forgiveness for those loans, effectively transitioning the PPP loan into a grant. We've also helped businesses gain access to over $6,000,000,000 in employee retention and paid leave tax credits. Returns for clients leveraging our ERTC service represent a significant amount for any business. 2 of our most recent technology innovations focus on employee retention.

Speaker 1

Our retention insights We also introduced a completely enhanced total compensation summary that can be used by employers to communicate the impact of their total pay and benefits Packages for employees. These are just two examples of the powerful technology and use of information we're providing to help employers compete And retain talent. We continue to enhance our technology solutions to deliver efficiency for our clients, their employees and Paychex through self-service and chatbots. Use of our cloud based applications continues to grow with double digit increases in both desktop And mobile devices. During our recent open enrollment period for our PEO clients, for example, 99% of our PEO worksite employees Their open enrollment digitally, resulting in a 26% reduction in call volume.

Speaker 1

Our continued emphasis and expanding the digital capabilities of Paychex Flex was validated by several recent awards. We were named by Nelson Hall, a leading global analyst research firm, As a leader in their annual NEAT vendor evaluation report for human capital management, Paychex placed in the leader quadrant of the next generation HCM Technology report. This designation was based on our ability to deliver immediate client benefits and meet clients' future requirements. In addition, Brandon Hall Group has just recognized Paychex Flex with 2 Excellence in Technology Awards. Our ERTC service was recognized in the category of best advance in HR and workforce management technology for small and midsized businesses, And Paychex PreCheck was recognized in the category of Business Strategy and Technology Innovation.

Speaker 1

This is our 9th We've been recognized for our technology in this award program, the largest and longest running award program in the HCM space. Before closing, I'd like to take a moment to discuss the recent change in executive leadership roles that took effect on December 1. I have John Gibson, our Senior Vice President of Service since 2013, has been promoted to the role of President and Chief Operating Officer. John has been an integral part of our executive team and has led the service and operations of all Paychex Businesses divisions, including HR outsourcing, payroll, Retirement and insurance. There remains continuity in leadership to drive Paychex of the future, and I'd like to thank Tom for his leadership and for his continued support as we move forward and wish Jan well in our future growth.

Speaker 1

In summary, we are proud of our performance during the Q2. We are well positioned with our set of innovative technology and solutions for this selling season and to continue providing industry leading value to our clients. I will now turn the call over To Efrain to review our financial results for the Q2. Efrain?

Speaker 2

Thanks, Marty, and good morning to everyone. I'd like to remind you that Today's conference call will contain forward looking statements that refer to future events and therefore involve some risks. In addition, I will periodically refer to some non GAAP measures, refer to the customary disclosures. So let me start by providing key points for the quarter, follow-up with greater detail in certain areas, and I'll finish with a review of our fiscal Our 2nd quarter results reflected strong internal execution and continued economic recovery. Both service revenue and total revenue increased 13 percent to $1,100,000,000 Within service revenue, Management Solutions revenue increased 14 $832,000,000 driven primarily by growth in client bases across our portfolio of solutions, higher revenue per client and improved Employment levels.

Speaker 2

Client based growth resulted from both strong sales performance and high levels of client retention. In particular, our HR Solutions business continues to benefit from strong demand as businesses look for more HR support. PEO and Insurance Solutions revenue increased 11% to $262,000,000 Our PEO has benefited from higher Average worksite employees, state unemployment insurance revenue and health insurance attachment. Interest on funds held for clients decreased 5% for the quarter to $14,000,000 as the impact of lower average interest Total expenses were up 6% to $668,000,000 The growth in expenses resulted from higher PEO direct insurance costs, an increase in benefit costs to our employees and continued investment in our products, technology, sales and marketing. Op income increased 24 percent to $440,000,000 with an operating margin of 39.7%.

Speaker 2

Adjusted operating margin was also 39.7% in the 2nd quarter compared with 36.1% for the Prior year period, an expansion of 3 60 basis points. Our effective income tax rate was 24% Compared to 22.1 percent for the same period last year. Both periods reflect net discrete tax benefits related to stock based compensation payments. Adjusted net income and adjusted diluted earnings per share increased 25% for the quarter to $330,000,000 and $0.91 per share, Year to date results, I'll touch on the highlights briefly here. This is for the 6 month period, obviously ending November 30th.

Speaker 2

Total service revenue and total revenue increased 15% 14%, respectively, to $2,200,000,000 Expenses excluding one time costs During the prior year increased 5%. Op income and adjusted op income were $883,000,000 Increases of 38% and 32%, respectively. Diluted earnings per share increased 37 Percent to $1.83 per share. Adjusted diluted earnings per share increased 32 percent to $1.80 per share. Let's talk about financial position.

Speaker 2

It remains strong with cash, restricted cash and total corporate investments over $1,100,000,000 in total borrowings of approximately $800,000,000 as of November 30. Cash flows from operations were $555,000,000 during the 1st 6 months, an increase of 29% from the same period last year. Free cash flow generated was $459,000,000 up 21% year over year. The increases were driven by higher net income, partially offset by fluctuations in working capital. We've paid out quarterly dividends At $0.66 per share for a total of $476,000,000 during the 1st 6 months, our 12 month rolling return on equity was 43 Percent.

Speaker 2

Now I'll turn to guidance for the current fiscal year ending May 31, 2022. The outlook reflects the current macro environment, which saw improvement in the quarter. We've taken that into account in the second quarter results And our 2nd quarter results actually exceeded expectations. We have some conservatism given the macroeconomic uncertainty that prevails during the remainder of the year. We provided the following updated guidance as you saw.

Speaker 2

Management Solutions revenue is now expected to grow in the range of 10% to 11%. We previously guided to a growth of approximately 8%. PO and Insurance Solutions is expected to grow in the range of 10% to 12%. We previously guided to grow in the range of 8% to 10 Interest on funds held for clients is expected to be flat year over year. Total revenue expected to grow in the range of 10% to 11%.

Speaker 2

We previously guided To growth of approximately 8%. Adjusted op income is expected to be in the range of 39% to 40%, Up from the previous guidance of 38% to 39%. Adjusted EBITDA margin is expected to be approximately 44%, up from the previous guidance of approximately 43%. Other expense net is expected to be in the range of $18,000,000 to $18,000,000 Our previous guidance was in the range of $23,000,000 to $26,000,000 with the change due to certain non operating income Our effective income tax is still expected to be in the range of 24% to 25% and Adjusted diluted earnings per share is expected now to grow in the range of 18% to 20%. We previously guided to growth of 12% to 14%.

Speaker 2

Turning to the Q3, we currently anticipate total revenue growth to be approximately 9% And we are expecting an adjusted operating margin of approximately 42%. So note that in your models, PEO and Insurance Solutions revenues for the 3rd Q4 of fiscal 2021 were impacted by timing of notification of changes in state unemployment insurance rates. This creates comparability issues for the 3rd and 4th quarters of fiscal 2022, doesn't affect the whole year. You'll look at our investor presentation when we post it in a little bit and we provided additional details you can get the split of the quarters, correct. Of course, everything that I just said is subject to our current assumptions, which could change given the current environment.

Speaker 2

We'll update you again on the 3rd quarter call. And with that, I'll turn the call back over to Marty.

Speaker 1

Thank you, Efrain. And Emma will now open the call for questions or comments, please.

Operator

And we will take our first question from Kevin McVeigh with Credit Suisse.

Speaker 3

Great. Thanks so much and congratulations on the results. Marty or Efrain, It looks like you delivered a 44.7% margin in the quarter. I think that's the highest on record and even going back to 'seven when I know that float income was half of what it was today. Can you maybe talk to just some of the structural changes?

Speaker 3

Marty, you talked to kind of the chat thoughts, things like that. But maybe just can you help us frame it, is there a new range of margins? Just Any thoughts as to just the leverage in the model, because obviously just you're seeing outsized margin expansion and really Still some headwinds around floating income, things like that. So just wanted to start there if we could.

Speaker 1

Sure, and I'll let Efrain jump in too. I think there's really Two parts to it. One is, we've been down some headcount temporary as in a challenging Hiring, but we really picked up a lot of hires in the Q2 due to some creative things we did. But I would say overall, the bigger impact is that we have Automated, a lot of the service models, when you look at it and you think about chatbots, when someone comes on the web now to ask Over 60% of the questions are being answered in an automated fashion with a chatbot before they go to anyone live. Also, as I mentioned in my comments, if you just think about the things we've done with Flex and our PEO offering, 99%, almost 100% PEO employees, worksite employees handled open enrollment online digitally now And that reduced calling in for questions and issues by over 25%.

Speaker 1

So a lot of the things we're doing not only with the product, But with the service models themselves have reduced the number of calls that are coming in, not only are the clients happier, they're getting a faster answer And it's being done the way they want to receive it, which is either automatically or through chat, etcetera. But also we're saving expense and time and allowing our specialists to handle more value added calls for the client. So is there a wider range? I think there's always a little bit wider range and that's our DNA is to kind of drive margin as best we can. I would say a little is temporary, but most of it is the things that we've been doing year after year.

Speaker 2

Yes, there's no Just to follow-up. Add there, Kevin, I mean, I just say that you know this very well and I think many Of the analysts that cover us, we have evolved significantly from a technology standpoint. We have evolved Significantly in terms of our digital capabilities and the model shows it, the margins show it, we will put up our margins against Anyone in the business because to Marty's point, it's durable, it's sustainable and it's technology

Speaker 3

No, I get that. And just a follow-up on that and then I'll get back in the queue because the numbers kind of speak themselves. But Is that the same level of success on the front end too in terms of the implementation? Like is there any way to think about when you're implementing a client for the first And how much of that is fully digitized as opposed to more a human component to it or is that too abstract?

Speaker 1

No, I know what you're yes, what you're saying is exactly where we're heading. There's more and more clients that can self onboard themselves. I'd say We're still more we're newer into that process, but that is happening not only because it's good for our expenses, it's really good for the clients. The clients want to self onboard. Share payroll division has been doing this for some time and Flex is continuing to grow into that.

Speaker 1

So if it's particularly Smaller clients, they want to start on boarding themselves. There's a couple of benefits, not only does it reduces costs, it allows the client to on board themselves at their pace. And it also really it creates a lot fewer errors and interactions with the service Because the client is doing it at their own pace and when they want to do it and how they want to do it. And the last thing is that it frankly Many times is a better sale if you're buying online digitally and then you start self onboarding yourself and you might need help, but if you don't, you complete that, It's better than multiple salespeople and service people talking to you to implement you. So we're definitely headed we're definitely down that path, More on the SurePayroll side, but Flex is increasing as well.

Speaker 3

Thank you. And again, congrats on the promotions.

Speaker 2

Thanks. Thanks, Chip. Thank you.

Operator

We'll go next to Bryan Bergin with Cowen.

Speaker 4

Hi, good morning and happy holidays.

Speaker 1

Thank you. I

Speaker 4

wanted to start with retention. Can you just talk about what you're seeing there? It sounds like it's still record, but You did expect some moderation in the year. So any change on that front? And can you talk about some of the underlying factors you Typically see that drive retention as it relates to out of business closures or normal client switching behavior?

Speaker 4

And just also beyond 2Q, if you can help us a little bit into the December

Speaker 1

Yes, I think so far, yes, and Q2 was still near record levels. It wasn't quite as high as the record and that we saw in Q1, But it's very close to that. I really still think, as I said last quarter, that we will kind of even out at some place better than we were pre pandemic. And I think A number of things that are helping that. There is fewer out of business, but there is also just the value of the product.

Speaker 1

What we're Seeing as the value, we're not seeing as many leaving for price value kind of category, because they're Seeing the value of the product, especially at a time of COVID, with all the value we're bringing them from the product side, from the technology, handling a distributed workforce, With all of the mobile apps that we have and ability and now the retention tools that we're giving them and the paycheck, pre check, Where we're allowing the employees to review and approve kind of their own pay before it even gets processed. All these things we're getting back from clients are adding value And that is doing exactly what we hoped, which is not only adding value to the client, but improving retention. So we're near record levels in Q2, Don't see anything changing at this point in December. Of course, December, January is really where we'll see the number for year end. And, but right at this point, we expect things to even out certainly better than pre pandemic levels.

Speaker 4

Okay. That's good to hear. And then the understand the conservatism and the outlook given everything that's going on with Omicron. Have you seen an actual impact in any Impact in any sales activity or pipeline yet or was it just conservatism making sure you may see some actual impact?

Speaker 1

I think we're always trying to be conservative, especially in an environment like this, like you said. But right now, record levels of par annualized revenue We're seeing growth in the first half of the year and in the second quarter. It still seems strong, but selling season is really when we How that will be, but right now, really all areas, retirement, HR solutions, Midsize business, our mid market business in virtual sales, digital sales, all going strong. Okay.

Speaker 4

Thank you. Be well.

Speaker 1

Okay. Thanks, Brian.

Operator

Our next Question comes from Andrew Nicholas with William Blair.

Speaker 5

Hi, good morning. I appreciate you taking my questions. I guess my first one is kind of sticking with the technology theme from the responses to the first couple of questions. Just as it relates to kind of paying for that kind of talent, my sense is that engineering software building talent is getting more and more expensive, has Just wondering how you think about that, both from an expense perspective, but also a labor supply perspective as you move forward here through the rest of the year and beyond?

Speaker 1

Yes, I think one thing, we've got a very tenured Team and Mike Gioia and the team have done just a great job. Mike has been in charge of that for over 10 years now Eddie has just done a great job with that team. And I think one of the things, yes, the costs go up and you have to compete in this market. And I think we've done that very effectively. We also make it a great place for them to work.

Speaker 1

They can all they're all can work from home, Yes, they also have great office space that's available to them to come in and they meet regularly, but they're all working from home. They're also working on some of the latest technology And digital services, and that adds a lot of retention as well. Years ago, say 10 plus, 15 years ago, There was always an issue, are we working with the latest technology? Well, we've blown well past that. We're a leader from an innovative Product development, not only in the products that we have, but the way we develop them and the infrastructure and architecture that we use.

Speaker 1

And so I think that is very attractive to candidates and attractive to the employees to stay here. So we're very proud of the tenure we have and I think we Pay very competitively, and that's why we've had good retention.

Speaker 5

That's helpful. Thank you. And then just for My follow-up, a different topic, just on the PEO Insurance business. Could you maybe break down the PEO performance versus insurance performance in the quarter? I think Your expectation last time we spoke was that insurance was going to be a bit slower this year.

Speaker 5

Just wondering if that's played itself out to this point, and if second quarter helps

Speaker 2

So when you look at the PEO Business versus the insurance business, the insurance business moderated the overall growth of PEO and insurance. PEO was solid double digits, growing nicely, good client adds, good client wins. Insurance is a tale of 2 cities. The health and benefits side grew upper single digits and but work comp Still remains a really tough compare because that market continues to be soft. I probably am going on 4 or 5 years of talking about softness in workers' comp.

Speaker 2

It is good to say it At least has moderated to the point where you were flat year over year, but Increasingly, it's a smaller and smaller part of the business, but it hasn't bounced back yet. So PEO doing very well. I'd say health and benefits on the insurance side doing well. Workers' comp kind of Creating a situation that moderates the overall amount. Hopefully, as we get into next year, that will start to turn around.

Speaker 2

But I've said that before and been wrong before.

Operator

We'll go next to Eugene Simon with MoffettNathanson.

Speaker 6

Thank you very much. Good morning. Wanted to ask first about Management Solutions. Very impressive performance this quarter, I think everybody's, including yours, expectations. You listed out a number of drivers that are behind that outperformance.

Speaker 6

Can you give us a little bit of color of which of these drivers are more one time kind of temporary in nature and which can be sustained as we're moving forward?

Speaker 2

Let me start and then maybe Marty can add So if you look at Management Solutions and you kind of apply Kind of a broad umbrella of what's in that revenue stream. You really have 3 important components as many of you know. You've got HCM solutions That are roughly about a little bit under half of that revenue stream. But then I would say there's 2 other parts that we don't talk about as much, but increasingly have become very, very important, which are The combination of retirement services and also what we would call ASO or HR outsourcing. This is not PEO.

Speaker 2

So if you look at that, those 2 in comparison to HCM, they're now almost 50% of what HCM is. And they're growing at rates that are faster than HCM. Now HCM had a very strong quarter. It's not that it did it. It's just that Retirement Services and, and HR Outsourcing had even stronger quarters.

Speaker 2

Now, Those are not one time things. There's demand in the environment for both retirement services, I think Marty mentioned, Pep plans, etcetera, and our success there, we are pretty clear we're leading the market In terms of selling of that product, if you look at if you trace that back, we didn't release it, but you trace that back to our sales, sales have been very strong. And on the HR outsourcing area, solution side, that's been very strong too. Both of those Are driven by unique factors in the market, HR because of the uncertainty of the environment, the demand is the value proposition Has never been higher and as a consequence, demand is very strong. And on the retirement side, there are increasing amounts of States that are mandating retirement plans for employees that have benefited our business and that continues to grow strongly.

Speaker 2

So what am I what have I just said? I've said that a lot of the demand forces within Management Solutions Obviously have benefited from a pandemic rebound, but if I isolate HR outsourcing and retirement services, Those are responding to other forces in the economy that we think are pretty durable. So Long story short, there isn't a lot of one time in there. There are some things, the rebound certainly is part of it, but there are also structural demands or Structural factors that are driving demand higher.

Speaker 1

Yes, I think that's very true. And as everyone went through, there's every product is strong. We didn't necessarily expect to be as strong as it is. And as I mentioned, our pet product, we were one of the first to come out with a pet product, the pooled employer plan back in just January of this year, so not even a year later, we're at 10,000 clients. We have sold that extremely well.

Speaker 1

And when you look across the board, Efrain mentioned, between time and attendance, but HR solutions in a COVID environment is so critically important And the technology that we've introduced on the mobile app, so the ability to really handle distributed workforces, to be able to track vaccinations And those who are unvaccinated, all these things are part of a digital experience that clients are really seeing. So I think most of it is sustainable Growth that we're seeing, even the macro that you're seeing, more checks and so forth, should be sustainable unless there's a drop off because of The variant in the next year, but we don't see that and still there is room to grow. There is a lot of people that are still not employed and we expect that Could pick up next in the first part of half of the next calendar year.

Speaker 6

Got it. Got it. Thank you. And then for my follow-up, I wanted to quickly ask About inflation impact, so with inflation being the word of the day, could you just remind us quickly of the kind of puts and takes of high inflation for your own business?

Speaker 2

So inflation in general is a net positive, hard to say it that way. What it does is because of the segment in the market that we're in, we have relatively more pricing Power than if you were in the enterprise space, although I suspect they'll have more pricing power. So it gives us In terms of our model, a measure of ability to price That may be a little bit higher than we have experienced in previous years. To the extent that inflation also drives Rates higher, that also has a benefit to the business. So obviously, there's a balance there in terms of If interest rates and inflation surge too high, could have a dampening effect on Economic growth, but assuming it's under some reasonable level, it's going to be a net positive

Operator

We'll go next to Bryan Keane, Deutsche Bank.

Speaker 7

Hi, guys. Congrats on the quarter here. I want to break down kind of my favorite topic looking at the revenue per client. I know that's been going higher. Just thinking about The drivers specifically on that and then price realization, I know that's almost a separate thing what you guys are doing on that front.

Speaker 1

Yes, I'll start and then let Efrain jump in. I think, 1, yes, I think we're just selling brand more services. The revenue per client It's really been helpful when you think about things like we've talked about time and attendance and some of the other ERTC, things that are driving The revenue and even really doing much stronger, even though the client growth is solid as well, We're really seeing more revenue because of more adoption of different services that the client is taking. From a price standpoint, I think we're We still have good price realization and I don't think there is some pressure on it, but as Efrain mentioned in this inflationary kind of timeframe, I I think it's, 1, probably is difficult to get it as it was. And also, while it's still very competitive in the market, But also the value that we're bringing, I think, well, it's just not challenged as much given how much we've been able to do.

Speaker 1

If you just take something like employee retention tax credit, We're bringing so much to our client at a relatively low cost that they're benefiting a lot. I think at that point, they start they see more and more value that we Bring through COVID, that has helped us get even better price realization.

Speaker 7

Efrain?

Speaker 2

Yes. So Brian, To your point, I think that we've had very, very good average revenue price Per client, especially on our HCM clients, it's been Very positive and our price realization in this environment when you triangulate the retention Plus the extra the additional value added in terms of services sold, We've been able to do very, very well. One thing we haven't talked about, which I don't want to Forgetting this process. One of the strengths of our model is that we are really very, very Quick, and Marty mentioned this earlier, we're very, very agile in terms of responding to 2 new opportunities that come up as a result of changes in legislation. So we mentioned that there is this Service, we call employee retention tax credit.

Speaker 2

We have, I think, throughout the pandemic shown agility In terms of responding very quickly and creating value added products and services for our clients, that's helped both To raise our average revenue per client also helped us to get to justify The price realization that we've done, Marty said, we've been losing very few clients to Because of dissatisfaction with value and price and it's part because we keep raising the value of what we're providing to clients and they've responded very well.

Speaker 7

Got it. And then the success you guys are having in the mid market, is there something Driving that difference or is there a competitive thing going on there?

Speaker 1

I think Brian, it's really we've got a very Much more tenured sales force now, great leadership that's been driving that now for a few years. I think the last year or so we ran into great presentations, but people not making decisions. And I think we're But people not making decisions and I think we're now going back at those and we're winning a lot of these deals Competitors, just won a big one yesterday and really doing well against the competitors that are out there, I think because of the product work that's been done And the technology that is really fitting exactly what they need at the moment. As Efrain said, the agility to be able to turn around things like employee retention insights, The fact that we can give them new compensation summaries for their clients or for their employees, whatever they needed, We're feeling like we're kind of a step ahead and in the mid market in particular, they're really feeling the pinch on retention and attraction of new employees, we're able to do that. And remember, we've talked about it on other calls, this partnership we have with Indeed, where you are connected digitally through Paychex Flex To Indeed, the world's largest job posting site, you get a credit on Indeed.

Speaker 1

Indeed, you can post the job electronically, Digitally then if they respond to the post, it goes right into the system. If you hire them, everything is paperless. These are all things that mid market clients in particular right Now neat and we've been ahead of it and really hats off to the product management and development teams. I mean, we have just been a step ahead of everything they need. So I think that is real and then the power of the sales team really has come through.

Speaker 1

The other thing I'd add Brian is that for in previous years we've talked a lot about Client size is trending down in terms of clients sold. In the last year, what we've seen is that client sizes, especially And our mid market business are trending up, not down. And I think that part

Speaker 2

of it is There in this environment, the ability to bundle the right level of value added services to a mid market client is valued very And not all of the competition can do that because not all of the competition has an integrated platform Plus world class service. And I think that that's a winning proposition in the marketplace right now.

Speaker 3

Got it. All right, guys.

Speaker 2

Have a great and safe holiday.

Speaker 1

Thanks, Brian. You too.

Operator

We'll go next to Jason Kupferberg with Bank of America.

Speaker 8

Hey, thanks guys. Happy holidays. Thank you. Thank you. Thank you.

Speaker 8

So as we entered Fiscal 2022, I think the expectation you guys had was for net client base growth to return to kind of the more normalized historical levels of 1% to 3%. But Based on how things have gone through the first half of the year, do you think that figure could come in higher? And to the extent that it does,

Speaker 2

So, yes, I think we're certainly trending at the high end of that range. We'll see whether we actually beat the high end, Jason. I think the second part of that is that It's really balanced performance. I'd say last year, when I reflect back, In this quarter last year, I think management solutions was up 1% and PEO and insurance was up about 3% or 4%. We were pleasantly surprised that actually we had started to see a quick return to revenue growth, But it really was fueled in an important measure by retention, which as Marty mentioned earlier, was at record levels.

Speaker 2

We still continue to have very good retention. That's been great, but our sales performance has been really strong this year. So A combination of both of those is really what's driving. I would say it tilts a little bit more towards the sales side rather than the retention side, but Both have been strong, absolutely.

Speaker 8

Okay. Maybe just picking up on the topic of sales since you are kind of Entering the key selling season here. So just in light of the new variant, is that having any bearing on your sales strategy here, Virtual versus in person over the next couple of months?

Speaker 1

Really, Jason, it's not. I mean, we've been very successful selling From virtually, and I think that will continue. They have the option if the client and the rep Agree, to get together, more of them are doing that. And I think even with the variant, I think they're still doing that. But So many of the presentations now, particularly in the mid market even, can be done virtually and really, I think we've really Fine tune that through this time.

Speaker 1

And the sales engineering team and so forth, they've just done a great job in kind of building out And boxes and different examples for a client that are very personalized to the client to say, this is what you're going to get, this is how you work through it. And frankly, it's probably easier To do it virtually and digitally than it is in front of the client, because they can all see it Right in front of them and they can take them through it. So, yes, I don't think it will affect us. We're well staffed. We're great products.

Speaker 1

Everything is really moving very well. So it feels very strong right now, but we will know at the end of the selling season, but we feel pretty good right now with the momentum.

Speaker 8

Okay. Well, I appreciate the comments guys. Thanks again.

Operator

We'll go next to James Bossetta with Morgan Stanley.

Speaker 9

Thanks very much. I wanted to follow-up quickly on retention insights. You mentioned that as a key tool For you and your customers, is the retention stability partly a function of retention And since integration right now into the Plice platform generally and can you give some idea on Client adoption of that product to date?

Speaker 1

Yes, Jade, it's pretty early, but we're getting a lot of great feedback from clients because Everyone is looking for that kind of information. And I mean, we certainly use the same kind of thing and have for some time internally, and now it's much more built For mid market and small clients to be able to use, it's using a number of factors just to look at which employees Do you think are most likely to leave that gives them some insight into that and can help them with the retention. So It's pretty early in the adoption. I guess early innings of this thing, I would say, but it's really been very well And I think they feel like it's an easy way to use Flex to get that insight. So I would say it's still early, but great feedback With what we're doing from a predictive analytic basis.

Speaker 9

Great. And then just a quick macro question from me. One of the big lingering uncertainties in the economy overall right now is just labor force Participation and being able to fulfill and fill openings. Can you give a little view into what you are seeing from that Are you seeing people come back to the labor force? Are there any particular areas or industries that are Responding better than others or are there industries that aren't responding?

Speaker 9

Just some macro insight there just as we try to get a grasp on kind of what's happening generally.

Speaker 1

Sure. Obviously, from our small business index, and that really looks at the clients of ours that are under 50 employees, we're seeing 61% participation rate, I think, which is down a couple of percentage points from pre pandemic. We're still short around 4,000,000 jobs From pre pandemic, dollars 1,500,000 of those are leisure and hospitality. So I would say the ones that are still struggling the most are the restaurants. And you probably know everyone's kind of sees that anecdotally from cut back hours or even closed a few more days Than they normally would.

Speaker 1

I think that's where still the biggest struggle has been. And it's a combination of the pay, which has gone up Dramatically. We're seeing average part time pay for our client base. Part time pay per hour is 19 point $0.62 last month. It's an amazing thing when you think 2 years ago, everybody was arguing about getting to $0.15 So it is more costly.

Speaker 1

The supplies are more costly as well. But I think from an employment perspective, that's probably the one that's suffering the most. But I do think that as things change now and some of the stimulus money Dries up, the unemployment has changed, of course, back to more normal levels. The child tax credit It may end up going away as well, that's been arguments. You got to pay your tuition payments now, they've been deferred, many of them Ren, I think you're going to see more people come back in the 1st and second quarter would be our guess based on what we're hearing from clients.

Speaker 1

So they've seen growth, But there's still a lot of people that are still sitting on the sidelines. But I think as depending on what the market does and of course just Overall cash balances, as things all come together, we expect more people to be hired in the next 6 months as that continues to pick up.

Speaker 9

That's great color. Thanks a lot, Marty. Thanks, Jeff.

Speaker 1

Thanks, Aaron. Thanks, James.

Operator

We'll go next to Kartik Mehta with Northcoast Research.

Speaker 10

Hey, good morning, Marty and Efrain. Efrain, I wanted to go back to a little bit of a comment you made of when you were answering a question on inflation and just pricing. I know usually you change pricing around May. And I'm wondering with the current environment, will you stay with the same strategy or is there an opportunity To change the timing and maybe get 2 price increases, 2 smaller ones that add up to a larger price increase?

Speaker 2

Yes, that's a good question. So I'd say 2 things. 1 is I'll make a statement of philosophy about what the company does and then The first thing is that I think you're right, Kartik, typically in the late spring, we actually We used to broadcast that, which I was not a big fan of, but we typically would look at it in late Bring in and raise it. I would say in the pandemic, we really have adopted a little bit more flexible timing. So we don't necessarily say we're going to do it April, May or we're going to do it in June, July and we look at what the circumstances are and then decide when it's right to Plug in a pricing.

Speaker 2

So that's the first part. I think that from our perspective, we think it's Important to be fair to customers. I think we're guided by that thought. The fact that we can take 2 or even more Price increases does not determine whether we will because in the end, we value our relationship with clients. Our job is to create value that supports a price increase.

Speaker 2

And Much of what Marty has been saying during this call, I think is an indication of that. And so we'll take a look in the spring, Figure out what makes sense. We certainly don't want to create a situation where clients Perceive that they're not getting the value for what we're charging. On the other hand, we task ourselves With creating greater and greater value for clients, so that when we do pass an increase along, they don't complain about it. And generally, that's what occurs.

Speaker 10

And then Marty, I think this is a difficult question, but maybe you have some insight. You talked a little bit about Employees coming back to the workforce in the next 6 months, if you look at your client base, is there a way to tell maybe How many openings there really are and if people do come back, what that could mean to your kind of pace per check?

Speaker 1

Interesting. I think we could tell with some of them because of course they use our products for posting jobs and so forth and we can see and we actually give them Kind of a notice that says, hey, if you've just Let someone if you've just reduced an employee, would you like to post this, would you like to do something with it? I don't have that number right in front of me, Kartik, but I think we continue to try to watch that to see and we know the average employees. I think definitely we have some sense that it would obviously continue to benefit us From where it is, we're seeing the tailwind of the economy and that our employees or that our clients are hiring. And As Efrain said, that would that we've seen the average size of the clients grow as well.

Speaker 1

So we still think there's some room to grow there and that would obviously give us continued And I'd say, Kartik, we obviously to put our plan together as we get into the spring of next year,

Speaker 2

we'll create A more detailed estimate of what we think. It will be really important to see where we end up in the January February timeframe. Last year, it seems like many, many years ago, there was an outbreak. There was the post Thanksgiving, our winter outbreak like we're having now in New York and it did have a little bit of impact. We're not seeing that right now, but we'll have to get through the next month, month and a half to get a better sense of where we're at.

Speaker 1

Yes. The other thing with that is even if we knew because we have sense of how many openings there are. You don't know if that restaurant or that business is going to backfill them or not. They may have become more efficient. We certainly have seen our clients become more efficient during this period and realize that they could do without this employer that one and not hire back after an extended period of time Not being able to get somebody.

Speaker 1

So it's a little hard to predict, but we still think there's certainly room for that to grow.

Speaker 10

Well, thank you both of you. Really appreciate it.

Speaker 1

Okay, Kurt. Thanks.

Operator

We'll go next to Mark Marcon with Baird.

Speaker 11

Hey, good morning and happy holidays, Marty and Efrain. And Marty and John, congratulations on the promotions. I have several questions. On the Paychex pre check, what sort of adoption are you getting and how much is that actually helping in terms of the accuracy of the payrolls?

Speaker 1

Yes, it's early innings for PreCheck, but we're getting Very good feedback that it's very easy for them to check that the accuracy that from a client perspective, they feel the accuracy Is helping them from the standpoint that their employees aren't going to complain that something they got something that they didn't expect in the paycheck, that they got A chance to see their hours, that they got a chance to approve those or be able to say from a digital standpoint, Hey, I disagree with this and I have a question that the employer can take care of. So it's early. Mark, I'd give you a better sense probably in a quarter or 2, but Really good feedback on the early clients that we've seen from that standpoint.

Speaker 10

Great. And then what are

Speaker 1

you seeing in terms of

Speaker 11

on demand payroll and the demand for that At the small end?

Speaker 1

Yes. It's been steady, but still I'd say pretty light. There are certain clients, More the hourly and restaurants, things like that. And they're still a little bit slow to adopt it, I think. I think we can We still got a lot of opportunity really to advance that as more people get used to it and there's more demand for it.

Speaker 1

I think Clients are a little concerned sometimes about offering it because they're not sure if that's going to have a cash flow impact, which it doesn't. And then the employees are not Aware of it and so they don't ask for it. I think you're going to see over the next it will take I think the next couple of years, but I think there will be a very big demand for that as Employees just say, hey, look, I want to get paid today. And I think you'll see a resurgence of more gig economy kind of thing where I'm working 2 or 3 jobs. And but they're all I want the money now because it's 8 hours here and 8 hours there.

Speaker 1

So I'd say it's still pretty light Success for those who do it, they like it, and we're trying to find new ways to build that out and grow that business, because we think it's really going to be a big

Speaker 11

And then in terms of the gross sales, you mentioned how strong things are. Obviously, you're in the middle of The key selling season. But I'm wondering in terms of what you've seen thus far this season, how would you Describe it between the micro versus the small versus your more medium sized clients And what are you seeing in terms of the differences between established versus brand new business formations?

Speaker 1

Yes, I mean really strong on all sizes, I would say, right from SurePayrolls size, very strong growth and from Sure Strong growth on the flex side from small to midsize and the mid market really we're doing very well. This is one of the best years we've had And yours, and I talked a little bit about that. Some of that is clients that got presented to last year that really were ready to decide. But I just think the overall package, as Efrain said, We're really the only one of the only maybe of 2 major competitors of the bunch that can offer everything in an integrated fashion With the latest technology. So you can buy parts from other competitors, but you're going to have to connect to 3rd parties.

Speaker 1

We can do that too. But if you want it all in one place And the HR expertise to back it up with over 650 hour experts, which people really like to have as a backup now, That's what they're seeing and is very strong. So we're seeing it across the board. Sorry, what was the second part of that? It was all the different

Speaker 11

The established versus the brand new businesses, but I mean what you were just saying in terms of like being the only one of 2 that can offer everything. Are you seeing an increased level of wins with companies coming back to you from Some of the newer competitors that are out there?

Speaker 1

We're seeing some, yes, in the mid market and we're winning more on the upfront. I would say it's stronger on the upfront like going head to head today than necessarily winning them back, but we're getting some of those as well. And I think and we're still seeing a strong growth in, as you know, new business starts. It's still I think it's up year to date, maybe 30% to 40%. So we're still getting very small on the low end.

Speaker 1

There is more typically on the very low end, as you know, but we're still seeing a lot of startup And I think it's just part of the economy right now.

Speaker 11

That's great. Thank you. Congrats.

Speaker 2

Okay. Thanks.

Operator

We'll go next to Tien Tsin Huang with JPMorgan.

Speaker 12

Hi, guys. It's Andrew on for Tien Tsin.

Speaker 1

I

Speaker 6

just want to ask a question.

Speaker 12

I know about a year ago in the earlier part of this Calendar year, we were talking about ASO outselling the PEO and I know last quarter we talked about PEO coming back strong and into this quarter. So I just wanted to ask how that's tilting today and just more at a high level how the margins differ across those two solutions?

Speaker 1

Yes. First, I'd say that the sales, Indoor, have evened out pretty good. I mean, we're having strong ASO and PEO sales. I think CEO has come on very strong, particularly in those the great markets that we're in. Hats off to the sales and service teams there.

Speaker 1

We're having not only good growth there, but also ASO. So here's really we're having good strong growth In both markets and I think just shows the demand for HR solutions that not only from a digital solution, but also with the HR That we can bring from both sides and the need for full benefits. One of the things that we just did a survey and it comes out very strong is The need if you're going to attract and retain employees, you got to really look out for their well-being and that's from a financial standpoint, that's from benefits, Retirement included, they're really looking for that overall perspective. I'll let Efrain, if Efrain, you want to

Speaker 2

take that? Yes. With respect To the question on margins, the margins on PEO are going to be lower, not because The core offering has lower margins, but because of the absence or I'm sorry, the inclusion of pass through revenues On insurance, so to Marty's point, when you sell the full benefit, you've got insurances attached, those carry lower costs Because a portion of them are pass through. So the margin is lower on the PEO, although the revenue can be higher.

Speaker 12

Got it. Thank you. And I just had one follow-up. We talked a lot about the retention tools you guys are offering to customers. But just on the hiring side, What are some of the ways that Paychex can help SMBs with the actual hiring?

Speaker 12

I recall last quarter you talked about the partnership with Indeed. I was just curious also if we could hear how that's trending.

Speaker 1

Yes, continuing to trend very well. It's a hot market, as everyone knows, to hire, it's very difficult. And I think that that partnership of being able to do it, to partner with Indeed, who as I said, is so many job postings that are the largest In the world, I think right now from a job posting site, to have that digitally connect, to also have a deal with them where they get some credits with Indeed to be able to post It's all very strong. And then I think that that also attracts people. Then the full benefit, the full HR solution that I just said, the benefits of retirement and all of the other benefits, insurance benefits, This is really attracting more people and retaining the clients.

Speaker 1

So that is all things that we can offer, not only from a full solution But from a technology standpoint, that really attracts a generation that is out there deciding where they want to work today. They want things on their mobile app. The Paychex Flex mobile app is full featured. You can have your retirement, your insurance, your pay stubs, you have now pre check. You're working for somebody who you feel like not only has full benefits, but they're a leader in technology when you use our products.

Speaker 1

So that's how we're helping Our clients, particularly, I guess, I'd say in the mid market, to succeed and that drives a lot of value for them and for us.

Speaker 12

Great. Thank you and have a happy holiday and New Year to you both.

Speaker 2

Great. Thank you, Andrew. Bye bye. Same to you.

Operator

We'll go next to Pete Christiansen with Citi.

Speaker 13

Good morning, Marty and Efrain. Happy holidays. Yes, thanks.

Speaker 1

Yes, thanks. Yes, yes.

Speaker 13

Couple of questions here. Efrain, you did mention new business formation continues to be strong and Certainly been observing that from the charts and it's been what 50% typically of new sales. But I was just wondering if you could talk about The opportunity or maybe the trends that you're seeing from the self file or maybe from some of the regional, Perhaps less sophisticated players out there. How are some of the trends there behaving as regards to new And then my follow-up would be, you've talked for a number of quarters since the pandemic, ASO HRO has been gaining, it's been really strong. Has that mix shift helped them To what degree is that mix shift helping the margin, I guess, is my follow-up.

Speaker 3

Thank you.

Speaker 1

So I'll start it out with some of the regional players. We're Certainly net adding from a regional player perspective, meaning selling versus losing. I think many of the regional players are struggling In this environment to provide as many as much value through COVID, the speed at which Regulations are changing and demands on small and midsized businesses for vaccination policy, the mandate, what's the latest, You're going to get that from someone like us. And in fact, many smaller players try to copy our stuff off the web. We have a very comprehensive Website from marketing that puts all the information out by state, telling you what you have to do, where you have to do it.

Speaker 1

And then here's the Products that will help you with that from a technology and a service standpoint. So, I think it's really been more difficult on the regional players today that just don't have the Players today that just don't have the breadth of service, knowledge or compliance people to be able to keep up with us. We have over 200 Compliance experts that follow every single thing that's happening and that may happen, so that we can be as agile as Efrain mentioned earlier on creating these products Almost as soon as the issues come out. So very strong from a regional competitor standpoint on the net adds that we've seen year to date. You want to take

Speaker 2

the year? Yes. And Pete, on the margin part, one of the things that I think you've seen in the model certainly over the last 3, 4 Quarters or so is that when you have growth in revenue, You don't have attendant costs associated with it typically, and so you scale nicely and drop a lot to the bottom line. I think That's particularly true on management solutions where that's a higher margin that's the higher margin portion of The revenue and so when ASO is growing at the rates that it's growing, because of the way that Our business model works, a lot of that ends up dropping to the bottom line. So it all of the mix Shift in terms of the way the business has been growing has been helpful to margins.

Speaker 13

Very helpful, gentlemen. Happy holidays.

Speaker 1

Any other questions?

Speaker 14

We'll take our final question from Scott Wirtzel with Wolfe Research. Your line is open.

Speaker 2

Okay, thank you. Thanks. Hi, guys. This is

Speaker 15

Scott on for Darren. Just first one, within Management Solutions, you guys called out one of the Drivers being improved market conditions for retirement services. I was just wondering if you could give a little more color on that.

Speaker 1

Yes, I think what's happening there is there's a lot of mandates now that are coming out by state. We still haven't seen necessarily the federal mandate, but that's been discussed a lot. But a lot of California, in particular, New York, some others are coming out saying that businesses of some in some cases, all sizes Have to offer a retirement plan of some sort to their employees. So there's going to be some there's some mandates there that will have penalties That are starting to be enacted. Some are in place already in California, I think coming up in June.

Speaker 1

So there's a lot of attraction there to people Not only looking at it from that standpoint, but also just from a hiring standpoint and a full benefits. There's a lot of interest, as I've mentioned, in Having a full suite of benefits for the well-being of the employees that's helping retain them and attract them in a difficult market. So it's retirement, it's insurance, It's what's your work from home policy, your hybrid policy of working in office and home, it's all those things kind of combined. It's not just Compensation, so that's really picked up and we've had continue to have a very strong retirement sales and the fact that we offer A multitude of products and we just went over 100,000 clients I mentioned earlier. It's a great milestone.

Speaker 1

We're still number 1 in new 401 plans that are offered. And I think between our PEP plan and our regular 401 plans and Irae's very strong Conditions in the market and great success from our selling team selling them and servicing them.

Speaker 15

Great. And then just one follow-up. As we think about Investments in the business going forward. I know over the course of the pandemic, you guys have been investing a lot on the digital and the self-service side of things. Just maybe as we hopefully approach more of a normalized environment, could you give a little more color on where you may be employing some investment dollars going forward?

Speaker 1

Yes, sure. It will continue certainly on the marketing side as well to get the leads are coming in from a digital standpoint. We've been very successful on the work that our marketing team and leadership have done. We expect that to continue. That is accelerated through COVID and how people are buying.

Speaker 1

But also, you'll continue to see it in the way we sell from a digital standpoint and the way we onboard as well. You're going to See that the self-service we talked about, that's going to be continued because this is the way clients, they want to go, it's no surprise, they want to go online, they want to See your product, test your product, price your product and even start implementing it themselves and be able to do that with a world class Innovative product and mobile experience, and that's what we've got. So you'll see our digital investments continue in that standpoint. We've seen a lot of success from the investment we've put out

Speaker 14

There are no further questions in queue at this time. I'd like to turn the call back over to our speakers for any additional or closing remarks.

Speaker 1

All right. Thank you. At this point, we will close the call. If you're interested in replaying the webcast that will be archived for about 90 days, thank you for the time you're taking to participate This is our first question. Thank you.

Speaker 1

Thank you.

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Earnings Conference Call
Paychex Q2 2022
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