Paychex Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
March 29, 2023

There are 9 speakers on the call.

Operator

Good day, everyone, and welcome to today's Paychex Third Quarter Earnings Conference Call. At this time, all participants are in a listen only mode. Later, you will have the opportunity to ask questions during the question and answer session. Please note today's call will be recorded and I will be standing by if you should need any assistance. It is now my pleasure to turn the conference Over to Mr.

Operator

John Gibson. Please go ahead, sir.

Speaker 1

Thank you, Todd. Thank you, everyone, for joining us for our discussion of the Paychex Third Quarter Fiscal Year 2023 Earnings Release. Joining me today is Efrain Rivera, our Chief Financial Officer. This morning before the market opened, we released our financial results As you saw in our press release, we delivered Solid financial results for the Q3 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.

Speaker 1

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 JAP Index the last 2 months as they contend with a constantly changing labor market, inflation, increasing regulations and rising interest rates. Before we get into the 3rd quarter results, I want to take a minute to address the recent volatility in the U. S.

Speaker 1

Banking market as a result of We have no cash, restricted cash or 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 the 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.

Speaker 1

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 PO model. In the Q3, 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 a difference in the customer experience.

Speaker 1

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 PO, stand at an all time record high year to date. PO and Insurance Solutions continues to show lower health insurance attachment and enrollment inside those clients that are attaching. This is specifically impacting our PO 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 We're in a normalize as the year progresses.

Speaker 1

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 up valuable time for them to focus on growing the business. Competing for and retaining employees remains 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.

Speaker 1

We have begun to launch campaigns to educate the market on the SECURE Act 2 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 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 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.

Speaker 1

In uncertain times, people look for stable, trusted advisors 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 were named 1 of Fortune's Most Admired Companies in 2023. And for the 15th time, we were named among 1 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 government governance and risk practices, including strong commitments to ESG and diversity, equity and inclusion.

Speaker 1

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 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.

Speaker 1

Now I'll turn it over to Efrain, who will take you through our financial results for the Q3.

Speaker 2

Thanks, John. Good morning to everyone on the call. I'd like to remind you Of the customary things, I remind you that during these conversations, we're going to talk about forward looking statements, Total revenue for the quarter as you saw was grew 8% to $1,400,000,000 Total service revenue Increased 7% to $1,300,000,000 Obviously, we're benefiting from increase in interest rates. Management Solutions revenue increased 7% to $1,000,000,000 driven by additional Attachment, HR ancillary services, that's largely what we've discussed previously, our ERTC product and price realization. We continue to see strong attachment of our HR solutions, retirement and time and attendance products.

Speaker 2

Demand for our ERTC service remains strong and contributed approximately 1% to revenue growth in the quarter. Demand for this product along with our internal execution have continued to exceed our expectations, while ERTC has been a And we expect demand to continue into fiscal year 2024. It will eventually become will eventually moderate and become a headwind as we progress through the next year, next fiscal year. Beyond Insurance Solutions revenue increased 6% to 321,000,000 driven by higher revenue per client and growth in average worksite employees. The rate of growth was impacted by factors previously discussed, including lower medical plan sales and participant volumes, along with the mix shift that ASO has John Called out.

Speaker 2

We expect these trends to normalize as we progress through fiscal 2024, meaning a little bit more of a balance between PDO and ASO. Interest on funds held for clients increased significantly to $35,000,000 in the quarter, primarily due, as you know, to higher average interest rates. Total expenses were up 8% to $769,000,000 Expense growth was largely attributable to higher head Wage rates in general course to support growth in our business. Op income increased 9% to $612,000,000 with an operating margin of 44.3 percent, a slight expansion over the prior year period. Our effective tax rate for the quarter was 24.3% compared to 22.3% in the prior year period.

Speaker 2

The prior year period included a higher volume of stock based comp and stock based comp payments and the recognition of a tax Credit related to our development of client facing software that generated the difference in rates. Net income increased 9% to $467,000,000 and diluted earnings per share increased 8% to $1.29 per share. Adjusted diluted earnings per share increased 12% for the quarter to $1.29 per share. Let me quickly summarize the results for the 1st 9 months of the fiscal year. Performance has been strong.

Speaker 2

Total service revenue increased 8% $3,700,000,000 and total revenue was up 9% to $3,800,000,000 Management Solutions, up 9% to 2,800,000,000 PEO and Insurance Solutions up 6% to $877,000,000 Op income increased 9% with a margin of 40 Adjusted net income and adjusted diluted earnings per share both increased 12 percent to 1,200,000,000 and $3.31 per share. Our financial position remains strong, as you can see, With cash, restricted cash and total corporate investments of more than $1,600,000,000 total borrowings of $808,000,000 as of February 28, 2023. Cash flow from operations, again, solid for the 1st 9 months, Was at $1,300,000,000 and was an increase from prior driven by higher net income and changes in working capital. We've had our quarterly dividends at $0.79 per share for a total of $854,000,000 during the 9 months Fiscal 2020 3 year or 12 month rolling return on equity was a stellar superb for 47%. Now let me turn to our guidance for the current fiscal year ending May 31, 2023.

Speaker 2

Our current outlook incorporates our results for the 1st 9 months and our view of the evolving macroeconomic environment. We have raised guidance on certain measures based on performance This past quarter, updated guidance is as follows. Management Solutions revenue now expected to grow at or Slightly above 8%. We previously guided to a range of 7% to 8%. PEO and Insurance Solutions outlook is unchanged and growth in the range of 5% to 7%, although we anticipate it to be towards the lower end of the range.

Speaker 2

We expect Q4 PDO and Insurance Solutions growth to be below 5% due to the factors that we've talked about through much of the year. Interest on funds held for clients is expected to be in the range of $100,000,000 to 100 and $5,000,000 Total revenue is expected to grow approximately 8%. Other income Expense net is now expected to be income of $10,000,000 to $15,000,000 obviously due to higher interest rates. Remember, we net interest income there with our expense on the debt. Adjusted diluted earnings Share is not expected to grow in the range of 13% to 14%.

Speaker 2

We previously guided to growth of 12% to 14%, so we tightened the range, Guidance for margins and effective tax rate are unchanged, but we do anticipate being on the higher end of the range for operating margin and the lower end of the range for effective tax rate. We currently are in the middle of our annual budget process and are working on expectations for next fiscal year. As you know, this is challenging for a number of different reasons, not the least of which are expected outcomes in terms of interest rates and also macroeconomic environment. We'll provide final guidance for fiscal 2024 during fiscal 2023's Q4 earnings call in June. However, Let me share some of our preliminary thought process around fiscal 2024.

Speaker 2

On a preliminary basis, We believe that the exit rate in the Q4 is a decent approximation for total revenue growth for 2024. This should result somewhere in the range of 6% to 7%. And again, we got more to do there, but And it's heavily dependent on what we think will happen with interest rates during the year and at this point our assumptions are conservative. Management Solutions is expected to be lower as a result of moderating ERTC Revenues, we called that out last year, didn't happen. It actually went the other way.

Speaker 2

We do think it's going to happen next year. And then PEO and insurance revenue growth is expected to trend higher as we progress through the year with moderation And some of the headwinds we have experienced this year primarily around insurance attachment and also as we called out several times a mix shift to ASO. We remain committed to improving margins and we anticipate that operating margin will expand at this stage in the range of 25 basis points to 50 basis points for fiscal 2024. Of course, all of this is subject to our current assumptions, which can change, especially if there are significant changes to the macro environment, which at this stage we are not seeing. I'll refer you to our investor slides on our website for more information.

Speaker 2

And now let me turn the call back over to John.

Speaker 1

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

Operator

Thank you. Our first question comes from Kevin McVeigh with Credit Suisse.

Speaker 1

Hello, Kevin. Great. Hey, John.

Operator

Hey, Efrain. Hey, 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.

Operator

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 nice outcome. I'm just trying to understand maybe that a little bit more.

Speaker 2

Yes. Let me I'll let John talk a little bit more to kind of what our thinking is from a macro perspective. But Kevin, just To kind of address some of the higher level assumptions that go into the plan, I called out the fact that ERTC is not going to be the headwind I'm sorry, the tailwind that it was this year. We called that out last year, but it's definitely going to happen Sure. Or I wouldn't say definitely.

Speaker 2

I will say I have a we have a very high degree of I believe that we won't see it. However, you're going to see that more in the second half of the year than the first half of the year. So That's the first thing I'd say. If we look back at where we started this year, we were getting a nice macro upload from employment as we Started the year, that seems to have run its course. It is not going the other way, but at this stage, what we're seeing is that there's been A pretty significant moderation in terms of employee ads and that's happened as we progress through the year.

Speaker 2

So those two things are head will become headwinds as we go through the year. Interest rates, I called out. The first half of the year, I think we've got some sense of where we're at. So where we're at, the market does too. What is really hard to understand is what happened in the second half of the year and whether we start going in reverse on interest rates.

Speaker 2

We're taking steps To position the portfolio to be able to deal with that, if that's what happens, but no one knows there. Now That's all the stuff that's headwinds. No, positives. We think HR continues to be strong. We think, as John pointed out, we think retirement continues to be strong.

Speaker 2

We think that HCM continues To proceed well, we think PEO, which has been a little bit of a tailwind to growth this year, Does better next year. The insurance business, although we call out PEO, a lot of the Moderation on the growth rate in PEO insurance coming from insurance. We think that starts to improve as we go into next year. And then we have the normal level of cost discipline in the business that drives the results that we're anticipating In 2024. So that's a broad overview of how the numbers we've put together.

Speaker 2

I'll talk let John talk To macro and to any other parts of the business we need

Speaker 1

to call out. Yes, yes. So I think Kevin, Keep in mind that we've certainly seen the deference and really expected to see some moderation. I mean, we don't expect another 4.5 Basis points increase in interest rates and we don't expect the type of hiring that we saw from the 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, 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 February that we've reported, is actually an increase in the index.

Speaker 1

And we really 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 Their demand for our products, the HR products, the online products that we're offering, HCM products, The 401 is really, really strong. I mean, we had a strong sales quarter in the Q2 and the Q3 was actually better than That even in a relative basis quarter to quarter from prior periods.

Speaker 1

So we're seeing good demand and what I would say, moderation and stabilization, we're certainly closely watching, all of the indicators, but we're not seeing anything. We've got a very the other thing I would point out on 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 more of a Main Street small A midsized business company. We're not the Silicon Valley.

Speaker 1

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 Main Street. And I don't think Main Street small business owners have been reckless in hiring or reckless in spending or able to spend more than they make. And so again, they struggled through this We've been helping them to get through it. So our retention has been strong as well, and particularly where accounts in our HR advisory products, both PO And ASO, again, at record levels.

Speaker 1

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 a tilt Towards ASO versus PO this year, I always look at it this way. Those 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 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.

Speaker 1

And I don't think the complexities Our technology is driving efficiencies. 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 don't think that gives you some color on what we're seeing.

Operator

Super helpful. I'm going to get back in the queue. Congrats again. Thank you. Our next question comes from David Togut with Evercore ISI.

Speaker 3

Thank you. Good morning. Good morning, Efrain. Good morning, John. Just to dig into the fiscal 2024 guidance a bit more, could you I'll walk through some of the underlying drivers of Management Solutions revenue growth for next year in a little greater depth.

Speaker 3

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 SurePayroll versus kind of more of the core And then in addition to that, if you could comment on your expectations for client revenue retention next year and also for pricing.

Speaker 2

Okay. Let me break it into 2 pieces and then I'll let John comment on the selling season. So David, look, to put the revenue plan together for Management Solutions, I'd say you've got to get several dimensions Reasonably right. The first is obviously what we expect from a client growth perspective. And John can talk to what we saw During the selling season, what I mean is unit growth in terms of sales.

Speaker 2

The second part is what do you expect from a Pricing standpoint, too early to talk exactly what we're going to do, but those two components, both plant growth And also pricing are part of our assumptions going into next year. You want to get the right level of product attachment, continued growth on the ancillary products In the bundled suite, including time and attendance, HR administration. And then, increasingly within Management Solutions, retirement and We're assuming strong years in both of those products, partly on the retirement side Based on what John said. So you put all those together, and that forms the basis of our thought Process around management solutions and then PEO and insurance, we expect to grow faster That we've seen this year, in part because some of the headwinds we feel will update as we Again, in the next year, although that may still be evident in Q1. You frame the question correctly in the If we come out of the selling season and we haven't felt like we've hit some of our objectives, it becomes a little bit more challenging The plan for 24 together, but John called out the fact that we thought we had a good Performance in the selling season, we obviously are not giving any percentages at this point.

Speaker 2

We think after Q4, we give you a lot of detail about client base, etcetera. We'll talk about that, but I'll let John talk to what we were seeing during the selling season.

Speaker 1

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 the HR our HR businesses were growing a good healthy clip before the pandemic. And when the pandemic hit, We started to come out and they accelerated 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, We're just seeing a lot of traction in our products and services that we saw in the Q3. And I said the Q3 was a step up From the Q2, we felt pretty good about the Q2.

Speaker 1

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 executing. Also, the other thing I feel good about in that quarter is We do. We saw a lot of our business, over 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 is 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 where 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.

Speaker 1

So I think that's also helped us in the Q3 as well.

Speaker 3

Thanks for that. Just pivoting to The float, Efrain, how are you positioning the float if the Fed is almost done raising short term interest rates?

Speaker 2

So that's an interesting point, David. I wonder whether they're almost done 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 long term rates in over a period of time So you can manage what happens on the downside of the cycle.

Speaker 2

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 are 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, whereas We were shorter earlier in the year.

Speaker 3

Understood. Thanks so much.

Speaker 2

Yes. You're welcome. Thanks, David.

Operator

Thank you. Our next question comes from Ramsey El Assal with Barclays.

Speaker 4

Hi. Thank you very much for taking

Speaker 1

my question this

Speaker 4

morning. Hey, Efrain, can I ask you to drill 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.

Speaker 2

Yes. So two things, Ramby. It's interesting. It's been an unusual year in the sense that we've seen softness in insurance Inside the PEO and we've seen softness in insurance, particularly health care insurance in our agency. I'd start with the kind of obvious point that at some point, people do need health And at some point, as clients grow within the PEOs, we add more clients, we're going to get more healthcare attachment.

Speaker 2

What's happened this year is that in the PEO in particular, you have renewals that occur in the fall and then you have renewals that occur At the beginning of the year. And if in that cycle, you don't get what you expected, you basically have to wait for some period of time before you Start all of that process all over again. So we as we went through the year, in the first half of the year, thought, okay, we're going to Come out of the year with a robust insurance as we get to the end of the year. It was better, but it wasn't what we expected. On the agency side, It's been moderating as we've gone through the year, and we've gone through cycles like this where it seems attachment So it's lower and then it picks up.

Speaker 2

So part of it is almost a mean reversion phenomenon that we think will occur. So the second part is we put a number of different initiatives in place that don't bear immediate fruit, but we think will Barrefred, as we go into next year. One thing that's really interesting, final point on that, John, Just to highlight something John said, which is this preference for ASO versus PEO isn't a permanent preference Many clients eventually that want a PEO solution because they want the benefit of Bumble, and we're expecting that we're going to see more of that as we head into next year. So while PEO performance, I would just highlight this PEO performance It's been lower than what we anticipated during the year. It's still been growing at a decent clip.

Speaker 2

It's being somewhat attenuated by the insurance business, which has been very, very sluggish through the year.

Speaker 1

Yes. I would add to that. I think it's important to understand that particularly on the insurance attachment side in the PO, remember that's a lot of pass 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 PO, right?

Speaker 1

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.

Speaker 1

We're doing a review of every market For the PO and looking at our health insurance lineup, making sure it's competitive, we're taking and affordable For clients, we're talking to our clients. We're already in the process of 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 PO sales Really prior to our acquisition of Oasis was coming from upgrading ASO clients into the PO business, a lot of inside the base. Now it's far more outside the base, but we still have that capability inside the base.

Speaker 1

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.

Speaker 4

Okay. Thank you very much for that.

Speaker 5

Let me sneak one follow-up. You

Speaker 4

called out higher revenue per client as a driver in the quarter. And I'm just curious over time, have you seen the kind of overall growth algorithm of the business Shift more such that that higher rev per client metric is sort of more important. I guess the underlying question is, Do you expect sort of ongoing gains there to sort of persist? Or is it was there something a little more lumpy about it that we should be aware of?

Speaker 2

No, for sure. I mean, if you look at the If you parse all the data, I'm not sure you get it from all of the public disclosure, you get pretty close. We'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 Units and price or we can talk about an algorithm that's really around revenue per client And revenue decline has become more important certainly in the last 5

Speaker 1

years. I think it's important, Randy, to keep in mind, We're at a stage where we're driving more value to the customer and in both through our technology as well as our advisory services. And that value is driving retention, it's driving pricing power And it's driving an openness, to add additional products and services, over time. So The old traditional model we've always had, which is we've always been able to drive price increases over time to cover our cost increases. We've been able to go into the base and drive attachment.

Speaker 1

I would lay on top of that, because we focus so much on the HR value proposition and driving customers up our kind of value continuum that the other benefit we're seeing here is revenue retention. And now They're looking at us as their trusted advisor and they're saying, I want my 401 with Paychex, I want my time and attendance with Paychex, I want my Other digital offerings from Paychex. I want my insurance from Paychex.

Speaker 4

That was very helpful. Thanks a lot.

Speaker 1

You're welcome.

Operator

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

Speaker 5

Hi, good morning guys. This is Daniel Maxwell on for Andrew today. Sort of Similar to the last question, but specifically on WSE growth in the PEO and ASO client base, if you can break apart How much of that is coming from existing clients versus new clients and attrition? And any color on Why there's been a preference for ASO over PEO and the reasons you expect that balance to normalize? Is that just coming from Increased confidence in upselling to PEO?

Speaker 5

Or is there anything else in there?

Speaker 2

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 ads versus existing base, the reality is that because the existing The base is so large, it dwarfs the impact of new ads from a WSE perspective, especially when you consider losses. So we've seen good growth on WSEs that makes us, as John said, more positive about The general value of our HR advisory services both across ASO and PE, I'll let John talk to The shifting preferences in a given year between ASL and PEO?

Speaker 1

Yes, Daniel. I think that what you're seeing is, and again, some of this is just speculation on our part, but when you see clients that had our insurance And we go through enrollment and where they had 25 employees that bought the insurance, now they have 22. Or you see clients that had your insurance in the PO and decide that they no longer going to have insurance or offer insurance for your employees. I just think you're in a position where given some of the uncertainty, people are being cautious on off of Adding a benefit, now it's interesting, they know they need to have benefits to attract and retain employees. So 401 is doing very, very well.

Speaker 1

It's a lower cost benefit. It's a lower commitment. And now when you take the SECURE Act 2, technically, if you're a $20,000,000 to $50,000,000 company, a person company, You now can basically get a 401 set up and have all of the set up costs and the annual cost covered Through tax credits. So those are things they're adding, but the health insurance because of the size of the expenditure and the fact of the matter is once you start offering It's a pretty long term commitment you're making. I think there's a degree of hesitance to that.

Speaker 1

And again, as I said, I think there's more we can do in going out and Looking for more innovative product sets that gives access affordable access to healthcare for our employees and our teams are working on that as we go through the new enrollment. But again, the issue you'll have there, that's going to be enrollment. We won't get into the fall of this calendar year and into the Q2 of our fiscal year. Does that help?

Speaker 5

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

Speaker 2

Look, with respect to buybacks, I think we've talked about what our philosophy is in general. And at this stage, we're evaluating a range of opportunities from an M and A perspective. And It's the right opportunity. I'll let John talk to that what we're looking at, but the right opportunity comes along. We obviously have to drive powder to be able to make something

Speaker 1

Yes, I think, Daniel, I don't 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 a leading digital HR Capital Management Provider. So, I would say I've seen some we've seen some valuations starting to come down. I'm sure the recent disruptions in the financial markets may create additional opportunities.

Speaker 1

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. We're going to be you're going to see the same financial discipline you've continued to see from Paychex. We believe that the market conditions are more conducive To us moving forward on the M and A front, but we'll see if that actually transpires.

Operator

Our next question comes from Samad Samana with Jefferies.

Speaker 5

Hi, good morning. Thanks for taking my questions. 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?

Speaker 1

So I wouldn't think anything about it. I would just really more commenting that's been Paychex for 50 years. Over 50% of our new clients have always come from Strategic alliances we have and we're a respected partner with the Association of Independent CPAs. And so they've always been a big source of ours. It doesn't do anything to our cost of acquisition.

Speaker 1

I just think, they killed it certainly during the selling season. We saw a good uptick in how they were referring Paychex over other options that they have. That was my comment.

Speaker 5

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?

Speaker 1

Well, actually what I would say is, we have good strength, I think across the board and actually what I would tell you is that we actually saw A little more strength upmarket, not just the small startup ones and twos and on the digital side, which is during the pandemic, That's where we saw a lot of growth. Remember, business starts, we're up through the roof crazy levels. They've subsided, but they're still at High levels in comparison to pre pandemic. So at that time, when all these startups were happening, also We do a lot of nanny payrolls and sure payrolls. So if you can imagine, a lot of people were hiring household staff during the pandemic.

Speaker 1

We saw a lot of escalation In the very micro end of that space, I would say that's balanced out. It's gotten back to a more balanced world. And What we saw in the Q3 was strength in the more traditional segments for Paychex.

Speaker 5

Great. Good to see the strong execution guys.

Speaker 1

Yes. Thank you.

Operator

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

Speaker 1

Hi. It's actually Jared Lovina for Brian today.

Speaker 2

How did the 3Q PEO revenue in worksite employees come in relative to your expectations? And then what is the expectation for 4Q in terms of how Worksite employees and at risk health insurance revenue will compare to 3Q. Yes. I Jared, I won't get into that level of granularity at this point. And So we'll report as we get through the quarter and year end.

Speaker 2

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 farther than that. We'll have more to say as we get through Q4. Okay.

Speaker 2

And then in terms of that 25 to 50 basis points of potential margin expansion for FY 'twenty four, can you discuss what the primary drivers of that expansion would be? Yes. I mean, it is it's an emphasis that the company has had. We're going through the budget process, frankly, after this call is done. We'll start the process of putting our budget together.

Speaker 2

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 and A. It's really across the business and where we see an opportunity to become more efficient, Not simply 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 year, we don't trump it, but we use.

Speaker 2

And we think that advances in things like AI can be a tremendous help To Tech Enabled Services businesses. So we're excited about the potential, understand the risks and are actively looking at how we can deploy those technologies To get more efficient, get better at serving our clients. Great. Thank you.

Operator

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

Speaker 6

Hey, good morning guys.

Speaker 1

So I guess there's a school

Speaker 6

of thought out there. Hey, Efrain. 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, etcetera.

Speaker 6

I'm just wondering what your take is On that, as we start to look into fiscal 2024, it doesn't sound like you guys are really assuming a recession per se in this preliminary outlook for next year. So just want to get reaction to that to start. Thanks.

Speaker 1

Yes, Jason. I think I kind of mentioned it in my remarks and some other questions. I don't think there's any doubt. I mean, Prime says 8% for small and mid sized business owners. And you talked to any regional bank That I've heard, and there's going to be some tightening of credit.

Speaker 1

That's part of the reason why we've seen a lot of our customers engaging us on our ERTC product. So it was interesting, I would say as we approach some of our clients, some of our clients were like, yes, I really don't need that. A lot of our clients don't. Again, we're Main Street small business owners. They're not looking for a handout And they're probably sometimes a little gun shy to get out.

Speaker 1

There's been a lot of talk about auditing this stuff. We had a bunch of clients come back And said, hey, I can use this money. And on average, it's $180,000 per client. So We've been doing that. We created partnerships with FinTechs, during the PPP, during the pandemic.

Speaker 1

And we're also helping our clients Of tax programs, of government programs. When you look at the PPP loans, 9% of all of the PPP loans in the U. S. It's placed by Paychex. That was more than JPMorgan and Bank of America, you guys combined.

Speaker 1

And so I think We're continuing to support them and help them and we'll continue to look for ways that we can help them access non traditional funding sources. And I think that's another part of our value proposition that our customers and our CPA partners are appreciating.

Speaker 6

Okay, understood. As a follow-up, I just wanted to ask on the float side of things, maybe a 2 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 with the short term component. I know you said so far to date, obviously, that's been the case.

Speaker 6

But Just wanted to make sure we shouldn't expect any material amount of realized losses. And then just any thoughts on FedNow coming this summer? Do you 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 the tax pieces?

Speaker 2

Yes. Let me take the first part. Yes, Jason, obviously, one as John mentioned earlier in the call, When you have interest rates rising 4 50 basis points at the pace it did and you're holding very high quality Securities, but our interest rates at 1%, 1.5%, you're going to take you're going to see some of the unrealized Lawson that you see in the portfolio. We hold our securities to maturity, so that really doesn't Initially, we've had swings from plus $100,000,000 plus now obviously This point has nothing to do with credit. So there's really no issues there.

Speaker 2

Understand why you asked and understand All of the concerns that others had. So those securities will roll off the portfolio As they mature, just to remind people on the call, our average duration is around 3.5 Years or so, so this is relatively quick. So no issues there. High quality, we really only invest Typically in A or above, and no concerns there. The second part of your question, I didn't catch, right?

Speaker 1

I was focusing too

Speaker 2

much on the I think too much on the first part, Jason. I was just asking

Speaker 6

yes, sorry, I was just asking about FedNow with those real time rails coming out this summer. Just Any thoughts on how that could, if at all impact, float balances, float income? Yes. Obviously, like we'll see how many banks adopt it, right? But then anything just on your float income, how it breaks down between the payroll and the tax pieces?

Speaker 6

Because I know obviously some of the float you hold a lot longer.

Speaker 2

Yes, yes, good question. So, yes, we've been anticipating that at some point The current landscape of payments, certainly ACH windows, which provide some measure of the float that we I was going to narrow, but you, of course, you know the business very well. A lot of our float income is Not coming necessarily from overnight payroll, it's coming from taxes and that should not be impacted significantly under the Fed rules. The other part that I would say and flip Around there is that we stopped and there's not been a lot of conversations really as much lately about real time payments. We do think that there will And that may be an opportunity to monetize even if you lose some element of a float income.

Speaker 2

Final point, just Advertorial, since this is my 12th year now, as you know, Jason, there was a point when our business It was heavily dependent on flow, 27% or so of net income. We're in a different world right now. We'll manage through it even if It doesn't materialize quite the way we expect it to, but that's a breakdown of the 3 pieces that I think We'll impact that still in the future.

Speaker 6

Okay. Well, thank you. Appreciate it.

Operator

Our next question comes from Kartik Mehta with Northcoast Research.

Speaker 6

Hey, good morning, John and Efrain. Efrain, I wanted to go back to your comment on Management Solutions, payroll and pricing. Do you think it's fair to assume that considering the inflationary environment we're in, and obviously that's impacting your costs as well, That the pricing on the payroll side will be higher than normal, maybe not as high as it was last year, but higher than normal?

Speaker 2

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 So meaning 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.

Speaker 2

I think it's 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 it. I'll let John comment on some of the things that We think about it in that respect.

Speaker 1

Yes. I think, Carter, we don't want to talk about future pricing on this call. But I think it's fair to say that we have gotten far more scientific and precise about the ability and willingness of our customer base to pay based upon a series of attributes about the way that they consume our services, The way they want to be served and what products that if we attach, we see better stickiness, and price elasticity. So A lot of AI, a lot of data science, a lot of modeling for us to be very precise in that regard. And then as Efrain said, I think we try and talk a lot more about value and about how we engage them in the utilization of our products and services.

Speaker 1

We approached Over for the first time in Q3, over 100,000,000 mobile, uses, interactions with our Paychex Flex product. And a vast majority of those are employees engaging the product. And we've been doing a lot to really introduce that to not only our clients, but their employees. But now they're getting accustomed to The notification, the way Paychex, the way they can make changes in real time. And what we're seeing is people that we can do that with Actually see that as a higher value.

Speaker 1

And you can as you can imagine, it's a higher it's a better customer experience and there's also Some service margin didn't fit there at the same time. So that's been another lever that we understand as well that we're pushing on. So I think what you're going to see is us continue to understand, what things we need to engage the customer around that if we engage them on those items, It's going to increase the value they get from Paychex and because of our competitive position allow us to, I think, generate more value to the bottom line at the same time.

Speaker 6

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 Yes.

Speaker 2

I'd say, Kurt, the way to think about it ASO does not, in general, including insurances. And so what you end up getting And a little bit of price on PEO on the base product is the added The added revenue that comes from benefit attachment, typically workers' comp and also healthcare. Not all clients take healthcare, but when they do, Then the revenue can be significantly higher.

Speaker 7

Perfect. Thanks, Efrain. Thanks, John. I appreciate it.

Speaker 1

Thank you.

Operator

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

Speaker 3

Good morning. Just a clarification on the preliminary outlook for fiscal year 2024. It doesn't sound like you expect the U. S. Recession In that guidance, is that correct?

Speaker 3

And I guess if we do see a U. S. Recession, how would it show up in the numbers, Efrain, because

Speaker 2

So Brian, that's a good point. And obviously, we all hear the same chatter everyone is hearing. So let me just give an answer to that that's a little bit more normal. 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 frankly Since the fall after Q1, but we don't see any significant signs of slowing.

Speaker 2

So we just got through the last 3 months. Sean gave an overview of kind of what was happening from the selling season. That would have been to us signaled that, hey, Maybe something is going on here that we needed to pay attention to and incorporate. At this point, during the selling season, we haven't Seeing signs of a slowdown. Again, have seen signs of moderation, and We've incorporated that in our thinking.

Speaker 2

To the extent that we saw A slowdown, obviously, we'd see it by July and we've incorporated that in our thinking and we come back and say, guess what, things Are slowing down. 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 3 or 4 years, is in 2 halves. So I think that our confidence in terms of what we expect to see in the first half is at this stage Decent, what do you mean by thesis? I mean, we've got enough trending to say something should not fall off The off the cliff in the first half of the year.

Speaker 2

The Fed is tight, and John said, our clients are going to be much More impacted by raises, increases in the primary 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 that produces the results we have.

Speaker 2

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 if that the trends that we expected to occur in the back half of the year actually materialize. At At this point, it's a little tough to call that 9 months out, but that's why we labeled it preliminary. Right now, the point out, Brian, after I said all of those words is simply to say, at this point, we don't have anything in our data that's suggesting to us that a slowdown is Or is it imminent? Now, if the Fed were to decide that it needs to go back to a cycle of 50 basis Point increase rates, we're going to have a different conversation really quick.

Speaker 2

Don't see that happening. And one final point, all of us on the call We're wondering 2 or 3 weeks ago, we're going to have a systemic banking crisis on our end, but we certainly were looking at that and concerned about it. It seems like I think we're resilient enough, but that did or 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.

Speaker 2

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.

Speaker 1

Yes. Brian, I would yes, Brian, I just point you to our Paychex IHS job index reports on our website and look at January and look at February, we release it every month. Both months, the job index improved. We didn't see that in any other consecutive months in the prior fiscal year. So certainly, we don't see as Efrain said, I'm not going to reiterate what Efrain said, but even the benchmarks that we would see that would be We've been doing this for a while.

Speaker 1

And we have a lot of historical models of what it looks like leading into recession. And we're just not seeing those. And what we hear from our clients in terms of the labor market, in terms of their employment, again, moderation, Stabilization, they're not signing up for any big pieces. And I understand the And I try to put it in perspective as saying, how can you hear all this on the TV and the newspapers of what's happening And then rationalize that with what I walk into the office in here every day. And I do think in some respects, I said it in earlier comments.

Speaker 1

And so the way I rationalized it is, we there's 2 different small business worlds. And I think there's a lot of money poured into a lot of tech companies, a lot of people that didn't have to make money, could spend money, could Pay whatever they needed to, could hire as many people even if they didn't have stuff for them to do. I think that bubble is bursting and you're seeing that being digested. I don't see the foundation of Main Street Small Business at this point, having those same type of dynamics that you're reading in the paper. I just simply can't put it any other way, but we're just not seeing it in numbers.

Speaker 1

Now, is there going to be a trickle down? And certainly, the banking thing last week was certainly Concerning because that gets contagious. Hopefully, the policymakers and individuals can do things to continue to help support Main Street Small Businesses From being impacted from those kind of irrational actors that are doing things that don't make sense. I'll get off that soapbox.

Speaker 8

No, that was great. Super helpful. Thank you.

Operator

Our next question comes from Peter Christiansen with Citi.

Speaker 1

Good morning, John, Efrain. How are

Speaker 2

you? Good.

Speaker 1

Good. Just wondering if we can get a sense for that, The health of the top

Speaker 2

of the funnel, if we

Speaker 1

were to exclude the ERTC side of things, What are you seeing from, I know new business formation and also Perhaps some share shift from regional cell filers, that kind of stuff would be helpful color there. Thank you. Yes. Peter, again, I'll go back. What we see is on business applications, business starts, again, they're back to pre pandemic level.

Speaker 1

So I was I was trying to explain to people that when you look when I look at it at 5 because we're doing our budget plan, so I'm looking back almost 5 fiscal years now. And fiscal year 2019 stands out because then you see all this oddity 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, small businesses starts, 2 years later, Most of them are in business. So when I look at it, there's a good there's good stable new business starts.

Speaker 1

When I looked at our sales for the Q3, 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 product and services that we're offering. Great. Thank you so much.

Speaker 2

Yes. You're welcome, Bill.

Operator

Thank you. Our next question comes from Mark Marcon with Baird.

Speaker 7

Good morning, John and Efrain. 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?

Speaker 2

Yes, it's a good question. Mark, I don't think float will play as big an impact on margin expansion as it did Because it will depend on where I end up in terms of float income for next year. We anticipate that it will grow, So that will have a modest impact on the it will exert A positive impact on margin next year. But remember, Mark, one other thing Is that we called out ERTC as moderating, that's going to exert a countervailing force. So when I pull those 2 together, I'll figure it out and answer on Q4.

Speaker 2

But I don't think I think there will be, at the end of the day, likely real improvement in operating margin when all is said and done.

Speaker 7

Do you think there will or will not be?

Speaker 2

Will, will, will. That's my expectation. But I haven't gone through it a while.

Speaker 7

So ex quote, we should see some margin improvement. 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

Speaker 2

Yes. Good question. I'll answer it in 2 ways and then let John give his commentary because I'm sure he will be scrutinizing every headcount in the sales budget. But the short answer is that We're Mark, we're it makes sense to add headcount to drive greater sales. We are likely to do that, and I'll let John talk to that.

Speaker 2

But I think you rightly identify something That has been a feature of the company, which is increasingly, if you look at not only in the U. S, but also in Europe, where we also A lot of our sales are done digitally and do not require, at least at a minimum, The level of sales involvement that our field sales force provides. So you're going to have a mix. And I don't think that we know quite yet whether there are ads, but I would be careful because I know our competitors Tout their headcount as a precursor or a driver of growth. That is not necessarily where we are at.

Speaker 2

We can grow without adding headcount, although there are places where we may choose

Speaker 1

to do that. I'll let John talk to that issue. Yes, I don't tell adding expense to the business very frequently. So I think 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.

Speaker 1

As Efrain said, I went back 5 years ago. Our digital, if you think about just in the U. S, I mean, including internationalpaychecks.com and surepayroll.com, Probably a 20 point improvement in the percent, 20 percentage point improvement in what we're getting there. We're driving analytics to make our sales force more productive. So instead of just cold calling across The market or insight on client base, we're using data analytics and models and triggers of behaviors of people engaging our systems to give them Active list, so I think there's opportunity for productivity.

Speaker 1

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.

Speaker 7

Fantastic. And then one last one. Did you say what your how much pace per control ended up increasing over the course This quarter or this year on a year over year basis. I've got some investors that are under the impression that Your pace per control might be up by 300 bps and then they're factoring in the ERTC and Looking at the underlying growth and I'm not sure that the numbers are right. So just What did you see in terms of pace per control for this last quarter?

Speaker 2

So we didn't talk about it, but I will say this. Through the year, we have seen increases in pay per control or we would say Checks and it moderated as we've gone through the year. So that in some ways, it's been a tale of 2 cities. The first half It's going to end up being different than the second half of the year.

Speaker 1

And then again, just keep in mind, remember where Main Street Small Business was a year ago in terms of their ability to hire people. They were understaffed. That's for to get people. So You got the benefit of that hiring up. It's not that there's a deceleration.

Speaker 1

It took them this has been an interesting year in terms of people getting and us helping them Getting staffed up. Now they're staffed up. I'm not expecting that they're going to add another a big group of employees, Regardless of whether or not there was a recession or not, right? I mean, they're fully staffed, and we would expect a moderation of the growth in the number of employees in our clients. Great.

Speaker 1

Thank you.

Operator

Thank you. Our next question comes from Eugene

Speaker 5

I just have one quick question. Wanted To follow-up on the comment, John, you made on SecureX 2.0, always very interesting to hear about how kind of regulatory developments can help you guys. So Can you elaborate a bit specifically on what the opportunity for Paychex might be from that act? And then What is the timeframe for where we might see that flow into your financial results?

Speaker 1

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. 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 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.

Speaker 1

Like I said, I think this secular labor problem is going to continue. I don't even we go through 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. We're at 3.4, 3.5 unemployment. And so I think the simple fact is Small and midsize businesses needing to compete against large employers who typically have richer benefit plans is going to be a secular Trem, it's going to continue and I think we're well positioned to do that.

Speaker 1

And I say that because that's going to create the opportunity for a 401 plan. And The Secure Act 2.0, just to give you an idea, pretty much if you're an employer with between 20 50 employees, We could provide you and start up a 401 plan and you would pay paychecks Literally nothing, because you would net. You'd pay us for a start up fee, you'd 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.

Speaker 1

I think there's not a lot of awareness. Look, we found the same thing with ERTC. There are just a lot of small midsize business owners not even aware 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 advisor to help them and help facilitate that. And so we're doing a lot of studies on it.

Speaker 1

We're trying to figure out how big the opportunity is. And certainly, we think it's a great thing for small and 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 that come to support Main Street Small Business Centers. Got it.

Speaker 1

Thank you. That's all I had. Yes.

Operator

Our next question comes from James Faucette with Morgan Stanley.

Speaker 8

Thank you very much, John, Efrain For all the detail and color. Just a couple of questions from me. First, 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 So this fiscal year and then kind of how that contributes to you thinking that it could flow a little bit in next?

Speaker 2

I'll just start, John can take from here. Yes, James, I think that When we entered the year, we thought that there was widespread understanding and knowledge of the program such that as we went Further and further into the base, clients will would have already availed themselves of the service. What we actually found was that they were anxious to hear and to be educated with respect to the program and the way it works and our ability to facilitate their access to the program Made them constructive about wanting to participate. The level of understanding was lower than we anticipated. John talked about that for many reasons.

Speaker 2

And it turned out that there was a much bigger Trinity, coming into this year than we had realized. As we get into next year, more and more time Has the lapsed, the ability to access the programs is running out. 1, It relates to a period of time that now will have been 18, 24 months ago. And so as we round the next year into the beginning of calendar 2024, we think that the Okay. That there will be as much demand or opportunity.

Speaker 2

And you want to add?

Speaker 1

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 TPP 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 partners, 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 we're just trying to do general education.

Speaker 1

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 some other government programs, They felt like, hey, I don't need this right now and I just can't I can't tolerate. I think we had 2 things kind of happen. 1 is Our data science team began to look at actual data models and we started to be able to pinpoint accuracy to 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, 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.

Speaker 1

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.

Speaker 1

And I think a lot of small business owners who said, 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 and audit would put them out of business Worse than anything else. So I think they were avoiding it.

Speaker 1

I think as we saw that happening, now the receptivity and the demand That said, hey, I really need that $180,000 to 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.

Speaker 8

That's really helpful color. And then just last thing for me is, Efrain, you talked about that at least at the initial planning stages, you think margins Next year can expand some. If I reflect back on where you've talked about your margin Targets in the past, we were kind of getting towards the upper end of that. Yes. Are we at a stage we can start contemplating that maybe Margin structure can even move above where you've talked about in the past or what would have to happen for that to be the case?

Speaker 2

That's a good question, James. So, and that's the benefit of listening to what I've said over a period Fine. If you would have said to me persistently, we could be above 40%, 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.

Speaker 2

I do think that you're right in saying that it's been reset a bit, Automate things that we if you would have said 7 years ago, is that a chatbot could be as good or better than a human answering 270 Five questions that are 90% of what clients want to know, I would have said, I don't know about that. And the short answer now is That number is not 275, it's probably 375 or 400 questions. 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 And it's not just pure technology, but I think we've learned to become more Automated efficiently. A lot of the initiatives that John started years ago have paid these dividends.

Speaker 8

That's great. Hey, thank you very much for all the input, John and Efrain. Have a good day.

Speaker 1

Thank you.

Operator

Thank you. Our last question will come from Andrew Pokrzywinski with JPMorgan.

Speaker 5

Hey, John and Efrain. Thanks for fitting in. Just wanted to ask, you mentioned earlier that it was a competitive selling season. So I just wanted to ask, if you could share where that competition is coming from, whether it's newer entrants, usual suspects like the regionals, And if there is anything to call it different from history regarding balance of trade?

Speaker 1

I wouldn't say any new entrants, It's the same suspects. I think what we found was just everyone was more aggressive in trying to go And grab market share. And I'm very proud of our sales team, for really out competing. The competitive metrics Very strong for the quarter, and I think in a very aggressive market. And I would say every one of our market segments That's all that.

Speaker 1

And I think that's going to continue. Look, I think very proud of where we are and where we're positioned. I'm sure a lot of our smaller competitors and those that are maybe a little more focused in niches that aren't doing as well As the traditional small business market is doing, we'll maybe get more aggressive, but I feel good about where our value proposition is. And I think what we're finding is, as I said, I think our strategic partners, our clients, and I think prospects Are beginning to put a premium on A. I want to be somewhere where they know what they're doing, they're doing it right, and they're stable, and they're going to be able to have the financial capability to continue to invest in their products and services over the long term.

Speaker 1

And so, I think there may be a little less chasing shiny objects as we go forward.

Speaker 5

Got it. Thank you. And I just had one quick follow-up on op margins. I mean, for the quarter, this quarter, it came out a little bit ahead The 44% to 43% you laid out 3 months ago. Just wanted to ask if there is anything that came out better than you expected 3 months ago relating the

Speaker 2

Well, I think revenue obviously was a little bit higher than we expected. A lot of the flow through And drove higher margins and our expenses were in line with maybe a little bit better than we anticipated. The combination of that is Really what drove better margin performance in the quarter.

Speaker 5

Great. Thanks and congrats again.

Speaker 2

Yes. Thanks.

Operator

To John Gibson for any additional or closing remarks.

Speaker 1

Well, thank you very much, Todd. I appreciate it. At this point, we'll close the call. If you're interested in the replay of the webcast, it will be archived for approximately 9 days on our website. Want to thank everybody for your interest in Paychex, and hope everybody has a great day.

Operator

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

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Key Takeaways

  • Paychex delivered 8% total revenue growth and 12% adjusted diluted EPS increase in Q3, driven by strong sales volumes and near-record revenue retention.
  • The company confirmed zero exposure to Silicon Valley Bank and Signature Bank, assuring client funds remain fully protected despite U.S. banking volatility.
  • Demand for HR outsourcing remains robust, with record-high retention in both ASO and PEO models and a continued shift in preference toward the ASO offering.
  • Utilization of the Employee Retention Tax Credit (ERTC) solution drove a ~1% revenue tailwind in Q3, earning a Stevie Award, though this benefit is expected to moderate in FY 2024.
  • Full-year Fiscal 2023 guidance was raised to ~8% total revenue growth (Management Solutions >8%), and preliminary Fiscal 2024 outlook projects 6–7% revenue growth with 25–50 bps margin expansion.
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Earnings Conference Call
Paychex Q3 2023
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