Q2 2024 Paychex Inc Earnings Call

December 21, 2023

Okay.

Good day, everyone and welcome to today's Paychex second quarter 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.

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It is now my pleasure to turn today's program over to you John Gibson.

Thank you Chelsea.

Thank you everyone for joining us for our discussion of the Paychex second quarter fiscal 2024 earnings release, joining me today is Bob Schrader, Our Chief Financial Officer. This morning before the market opened we released our financial results for the second quarter you can access our earnings release on our Investor Relations website, and our form 10.

<unk> Q will be filed with the U S.

E C within the next day.

This teleconference is being broadcast over the internet and will be archived and available on our website for approximately 90 days I'm going to start today with a brief update on the business highlights for the second quarter, and then I'll turn it over to Bob for a financial update and then of course, we will take your questions.

We had solid results in the second quarter and for the first half of the fiscal year with particularly strong performance in the P. O Midmarket HCM and retirement revenue for the first half was up 6% year over year and our adjusted diluted earnings per share was up 10% double digits.

The demand for our HR technology Advisory solutions remained strong as business leaders continue to face a very challenging small and midsize business environment.

The tight labor market and rising health care and benefits costs are forcing many to rethink their HR and benefit strategy and they can turn to paychex as a trusted business partner in these times.

As we sit here today, the selling season for our Midmarket HCM and our teams are in their final phases.

And our insurance open enrollment is underway.

All are going well and in line with our expectations. Our pipelines for these solutions are strong and up from this time last year in the small business market selling season is just ramping up we still have a critical third quarter to go both in terms of selling and delivering for our clients during year end, but we are.

Fully staffed and well positioned at this critical time of year.

Our revenue retention amines remains above pre pandemic levels as we continue to focus our resources on acquiring and retaining high value clients client retention has improved over last year and retention in our HR outsourcing solutions remains at record levels.

I'd like to highlight the success, specifically in our <unk> business, which we've talked about on prior calls.

It has it has continued to gain momentum with strong results. During the first half of the fiscal year, we have seen a back a shift back towards the P O offering both outside and inside our client base.

This shift in mix has a long term positive impact on customer lifetime value on our business model, particularly as clients attached insurance benefits.

We previously discussed the actions we took to help them recover after last year's challenges, including one redesigning our health offerings second leveraging AI to revamp, our sales and marketing models and to identify and attract high value prospects.

Three putting more focus on upgrading existing HCM and <unk> clients to the PEO model and finally improved sales execution.

As mentioned earlier, our insurance enrollment is underway and it.

And the attach rates are up after a challenging year last year.

Want to specifically, thank and congratulate our PEO team for all the hard work and success of the past year so far.

The macro environment and labor environment continued to be challenging for small and midsized businesses are small business employment watch continues to show moderation in both job growth.

Wage inflation, which is indicative of a stable macro environment and that the actions taken by the fed are having their desired impact.

While we haven't seen any normal signs of a recession in our data we started to see some softening in seasonal hiring in the quarter, particularly in our large client segments, including our HR outsourcing businesses, many of which typically add seasonal employee employees at this time of year.

Smbs are still challenged with access to capital the high cost of capital inflation and macro uncertainty well, while we certainly don't see any signs of economic downturn, we are ready to take the required actions if such trends emerge as one of the best operators in the business. We have demonstrated that we are able.

To respond and successfully navigate changes in any economic environment.

I know that AI and related technology.

Advancements remain a hot topic in our industry as I've noted in past calls AI at Paychex is nothing new we have over hundreds of and growing models AI models that are actively working in our business today designed to provide valuable insights fueled by our vast data assets.

We are actively investing in gen AI and exploring how it can be used to improve efficiency.

And the customer experience and provide actionable insights to us and our clients to help them succeed.

Currently recently, we partnered with this year, a global leader in people analytics and workforce solutions to offer new benchmarking reports, an AI powered HR analytics solutions to our customers.

This enhances our current reporting and analytics available in paychex flex and will perfectly complement our industry, leading HR advisory services.

The partnership provides core HR and compensation analytics and compensation and salary benchmarking.

And AI driven model with benchmarks against $750 million.

$750 million market data points.

This offering in addition to our AI driven retention insight solution that we launched over a year ago is just the beginning of how we will leverage AI to help businesses succeed partnerships with vizio like our recruiting and Onboarding partnership with indeed is another example of how paychex is bringing together the power of <unk>.

Partnerships are.

Large data assets and integration to improve the customer experience and deliver real value that real value and business outcomes for our clients.

We are also pleased that for the seventh consecutive year, we have been positioned in the leader quadrant as part of the Nelson Hall as 2023 vendor evaluation report for visit for a payroll service providers. This provides further evidence of our leadership position based upon our robust technology.

And customer support.

We're also very proud to be recognized in the safety at insights group voice of the customer top five vendor survey for 2023, and 2024, receiving top five ratings and fixed category expanding payroll HR time and attendance learning and performance.

And really what I'm. Most proud of is that the Sapient report is actually based on actual voices of our customers and customers from across the competitors.

Which demonstrates our leadership position across the industry.

As we head into selling season in calendar year, and I am confident in our global Paychex team.

And that they will constantly delivery and consistently deliver for our clients. We remain driven to be the trusted partner for small and mid size businesses that deliver industry, leading HCM technology and advisory solutions that help our clients succeed.

I'll now turn it over to Bob to give you a brief update on our financial results in the quarter, Bob Hey, Thanks, John and good morning, everyone I'd like to remind everyone that today's commentary will contain forward looking statements that refer to future events and involve some level of risk.

Refer you to our customary disclosures in our press release as well as our Investor Relations.

Dentation that should be on our website.

I will start by providing a summary of our second quarter financial results total revenue for the quarter increased 6% to $1 $3 billion management solutions revenue increased 4% to $931 million that was primarily driven by growth in a number of our clients served across our suite of HCM solutions.

This realization increase.

Increased product penetration and growth in ancillary services.

Oh and insurance solutions revenue increased 8% to $296 million that was driven primarily by higher revenue per client, including higher insurance revenues and average worksite employees as John mentioned, our PEO side continued momentum in sales activity and medical planned purchase volumes during the second.

<unk>.

Interest on funds held for clients increased 44% to $31 million that was primarily due to higher average interest rates.

Total expenses increased 5% to $752 million expense growth was largely attributable to higher compensation costs PEO direct insurance costs and continued investments in sales marketing and technology.

Operating income increased 7% to $506 million for the quarter with an operating margin of 42%. That's a 50 basis point expansion over the prior year period, and both diluted earnings per share and adjusted diluted earnings per share increased 9% to $1 eight per share I will now quickly touch.

The results for the first six months of the year total revenue grew 6% to $2 5 billion manner.

Management solutions revenue in the first half of the year increased 5% to $1 9 billion PEO and insurance solutions was up 7% to 593 million and interest on funds held for clients increased 62% to $64 million. Our total expenses for the first half of the year were up 5% to $1 5 billion and our operating margin.

After this first six months were 41% and that was a 60 basis point improvement over the prior year.

Diluted earnings per share and adjusted diluting earnings per share both increased 10% to $2 24, and $2 23, respectively.

I'll take you through a quick overview of the company's financial position as you. All know we maintain a strong financial position with high quality cash flows and earnings our balance for cash restricted cash and total corporate investments was more than $1 4 billion and our total borrowings were approximately $812 million as of the end of November.

Cash flow for operations for the six first six months of the year were $1 billion and that's up 40% compared to the same period last year. This was primarily driven by higher net income and fluctuations in working capital do you want to call out similar to last quarter. There are some timing differences there based on where theyre at quarter end.

Ended.

Ended on a collection day, that's driving higher operating cash flows. That's why you see the 40% level that will moderate as we as we move through the year.

We returned a total of $811 million to shareholders. During the first six months that includes $642 million of dividends and $169 million of share repurchases and our 12 month Rolling return on equity remained strong at 47%.

I will now I will turn to our to our guidance for the fiscal year ended May 31, 2024, we've raised guidance on certain measures based on our performance. This past quarter for other measures I will also provide some color on where we now expect to be within the ranges and certainly we can provide some more detail when we when we get to Q&A.

The outlook assumes the current macro and competitive environment, which has some uncertainty, particularly as it relates to future interest rate changes in the economy. So our current outlook is as follows.

Management solutions is unchanged with growth in the range of 5% to 6%, although we do anticipate it will now be at the low end of the range.

And insurance solutions is now expected to grow in the range of 7% to 9% that's up from our previous guidance, which was 6% to 9% expectation interest on funds held for clients has not changed we still expect that to be in the range of $140 million to $150 million.

Total revenue is expected to grow in the range of 6% to 7%, but we now expect it to be more in the middle of the range I know last quarter, we thought that might be a bit stronger. We now expect the total revenue guidance to be more aligned with our original guidance of 6% to 7% off.

Operating income margin is expected to be in the range of 41% to 42%. Although we now anticipate that we will probably be towards the upper end of that range.

Other income net is expected to be income in the range of $35 million to $40 million net range from our previous guidance of 30% to $35 million no change to the effective income tax rate, we still expect that to be between 24, and 25% and then adjusted diluting earnings per share is now expected to grow in the <unk>.

10% to 11%. So we raised that last quarter to 911% just based on what we're seeing.

We expect that to be a bit stronger and we're raising that guidance to 10% to 11%.

Got it.

Turning to the third quarter to give you a little color on the third quarter. We are currently anticipating total revenue growth for the third quarter to be in the range of 5% to 6% and operating margins to be in the range of 44% to 45% as it stands right now we would expect to pretty much be right in the middle of those two ranges and I would like to remind every.

<unk>.

We've talked about this in the past that <unk> becomes a headwind in the back half of the year. If I go back and look over the last two and a half years that we've been selling <unk> Q3 of last year was the largest quarter that we had with the RTC and so that's a bit more of a headwind in Q3 than Q4, but will be a headwind in the back half.

For the year.

Of course, all of this is based on our current assumptions, which are subject to change.

We'll come back and update you again on the third quarter call.

As I mentioned, our investor slides are posted on the website. So I'll refer you there for additional information and with that I will turn it back over to John Okay. Thank you Bob.

We'll now open it up the call for questions Chelsea.

At this time, if you would like to ask a question. Please press the star and one Keith on your telephone keypad.

You may remove yourself from the queue at any time by pressing star Q.

Once again that is star one to ask a question.

And our first question will come from Kevin Mcveigh with UBS.

Thanks, so much and congratulations as you close out the year, John Bob and I want to thank everyone. Because I think this is in the list.

Quarter after and it'll be on the call to Adam.

John or Bob I think you talked about revenue retention at record levels and client retention improving.

Can you, maybe dimensionalize that a little bit and because it feels like that's getting a little bit better, but the revenue may be more of the middle of the middle of the range. So what's driving the improvement and then kind of maybe just that.

The tweak on the revenue expectations overall.

Yeah, Kevin I'll start off on retention and we can talk about the revenue expectations, Bob Bob will add some color on that then I'll I'll jump in.

If we continue to be very pleased with where we are on revenue retention I think as we've continually talked about we've really been highly focused on having an impact in those critical areas, where it counts and that's our high value <unk>.

<unk> and that's what we've seen.

Our HR outsourcing business, both ASO and PEO record levels of retention.

And I'm very pleased with that client retention across the business.

Was was actually better in the first half of this fiscal year than it was last fiscal year and that's really attributable to the teams great job of really managing the controllable.

We're continuing to see on the lower end of the market bankruptcies out of businesses and non controllable losses being higher year over year, that's not surprising to me when you see the level of business starts that we've seen during the COVID-19 period really at elevated levels.

And we just know a lot of those are small companies that start out two years ago.

Most of those you'll.

I have trouble financially and so overall our revenue retention continues to be at.

Pre pandemic levels, which I would remind you was.

Near historic highs for the company.

Speaker Change: Yeah, Kevin I'll, just add on the guide as you guys remember Ed at the end of Q1, I think where we ended the quarter. We had said we expect it to be towards the high end of the range I think there were a couple of reasons at that time.

Why we felt confident in saying that I would say one that the positive trends that we were seeing in the PEO business I think we wanted to wait another quarter before we raise the guidance, but we definitely saw some positive trends really going back to the end of last year that continued into Q1, I would say that gave us a little bit of.

<unk>.

And as you guys know, we did do a small acquisition.

At the end of Q1, not a big contributor to growth, but I think those those two things combined really gave us.

A bit of confidence that we thought we might be towards the upper end of the range I would say as we got through Q2.

The one thing that I'll highlight I think John made reference to it although we didn't have.

Big growth assumptions in the plan related to employment growth.

Particularly in our larger.

Employee sizes across both management solutions and the PEO we.

We typically get some seasonal hiring.

We expected to see some growth there that didn't materialize to the level that we expected and certainly what we've seen in the past and so that's given us a little bit of a pause and as I mentioned that that was across both categories management solutions <unk> insurance the insurance for the most part they've been able to outrun that I would say just given the strength.

The business John talked about the strong demand there and some of the action plans that we have taken have really paid off there, but management solution side. It has been a little bit of a headwind and that's kind of what you see.

In the quarter as well as kind of the fine tuning of the guidance ranges.

That I just provided.

Very helpful. Thank you Seth.

Thank you.

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

Hi, Good morning, Thanks for taking my question really strong quarter on the PEO front I wanted to ask about pricing dynamics there.

And in health insurance more specifically, we've heard from some competitors within the space.

That there are certain players that are being more aggressive on the health side. During this year's renewal cycle I'm just kind of wondering if you've seen that how paychex is navigating that environment stacking up in terms of rate increases relative to those peers and maybe just how you are faring broadly on the pricing side.

Yeah. So thanks for the question Andrew.

I'll say this.

P O you can tell by the growth numbers.

Continue to improve as the year has gone on.

And I would tell you that our pipeline is very strong in comparison to last year. So whatever the competitors are doing.

Our value proposition is resonating.

I can assure you that we're not using cheap health I think that part of the value proposition.

Yes.

We will go at it more as a comprehensive HR outsourcing value proposition and if clients are looking for cheap health of there probably were probably not engaging in that conversation very long.

We have the capability as you know to also leverage our insurance agency within our PEO as well, but very pleased.

Pleased with where we are with.

With the PEO right now very strong performance. The pipeline is solid we are in the final stages as you can imagine that that in the mid market as you know typically the selling season as much earlier, it's pretty much in the final innings.

Both pipelines I would say for the <unk> are very very strong both in terms of insurance attachment in.

In terms of sales.

Great.

If you don't mind, just a few.

Follow up on the RTC it sounds like that's trending towards your expectation that the comp in the fiscal third quarter is a bit tougher.

And to confirm that and then also.

It looks like the IRS.

<unk> has taken a stance with respect to <unk> and potentially making Ceos.

Buyable for that.

Just wondering if that presents any risk or how you're kind of thinking about that.

That dynamic.

And that part of the business. Thank you.

Yes.

I'll start on just kind of the the financials I'd say for the most par <unk>.

We finally got it right from a forecasting standpoint after three years, it's been it's been a little challenging to forecast that but for the most par is lined up with our expectation.

Most of that was assumed to be in the front half of the year, that's behind us there's still a little bit in the back half of the year, but.

Speaker Change: For the most part it is.

Lineup I've gotten this question a lot I promise to provide an update on <unk>, so I'm going to I'm going to stick to my word which was essentially we had said.

Prior that we expected it to be a slight tailwind in the front half of the year.

That's where the front half landed it was a slight tailwind we expected it to be a headwind in the back half of the area will be.

A headwind in the back half of the year, but I wanted to provide a little bit more color you guys can kind of do the math and back into it but on a full year basis.

With the with the tailwind in the front half and the headwind in the back half we would expect it to be about a 1% headwind on a full year basis to growth.

And then I don't know if Jan you might address that yeah, Yeah, I think relative to your question on the PEO in RTC and the IRS.

<unk> on it.

I would say the IRS has been trying to look for bad actors in both parts of that equation of tightened rules as.

As you can imagine we've been very diligent with our compliance teams and setting up our process. In fact, we were a little slower going out on the RTC product in the P. O. Because we wanted to work through all of those compliance and the way we approach to contracting with our clients for that services.

So I would tell you we feel very good about our position and where we are.

In terms of advantages that that risk.

Perfect. Thanks, so much.

Thank you.

Our next question will come from.

<unk> with Barclays.

Alright, thanks, so much for taking my question.

I had a follow up on <unk>.

It strikes me that there's a kind of a backlog building right is it paused processing. So is this the type of thing that we should think about yes, it's a headwind in the back half of the year, but eventually as the IRS begins processing again that revenue might start to flow again.

And the future is it sort of more of a shift of revenue into the future and I know, it's complicated and they're rolling in some deadlines in 'twenty for calendar 'twenty for US I was just curious how we should how youre thinking about that <unk> revenue not just for the following quarters, but maybe a little bit beyond that.

Not really Randy because what we're basically doing is we're amending their returns and filing the submissions for our clients with the IRS continues to accept and so we're recognizing recognizing the revenue.

As we do that and there is still.

Excepting submissions, so theres really not a timing shift there.

The change at the IRS made at the end of Q1 really hasn't impacted our ability to continue to go into our base and sell it.

It hasn't impacted our forecast from a revenue standpoint, the big differences that you have the deadline here you're approaching a deadline here at the end of this fiscal year end.

We're three years into it and.

We've been through our base and really have identified all of the clients that are.

Qualify for the opportunity we've talked to them and if we haven't talked to them you can turn on the radio.

One else has talked to them. So it's just hey were three eight years into it and I think most small businesses that qualified for this.

Benefit and taken advantage of the opportunity and there may be some a little bit that.

Flows into next year, but nothing of significance I am hoping at some point in time I can stop start stop talking about D. C. But there's really no timing shift there related to what the IRA IRS did.

Great. That's very helpful and the follow up secure act to porno.

And any of your conversations in the selling season give us kind of your latest view about how that opportunity is framing up for for paychex.

I think we highlighted and mentioned first half 401, K a very solid continued performance. So we're very pleased with that.

<unk> I think as you know, we probably go out to the market with the most comprehensive retirement offerings.

For small businesses anywhere from simple IRA.

<unk>.

Our step plan that we are one of the largest providers if not the largest provider of Pep plans.

So very pleased with that it is part of our selling season campaigns.

I think as I said, one of the things we've learned a lot about the retirement business from some of the state mandates I continue to try to.

Pound and said is this is one of the things you still have a lot of education to do.

For the small business owner, even though there's a lot of benefits to it there are cost involved there.

Compliance issues and so this is not something that people just sign up for so there's a lot of education and pre marketing that has to be done, but we're certainly leveraging the secure.

Act as a means to entice clients into a conversation and we're finding it's successful once we do and getting them to understand the benefits of our offerings.

Got it alright. Thank you so much happy holidays by the way.

Same deal.

Thank you.

Our next question will come from Bryan Bergin with Cowen.

Hi, guys. Good morning. Thank you so wanted to start on management solutions.

Seasonal hiring that you've called out here.

The weaker view can you just dig in more on that client profile and is this more so.

Paul back in demand for employees or issues in our hiring so I'm curious what you might be seeing as it relates to clients talent acquisition funnels and job openings that protect things like that.

Yeah, Brian it's a good that's a very good question very insightful question, because we're trying to we're trying to get under that a well here's what I'll tell you. It is a very challenging environment for small and midsized businesses I think they are still challenged and we're seeing it in our HR advising theres still challenged with a very challenging labor market.

In terms of finding qualified workers always leave it at that so I think that's certainly.

Part of the part of the issues.

I think there certainly with the high cost of capital also with lower access to capital I think they are being very cautious about investing for growth. So they're trying to figure out how do I do more for less so there may be a little bit of a hesitancy at the time at the same time, what we hear our people.

Want to hire qualified people and I think they had some experience with a small group that I was talking to.

What they found was they were paying higher rates for less qualified people and then our HR matters that we were dealing with disciplinary issues. No shows all of these types of issues I think a lot of business owners are saying if I can't hydro qualified person I may be better off to try to figure out how I can use the people I have to get there. So I just I.

Green Dot is a macro environment, because we're not seeing anything in our data that would say mass downsizings or a reduction that's not what we're seeing.

And the higher end enterprise side, you are seeing right size isn't going on in the business when you get into the into the mid market.

Really what we're seeing is a little more choppiness in hiring across various industries, and particularly it's mostly upmarket and what I would say, what we've typically seen seasonally seasonal hiring.

That's where we did not see that at the rates that we historically have seen now what's interesting about that I'll point out is when you see it when I see the impressive results of our P. O team remember a lot of our clients are in Florida, which as you can imagine is a pretty seasonal state. This time of year. So the growth numbers youre.

Seeing there.

With a headwind of not having as much seasonal hiring we saw the similar thing in our ASO business, which is a managed solutions and to a lesser extent in our HCM mid market business. So I would say more choppiness there in the small market. It's more of the same moderation that you see in our index I'm really not what I would.

Say downsizing or clients taking.

Actions from an employment perspective, but more of either they can't find people to fill those spots they want or they're being hesitant on adding additional head count at this time. So that gives you some additional.

Hey, Brian I, just wanted to add a little bit you didn't specifically ask this but just as your comment as it relates to the weaker management solutions. The other part of that beyond that.

The softer hiring versus what we expected the other part of that has to do with the strong performance in PEO as well. We took we talked to you guys about the PEO business that we've had a lot of questions.

On that and our ability to kind of reaccelerate growth there and one of the strategies. There was that we knew the ASO was really strong last year.

We had put a plan together to really go back inside of the base leverage our data leverage our AI models really.

Look at the clients that we thought would be good PEO fits and we've been executing on that plan over the last six months and that has actually been a little bit better than than what we anticipated. So now the pendulum has swung back a little bit the other way, we probably should just put these two businesses together in one category. It would make my and John's job much easier, but we've had a lot of.

Success with PEO I think that's why you see.

The raise there and that is impacting to some extent.

To use your word that a little bit weaker performance in management solutions.

Okay. That's all helpful color and then on fully understand the ASO versus kind of PEO shift there maybe.

Speaker Change: Maybe just a follow up here on the PEO. Okay can you just dig in a bit more around the expectations of at risk health insurance attach and participation rates as you go towards the one one gigawatt period, and specifically the PEO bookings accelerate in the quarter relative to last quarter.

Well, let me take the last one first yes.

I would tell you that we.

We talked about the <unk> in the fourth quarter.

Of the last fiscal year.

We told you about the changes we were making across that business.

Began to see acceleration there.

It accelerated further in the first quarter and it continued in the second quarter and it continued both.

Outside the base as.

As well as inside the base so.

Bob pointed out to say it so to Pau a convergence so we've seen a V.

Very healthy pipeline and I would say not only in the Po also in our mid market. So when you look at the when you look at the two businesses that are that are still in summary, if you were sitting here today in the selling season in our Midmarket HCM and Poe.

All underway there really in the final stages.

Our pipeline was very strong and then the enrollment of the insurance. It was very strong as well I would tell you that we're getting back in line to where we've been historically if you remember right, we had a little degradation and actually what we saw inside the existing.

Existing customer base wasn't increase I'd say, maybe single digit increase.

In penetration and similar to last year, we haven't we had some are poised it didn't sign up for plans. We did some things on changing our plan lineup. We did some things in the way, we're doing education and help with enrollment there and the team's done a great job of improving our attach rates within the existing client base as well during this enrollment.

Alright, Thank you happy holidays.

India.

Thank you.

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

Jason Kupferberg: Good morning, guys I wanted to ask a follow up just on management solutions I mean, I know, we're talking about the lower end of the five to six for the year. So you basically need to maintain the 5% growth rate that you saw in the first half in the second half. Despite the fact, you're lapping you are.

T C and it sounds like maybe the tone on overall health of Smbs is down ticking a little bit. So just wanted to get your perspective on the visibility.

Paychex has the ability to maintain that 5% growth in the second half given some of those those moving parts out there. Thank you.

Yeah, I mean, I can start and then giant John can add on I mean, obviously there is the headwind there with E. R. D C, but there's other areas of the business and although.

So we had some of the hiring.

Challenges that John referenced as well as better PEO performance ASO still continues to be a strong contributor to growth and we expect to continue to be the case in the back half of the year.

We talked about retirement that has been a really strong driver of growth for us and just really increased product penetration, we expect that to continue.

And into the back half of the year, Jason that will offset to some extent some of the <unk> headwind and again, we did do a small acquisition, it's not a huge contributor to growth and on a full year basis, but again that will help mitigate some of that headwind as we move into the back half of the year and when we kind of put all those things together we would.

Management solution that to be in a similar growth rate in the back half of the year than the first half. They were the same as the first half yeah J T. I just think the only thing I would add on commentary relative to the SMB market.

Not even in the really the key selling season. So we're just in the selling season, that's just beginning to kick off and we have a lot of execution during January as you know.

To go out in the marketplace. So that's just starting so the areas, where we are nearly complete with the selling season.

Mid market the PEO the high end of ASO.

Pipelines were full much better than last year and really in that small market. We're just beginning to enter the selling season with a lot of execution to go.

And in the next 60 days.

Okay, that's the Pep.

Good color.

I know you talked about how you're thinking about overall revenue growth for Q3 versus Q4, but could you just parse out maybe your segment level growth expectations are for Q3 versus Q4, just so we get our models tuned properly. Thank you guys have a great holiday.

Thanks, Jason happy hours.

Yes, I'm, just taking I'm, taking a look at that Jason obviously, the management solutions will will probably be a bit lower in Q3 than Q4 because of the the headwinds that we talked about being greater with the RTC in.

In Q3, and then the PEO and insurance.

Those growth rates are going to be similar to where they were in Q2 and hopefully when you look at the full year guidance. The guide that I gave you on Q3, you can kind of do the math and should get you should get you close yeah. The.

The other thing I, just think again on color on this.

Bob said that this geography shifting going on last year.

Counter rotated ISO from.

From the T O offering when we're offering both there's more movement that way. So we're talking geography now were talking the geography move from management solutions to PEO and insurance, because it's tilda and kind of the other way. The other thing that I would remind everybody which is a little different on the ASO to Po conversions.

Theres not a selling season for that we do those migrations all year long.

And so you know what.

We continue to see good traction there and we don't intend to slow that down and there's no reason to it's a higher revenue with a higher lifetime value and our overall model. So again just relative to forecasting between the two areas as well.

Bob's got a model you'll go through it with you, but the caveat I always have that I'll say on that geography thing is if we can continue to move more of our clients from HCM in ASO to PEO in the back half of the year, we will do that.

Okay. Thanks again.

Okay.

Thank you.

Our next question will come from Peter Christiansen with Citi.

Good morning, Thanks for the question nice execution here.

John Bob I was just hoping if you could talk a little bit about kind of the trend and any trends that you're noticing, particularly the management solutions area and then and John You also mentioned you know.

AI playing a part in sales role just wondering if you could dig a little bit into that.

And it gives you a sense of where you're making headway on that front.

I appreciate the commentary happy holidays.

Thank you very much no look I think relative to across the across the platforms in the mid market very pleased with the growth. We have there we've talked about the Po already very happy with where we are there as I look across the small business.

It's a competitive market I wouldn't say, there's any major changes.

And I would say I've talked about on the last call our balance of trade metrics continue to look solid I always say, we're entering the selling season in the next 60 days.

That is all about that and it's a competitive market. So we'll see but as we sit here today the known knowns.

Very happy with our progress.

Market in the Midmarket HCM very pleased with where we are on PEO upper into the ASO market and then as I said as we sit here today I am pleased with our balance of trade.

In the other areas.

Question, I mean, I think that's something that as the balances come down.

Yes.

On the AI front I think you mentioned it Oh, yeah, yeah. Thanks.

Yeah.

I can't believe I passed up on opportunities talk about AI.

Hum.

Yeah look I think AI is I will tell you we've been doing a lot around this for decades.

And now it's kind of out there in the public domain.

But it's really it's really quite amazing so let's talk about on the sales side, we've talked about on the PEO side, we're using it in our underwriting we're using it in our targeting and we're using it in the mining of our base the productivity lift that we get in terms of being able to understand where we can add value you're almost getting to the point, where you're almost like having a pre proposal because you're almost.

No the client is going to be.

It's going to like what they see so we're doing a lot of things, they're using AI models in our data models, they're doing a lot of a lot of this.

Talk a bit about pricing.

And one of the things we know happens we have all of our major sales teams on one common platform in terms of proposal proposal management and pricing management and we're actually building AI models started to use that in the mid market that actually then gives our sales reps in real time based upon numerous factors.

<unk>.

What price and what level of discounting we would allow for a particular client based upon the value of the client based upon the competitive set et cetera, and thats actually, allowing us to maximize both volume and rate and we're going to continue to refine those models and expand those across the teams, but what we're getting from a sales productivity perspective.

What we're getting in terms of our marketing targeting perspective, what we're getting in terms of the ability to set the right price and right to get the biggest competitive advantage all of those things are pretty impressive then on top of that we're actually using it for analytics, we're actually taking and using voice.

On the conversations we're having with prospects and in real time able to give coaching to our sales teams relative to what what phrases are working what messages are working and we can dynamically change those things on the fly with our marketing messages and sales scripts. Accordingly, So just there's just a ton of.

Very interesting things that we're doing what's interesting is a lot of these changes to our go to market. We actually started piloting in the P. O back in the second half of the last quarter. When we were having some challenges we thought that was the best place to start.

And see if we could get some lift and some of what we've seen in the <unk> I think is a direct result of some of these some of these tactics.

Thank you.

Yep.

Thank you.

Our next question will come from Kartik Mehta with Northcoast research.

Hey, good morning, John and Bob.

Laura talk a little bit odd.

Okay.

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

I you know Kartik Cook I don't look at the competitive market and it has been as long as I've been in the industry 27 years.

So.

Look I think there's all kinds of tricks theres all kinds of market were even using them.

Yeah.

The fact that matters I think theres a lot of offers out there when you get into the details of.

How long do you have to be there whether the strings attached really what it is it's basically it's the same kind of environment in terms of of discounting. It is it is very aggressive but I would say this I mean look we continue to see that we have price value and pricing pressure pricing power both within our <unk>.

Base and in the market.

And that was very high the last two years I think we had been very able with the PPP and <unk> to be able to really command.

Very strong pricing power.

That being said we've done it for decades, I mean, we're not the lowest cost provider out there.

And haven't been for decades.

Well I think what you see is when you look at our retention levels with our existing clients at record highs.

I think that says something about the value proposition. The end of the day, I think small and medium sized business owners buy on value not necessarily on price. So we're gonna be competitive we're going to meet people, where they are head to head, but we're not gonna be we're not gonna be stupid.

You can see that we're being competitive we're winning where we've been in combat and then.

In the market.

Got a good pipeline and good track record of success and as you can tell from our margins, we're not giving away the store.

And then Bob just a.

On the management solutions, and you're talking about because he's the one for you.

If we kind of Uh huh.

Consolidated all of that is it just a matter of your pays per control expectations, where export they came in a little bit less because growth.

What you're saying.

Yeah.

I'd say, it's more than that kartik, because as we've talked about on a full year basis, we had some moderate expectations for clients, adding employees. It wasn't a big driver of growth overall as I mentioned across both management solutions and PEO that was a little bit softer, but where we're really seeing is not on.

The low end of the market it has with its with our larger sized clients.

Particularly in those ASO and PEO models.

They are bigger client sizes, and we typically get some seasonal hiring we get it every year, we had some assumptions around what that would look like in Q2 and that hasn't materialized to the to the level of our assumption or what we've seen in prior years. So it's really it is across the board.

It's a little bit softer than what we anticipated but to the John's point earlier, it's not that small businesses are getting rid of employees, they're just not adding to the level of debt that we assumed in the plan.

Okay. Thank you both of them I appreciate it.

Welcome.

Thank you.

Our next question comes from Samad Samana with Jefferies.

Okay.

Hey, good morning, Thanks for taking my questions.

Just stepping back and since the last time, you guys reported the company put out mid term financial goals.

Wondering if maybe you can just provide us some context on the assumptions in that upper single digit target for revenue, especially as we think about it.

Climate may be peaking.

And rates being what they are just.

And that assumption, especially given that it was put out there between the last time you guys reported and now just maybe help us understand what the building blocks are.

Yeah.

Yeah, It's Mike Yeah, you know I've gotten this question a lot I think if you look back at it and we've talked about this.

I've talked about it with many of you on this question specifically, but if you look at what we've done from a revenue growth.

It's over the last.

Five years or 10 years, it's well within.

The range of that midterm guidance that we gave I would also say that the guidance that we're providing this year at least the way I think about it is well within that range as well.

As you know better than anyone we have.

The way, we go about delivering that growth.

The mix of client base growth.

And I would say that we would assume that to be similar with past performance. One thing that we're really good at is getting a larger share of wallet out of out of our client base with our particularly with our higher value solutions DSO PEO retirement, we still think there's a lot of opportunity inside of the base. When you look at a lot of that.

<unk> key solutions that penetration.

Rates are fairly low and so we believe we have a lot of opportunity to continue to drive growth. There as John mentioned, we have pricing power right, we deliver a strong value proposition and our expectation is that hey, we might not be capturing price at a level that we did over the last couple of years, where inflation was but we believe we have a strong value.

Proposition that is going to enable us to continue to capture price in the future and I think when you put all that together I.

I'd say the other component of it when you look back historically, we have used M&A as a way to drive growth in the business and that had been part of our growth Formula. It's part of what we've delivered over the last five and 10 years and we expect it will continue to look for opportunities and that will be part of our growth in the <unk>.

So when you kind of put that all together that gives us confidence that we can continue to deliver in that upper single digit level, it's not going to be.

It'll vary year by year, but for the most part we expect it to be in that range.

Understood.

Thanks for that and then maybe just a follow up based on the trends that you guys had called out so far.

<unk> been in this most recent quarter I think that maybe your own near term hiring plans for quota carrying sales reps or just your own sales organization any change to that plan based on what you just observed in the prior quarter.

No were fully staffed and are intended to continue to.

Gross sales, but look our business starts are up we feel like the opportunity in the marketplace is strong now I will I will tell you. The thing we are trying to balance is the.

Is the productivity gains that we can get out of some of the go to market strategies as I said, we did we did see some some test and learn in the P O.

That showed some really good lift and so quite frankly, I think we're going to apply those in the mid market.

And in the upper end of the.

SMB market and I think those could also be a lift as well, but we have no plans or pulling back on it.

Vesting in growth.

Great. Thank you enjoy the holiday season.

Great.

Thank you.

Our next question will come from Bryan Keane with Deutsche Bank.

Hey, guys. Good morning, just a couple of clarifications from me.

When you talked about smbs investing for growth.

Is it patients some hesitation there does that impact their willingness to buy ancillary services and maybe has impacted the management services growth as well.

We've really not seen that Brian I think what we've what we what we see is probably in the case of why not just use an example, western for example.

You may have a very good business owner.

And a couple of franchises.

Doing very very well financially.

And probably could justify adding another franchise store somewhere but the cost of capital access.

Access to capital is constrained and they are holding back on doing that because the hurdle rate just can't be met so that's more what what I, what I see then people pulling back and saying that I don't need that again most of the time when you look at our products and services that we're offering there either driving efficiency.

Or are there, helping them retain and attract.

Quality employees, either by enhancing their benefits or by having an HCM solution. So I kind of view that most of our clients that are looking at our services understands the value of the products and services.

I believe that they're actually going to help their business be more successful and so I don't I don't think they always view it as an expense line item.

But if you know what I mean.

Got it got it and then the other clarification I had as did the shift to ASO. The PEO did that surprise you guys or was that all part of the plan and pretty typical.

No I mean, it's something we've always historically historically done what I would say is that it turned out better than we expected now now let's keep in mind that last year, when we're out in the market with a piano.

And then ASO offering we saw a tilt towards where we have great HR outsourcing sales last year, we have great HR outsourcing sales. This year's Theyre just in different locations on on the reporting structure and so last year. We knew we had a lot of clients that we would have typically seen the great candidate.

For PEO and they for whatever reason went to the ASO offering and we said we said in the calls we felt like that would be a good opportunity to go back to them once they've experienced our human capital management system. The benefits of our HR Advisory solutions, and our <unk> to go back and kind of.

Jason Kupferberg: It reintroduce them to the comprehensive outsourcing of the PEO model, that's exactly what we did and so we had a bigger group of clients inside the base because of this because of the success of ASO last year to go in mind and then the other point that I said, what we're doing in terms of analytics to be able to dinner.

<unk> clients that we have a high degree of certainty that they're going to benefit from the co employment relationship that Apio provides and that's enabling us, but what I would say a little bit better carry tick inside our vast customer base, who we should go after.

Got it that's helpful. And then just a quick one for Bob just to quantify the small acquisition does it add about a one to two points of revenue for third quarter or how do we think about par.

I know, it's small I don't have the exact number Brian on.

On a full year basis, we said, it's not a material contributor to revenue growth at all I mean, we're way way less than 1% I don't have the split in front of me Mike.

By quarter, Yeah, I was just thinking maybe you could offset some of the Trc.

It certainly is and that's assumed in the guide and it certainly is offsetting it but <unk> was so large in the back half of last year, particularly in Q3 and unfortunately it comes nowhere near close enough to offset the full thing, but it does minimize it a little bit the headwind.

Happy holidays, Yes, San Diego.

Thank you.

Our next question will come from James Faucette with Morgan Stanley.

Great. Good morning, guys. Just a couple of quick follow up questions in terms of back to this point on seasonal hiring maybe being a little bit weaker I'm just wondering.

From your perspective, if there's been any impact or truth, even before now to this narrative that we've heard a lot around labor.

Labour hoarding and that.

While our businesses in particular, we're keeping people.

One on payroll or employed that they maybe otherwise wouldn't have just because they were concerned about shortages and just wondering if you know you'd seen any evidence of that actually in your customers and if that could be impacting the seasonal hiring at all.

Well no I actually would say as a small business, it's not been affording at all it's been a deficit now to be fair in our index, which we follow very closely and have reported a lot on this small business is probably nine months ago kind of got back to a level playing field I think where you saw a horse.

It was more in the upper end and enterprise side of the space. I think you saw that now so that's where I think you saw hoarding and hiring of people maybe they didn't even need.

And any stats, where you've seen some of these bigger downsizing I think to the point you may be making is is I do think that small and mid sized business owners. We're reluctant.

To change employees out.

And because they were trying a lot of focus on retention and that's why we launched the retention insights AI offering over a year ago because.

Small business owners want to keep their good employees.

I do think now that that small business owners are trying to make sure that they have high quality.

Workforces and that's why we see them talking to our HR generalist about is really more about how do I weed and feed my employee base I, maybe don't have the employee base that I wanted because I was kind of forced to hire some people two years ago. When it was hard to find people know there's more.

<unk> yet to Upskill my workforce, that's kind of what we're seeing in the slow and I wouldn't say any hoarding.

Okay.

Got it I just want to make sure that I was interpreting that correctly. Thank you and then you know you mentioned that we still are in a period of strong business starts what about on the other end I think there had been this view.

Viewed over and the economy generally that we werent seeing failure rates are out of business rates get back to pre pandemic levels, yet, but can you just give us an update on.

What kind of out of business levels, we're seeing in and how much and in particularly in the context of continued strong business stores I'm just wondering on that component of the customer set.

Yeah, I would tell you that bankruptcies are up and had been on the rise probably over the last the last year.

Youre still seeing a burst.

Outpacing doubts in our desk typically report a little a little lag I would just tell you in our data that bankruptcies continue to accelerate this year over last year in terms of out of business reasons.

Again, what I always want to warn people here, because I think people read into that data.

Other concerns on a macro basis I don't view it that way. The fact that matter is we had such high levels of new business burst two years ago. During the pandemic that if you just do the math of survivability rates of those businesses that most of them are gone and after five years and 50.

Percent of them are gone in the first two years. So what youre seeing is that shedding of that big bulk that that started two years ago. The first group of those are going out of business and so I think it's it's not a sign that there.

Theres, an abnormal level of bankruptcies given the level of business starts that we had over the last three years, if that makes sense. So let's say that properly. It doesn't yeah. Yeah, just on that on that point. So clearly bankruptcies have been rising but have they and your customer set today surpassed pre COVID-19 level.

<unk>.

Or not yet or and it sounds like given the large number of burst, we probably should expect them to surpass pre COVID-19 levels at some point if they happen right.

Yeah.

Well I mean, let me.

Do you like here because I.

What I would tell you the bankruptcies or are definitely are definitely definitely up and.

Have surpassed.

The fiscal year 'twenty levels.

Which is just they got it got it.

Yep.

And Jeff Okay, that's that mark in the second quarter.

Okay.

Thank you so much for that.

Thank you.

Our next question will come from Mark Marcon with Baird.

Hey, good morning, and thanks for taking my questions.

So on management solutions, and John and Bob you started off by talking about the.

The upper mid and upper end being a little bit stronger and seeing good performance. There I'm wondering to what extent is that being driven by.

Some of the new.

New tools that you've recently introduced in other words and what are you seeing just in terms of the strength.

Dissecting between new logos versus.

You know.

Further.

Upsells into the existing client base.

Yeah.

John mentioned I think we've seen a lot of strength in the in the.

Mid market and from a from a sales performance standpoint.

Our unit performance.

That we had in Q2 I think you mentioned in the prepared remarks, John was above where we were at this time.

Last year, we continue to see strong penetration within within the existing client base up sells into the base, whether that's ASO.

Retirement.

I would say market there is strength across the board both from a new logo standpoint, particularly in the mid market as well as up sells into the base.

Great and then.

And then you know despite that.

<unk> growth.

The.

We're basically assuming a slightly slower.

Pace with so is it basically would be the Sps side and you've mentioned an increase in terms of bankruptcies in terms of the selling season are there any things that you're seeing in terms of differences between them.

Paychex versus sure payroll.

Any sort of.

And any sort of difference as you know and I know, it's still early in the selling season, but.

Any color that you would think would provide above and beyond what you've already said.

Yeah, Yeah, no Mark I would say I would say well what we're seeing is that what we've typically seen again sure payroll more than the micro set so if I look at the Microstat.

Continuing to see similar type of Theres, a lot of new business starts so there's a lot of opportunity there.

For growth.

And then in the small business. We're just so early in the in the key selling season.

Really as you know the next the next 60 days are really going to tell us.

How that's going to shake out.

You're back to I think what your original question was as well and manage on management solutions is remember you have that you have the geography issue occurring at the same time, so while we're selling a lot more inside our human capital management base and into our ASO base. Some of what we're upselling as PEO and so they're moving over to the other geography.

On the on the P&L, which is a good thing from a from a long term perspective, and then as we said this issue relative to.

The seasonal hiring which happened in the upper end of the market that impacted both the P. O on the insurance side and the ASO market on the management solutions side.

That's a great point and then on the PEO side, just one question with regards to the.

Insurance costs.

Happily for apples basis, what sort of price increase are you seeing you know for similar plans relative to what was offered last year.

Through your various health insurance partners.

This coming enrollments.

Yeah look.

You're pointing to an item, which I think is a.

It is a tailwind.

That I think will continue to evolve and that is health care inflation.

And really I think you'll see that evolve in the future post pandemic.

Pushing costs through the health system is a slow process. It starts with more expenses at the hospital they have to negotiate with carriers. They have contracts that takes years to do.

In our local community there is unionization and strikes going on at the local hospital for more pay then that has to get approved by state legislature. So there's that.

The cost increase that we saw inflationary and health care.

Last two years is going to start making its way to health plan cost in the future. We're certainly aware of that and we're doing things.

To prepare for that and when we talked about that last year. We did a lot of changes in our health care lineups to get more choices to people, making sure that we have the right plans and I would say that our <unk>.

<unk> samples was actually highly competitive what the to what the general inflation was.

And we're keeping our mlr's in line towards they've historically been at the same time and so through some plan designs and some other.

Ways in which our teams have been creative in coming up with some creative solutions I think we got a good portfolio of products and services that our clients are finding a very competitive to alternatives that they have I don't know if that helps.

It does but would you say John that that's that you would be looking at increases for this year in terms of.

Would they be higher than last year, and then you know what sort of impact does that have.

Does it make your PEO offering.

More or less attractive relative to everything else. That's out there is a small business owner that's trying to manage.

Through that situation.

I would I would say given the results in the pipeline that I see that's made us more successful.

That's the results I look at where we're not in a we're in a very competitive environment. So most of the deals that we're involved in someone else's involved in and I think our lineup is very comparable I think what you would what I would say is that we.

We manage our plans in such a way that we tend to beat the standard health inflation and we've broadened our portfolio of.

Offerings, such that I think there is something for every client they can find something that they want and our plans and I think that that breadth of services.

And breadth of options is one of the things that differentiates us from others.

Great. Thank you and happy holidays MD office.

Thank you.

Our next question will come from Scott <unk> with Wolfe.

Restarts.

Yeah.

Hey, Good morning, guys just one from me quickly.

Can you remind us of what your top end market exposures or by vertical and maybe in the PEO segment.

I've heard from one of your peers, who were seeing some challenges sort of on the pays per control worksite employee side and PEO, mostly due to some certain end market exposure. So it would be very helpful. If you guys can just remind us of where you guys have some of your larger exposures in the PEO.

Scott, we do not we do not have any high concentrations in our PEO.

It's the general market remember.

Historically, our T O was really an upsell within our client base, our payroll client base, our payroll client basis is as diverse as the country small business market.

We didn't originate in a vertical strategy as a business from <unk> perspective, So we never got highly concentrated in any particular area. We maybe had some geographic concentrations before the acquisition of the weight of Oasis is that the Oasis acquisition really made us a broad Nash.

No player and so there's no one industry concentration that that really that really drives that business.

Great that's super helpful. Thanks, guys.

Yep.

Thank you.

Our next question will come from Ashish <unk> with RBC capital markets.

Yeah.

Hi, Good morning. This is David on David Page on for Ashish I, just had a quick one regarding the organic growth and management solutions in the quarter. It looks like you grew revenue by 4% but.

Maybe you could just.

If you can remind us what the organic growth there. So it looks like you had a small 200 million dollar acquisition, so that'd be helpful.

Yes, I mean that was a very small contributor David to growth in the quarter and.

The other thing you need to keep in mind.

We kind of gave you color on <unk> being a slight tailwind.

Tailwind in <unk>.

In the first half.

A headwind in Q2, so most of that came in Q1. So you kind of you know you have the headwind of.

<unk> you.

Have a slight tailwind from from from the acquisition, but you know the organic growth rate is not going to be too too far different from from what you see as reported.

Okay, great. Thank you happy holidays.

Are you.

Thank you.

Our last question will come from Tien Tsin Huang with Jpmorgan.

Okay.

Hey, Thanks, Yeah, just to close out the cards you mentioned the LTV for the PEO business being.

Frankly, I don't think I've heard that from Pittsburgh. After all these years. So could you elaborate on that relative to the S O or HR or.

What do you think you can size it just with the ratio there just love to learn more on that.

I mean, we've talked about in the past that certainly when we look across all the different solutions that we offer.

The PEO is certainly the highest lifetime.

Value and as you can imagine.

When you start getting all of the dip you get into that PEO model.

And they have the client has their health insurance and their workers comp insurance and they're Sui with us and you know all the different offerings, that's really our full.

Solution.

That we offer them youre getting more hooks into them and in.

<unk> when they have their health insurance with us.

They have their health insurance with us.

They were to leave the PEO that would be very disruptive for their employees. They may have to get new insurance card. They may have to you know they might be in a different network might have to change doctors. So it's very disruptive and.

So you get a lot of hooks into them in that model and as you know retention is a big driver of lifetime value. So although when were selling clients, we want to put them in the right model that meets their needs ultimately and that was as we've talked about one of our strategies. This year is really to go back into that base get them over into that PEO model because it.

The economics are in that model over the long term are very favorable and so that's part of our strategy.

Got it yeah, I know that notional is are high but in my mind the payroll cost.

I think payroll business and retention.

Margins are so high I figured that was also the Pep competition, yeah, it's really the retention there.

Yeah Yeah.

I think it's I think it's a very easy thing if you think about the way we approach. It you've got you got you got our HCM platform and you know that on a standalone basis is a good business to be in.

We then add our or what you would say is ASO. So you add the HR professional now you've got somewhat advising your business. There's more value. There we know or we tend to have natures of that is as high now you get into adding the insurance and as Bob said, because we've done such a strong job of managing that over the long term.

Term debt, there's a predictable health inflation metric that becomes very attractive in terms of certainty for the clients. There and then you mentioned Sui mentioned everything else so you've got a.

Profitable business on top of a profitable business on top of a sticky product and so you just keep it there and I think the evidence is both in terms of you look at the National studies et cetera is the survivability and others to be fair tends to be more attractive to larger clients you know 20 plus.

If you will so they naturally have a higher survivability rates, but the simple fact is what we see is there's a higher business survivability rate and those that are going with the Po.

Solution and then they are staying with us longer and we're getting all of the flow through and benefit of the HCM in the HR outsourcing margins.

And the cat because also though because a good chunk of it is still selling it to exist I know you said that's coming.

Good point, good point, yes point yeah.

Speaker Change: Okay very good thanks for the education and haven't seen in several years.

He gets it.

Okay, I think that was it at this point well close the call if you're interested in a replay of.

The Webex of this conference call will be archived for approximately 90 days on our website.

We would certainly want to wish all of you and your families a very safe and happy holiday season, I want to continue to thank you for your interest in Paychex and hope everyone has a great day take care.

Okay.

Thank you ladies and gentlemen, this concludes today's program and we appreciate your participation you may disconnect at any time.

Okay.

Hum.

[music].

Uh huh.

Uh-huh.

Uh huh.

[music].

Good day, everyone and welcome to today's Paychex second quarter 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.

You May register to ask a question at any time by pressing the star and what Keith's outdoor telephone keypad.

Please note this call is being recorded and that ought to be standing by should you need any assistance.

It is now my pleasure to turn today's program over to John Gibson.

Thank you Chelsea.

<unk> Q will be filed with the FCC.

SEC within the next day.

We had solid results in the second quarter and for the first half of the fiscal year with particularly strong performance in the PEO Midmarket HCM and retirement revenue for the first half was up 6% year over year and our adjusted diluted earnings per share was up 10% double digits.

The demand for our HR technology and advisory solutions remained strong as business leaders continue to face a very challenging small and midsize business environment.

The tight labor market and rising health care and benefits costs are forcing many to rethink their HR and benefit strategy and they can turn to paychex as a trusted business partner in these times.

As we sit here today, the selling season for our mid market HCM and our teams are in their final phases.

And our insurance open enrollment is underway.

Fully staffed and well positioned at this critical time of year.

Speaker Change: I'd like to highlight the success, specifically in our <unk> business, which we've talked about on prior calls.

It has it has continued to gain momentum with strong results. During the first half of the fiscal year, we have seen a back a shift back towards the PEO offering both outside and inside our client base.

A shift in mix has a long term positive impact on customer lifetime value on our business model, particularly as clients attached insurance benefits.

Speaker Change: We previously discussed the actions we took to help them recover.

After last year's challenges, including one redesigning our health offerings.

Second leveraging AI to revamp, our sales and marketing models and to identify and attract high value prospects three.

Three putting more focus on upgrading existing HCM and ASO clients to the PEO model and finally improved sales execution as mentioned earlier, our insurance enrollment is underway and <unk>.

And the attach rates are up after a challenging year last year.

I want to specifically, thank and congratulate our PEO team for all the hard work and success in the past.

So far.

The macro environment and labor environment continued to be challenging for small and mid sized businesses are small business employment watch continues to show moderation in both job growth and wage inflation, which is indicative of a stable macro environment and that the actions taken by the fed are having their desired.

Smbs are still challenged with access to capital the high cost of capital inflation and macro uncertainty well, while we certainly don't see any signs of economic downturn, we are ready to take the required actions such trends emerge as one of the best operators in the business. We have demonstrated that we are able to reach.

Spawn and successfully navigate changes in the <unk>.

The economic environment.

I know that AI and related technology.

Advancements remain a hot topic in our industry as I've noted in past calls AI Paychex is nothing new we have over hundreds of and growing model to AI models that are actively working in our business today designed to provide valuable insights fueled by our vast data assets.

The exciting transformation that is now occurring around generative AI opens up the opportunity for us to bring AI solutions to our employees. So they can be more effective and efficient and to our clients. We are actively investing in gen AI and exploring how it can be used to improve efficiency.

And the customer experience and provide actionable insights to us and our clients to help them succeed.

Currently recently, we partnered with <unk>, a global leader in people analytics and workforce solutions to offer new benchmarking reports and AI powered HR analytics solutions to our customers.

This enhances our current reporting and analytics available in paychex flex and will perfectly complement our industry, leading HR advisory services the.

The partnership provides core HR and compensation analytics and compensation and salary benchmarking.

And AI driven model with benchmarks against $750 million seven.

$750 million market data point.

Gartner ships are large data assets and integration to improve the customer experience and deliver real value real value and business outcomes for our clients.

We are also pleased that for the seventh consecutive year, we have been positioned in the leader quadrant as part of the Nelson Hall as 2023 vendor evaluation report for <unk>.

Payroll service providers. This provides further evidence of our leadership position based upon our robust technology and customer support.

We're also very proud to be recognized in the safety at insights group voice of the customer top five vendor.

Survey for 2023, and 2024, receiving top five ratings and six category expanding payroll HR time and attendance learning and performance.

And really what I'm. Most proud of is that the Sapient report is actually based on actual voices of our customers and customers from across the competitors, which demonstrates our leadership position across the industry.

As we head into selling season in calendar year, and I am confident in our global Paychex team.

Hey, Thanks, John and good morning, everyone I'd like to remind everyone that today's commentary will contain forward looking statements that refer to future events.

<unk> involves some level of risk I'll refer you to our customary disclosures in our press release as well as our Investor Relations.

Presentation that should be on our website I will start by providing a summary of our second quarter financial results total revenue for the quarter increased 6% to $1 $3 billion management solutions revenue increased 4% to $931 million that was primarily driven by growth in a number of our clients served occur.

Our suite of HCM solutions price realization increase.

Increased product penetration and growth in ancillary services.

<unk> insurance solutions revenue increased 8% to $296 million that was driven primarily by higher revenue per client, including higher insurance revenues and average worksite employees as John mentioned, our Poe saw continued momentum in sales activity and medical planned purchase advanced volumes during the second.

<unk>.

Interest on funds held for clients increased 44% to $31 million that was primarily due to higher average interest rates total expenses increased 5% to $752 million expense growth was largely attributable to higher compensation costs PEO direct insurance costs and continued investments in sales marketing.

And technology.

And the results for the first six months of the year total revenue grew 6% to $2 5 billion.

For this first six months were 41% and that was a 60 basis point improvement over the prior year.

Diluted earnings per share and adjusted diluting earnings per share both increased 10% to $2 24, and $2 23, respectively.

Cash flow for operations for the first six months of the year were $1 billion and that's up 40% compared to the same period last year. This was primarily driven by higher net income and fluctuations in working capital do you want to call out similar to last quarter. There are some timing differences there based on where the quarter Ed.

Ended.

Ended on a collection day, that's driving higher operating cash flows. That's why you see the 40% level that will moderate as we as we move through the year.

I'll now turn to our to our guidance for the fiscal year ended May 31, 2024, we've raised guidance on certain measures based on performance. This past quarter for other measures I will also provide some color on where we now expect to be within the ranges and certainly we can provide some more detail when we when we get to Q&A.

The outlook assumes the current macro and competitive environment, which had some uncertainty, particularly as it relates to future interest rate changes in the economy. So our current outlook is as follows.

Management solutions is unchanged with growth in the range of 5% to 6%, although we do anticipate it will now be at the low end of the range.

And insurance solutions is now expected to grow in the range of 7% to 9%.

Up from our previous guidance, which was 6% to 9% expectation interest on funds held for clients has not changed we still expect that to be in the range of $140 million to $150 million.

Total revenue is expected to grow in the range of 6% to 7%, but we now expect it to be more in the middle of the range I know last quarter, we thought that might be a <unk>.

Stronger we now expect the total revenue guidance to be more aligned with our original guidance of 6% to 7%.

Operating income margin is expected to be in the range of 41% to 42%. Although we now anticipate that we will probably be towards the upper end of that range.

Other income net is expected to be income in the range of $35 million to $40 million net range from our previous guidance of 30% to $35 million no change to the effective income tax rate, we still expect that to be between 24 and 25% and then adjusted diluted earnings per share is now expected to grow in the <unk>.

Speaker Change: 10% to 11%. So we raised that last quarter to 911% just based on what we're seeing.

We expect that to be a bit stronger and we're raising that guidance to 10% to 11%.

Now im going to turn to the third quarter date to give you a little color on the third quarter. We are currently anticipating total revenue growth for the third quarter to be in the range of 5% to 6% and operating margins to be in the range of 44% to 45% as it stands right now we would expect to pretty much be right in the middle of those two ranges.

I'd like to remind everyone that we've talked about this in the past that <unk> becomes a headwind in the back half of the year. If I go back and look over the last two and a half years that we've been selling <unk> Q3 of last year was the largest quarter that we had with <unk> and so that's a bit more of a headwind in Q3 and Q4.

But will be a headwind in the back half of the year of course all of this is based on our current assumptions, which are subject to change.

We'll come back and update you again on the third quarter call.

As I mentioned, our investor slides are posted on the website. So I'll refer you there for additional information and with that I will turn it back over to John Okay. Thank you Bob We will now open it up the call for questions Chelsea.

At this time, if you would like to ask a question. Please press the star one Keith on your telephone keypad.

You may remove yourself from the queue at any time by pressing star Q.

Once again that is star one to ask a question.

And our first question will come from Kevin Mcveigh with UBS.

Thanks, so much and congratulations as you close out the year, John Bob and I want to thank everyone. Because I think this is the list quarter Efrain will be on the call to Adam.

John or Bob Thank.

Thank you talked about revenue retention at record levels and client retention improving.

Can you, maybe dimensionalize that a little bit and because it feels like that's getting a little bit better, but the revenue may be more of the middle middle of the range. So what's driving the improvement and then kind of maybe just that.

The tweak on the revenue expectations overall.

Yes, Kevin I'll start off on retention and we can talk about the revenue expectations, Bob Bob will add some color on that and then I'll, let Paul jump in.

We continue to be very pleased with where we are on revenue retention I think as we continually talked about we've really been highly focused on having an impact in those critical areas, where it counts and thats our high value.

Segments, and that's what we've seen.

Our HR outsourcing business, both DSO and <unk> record levels of retention.

And I'm very pleased with that client retention across the business.

Was actually better in the first half of this fiscal year than it was last fiscal year and that's really attributable to the teams great job of really managing the controllable.

We just know a lot of those are small companies that start out two years ago.

Most of those.

I have trouble financially and so overall revenue retention continues to be at.

Pre pandemic levels, which I would remind you was at near historic highs for the company.

Yes, Kevin I'll just add on.

The guide as you guys remember Ed at the end of Q1, I think where we ended the quarter. We had said we expect it to be towards the high end of the range. I think there were a couple of reasons at that time why.

While we felt confident in saying that I would say one the.

The positive trends that we were seeing in the PEO business I think we wanted to wait another quarter before we raise the guidance, but we definitely saw some positive trends really going back to the end of last year that continued into Q1, I would say that gave us a little bit of confidence.

And as you guys know, we did do a small acquisition.

At the end of Q1, not a big contributor to growth, but I think those those two things combined really gave us.

A bit of confidence that we thought we might be towards the upper end of the range I would say as we got through Q2.

The one thing that I'll highlight I think John made reference to it although we didn't have.

Big growth assumptions in the plan related to employment growth.

Particularly in our larger.

Employee sizes across both management solutions and the PEO we.

We typically get some seasonal hiring.

We expected to see some growth there that didn't materialize to the level that we expected and certainly what we've seen in the past and so that's given us a little bit of pause and as I mentioned that was across both categories management solutions <unk> insurance the insurance for the most part they have been able to outrun that I would say just given the strength.

The business John talked about the strong demand there and some of the action plans that we have taken have really paid off there, but on the management solutions side, it's been a little bit of a headwind and thats kind of what you see.

In the quarter as well as kind of the fine tuning of the guidance ranges.

Very helpful. Thank you Kevin.

Thank you.

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

Andrew Nicholas: Hi, Good morning, Thanks for taking my question really strong quarter on the PEO front I wanted to ask about pricing dynamics there.

And in health insurance more specifically, we've heard from some competitors within the space.

Yeah. So thanks for the question Andrew.

I'll say this.

You can tell by the growth numbers.

Continue to improve as the year has gone on.

And I would tell you that our pipeline is very strong in comparison to last year. So whatever the competitors are doing our value proposition is resonating.

Can assure you that we're not using cheap health as part of the value proposition. So.

We will go at it more as a comprehensive HR outsourcing value proposition and if clients are looking for.

Chief Health of there probably were probably not engaging in that conversation very long.

We have the capability as you know to also leverage our insurance agency within our PEO as well, but.

Andrew Nicholas: Very pleased with where we are with.

With the PEO right now very strong performance. The pipeline is solid we are in the final stages as you can imagine that in the mid market as you know typically the selling season as much earlier, it's pretty much in the final earnings.

Both pipelines I would say for the <unk>.

Very very strong both in terms of insurance attachment.

In terms of sales.

Great.

If you don't mind is just a follow up on the RTC it sounds like thats trending towards your expectation that the comp in the fiscal third quarter's a bit tougher just wanted to confirm that and then also.

It looks like the IRS.

<unk> has taken a stance with respect to <unk> and potentially making Ceos.

<unk> for that.

I'm, just wondering if that presents any risk or how you're kind of thinking about that.

That dynamic.

And that part of the business. Thank you.

Yes.

I'll start on just kind of the financials I'd say for the most part RTC.

We finally got it right from a forecasting standpoint after three years, it's been it's been a little challenging to forecast that but for the most par at his lined up with our expectation.

Most of that was assumed to be in the front half of the year, that's behind us there's still a little bit in the back half of the year, but for.

For the most part.

Lined up I've gotten this question a lot I promise to provide an update on <unk>, so I'm going to I'm going to stick to my word which was essentially we had said.

Fire that we expected it to be a slight tailwind in the front half of the year.

That's where the front half landed it was a slight tailwind we expected it to be a headwind in the back half of the year it will be.

A headwind in the back half of the year, but I wanted to provide a little bit more color you guys can kind of do the math and back into it but on a full year basis.

Andrew Nicholas: With the tailwind in the front half and the headwind in the back half we would expect it to be about a 1% headwind on a full year basis to growth.

And then I don't know if John you might address the PEO yeah, Yeah, I think relative to your question on the PEO in RTC and the IRS.

<unk> on it.

I would say the IRS has been trying to look for bad actors in both parts of that equation of tightened rules as.

As you can imagine we've been very diligent with our compliance teams and setting up our process. In fact, we were a little slower going out on the RTC product in the <unk> because we wanted to work through all of those compliance and the way we approach to contracting with our clients for that services.

So I would tell you we feel very good about our position of where we are.

In terms of advantages that risk.

Perfect. Thanks, so much.

Thank you.

Our next question will come from Ramsey El <unk> with Barclays.

Alright, thanks, so much for taking my question.

I had a follow up on <unk>.

And the future is it sort of more of a shift of revenue into the future and I know, it's complicated and they're rolling into some deadlines in 'twenty for calendar 'twenty for US I was just curious how we should how youre thinking about that <unk> revenue not just for the following quarters, but maybe a little bit beyond that.

Not really Randy because what we're basically doing is we're amending their returns and filing the submissions for our clients, which the IRS continues to accept and so were recognized in recognizing the revenue.

And as we do that and there is still.

<unk> submission, so theres really not a timing shift there.

The change at the IRS made at the end of Q1 really hasn't impacted our ability to continue to go into our base and sell it really hasnt impacted our forecast from a revenue standpoint.

Big differences that you get you have the deadline here youre approaching a deadline here at the end of this fiscal year end.

Three years into it and.

We've been through our base and really have identified all of the clients that are qualified.

Qualify for the opportunity we've talked to them and if we haven't talked to them you can turn on the radio and everyone else has talked to them. So it's just hey were three eight years into it and I think most small businesses that qualified for this.

Benefit have taken advantage of the opportunity and there may be some a little bit that.

Flows into next year, but nothing of significance I am hoping at some point in time I can stop start stop talking about the guarantee fee, but is there is really no timing shift there related to what the IRA IRS did.

Great. That's very helpful and the follow up secure act 2.0 is that in any of your conversations in the selling season give us kind of your latest view about how that opportunity is framing up for for paychex.

I think we highlighted and mentioned first half 401, K very solid continued performance. So we're very pleased with that offering I think as you know, we probably go out to the market with the most comprehensive retirement offerings.

For small businesses anywhere from simple iras.

Our set planning that we are one of the largest providers if not the largest provider of Pep plans. So very pleased with that it is part of our selling season campaigns.

I think as I've said, one of the things we've learned a lot about the retirement business from some of the state mandates I continue to try to.

Pound and said is this is one of the things you still have a lot of education to do.

For the small business owner, even though theres a lot of benefits to it there are costs involved there.

Compliance issues and so this is not something that people just sign up for so there's a lot of education and pre marketing that has to be done, but we're certainly leveraging the secure.

Act as a means to entice clients into a conversation and refining its successful once we do and getting them to understand the benefits of our offerings.

Got it alright. Thank you so much happy holidays by the way.

Hey, David.

Thank you.

Our next question will come from Bryan Bergin with Cowen.

Kelly.

Hi, guys. Good morning. Thank you. So wanted to start on management solutions that delight seasonal hiring that you've called out here.

The weaker view can you just dig in more on that client profile in this more so a pullback in demand for employees or issues in the hiring so I'm curious what you might be seeing as it relates to clients talent acquisition funnels and job openings in spec projects things like that.

Yes, Brian that's a good that's a very good question very insightful question, because we're trying to we're trying to get under that a well here's what I will tell you. It is a very challenging environment for small and midsized businesses I think they are still challenged and we're seeing it in our HR advising theres still challenged with a very challenging labor market.

In terms of finding qualified workers always leave it at that so I think that certainly.

Part of the part of the issues.

I think certainly with the high cost of capital also with lower access to capital I think they are being very cautious about investing for growth. So they're trying to figure out how do I do more for less so there may be a little bit of a hesitancy at the time at the same time, what we hear our people.

Want to hire qualified people and I think they had some experience with a build small group that I was talking to.

Read that as a macro environment, because we're not seeing anything in our data that would say mass downsizings or our reduction that's not what we're seeing.

In the higher end enterprise side, you are seeing right size isn't going on in the business when you get into the into the mid market.

That's where we did not see that at the rates that we historically have seen now what's interesting about that I'll point out is when you see that when I see the impressive results of our PEO team remember a lot of our clear.

Clients are in Florida, which as you can imagine is a pretty seasonal state. This time of year. So the growth numbers youre seeing there.

With a headwind of not having as much heightened seasonal hiring we saw the similar thing in our ASO business, which is a managed solutions and to a lesser extent in our HCM mid market business. So I would say more choppiness there in the small market. It's more of the same moderation that you see in our index really not what I would say.

Downsizing or client taking.

Hey, Brian I, just wanted to add a little bit you didn't specifically ask this but just as your comment as it relates to the weaker management solution. The other part of that beyond that.

The softer hiring versus what we expected the other part of part of that has to do with the strong performance in PEO as well.

Talk to you guys about the PEO business that we've had a lot of questions.

On that and our ability to kind of reaccelerate growth there and one of the strategies. There was that we knew the ASO was really strong last year.

We had put a plan together to really go back inside of the base leverage our data leverage our AI models that really look at the clients that we thought would be good PEO fits and we've been executing on that plan over the last six months and that has actually been a little bit better than than what we anticipated. So now the pendulum has swung back a little bit the other way.

We probably should just put these two businesses together in one category it would make minds and jan's job much easier, but we've had a lot of success with PEO I think thats why you see.

The raise there and that is impacting to some extent.

To use your word that a little bit weaker performance and management solutions.

Okay. That's all helpful color on par.

I understand the ASO versus kind of PEO shifts there.

Maybe just a follow up here on the PEO. Okay can you just dig in a bit more around the expectations of at risk health insurance attach and participation rates as you go towards the one one gigawatt period.

And specifically did PEO bookings accelerate in the quarter relative to last quarter.

Okay.

Well, let me take the last one first yes.

I would tell you that we.

We talked about the <unk> in the fourth quarter.

Of the last fiscal year, we told you about the changes we were making across that business well.

We began to see acceleration there at.

It accelerated further in the first quarter and it continued in the second quarter and it continued both.

Outside the base as well as inside the base so.

Bob pointed out to say so to Po conversion. So we have seen.

Very healthy pipeline and I would say not only in the PEO also in our mid market. So when you look at the when you look at the two businesses that are that are still in summary, we're sitting here today in the selling season in our Midmarket HCM and Poe.

Andrew Nicholas: All underway that really in the final stages.

<unk> customer base wasn't increase I would say maybe single digit increase.

In penetration and similar to last year, we had some are poised that didn't sign up for plans. We did some things on changing our plan lineup. We did some things in the way, we're doing education and help with enrollment there and the team has done a great job of improving our attach rates within the existing client base as well during this enrollment.

Alright, Thank you happy holidays.

India.

Thank you.

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

Good morning, guys I wanted to ask a follow up just on management solutions I mean, I know, we're talking about the lower end of the five to six for the year. So you basically need to maintain the 5% growth rate that you saw in the first half in the second half. Despite the fact you are lapping.

T C and it sounds like maybe the tone on overall health of Smbs is down ticking a little bit. So just wanted to get your perspective on the visibility.

Of Paychex <unk> ability to maintain that 5% growth in the second half given some of those those moving parts out there. Thank you.

Yes, I mean I can start and then John John can add on I mean, obviously there is the headwind there with <unk>, but there's other areas of the business and although.

So we had some of the hiring.

Challenges that John referenced as well as better PEO performance ASO still continues to be a strong contributor to growth and we expect to continue to be the case in the back half of the year.

We talked about retirement that has been a really strong driver of growth for us and just really increased product penetration, we expect that to continue.

Into the back half of the year, Jason that will offset to some extent some of the RTC headwind and again, we did do a small acquisition, it's not a huge contributor to growth on a full year basis, but again that will help mitigate some of that headwind as we move into the back half of the year and when we kind of put all those things together we would.

Management solution to to be in a similar growth rate in the back half of the year than the first half. They are the same as the first half yes, Jason I think the only thing I would add on commentary relative to the SMB market.

Not even in the really the key selling season. So we're just in the selling season, that's just beginning to kick off and we have a lot of execution during January as you know.

To go out in the marketplace. So that is just starting so the areas, where we are nearly complete with the selling season.

Mid market the PEO the high end of ASO.

Those pipelines were full much better than last year and really in that small market. We're just beginning to enter the selling season with a lot of execution to go.

In the next 60 days.

Okay. That's good color.

I know you talked about.

How are you thinking about overall revenue growth for Q3 versus Q4, but could you just parse out maybe your segment level growth expectations for Q3 versus Q4, just so we get our models to properly. Thank you guys have a great holiday.

Thanks, Jason happy hours.

Yes, I'm, just taking I'm, taking a look at that Jason Obviously management solutions will will probably be a bit lower in Q3 than Q4 because of the.

The headwinds that we talked about being greater with the RTC in.

In Q3 and then.

And in insurance.

Those growth rates are going to be similar to where they were in Q2 and hopefully when you look at the full year guidance. The guide that I gave you on Q3.

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