Paychex Q1 2024 Earnings Call Transcript

Quartr
Provided by Quartr
September 27, 2023

There are 16 speakers on the call.

Operator

Please note this call is being recorded and I will be standing by if

Speaker 1

you should need any assistance. It is now my pleasure to turn the conference over to John Gibson.

Speaker 2

Thank you, Shelby. Thank you, everyone, for joining us for our discussion of the Paychex Q1 fiscal year 'twenty four earnings release. Joining me today is Efrain Rivera, our Chief Financial Officer and Bob Schroeder, Vice President of Finance and Investor Relations. This morning before the market opened, we released our financial results for the Q1. You can access our earnings release on our Investor Relations website.

Speaker 2

Our Form 10 Q will be filed with the SEC within the next day. The teleconference is being broadcast online It will be archived and available on our website for approximately 90 days. I will start the call with an update on the business highlights for the Q1. I'll then turn it over to Efrain and Bob for a financial update, and then we'll open it up for your questions. But before getting into the discussion of our earnings results, I want to take a brief moment here to make a few brief comments to acknowledge October 12, 2023, though he will remain as a senior advisor at least through the end of the calendar year.

Speaker 2

Efrain has been a valuable member of this senior leadership team at Paychex for the past 12 years. He has provided strong financial stewardship, but more importantly, great strategic leadership as well. During his time with Paychex, the company has transformed into a technology enabled services company, and we significantly expanded Our HR solutions and capabilities. Efrain has been a key strategic advisor and a catalyst for this transformation. Efrain, I think you know how truly I appreciate your intellect, your wisdom, your integrity, The guidance you've given me personally over my decade here, and to the company.

Speaker 2

And we're all in great gratitude for what you've done For each one of us personally and for the company, our customers, our employees and our shareholders are better off because you were here. So thank you. Joining us today is Bob Schroeder, who will succeed Efrain as CFO. Bob joined Paychex back in 2014 and is taking on progressive leadership roles over the past 9 years, including over the last year and a half since I was named President and Subsequent CEO Being the co lead of many of our strategic review efforts and strategic initiatives. Bob's promotion is a part of a strategic succession plan To bring in an innovative leader who will continue to guide the company going forward.

Speaker 2

I want to congratulate Bob. And Bob, I look forward to continuing to work With you as I have the last 10 years, as we continue to continue our track record of delivering strong financial results And continuing to position Paychex as a leader, an innovator and a company that you can count on for predictable and sustainable results. Now moving on to the Q1 results, seeking of predictability and sustainability. We have begun the fiscal year 'twenty four with solid growth of 7 In total revenue and 11% in adjusted diluted earnings per share. We've seen operating margin expansion approximately 60 basis points year over year, While still investing in our business to drive future growth, our Q1 reflected solid execution by our sales, service and all of our teams across Paychex.

Speaker 2

The demand for our HR Technology and Advisory Solutions continued, resulting in strong quarter new sales, Revenue growth. We saw positive trends in client, revenue and HR outsourcing worksite employee retention during the quarter, And we continue to focus our resources on acquiring and retaining high value clients. We are starting to see improvements in some of our DPO and insurance metrics during the quarter with good results across sales activity, insurance attachment and retention. We will know more after our open enrollment season is completed, which primarily runs from October through January. Well, at this time, we believe that the actions we have taken in response to headwinds we faced in 2023 are beginning to gain traction.

Speaker 2

Employment levels within our client base have remained stable. Small businesses, which are central to the U. S. Economy, continue to show their resiliency. Our small business employment watch has shown that small businesses continue to add workers at sustained but modest rates.

Speaker 2

Also the trend in wages has shown some cooling in wage growth consistent with overall inflation. Our data indicates a continued Stable macro environment for small and midsized businesses. We continue to monitor our leading indicators and are prepared to take appropriate actions To navigate any changes, but again, at this time, we don't see any material change to the macro environment. Small businesses have faced challenges getting access to capital and managing cash flows in this environment. This has continued to drive demand for our Full service employee retention tax credit service.

Speaker 2

I know there's been some recent news of the IRS pause in ERTC processing in order for them to This is not expected to have an impact on our ability to provide this service, though it may take longer for our clients to receive their funds. We continue to communicate this opportunity to existing clients and prospects, and we continue to file amended returns with the IRS on their behalf. We anticipate that ERTC revenue will be a slight tailwind for the first half Of the fiscal year and then turn to a headwind in the back half as the program ends. We are seeing greater adoption of HR software as businesses look to digitize their HR efforts to support the complexities of managing today's workforce in a more efficient manner. We also continue to see strong demand for our HR advisory solutions as businesses deal with the continued challenges Of being an employer in today's challenging employment world.

Speaker 2

Paychex is uniquely positioned to offer a continuum of HR products, Technology and services from do it yourself payroll all the way to full service PO HR outsourcing. All of these products deliver a strong return on investment for our clients. For the 13th year in a row, we were named the leading retirement record keeper By number of plans, by Plan Sponsor Magazine, our leadership position in retirement makes us an excellent resource for small businesses, And we continue to educate and execute on this opportunity. There has Certainly, there's been a lot of excitement about AI and related technology advancements around the monetization of large datasets. At Paychex, as we've talked on prior calls, this isn't anything new or it's not a fad.

Speaker 2

We have been using artificial intelligence To transform our business for over a decade, we have over 200 AI models that are actively working in our business today, designed to provide valuable insights Fueled by our vast data assets, our award winning retention insight tool uses AI based predictive analytics to provide HR leaders with early insights into potential employee retention issues. Our Flex Intelligence engine is an embedded I chat capability within our Flex platform that allows the customer to get quick answers to over 900 of the most common questions And access over 1200 instructional resources. Companies like Paychex with large amounts of Data will clearly be the winner with AI and we will continue to harness the power of AI and leverage our extensive data to drive internal efficiencies and provide actionable insights and solutions to our clients. This quarter, we continue to be recognized for our innovation, Service and the positive impact we are having on our customers, our industry and the world. For the 3rd time, Paychex has been recognized by TrustRadius with a 2023 Tech Cares Award for the company's corporate social responsibility program And our Community Impact.

Speaker 2

We also received an award from Selling Power for our commitment to fostering a diverse and inclusive workforce And from Ford as one of the best employers for women in 2023. On the product and service side, Nelson Hall once again identified Paychex as a leader in its 2023 Next Generation HCM Technology Market Report. We also learned a silver Brandon Hall Group 2023 HR Excellence Of the employer employee relationship. Paychex was also named the 2023 Constellation Research on their shortlist For best payroll for North American small and midsized businesses. The depth and breadth of our product suite provides American businesses the freedom to succeed With the technology and advice that they desperately need to remain competitive in a very complicated world.

Speaker 2

I want to thank our over 16,000 global employees who consistently deliver for our clients and our shareholders. It's because of them that we're off to such a good start this fiscal year. I'll now turn it over to Bob Schroeder to give you a brief update on our financial results for the Q1.

Speaker 3

Yes. Thanks, John, and good morning. It's good to be here with you this morning, and I certainly look forward to working with each of you as we move forward. I'd like to remind everyone that today's commentary will contain forward looking statements. Obviously, those involve risk, and we will refer to some non GAAP measures.

Speaker 3

I'll refer you to our customary disclosures in our I'll start providing a summary of our Q1 results and then I'm going to turn it over to Efrain and he'll give an update on our position and updated guidance for the year. Total revenue for the quarter increased 7% to $1,300,000,000 Management Solutions revenue increased 6% to $956,000,000 primarily driven by higher clients and client employees, Product penetration, price realization and HR ancillary services. We continue to see increased attachment and demand for our HR solutions, Retirement and Time and Attendance Solutions. PEO and Insurance Solutions revenue increased 5% to $298,000,000 Driven primarily by higher revenue per client and higher average work selling employees, as John mentioned, we definitely saw some positive momentum in PEO in the Q1 as it relates to both sales activity and medical plan participation and attachment, those were obviously headwinds Last year and we're definitely seeing some positive signs as we move through the Q1 here. Interest on funds held for clients increased 83% to 33,000,000 Primarily due to higher average interest rates, total expenses increased 5% to $750,000,000 Expense growth was largely attributable Higher compensation costs, PEO direct insurance costs and investments that we've made into the business.

Speaker 3

Operating income increased 8% to $536,000,000 with an operating margin of 41.7%. That's a 60 basis point improvement versus the prior year period. And diluted earnings per share increased 10% to $1.16 per share and adjusted diluted earnings per share increased 11% for the quarter to $1.14 per

Speaker 2

I'll now turn

Speaker 3

it over to Akram to take you through our financial position and our updated guidance for the year.

Speaker 4

Thanks, Bob, and good morning to everyone on the call. I start, just wanted to say thank you, John, for the generous words. It's been an absolute Professional privilege and honor to have been with Paychex during all this time. As you all know, we maintain a strong financial position with high quality cash and earnings. Our balance for cash restricted cash Total corporate investments was more than $1,700,000,000 Total borrowings were approximately $812,000,000 as of August 21, 2023.

Speaker 4

Cash flows from operations were 656 $1,000,000 for the Q1 was driven by net income and changes in working capital. There was some influence of timing there. It wasn't quite As strong as the percentages would indicate, but nonetheless, it was a very solid quarter. As you know, Our earnings quality, which many some of you have pointed out is among the best candidly In the entirety of the S and P 500. In the Q1, we acquired a small company that purchases outstanding accounts receivable of Under non recourse arrangements.

Speaker 4

This acquisition is a good strategic fit with another business that we have called Paychex Advance In that business purchases accounts receivable for temporary staffing clients. This acquisition will provide an opportunity for our Small Business clients to manage working capital challenges. As John alluded to earlier, we've seen over the last several years that access Financing is very important for small and medium sized businesses. We think this plays well into our in our portfolio of businesses that we have. We're very The acquisition at this stage is not anticipated to have a material impact on our financial results this year.

Speaker 4

We paid a total of $322,000,000 in dividends during the Q1. Our 12 month rolling return on equity was a Stellar, superb, amazing, 47%. Now let me turn to guidance for the fiscal year ending May 31, 2024. I'm going to give you color on not only the full year, the first half and the second half, And we typically do that at this stage. As you noted, we have raised guidance For interest on funds held for clients and for adjusted EPS, but I want to go through a little bit of color as we go through to Give you a sense of what our thinking is.

Speaker 4

Our current outlook is as follows. You saw that Management Solutions Still expected to grow in the range of 5% to 6%. PO and Insurance Solutions expected to grow in the range of 6 To 9%. Interest on funds held for clients now, as I mentioned, expected to be in the range of $140,000,000 to 100 and $50,000,000 raised from our previous guide of $135,000,000 to $145,000,000 And before I get the question The range are we anticipating a range of additional increases? No.

Speaker 4

We're poised I'm looking at what the Fed is doing just like everyone else is, but this is our best estimate of at least some Additional activity by the Fed, but not likely not contemplating all of it to the extent that the Fed does something We'll have a conversation later in the year. Maybe the Fed will decide that they actually do want to pause. But at this point, that's where we anticipate being. Total revenue is expected to grow in the range of 6% to 7%, but now we think this is likely towards The high end of the range. So operating income margin is expected To be in the range of 41% to 42%.

Speaker 4

Other income net is expected to be income in the range of $30,000,000 to 30 $5,000,000 effective income tax expected to be in the range of $24,000,000 to $25,000,000 Adjusted diluted earnings per share is Expect it to grow in the range of 9% to 11%, and this is raised from our previous guide of 9% to 10%. This full year outlook assumes current macroeconomic conditions, which have some uncertainty surrounding future interest Changes and their impact on the economy. And I would just say, it's been almost, I would say, at least 6 quarters Where we keep saying, hey, we don't know what's going to happen in the back half of the year and it could change our outlook. I think John summarized it very well. At this point, things look pretty stable.

Speaker 4

So we're feeling Directionally more and more confident in the back half. Projecting the second half of the year, we anticipate Total revenue growth of approximately 7% and operating margin in the range of 42% to 43%. I heard some comments after First, when we released guidance that we have a ramp in the back half of the year, I wouldn't describe Our current guidance has a significant ramp in the back half of the year. Obviously, there are differences in the back half The year that we'll navigate through and talk to you, but the difference between first half and second half is not dramatic. Of course, all of these comments are subject to our current assumptions, which are subject to change.

Speaker 4

We will update you again on the Q2 call. So let me just repeat a couple of things to make sure. First half 2024 total revenue growth in the range of 6% to 7%, operating margin in the range of 40% to 41%. Then in the second half at this point, we anticipate total revenue growth to be approximately 7%, operating margin in the range of 42% to 43%. I refer you to our investor slides on the website for additional information.

Speaker 4

Before handing things back over to John, I would just like to say that I appreciate the relationship I've built with each of you during my time here at Paychex. We've had a long time together and it's Time to hand the reins over to someone else who I think will do an even better job than I have. One of the things that strikes me during that entire time and many of you have been here for the entire ride. I got a call when someone or I got a note and someone said, Efrain, you're making me old because I've retired 2 CFOs at Paychex. So I think that's unfortunately true.

Speaker 4

We're all getting a little bit older. But one of the things that always strikes me is that we are covered The best group of analysts in the business. I say that even though I've disagreed with some of you over the years and I still think you have us rated too low, But be that as it may, I can't argue with some of the things, but you're right. So And in a separate note, I just want to say this. I've worked with Bob Schroeder for many years, both here and prior to Paychex.

Speaker 4

I know that I'm leaving you in very And I'm sure that Bob will do an even better job than the one that I do. And with that, let me turn it back to John.

Speaker 2

Well, thank you, Efrain. Before I open the call for questions, probably two things. 1, We have a lot of people here and last time Efrain did a great job of providing rules on questions, particularly around Compound questions and multiple follow ups. So if we could just follow the Efrain rule in honor of Efrain's retirement, I know he would greatly appreciate it. And maybe we can create a new tradition here.

Speaker 2

But no, feel free to answer any questions. But I would like to Also add, make everyone aware, there's many ways you can learn more about Paychex, and really the amazing success stories and the impact that we're having We've recently launched a series of reports that you can find on our investor page, Both our annual report, our ESG report and a new client impact report. And very shortly, you'll be seeing a new Investor Relations 101 presentation that will be launched on the website prior to our annual meeting in the coming weeks. And again, I think these Documents provide a lot more color and really a lot more insights of just how significant, how broad our products are, How big an impact we're having on our customers, how big an impact we're having on our employees, how and why Paychex is known as one of the most admired, The most ethical and most innovative companies in the world, and I encourage you to check that out. So With that advertisement of our investor website, Shelby, you can now turn it over for questions.

Speaker 1

And we'll take our first question from Ramsey El Assal with Barclays. Your line is open.

Speaker 5

Hi. Thank you for taking my question and congratulations to you, Efrain. Thanks. We will miss hearing your voice on these calls certainly. I was wondering if you could comment on the interest from corporate investments was relatively high in the Q1 and it doesn't necessarily feel like that's going to flow through for The full year guide in terms of maybe recurring each quarter.

Speaker 5

So maybe if you could talk about that contribution to other income and just how you might see it trending the rest of the year?

Speaker 4

Yes. So Ramsey, there's a couple of things that go into that line beyond just so For everyone who isn't focusing on that line that much. So that's a combination of our interest expense, Our interest income from corporate portfolios primarily and also some gains and losses on investments That we have in a small investment fund that we have. Those things can swing a bit During the year and are subject to whatever we think the balance is going to be on corporate Funds during the year, we made an acquisition, so we expect that during the year, our average corporate balances will be lower, so that will generate lower Interesting. And then the other part of that, Ramsey, is gains and losses on that other investments as we mark to market It can change from quarter to quarter.

Speaker 4

So there could be a little bit of lumpiness in that number, but it might be a little bit different. I would say one other Just a way of color on that line. We ended up with a fairly high cash balance that was influenced by I mean, I think I called that out, or if I didn't, let me call it out now. It just really had to do with the day on which we closed Closed the quarter, so our cash balances were higher. They're likely to be a bit lower, not a bit lower, but lower as we progress through the year.

Speaker 4

So you might see that number change a bit.

Speaker 5

Okay, fantastic. And a quick follow-up, if you could talk about SecureAct 2.0, how you see that evolving and how you see that We presumably benefiting the business over time.

Speaker 2

Yes, look, Secure Act 2.0, I think is a Great action and great step that the government's taken encouraging and helping small and mid sized businesses provide for the retirement of their employees. We're certainly out there educating the market on the opportunity. It really provides an opportunity for them to At a 401 plan, get a tax credit back for the implementation fees or the setup fees of the plan And it allows them to actually do a match for their employees and get that back into a tax credit as well. So we're Very happy our four zero one business has continued, has very, very strong growth. That has continued.

Speaker 2

The thing I continue to remind people, we have some Experience in this and other state mandates, and what we realized is that there's a lot of education that has to go on To get the market educated about the cost of a 401 plan, the benefits of a 401 plan. And certainly, we're out actively in the Educating the market, educating our strategic partners on that. And we believe that Secure Act 2.0 is going to allow us to continue to sustain The double digit growth rates that we've seen in the retirement business over the last several years.

Speaker 5

Fantastic. Thank you very much.

Speaker 1

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

Speaker 4

open. Hi, good morning, guys. This is Daniel Maxwell

Speaker 6

on for Andrew today. To start off, I was hoping you could dig in a little on any changes to the dynamic between ASO and PEO and weather over the past couple of months, you've seen any preferences shift on that. You called it out the last couple of quarters. I was wondering if anything changed?

Speaker 2

Yes. So I would say this, we continue to see strong demand for our HR outsourcing solutions across the board. And I would say that the balance is probably more back to prior to 2023 where we saw a little shift To ASO, we've seen more of what I the more traditional balance of ASO to PO. As we mentioned on our Last call, we've made some changes, I think, to our product portfolio in the PO that I think has balanced that out a little bit. The other thing that I would point to That we mentioned on the prior call is that when we over index with ASO in the prior year, we always look at that as a great opportunity 1st go back to those customers and then upgrade them or select them into our PO product.

Speaker 2

And when we started doing that, Actually that's a good example of AI. We're actually using AI tools to be able to go into the ASO So base and find clients that we believe there's going to be a valuable value proposition to be in a PO relationship For a multitude of different reasons, and that program actually has shown results in the Q1. It's early in the process, but I would tell you that our transition of ASO to PO customers, The number of customers that we transitioned this Q1 versus last Q1 was nearly 2x The number of clients. So exactly what we thought could happen, which was we over index when the ASO in the prior fiscal year, We continue to sell outside to new logos and that was also double digit strong in the PO in the Q1. So we had both benefits.

Speaker 2

We had Strong outside the base, growth in PO in the Q1 and we had good migration or upgrades ASO to PO, Which was a good start to the Q1. We still got 3 quarters to go and we're in the middle of our open enrollment, which is critical there, but good early signs. We had good signs in the PO in the Q4 and we talked about that on the last call and that just accelerated in the Q1. So now we just got to see if That can continue into the core selling season.

Speaker 6

Great. Good to hear. And then For my follow-up, any detail you can give on the increase to the direct insurance costs from workers' comp? Any color or any reminder of your exposure to any volatility in that area?

Speaker 3

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

Speaker 2

There's been no change to our underwriting standards. There's no change to our programs in terms of caps and limits, and No real change in the overall program performance.

Speaker 6

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

Speaker 7

Thank you.

Speaker 1

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

Speaker 8

Hi, good morning, guys. Thank you. Efrain, Bob, let me echo my congrats as well. Efrain, it's been nice working with you here. Enjoy your retirement.

Speaker 8

I got to ask a question because we've gotten a lot of questions just as it relates to ERTC. So it doesn't sound like you have any change in your fiscal 2024 revenue expectation there surrounding Your TC after this recent IRS announcement, but can you just dig in there a little bit more since there have been a lot of questions? Is there any evidence of any clients wanting Potentially delay submitting new claims there, any dynamic there to be mindful of?

Speaker 2

Listen, Brian, appreciate the question. Look, ERTC was in line with our expectations in the Q1. We continue to submit. No one's wanting to delay. The program is going to end.

Speaker 2

And again, the IRS announcement is not Stopping anyone's efforts in our efforts in approaching clients or assisting them in filing the tax credits. And in fact, the IRS specifically commented to clients and small business owners that they should seek trusted partners to complete their filings. The IRS pause in processing, not in accepting. So they're accepting filings. It's really due to some just really bad actors out there that are providing bad advice to small businesses and putting them at risk.

Speaker 2

I talked about this probably a year ago when this started And these little pop up companies started to show up. And again, I think that the IRS is trying to do a prudent thing to Tamp down on fraud and also to make sure that small businesses are not getting bad advice from these pop up firms. So We actually are continuing to accept and encouraging our clients and prospects to file and we provide a service where we are confident That the advice we're giving them is adequate and we'll continue to try to get their processing done before the Filing deadline early next calendar year, the delay impact for the client It's really going to be in the processing, which is really going to be when they get the refund.

Speaker 8

Okay. Very good. That's clear. And then my follow-up just on the target here. Can you share as it relates to the M and A, the financial profile of this target, just any revenue attribution to call out now In the current year outlook, I did hear you mention, I believe, the upper end of your growth range, but just wanted to confirm there were no organic

Speaker 7

offsets Off

Speaker 4

that. Organic offsets, what should we

Speaker 8

do? As far as anything in the organic side being offset By now any incremental inorganic in the year?

Speaker 4

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

Speaker 8

All right.

Speaker 4

Thank you. Yes. You're welcome.

Speaker 1

And we'll take our next question from Ashish Sabadra with RBC Capital Markets. Your line is open.

Speaker 9

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

Speaker 9

Thanks.

Speaker 4

Yes. So one is kind of, I'd say, process and structural. And then the second is The substance of what we saw in the first half. So the process and the substance is simply that at a point in time, you're taking a snapshot and Okay. When we issued the guidance back 4 months or so ago, we had a certain set of macro conditions.

Speaker 4

We didn't know whether they would Hold at that point. The macro conditions, as John said earlier, haven't changed significantly. So we fast forward 4 months and now we have More certainty as to what environment we're looking at, at least in the medium term, medium term being 3 to 6 months. So that's 1. The second part is we look at the trends in the business.

Speaker 4

Where are we close? Were we correct in terms of the trends that we saw? You heard some of the comments that John said On the PEO, so much of that was what we expected from an execution standpoint, but it's one thing that Expected, it's another thing to deliver it and thus far we've started on a good note. So those are two parts of it. So by the time we get to September And we're into October now.

Speaker 4

We know with reasonable degree of certainty what Q2 looks now. We project Forward into the back half of the year and do feel reasonably confident based on the combination of all the factors That we're seeing that the back half expectations will be as we expect. As we sit here, the answer is yes. So As you look at the guidance, it anticipates that PEO will strengthen in the back half of the year. And at this point, we're seeing indication.

Speaker 4

Can we say that certainty? You can never say anything certainly. But we based on all of that combination of factors, we feel Pretty positive about where things are trending.

Speaker 2

Yes. Just to add on to that, I think, Again, every business has we have a rhythm and the Q3 is a critical that's our selling season. And so what the macro environment will be in the Q3, Q4. Those are always the things we're trying to guess. I think what I would characterize at this point in time is When we left the Q4, I talked about the second half of our last fiscal year, we actually saw new sales bookings, Both in Management Solutions and the PO in Insurance, accelerating.

Speaker 2

We continue to see that double digit momentum in the Q1. HR Outsourcing, ASL and PR, strong mid market in the quarter, retirement strong, digital payroll strong. So when we look at the demand environment, then we look at the employment environment with our index and what we're seeing, The Q1 set up to be kind of a repeat and continuation of what we saw in the second half and particularly the Q4. Now as it relates to the PO business, as we talked about, the insurance is a portion of that insurance attachment is part of the reason why we have a little bit wider range. What you have to determine there is how many companies continue to offer benefits to their employees.

Speaker 2

That's the first choice. The second choice is how many of those employees sign up for health insurance, and what plans do they sign up for. Now we are only a quarter way through that decision process, which really has already started about 25% of the way through. What I would say at this point, 25 percent away, we're running a little bit on par where we expected. I mean, if that continues, I think that's what gives us confidence in the back half.

Speaker 2

But again, I still got 3 quarters of that process left. And again, I want to be predictable relative to what you should expect. And so we're being, I think, prudently I'm cautious in making sure that we're executing both management solution. We're taking advantage of the opportunities in the marketplace. And then in the PO and insurance, making sure we need we're doing what we need to do to make sure we have a successful open enrollment and drive insurance attachment.

Speaker 9

That's great color. And maybe if

Operator

I can just ask a

Speaker 9

quick follow-up question on the commentary on the PEO side On the improved insurance attach rate, obviously, last quarter you had also talked about a leaner product and I was wondering if that's driving better adoption or you're seeing Just better off the demand or stronger demand for insurance products. Thanks.

Speaker 2

Yes. So I would say that There's a multitude of things that we probably tweaked every aspect of how we approach the insurance, both in terms of analytics What we're doing relative to targeting customers that we think can drive we can drive the value proposition there. We changed the technology. We changed our advisory approach and we've expanded the products of choices that both employers and employees can have. Have improved our educational tools in that process.

Speaker 2

We've got a lot more engagement with our HR advisors with clients around that. So I would say across the board after what we experienced a year ago in Q1, we've looked at every aspect of it and the team has really done a great job there And just reimagining how we need to approach this. And again, we're only 25% of the way through, but we're seeing results From those activities. And I do think demand for insurance, I think it's going to be interesting. We were very pleased with our renewals.

Speaker 2

I mean, if you read in the general press, right now you will see that there is a degree of health inflation. And when that occurs, we do typically see more Customers shopping for alternatives and we think we have a good value proposition there.

Speaker 9

That's great color. Thank you.

Speaker 1

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

Speaker 10

Great. Good morning, guys, and thanks for taking my question. Maybe just going back to the acquisition, just wondering if you can maybe give a little bit more color on the strategic rationale behind it and sort of said another way like why now with this deal and maybe relative to some of the other targets you were looking at?

Speaker 4

Well, I'll bracket it in 3 ways. The first thing is that, John alluded to or said earlier, the ability for small businesses To access funding, and small and medium size, I should say, access funding is important. So we had our eyes on looking to build our capability in that area. The second thing is acquisitions are, as you know, they don't always present themselves in exactly the timing, Which you expect them to and when an opportunity arises And you do what you need to do to take advantage of it. We saw an opportunity for a high quality asset and decided that It was the right time.

Speaker 4

And I'd say the third is that it's an interesting environment for small So where access to funding opportunities is becoming more Tricky, given what's happened with banks and with rising interest rates. So we think the timing seemed to fit pretty well. As again, yes, I don't want to spend too much time. It's a relatively modest acquisition based on our revenue side, but we think we've had a lot of With our Paychex Advance acquisition and it's a very profitable corner of the market And we think we can do the same thing with the company that we bought, called Alterna by the way.

Speaker 2

Yes. I would just add that neither one of these things are new to us. We kind of got dragged into this when COVID hit. If you remember the PPP program and the banks were struggling to figure out how to access it and we put a program together And that started a partnership with several fintechs and we did both technology integrations etcetera and that led More of a partnership approach and we have several partners that if we have clients that meet our risk profile and Or wanting to maybe need to fund a payroll or something like that. We've got partners that we can introduce them to.

Speaker 2

So we've got kind of introduced to this concept And certainly been the macro environment we play out from just that banks raising interest rates and we just know we have a lot of great customers out there, Small and midsize customers are strong businesses that just really struggle to get access to capital at affordable rates. And so That started just through a partnership piece. And then we had the advanced business, which was kind of doing this for staffing companies and we've been in that has been a great business for us, a great acquisition business for us, introduces us to payroll customers. It does just a lot of positives there And those are adjacent. And so literally it's one of those classic, you're at a conference and you know people who know people and the timing seemed right.

Speaker 2

And just based upon the need we saw and the fact that we thought there were opportunities for us to potentially help our strong Customers continue to grow their business, and we've already been introducing them to partners. Why not introduce them to ourselves And get a piece of that action. So that was kind of the strategic rationale. It's a small like you said, very small at this point in time.

Speaker 10

Got it. That's super helpful. Thank you. And then just as a follow-up, I mean, just one quickly on the float portfolio. When we think about the recent Fed commentary and dot plot showing maybe a sustained higher rate trajectory than maybe we were A few months ago, I'm afraid I know you've talked about in the past wanting to position the portfolio more at longer duration securities.

Speaker 10

I'm just wondering if this the recent That commentary sort of gears you even more towards sort of the longer duration securities in the portfolio rather than shorter duration. Thanks.

Speaker 4

Yes. We are reviewing it monthly to figure out based on and looking at the same dot plots you are To see what happens. I would just go back to something I've said from the point that the Fed started raising rates. The problem isn't taking advantage of the rates Going up, the problem is what happens when you come down. And so we're positioning the portfolio.

Speaker 4

We will position the portfolio. And I'm sure Bob will do the same. To be able to manage it in an orderly way on the way down. So We're looking at this is a time when you want to go longer if you can, even if perhaps So there are opportunities on the short end of the curve, because at some point what comes up will come down. And that's what you got to figure out how best to manage, and that's what we're working on.

Speaker 10

Great. Thank you and congrats. Thank you.

Speaker 1

And we'll take our next Question from Tien tsin Huang with JPMorgan. Your line is open.

Speaker 11

Hey, good morning. Thanks. I also wanted to follow-up on the acquisition, the $200,000,000 acquisition here and the strategic Fit with Paychex Advance, I remember when that deal was announced and it was a lot about payroll funding and In factoring and whatnot, is this now more about early wage access and some of the more modern Funding opportunities for employees. I just want to make sure I understand what you're adding specifically here.

Speaker 4

Yes. The short answer is no. So that's A separate initiative that at some point we'll talk about when it becomes more significant. Tien Tsin, what they do is more focused on receivable. So Yes.

Speaker 4

Obviously, we dipped our toe in the water with staffing firms, but we saw an opportunity that was broader than that because All of our clients have to one degree or another receivables and it can become a source of financing and we've got the data to make it work.

Speaker 11

Okay, very clear. So this is an AR opportunity. Understood. Okay. No follow-up for me.

Speaker 11

Just want to wish you, Evan, all the best, of course, for the next And I've said it before, you've been real helpful for us for a long time. So thanks for that. Difficult to miss talking to you.

Speaker 4

Thanks, Finjan.

Speaker 1

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

Speaker 12

Good morning. Welcome and congrats to Bob and certainly congrats and thank you to Efrain. John, I want to dig a little bit into your thoughts on S and B lending in general. Obviously, this news of big money center bank is Getting into the payroll business a bit more and SMB lending is often thought as a nice adjacency here. Should we consider the possibility that Paychex may further Delve into S and P lending, whether it be merchant cash advances or other types of working capital solutions.

Speaker 12

Do you see that in Paychex's future?

Speaker 2

Well, look, I think what we're trying to do is make sure that we're focused on what do we need to do to help our clients And as I said, whether that's through partnership or if there's opportunities for us to participate in that process, Integrating that with our technology, those are really the things that we're interested in. And When we hear our clients and we're engaging those clients to our advisors on a constant basis, say this is an issue for them. We go and search for answers And partnerships are part of that. And as I said, we have several partnerships with FinTech that we're doing relationships with large banks. I can go deeper on that if you want to know about banking and banks and payroll.

Speaker 2

We have businesses They do that. But I think, Jill, you should not read anything more into this than the fact there is a need out there That we had an adjacent business that has been very successfully managed and has been a good return for our shareholders. And there was a natural relationship and opportunity that we thought by us coming in with our balance sheet, with our expertise, with our client base That we could potentially make something of this. And so I don't think you should read anything more into it than an opportunistic acquisition that matches a need that we're seeing From our customers and one that based upon the macro environment we think are going to grow. And I don't think this is a competition with any of the major banks.

Speaker 2

Most of these clients are just Not getting access to the funds. It's just not available. And if there's more tightening at the regional bank, which is generally the go to place For a lot of these small and medium sized businesses, that's not good for small business owners. And so we're going to try to figure out

Speaker 12

Thank you. That's super helpful. And then just as

Speaker 2

a follow-up, Just wondering if you

Speaker 12

could call out any trends down to trade wise. Are there areas where you see Paychex has an opportunity to improve competitive dynamics or vice versa, some areas You're a bit more on defense versus offense. Just any sense on balance of trade versus some of your competitors and Maybe some of the regionals as well.

Speaker 2

Well, I mean, I'd just say this, as we've talked about, our sales momentum continues In the Q1 that we saw on the Q2, on a macro side, when I'm looking at it, I'm not seeing major shifts at all relative to balance of trade In the competitive environment, I commented on the Q4. When I do look under it, again, these things go back and forth. I would say it's leaning a little more in our favor on the competitive front in several key areas that we monitor. We had a good Q1 in the mid market. That was a good there were several good signs there as well, but it's not monumental, Peter.

Speaker 2

It's the same market, Very stable competitive environment, same set of competitors, low end, mid, high end, PO. It's the same cast of characters, same kind of Pricing environment, competitive environment, it's a competitive marketplace. We'll leave it at that and I think we're winning more than our fair share.

Speaker 12

For sure. Thanks again and congrats, Efrain. Good luck.

Speaker 4

Thank you.

Speaker 1

And we'll take our next question from Bryan Keane with Deutsche Bank. Your line is open.

Speaker 4

Hi, Brian.

Speaker 2

Hi, good morning. I want

Speaker 4

to ask about the free cash flow increase year over year in the Q1. It was Substantial, I think it was up over 23%. How much of that was that one time in working capital? And how much Should that carry through the fiscal year or should we see a decrease in kind of growth rate in free cash flow to equal out to The same growth of the 9% to 11% earnings growth by the time we get to the end of the fiscal year.

Speaker 3

Yes, Brian, this is Bob. I mean, I think that's a fair way to think about it. I think as you guys We typically don't have big swings in our working capital. And as Efrain mentioned, we had a little bit of a timing there at the end of the quarter. The quarter It ended on a big collection day, so we had a big influx of cash that would go out the next day.

Speaker 3

So the way to really think about our operating cash flows and then obviously free cash flow It gets impacted by M and A, so there was a little bit of an impact there in Q1 to free cash flows. But typically, our operating cash flows Growth is going to trend in line with our net income growth. And so you'll see that moderate as we move through the year and that's what you should expect from a growth standpoint.

Speaker 13

Got it. Got it.

Speaker 2

And then just a follow-up,

Speaker 4

I was hoping to get an update on what you guys are seeing for SMB bankruptcy rates. I know they've been a little bit elevated in the recent past here and just curious if that's still elevated levels or has it become more normalized?

Speaker 2

Yes. So when we say elevated, I think that they're elevated over what we saw during the COVID period that is 2 Actually bankruptcies are still slightly below where they were pre pandemic And kind of trending to more normalized rate. We have seen that, I would say, particularly in the startup businesses when we had the big startup boom, We've seen a lot more out of businesses on the very small and I think we called that out in our press release. Revenue retention At near record levels and when you look at our HR outsourcing businesses at record levels and so that's what we've kind of seen on The other interesting stat related to bankruptcies that kind of surprised me in the Q1 is we actually saw an uptick in new business starts. And again, we had this big elevated area and then we kind of gravitated back down towards kind of normal levels.

Speaker 2

And we actually saw in the Q1 New business starts click up, which was interesting.

Speaker 4

Got it. Great. And Efrain, it's been a real pleasure working with you. You'll be missed. Thank you, Brian.

Speaker 4

Appreciate it.

Speaker 1

And we'll take our next question from Samad Samana with Jefferies. Your line is open.

Speaker 7

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

Speaker 14

Appreciate it.

Speaker 7

Maybe just a quick one for me. A lot of my questions have been asked. But Just how are you guys seeing the top of the funnel in terms of inbound leads to the digital channel? Any change in maybe interest levels, registrations for webinars? Just I would look at it as a leading indicator of bookings and how that trended maybe Q1?

Speaker 2

Again, I'll go back. If our sales are growing at double digit rates in the Q1, digital is a ever growing Portion of that business, you can surmise that that's growing as well. So we continue to see strong demand On the environment across the businesses, both digitally and really across the board, I wouldn't that's about it.

Speaker 7

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

Speaker 2

No, really no change in plans. We're certainly in the 2nd quarter always in the staffing up and making sure we're fully staffed and able to cover Any thought or planned attrition going into the selling season, both on the service side and the sales side. So I think it's fair to say, When you have now going on close to 3 quarters of strong demand when you've been relatively, is it going to stay, is it going to stay? We certainly want to make sure that we're properly staffed to take full advantage of all the opportunity in our selling season and we're fully staffed on the Operations and service side to make sure that we can both onboard and services clients during year end.

Speaker 7

Great. Appreciate taking my questions. Thank you.

Speaker 4

Thank you.

Speaker 1

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

Speaker 15

Thank you. Good morning, guys, and congratulations Afternoon, Bob. I miss working with you. Bob, look forward to working with you. Just have two quick follow ups.

Speaker 15

One tying together your comments on sales and turn, can you comment how that's together to Time growth trends this year so far. Last year was a bit below your historical target range. And I think you commented last Quarter that this year you're looking for reacceleration in client growth kind of above 2% a year. So can you comment on how it's growing so far?

Speaker 4

Hey, Eugene, I'll start that and then John can cover. It really if I were to give you a number, it would give you some sort of false sense of what reality It's almost impossible to draw a conclusion on that or where you are in Q1. In some ways, Some trends are positive, and you can draw conclusions on project outs through the year, but client base is really a Tricky, one of the reasons is just lose so many and gain so many in the selling season that It's almost difficult to predict. We expect to be a bit better than we were last year, but it's still early innings.

Speaker 15

Got it. Okay. And then another follow-up is on the PO and the question there is In your PO customer base, in terms of kind of checks per control, are you seeing any trends that are different from your overall base, Whether better or worse employment growth?

Speaker 2

Yes. I would say

Speaker 3

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

Speaker 2

Got it.

Speaker 15

Okay. Thank you very much guys.

Speaker 4

Thank you.

Speaker 1

And we'll take our next question from Mark Marcon with Baird. Your line is open.

Speaker 14

Hey, good morning. Hey, friend, we go back a long ways. It's been an absolute pleasure working with you and I want to thank you for the relationship. And Bob, looking forward to working with you. But it's been an absolute pleasure.

Speaker 4

A lot

Speaker 14

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

Speaker 2

Wow! That's Mark, that is a big question.

Speaker 14

Everybody is asking about the quarter.

Speaker 2

No, and it's a great one because I really think this is probably Has the potential to be one of the biggest differentiators that's going to help a company like Paychex, separate ourselves From the rest. Because as you said, the large language models, it starts with a large. And the only way that this works You've got to have large sets of data and large sets of data coming through to continually train those models. I will also say relative to, it's expensive to do and it's getting more expensive, both in terms of finding the people And buying the technology and I think that's going to also back some people out. But let me just give you some idea.

Speaker 2

I mean we have Multiple teams across the organization looking at every aspect of our business, front office, back office, G and A And evaluating how we could better leverage all of the capabilities of the data that we have. So Think of it today, we're recording 6,500,000 calls with our clients. This year, we're transcribing those calls. We are using analytics to determine whether or not we have a service opportunity or if we have a sales opportunity or an upsell In the conversations that we're having with our advisors. We are already doing almost 1,000,000 natural language processing analysis On our sales conversations with prospects, looking for what are the right phrases, words, markets, segments We're winning and then adjusting that overnight and changing our sales plays the next morning.

Speaker 2

Using some of that In our PO, we nearly doubled our close rate in the Q1. I mean, I just could go on and on about where we're piloting and testing and using our data to do this. And so I think there are tremendous opportunities. And then when you begin to productize this and start thinking about the value that we can provide, the retention insights which we launched, keep bringing this up. We launched this a year and a half ago.

Speaker 2

We won an award for AI and I think at the time no one even wrote anything much about it Because I was thinking people knew what AI was. And quite frankly, it's I think that's just one example of multiple examples we're going to be able Drive more value to customers. And so I think we're going to be able to go with the value proposition. And to be fair, there's other large Competitors that probably are going to make similar claims, but I certainly think it's a differentiator. If you run a local payroll company, You're not going to have the same data and the insights that Paychex has relative to what's going on in your area and what's going on in the labor market.

Speaker 2

And if we can harness that and use technology to deliver that to our sales people, our service people and our HR advisors, I think the trusted advisor position that we've already established ourselves for small and medium sized businesses is only going to be Further sustained and probably increased. So I think Bob is going to give me the hook to give out the family.

Speaker 14

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

Speaker 4

Yes, I think that's it, Mark. It's a couple of things. One is, if you noticed the pattern in P and L, pretty obvious. We have tended to Front load a little bit more of spending in part to make sure that we're prepared For selling season and then as we get into the Q4, typically, we've heavied up our spending In anticipating in anticipation of starting the year stronger, Q3, as you know, because you have that influx Of annual processing generally makes Q3 margins higher and then Q4, don't It will be quite as heavy than in prior years when you combine those 2. You get to a little bit more spending in the first half, A little bit less in the back half, but more revenue in the back half without creating the margin uplift That I mentioned, there's nothing unusual about it.

Speaker 4

It's just in the way that revenue and expenses flow through.

Speaker 14

Terrific. Thanks again, Alfred. Thanks. Kind of a nice working with you.

Speaker 4

Yes. Thank you.

Speaker 1

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

Speaker 13

Thank you very much and I want to share my congratulations to Bob and Efrain. Just wanted to quick Follow-up question here on PEO. And you had mentioned some of your customers, and I think you've kind of talked about this and had Hold back on providing ancillary services like insurance and 401 ks etcetera. But now you're calling out some growth in those same ancillary services As the driver of PO growth in the quarter, what are the things that you're watching for to gauge like the durability Of that improvement and kind of response by your customers and employers.

Speaker 4

So James, you mean what are we looking at?

Speaker 2

Yes. Like One of the things in

Speaker 13

the more macro economy or even in your customer behavior to try to gauge and project the durability of that improvement?

Speaker 4

Let me start and then John can and maybe Bob can weigh in. So I just want to make sure that I'm answering the question correctly. I think the key thing in if you Step back on the PEO is, we saw that attachment last year wasn't where we expected it to be. And also we just want an opportunity to tilt the balance a bit between what was an ASO sale versus a PEO sale. So what we're looking at, at least to start the year is first, are we positioned appropriately on the insurance side to be able to take advantage of that And create momentum as we go into some key points in the year, which occur in the fall and Then at the beginning of the year on insurance and attachment.

Speaker 4

One thing, James, that's important to point out. Last year when we were talking at this We were seeing actually something unusual where we were seeing clients dropping insurance and actually lowering I'm sorry, not their attachment, their Roman. So we haven't seen that start of the year. So the absence of a negative is positive. So I think we're looking at that.

Speaker 4

That's one piece and John called out something I think That is important. Also that balance between what we're seeing on ASO and PEO that seems to Come into a little bit more balance. So I think those two things, both have started the year well.

Speaker 2

Yes, I know, I just try to understand. So remember, we've got you've got existing client behavior, particularly as it relates to attachment. And again, It's always difficult because the insurance is pass through, it doesn't have a huge impact on margin as an oversized impact on the revenue number, right, The way it works. And so you had 2 dynamics. 1 was existing customers that have the product, Are they continuing to want that attachment?

Speaker 2

And then what are they attaching? Are they attaching the catalytic plan or the basic low value plan? That's the first decision. And last year, we had something we normally don't see and we have not seen thus far through our enrollment Of people, as Efrain said, instead of going to a work plan dropping and not offering. We're not seeing that behavior.

Speaker 2

We saw that last year. We saw less people opting to want to add that or seeing value in adding the insurance, but they wanted the HR and they wanted the technology And they wanted our advisory services. They went in the ASO bucket. Now we're going back to some of them that are now saying, okay, wait, Now I do want to add the insurance and now we're upgrading them to the PO offering. So what we're seeing is Both in terms of new logo demands of new net customers to Paychex, we're seeing strong demand in our ASO And PO market with attachment rates in the PO similar to what we saw prior to the 2023 experience.

Speaker 2

And then the third thing that we've got going on is we're going back into this ASO group of clients that we were last And we're going back and using analytics and using value propositions, to see if we can go back and have some of those clients upgrade and add Insurance is part of their value proposition. I hope that answers your question. I wasn't clear James would have Yes.

Speaker 13

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

Speaker 2

Yes, that's what I would say. And again, you just make stuff up. I try to remember 2 years ago was the great resignation. Last year this time, the bottom was going to fall out of the economy and all the recession was right around Corner. Did everybody recall that?

Speaker 2

I mean, it's just it's been a very emotional roller coaster ride for small and medium sized businesses. And when you're making a decision of this magnitude, because you're making a commitment to your employees that you're going to offer a benefit And the expectation is you're baking that into your business model going forward. And so I think there was a lot of hesitancy. Now does that mean Small and medium sized businesses are more confident today than they were last year. I don't know, but what I can tell you is we're seeing more behavior that is similar To what we've seen in historical patterns and last year seems to be an anomaly.

Speaker 2

Again, I'm only 25% through the enrollment, What I'm seeing right now, we'll know more in the next call. Let's leave it at that.

Speaker 13

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

Speaker 2

Okay, Shelby. I think that wraps it up. At this point, we will close the call. If you are interested in re Playing the webcast of this conference call, it will be archived for approximately 90 days. Again, that's on the Paychex Investor website where we also have all these Fabulous reports for you to read.

Speaker 2

And again, we want to thank you for your interest in Paychex and hope everyone has a great day.

Speaker 1

That concludes today's teleconference. Thank you for your participation. You may now disconnect and have a wonderful day.

Powered by Quartr
Earnings Conference Call
Paychex Q1 2024
00:00 / 00:00