Paychex, Inc.

Good morning. My name is Lisa, and I will be your conference operator today. At this time, I would like to welcome everyone to the Paychex Third Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. I would now like to turn the call over to Mr. Martin Mucey, President and Chief Executive Officer. Please go ahead, sir.

Thank you. And thank you for joining us for our discussion of the Paychex Third Quarter Fiscal 2020 Earnings Release. Joining me today is Efren Rivera, our Chief Financial Officer. This morning before the market opened, we released our financial results for the third quarter, ended February 29, 2020. You can access our earnings release on our Investor Relations webpage. Our Form 10-Q will be filed with the SEC within the next few days, and this teleconference is being broadcast over the Internet and will be archived and available on our website for approximately one month. I will start today's call with an overview of how we are responding to COVID-19 and then review business highlights for the third quarter. In effort, we'll review our third quarter financial results and discuss our guidance for fiscal 2020, including our current thinking on the potential impacts of COVID-19 on on our business, and then we'll open it up for your questions. First and foremost, I want to address the evolving situation we are currently facing with COVID-19. Our number one priority is the safety and well-being of our employees and serving our clients and their employees. Our business continuity plan was implemented and our teams are working around the clock to ensure that we take the necessary steps to ensure our employees' safety while continuing to support our clients through this unprecedented time. Early on, we instituted travel restrictions and began to reduce the number of employees working in our offices. At this time, all employees, unless designated as critical on-site person, that's less than 5%, are now working from home, and our service metrics and client response time has been excellent. In fact, our average answer performance yesterday was seven seconds. Extremely proud of this team and the work they've done in a very fast period of time. I'm incredibly proud of how the whole leadership team and employees have responded to this situation. Because of their hard work and efforts, we've been able to complete all of these transitions without any service disruptions. We continue to help our clients navigate the significant amount of information and changing regulations from state and federal governments, including the Families First Coronavirus Response Act. Our compliance team also remains in contact with federal, state, and local government authorities. on a real-time basis to ensure we are aware of and offering support and ideas on any new regulations or support initiatives related to COVID-19 that could impact our clients. So far, we've seen minimal changes in our key metrics. However, with the expanding shutdowns of businesses throughout the nation, we do expect that this will be a particularly challenging time for small and mid-sized businesses. This will have impact on our results, and Efren will provide some color when he discusses our current outlook. The federal government has taken a number of steps to stabilize these issues and is considering more relief actions as we speak. I'm sure you're all aware of the at least handshake agreement last night, and we're working through those detailed changes as we see how the vote and the presidential approval goes probably today. Small businesses in particular are in need of aid to be able to stay in business and pay their employees. The speed in which relief actions are put in place will impact the severity of the economic impacts resulting from this virus. Last weekend, we were part of a small group that sent a letter to Congress supporting the small business loan program to help businesses continue to pay their employees and offered our assistance as a payroll processor to do that in the most effective and timely way. We continue to monitor leading indicators to gauge the changes in the small business environment. We believe we are well prepared to navigate our way through these uncertain times. The significant investments we've made in our technology, and in particular our mobile app, Our expanded product and features and our service model options allow us to support our clients in any environment. And as you are well aware, we maintain a strong balance sheet and cash position. We will continue to focus on our business objectives and invest in our people and our clients. This is a rapidly evolving situation, but we will keep you informed on the expected impacts as events continue to unfold. Now I will update you on our business and financial results for the third quarter, which reflect good progress on our key initiatives. Total revenue growth was 7% for the quarter, management solutions revenue grew 6%, and PEO and insurance solutions revenues grew 10%. Through the third quarter, we have continued to see strong execution and operations with record high net promoter scores and client retention. In addition, we have had strong results in our virtual sales divisions, digital marketing efforts, and mid-market sales through the selling season. As we have discussed on previous calls this fiscal year, we had a slower start than anticipated on the integration of OASIS. We believe we have addressed these issues in sales. We are now fully staffed and have a new leadership team in place. For service, staffing levels are stabilized, and the focus now continues to be on servicing our clients with less need to work on integration of the clients into the platform. The business has strong fundamentals that will drive growth over the long term, and we remain very positive about the continued strong demand for HR and insurance support and PEO services, particularly in this difficult environment. As the largest 401k record keeper in the U.S., Paychex was prepared to respond to the SECURE Act, which was enacted in December of 2019. This legislation provides incentives for employers to offer retirement savings plans and provisions to improve savings for millions of Americans. With our strong expertise in retirement plans and our award-winning retirement services participant portal, we are well-positioned to assist small and mid-sized businesses and their employees as they navigate this new legislation and plan for retirement. We launched Pay on Demand in December, which improves the employee experience by offering them flexible access to wages they have already earned before payday, helping them manage their personal cash flow. This is a valuable tool for employers to help attract and retain talent. Other companies in the industry offer similar services on a smaller scale, but our solution is unique in that it provides our clients with flexible payment options, including direct deposit, pay card, and digital payment into Amazon or PayPal accounts. We also believe that pay on demand will see increased usage in this current environment with employers needing a more flexible workforce that will need much more flexible pay options and probably more immediate pay. We were excited to launch the first of our wearable apps as well, which we demonstrated in October at HR Tech. Paychex Time for the Apple Watch was launched in January for Flex customers. This allows clients, employees the flexibility and convenience of punching in and out on your Apple Watch. We also launched Paychex Flex Help Center, which provides dozens of training resources and how-to tutorials for assistance using Flex technology from within the application itself. Help Center allows customers to access help materials that are relevant and easy to consume via their individual preferred learning method, whether that is video tutorials, step-by-step instructions, or chat. The latest product releases included significant enhancements to existing features, which continue to add value by making things simple for our clients and allowing users flexibility and choice. These enhancements include electronic signature capabilities in our document management tool, improved visibility into labor costs and employee data with live reports, and additional integrations with some of the top HR finance time and attendance and benefits solutions in our Paychex integrations solution. While Flex, Paychex Flex, does provide a full suite of HR solutions, the open platform allows customers the flexibility they may need to integrate with other tools if they so choose or if they already have them and don't want to switch out of them. Products like learning management services with online training, electronic signature capabilities of document management will support the needs of clients in this time of remote workforces. Our real-time payments offering will be introduced in April. We believe we are one of the first to offer this capability to customers, and this will allow employers to pay employees faster, which can help attract talent, can also help quickly resolve any issues with payroll. Our technology roadmap continues to focus on the area of emerging technologies such as wearables, real-time payments, product integration options, data analytics, and AI, all of which will play an important role in helping clients in this current environment. We are proud that Paychex's commitment to technology innovation has been recognized by industry experts. Our Paychex Flex Assistant was selected as a Stevie Award winner for Best Use of Technology in Customer Service. Flex Assistant answers over 250 questions covering the breadth and depth of the Paychex payroll in HR Suite. What differentiates our technology is that it seamlessly connects to a live specialist in real time if the user wants more assistance, and the entire bot transaction is visible to that specialist, so no repetition is needed. Both Paychex and SurePayroll also receive Stevie Awards for our excellent customer service. As a critical business partner for many of our clients, we pride ourselves on doing business with integrity. It is ingrained in our corporate culture and very evident in the last few weeks as we quickly implemented our business continuity plans for our clients and employees. I'm extremely proud that Paychex has once again been recognized by Ethisphere as one of the 2020 world's most ethical companies, the 12th time we've received this recognition. And in summary, as we navigate these unprecedented times, We continue to support our clients, our employees, our communities, and our shareholders. We have invested heavily in making our technology solutions and service flexible and mobile, and we are more prepared than ever to handle this current environment. I would like to thank our IT, sales, service, compliance, marketing, and HR teams who have worked diligently to ensure regular communication to our employees and our clients is and that all employees have the equipment they need to work remotely and stay connected with each other and our clients. Also, thank you to our employees who have maintained diligence and flexibility during these transitions in the way we all work. I will now turn the call over to Efren Rivera to review our financial results for the third quarter. Efren?

Thanks, Marty. Good morning. I'd like to remind everyone that today's conference call will contain forward-looking statements that refer to future events and such involved risks please refer to the customary disclosures in our earnings release. In addition, I'll periodically refer to non-GAAP measures such as EVA Digest and net income adjusted diluted earnings per share. Again, refer to the press release. Before I start, I hope that as we speak, you all are safe and in good health. That's the most important thing at times like this. If you have loved ones who are affected by the virus and its impacts, please accept our thoughts and prayers for you and for your family. Being human at this time is the most important thing we can do. So now let's talk finance. I'll start by providing some of the key highlights for the quarter and then follow up with some greater detail in certain areas. I'll wrap with a review of fiscal 2020 outlook and some high-level commentary on fiscal 2021. Yes, some high-level commentary on fiscal 2021. Stay tuned. Based on preliminary looks into next fiscal year. Total revenue, as you saw, grew 7% for the third quarter to $1.1 billion. OASIS contributed about 1% to this growth. Expenses increased 5% to the third quarter to $673 million. Increases in compensation costs and PEO direct insurance costs contributed to total expense growth, partially driven by the acquisition of OASIS. Up income increased 10% to $470 million. Up margin was 41.1% for the third quarter compared to 40.1% for the third quarter fiscal year 19. EBITDA increased 8% to $520 million. EBITDA margin was 45.6 compared to 45% for the same period last year. Very strong results. Other expense net for the quarter of $6 million includes interest expense related to long-term borrowings. Our effective income tax was 23.6% for the third quarter compared to 23.7% for the same period last year. Net income and adjusted net income for the third quarter both increased 9% to $355 and $351 million, respectively. Diluted earnings per share and adjusted earnings per share each increased 9% to $0.98 per share. and $0.97 per share, respectively. We received approximately $0.01 of benefit from stock-based comp payments during the third quarter, which is included for GAAP but excluded and are just diluted EPS. Let me provide some additional color in selected areas. Service revenue increased 7% for the third quarter to $1.1 billion. Within service revenue, management solutions revenue increased 6% to $850 million. P.O. and insurance solutions increased 10% to $72 million. So you saw through the third quarter continued strong performance on management solutions. This is primarily driven by increases in our client base across many of our services, along with growth in revenue per client. Revenue per client improved as a result of higher price realization, increased penetrance of arts. suite of solutions, particularly retirement services, time and attendance, and HR outsourcing. PEO and insurance solutions revenue growth of 10% was driven by the growth in clients across our PEO businesses. Insurance solutions revenue benefited from an increase in the number of health and benefit applicants, partially offset, as we've been saying all year, by the impact of softness in workers' compensation premiums. Interest on funds held for clients decreased 7% for the third quarter, primarily as a result of lower interest rates earned partially offset by higher average interest investment balances, I should say, and realized gains. Funds held for clients' average investment balances were impacted by wage inflation and increases within our client base offset by changes in client base mix and timing of collections and remittances. These results obviously do not include the impact of the 2 March rate cuts by the Federal Reserve. Turning to our investment portfolio, we continue to invest in high-quality credit securities. Long-term portfolios have an average yield of 2.1% and average duration of 3.1 years. Combined portfolios have earned an average rate of return of 1.8% for the third quarter, down from 2% last year. Now year-to-date. Total revenue increased 12% to $3.1 billion. Service revenue increased 12% with management solutions reflecting growth of 6% to $2.3 billion and PEO and insurance solutions reflecting growth of 36% to $763 million. OASIS contributed approximately 28% to the growth. Interest on funds held for clients grew 6% to $62 million. Operating income increased 10% to $1.2 billion. Net income and diluted earnings per share each increased 9% to $877 million and $2.43 per share respectively. Adjusted net income and adjusted diluted earnings per share both increased 8% to $863 million and $2.39 per share respectively. Let me talk about our financial position, which I think is really, really important in a time like this. It remains obviously very, very strong with cash, restricted cash, and total corporate investments of $930 million as of February 29, 2020. Funds held for clients as of February 29, 2020 was $4.4 billion compared to $3.8 billion as of May 31. Funds held for clients, as you know, vary widely on a day-to-day basis and average $4.5 billion for the third quarter. Total available for sale investments, including corporate investments and funds held for clients, reflected net unrealized gains of 84 million as of February 29, 2020, compared with 20 million as of May 31, 2019, and as interest rates oscillate, that number changes very, very significantly. Total stockholders' equity was 2.8 billion as of February 29, reflecting 667 million in dividends paid and $172 million of shares We purchased during the first nine months. Our return on equity in the past 12 months was a very robust 42%. Cash flows from operations were $1.1 billion for the first nine months, an increase of 3%. Over the same period of last year, the increase was driven by higher net income offset by timing fluctuations in working capital. Let me just summarize our financial position because it's very, as I said, important. We are very solid. with our cash position is strong. We have $900 million in cash. We have an undrawn revolver. We have the highest cash generation of our peer group. We have the highest dividend. And we have confidence that we will weather the storm for both our clients, our employees, and our shareholders. Now I turn to guidance for the current fiscal year ended May 31, 2022. First, I want to provide context. As you know, there are new events unfolding daily and we're constantly incorporating this information. Our guidance reflects our assumptions as of today based on the information that we have regarding potential effects on the business. This guidance also reflects the impact of 150 basis points of interest rate cuts that have occurred in March. Our guidance for the full year fiscal 2020, as you saw in the press release now, is that we anticipate management solutions to grow approximately 4%. PEO now about 24% for the full year. Interest on funds sold for clients is anticipated now to decline in the range of 2% to 3%, and total revenue is now anticipated to grow in the range of 8% to 9%. Op income as a percentage of total revenue is anticipated to be approximately 36%. EBITDA margin for the full year 2020 is expected to be approximately 41. Other expense net is expected to be in the range of 22 to 24 million. And the effective income tax rating is expected to be in the range of 23.5 to 24%. Net income diluted earnings per share growth are now anticipated to increase approximately 7. And adjusted net income and adjusted diluted earnings per share are expected to grow approximately 6%. For the fourth quarter, as you can do it when you plug in your models, you can see that the guidance implies we're anticipating the total revenue will decrease modestly, and operating margins will be approximately 32%. We monitor a variety of leading internal business indicators to drive this estimate. Let me just provide some thought on that, and then I'm going to talk about next year. So we look at leading indicators, and as I'm sitting here, I have a 42-page a document from our data analytics group that tells me a lot of stuff about what's going on in the business. Not everything, can't forecast all of the future, but we see what's happening in real time. We, through the middle of March, were not seeing significant impacts. Marty mentioned earlier that we were monitoring key metrics, didn't really see significant drops. And then towards the last, the second half of March, we started to see the impacts on the business roll through. We've incorporated as much of that into the guidance in fourth quarter as we can. We think we have a reasonably good handle on what's going on. But you also temper that with experience of both what happened in 9-11, because that was an endogenous shock that was more short-lived, And then you also balance that against the 08-09 recession. So all of those ideas are part of the information we're triangulating to get not only to fourth quarter, but to the next year, which I'll talk about in a second. It is, for many of you, as you know, it's as though we are on the LIE expressway on our way to the beaches. You know there is, the traffic is flowing smoothly, but you know there's a stop ahead. What you don't know is, those of us who've been caught there, whether it's a two-hour stop, a three-hour stop, or something longer. And so we know a stop is coming. We expect that impacts will be felt in April and May for the remainder of this year. We've estimated them as best we can, but circumstances can change, especially as more states decide to go on on full lockdown. So with that, that analogy, and with the caveats that I just am about to mention, let me talk about next year. We typically give at least a preview of where we expect next year to be. And we won't bail out and say it's too early to say anything, we know some things and we'll give we'll tell you what we know. We will give guidance during our fiscal 2020 in the fourth quarter call in June. So our intent is to provide you with guidance that's more complete then. But let me tell you about our thought process based on everything that we're monitoring. And again, we're early on in the process and subject to change. By the way, shout out to Accenture. They went first. They said what they could, and obviously circumstances have changed. I am certain that when others report later, circumstances will have changed. They'll be in possession of better information, but this is what we have at this point, and we'll share it with you. So based on the leading indicators that we have, and then based on modeling on the impacts of the business in other business contractions, on a very preliminary basis, our thought process is that total revenue is going to be flattish to down low single digits for fiscal 2021. This scenario, remember, includes the impact of the most recent cuts to interest rates, and so that will impact total revenue growth next year. We're anticipating at this point that impact will be somewhere in the range of about $20 million off of where we end this year. That part, we have some some understanding of, but obviously if the Fed decides to go negative, we'll have a conversation about that. Looking very preliminarily, we would anticipate that operating margins will be somewhere in the range of about 35%. We would obviously manage the business to that, and our tax rate before discrete items will remain consistent with fiscal year 20. I just can't emphasize enough that this is preliminary subject to change. At this point, the scenario that we see unfolding is significant impact in Q1, followed by some improvement in Q2, moderate improvement through Q3, and then more of a recovery in Q4. That is consistent with the shock that we saw when we went through 9-11. We continue to update our information every day, literally, and wanted to give you at least an understanding of how our thought process is going at this point. So with that, I will turn it back to Marty. One thing I would say is we want, I get a lot of questions at the end. Why don't you guys just stop taking questions at a certain point? We will not do that. We'll answer every single question you got. The only issue I would ask is that you keep them brief and focused. If someone's asked the question before, unless you need clarification on it, please don't repeat the question so everyone can have a chance to talk before our voices give out. So with that, I'll turn it back to Marty.

Great. Thank you. Lisa, if you could now open the call to questions.

At this time, I would like to remind everyone, if you would like to ask a question, please press star and the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Ramsey Ellison with Barclays.

And for taking a stab at guidance in a really difficult environment. We appreciate that. I wonder if you could go into a little bit more detail in terms of the expense levers and the different levers you have in your business. to sort of manage, you know, to protect the bottom line in adverse scenarios. What do you have that you can kind of – dials that you have that you can crank to kind of get where you need to get to?

Yeah. So, you know, like most service businesses, 65% of your costs are people costs and 35% are variable costs. we obviously will go right after as much variable cost as we can, and then we'll look at where there are other opportunities. I think that's the order in which we'll do it.

Yeah, I think with the changes, when you look back to the financial crisis of 8 and 9, we were very quick to react there and yet keep full employment of the people that we had, given some of the turnover that we had and so forth. I think we have a pretty flexible ability to keep a focus on the margins, as we always have. As Efren said, you know, we've always led by far the industry in margins, and we certainly keep a close eye on that.

Okay. And my second one is on the PEO and insurance segment in the quarter, can you parse out what growth would have been there without the OASIS stub? And then just more broadly, in the insurance part of your business, can you talk about sort of, you know, risk management strategies in the context of the environment we're in? And I'll hop back into the queue after that.

Okay.

So I'm going to ask you to repeat the second question to clarify what you're asking, because I think – the way you asked it, I can answer it in a variety of different ways. But if you look at PEO and insurance, I'm sorry, the PEO business, we would have grown about five, mid-single digits, I'd say, in the PEO business in the third quarter. The second question I didn't get, I didn't understand.

It was just basically in terms of the insurance part of the business. Maybe I'll rephrase the question and just sort of ask it as How do you see that business sort of – have you seen preliminary signs in that business of any type of deterioration in terms of leading indicators? And how do you go about managing, you know, risk in that side of the business throughout a downturn? Maybe I'll leave it to you to answer it as you would.

Yeah, yeah. Let me just explain why I'm pausing. So PEO and insurance – I've mentioned this to many of you. is both the brokered insurance business, which is roughly, call it, 18% to 20% of revenues in that category, and the PEO business. So that causes sometimes confusion when people look at it. On the brokered business, we bear no risk. So the short answer to your question, which I don't think is what you're asking, is that it really doesn't have much of an impact. The softness in the insurance I keep calling out is really the softness in the workers' comp insurance portion of the brokered business, not in the PEO. I think what you're asking is, if I understand the question, is how are we monitoring the at-risk portion of the insurance in the PEO? I think that's the issue. So the short answer to that is that it's predominantly in the state of Florida. That's one. So number two, we look at medical loss ratios, and they have been running very favorable. And the third is which requires a much more understanding of the way we operate the PEO, we don't anticipate that we will make insurance, make a profit on the insurance portion of the at-risk, particularly health insurance. What that means is that we are very cautious and very conservative in the amount of reserves that we provide. So the short answer to your question is that we've stress tested that population, which again is primarily in the state of Florida. By the way, just if you want to know, the average age of that population of worksite employees is about 38. What would happen if the medical loss ratio increased by 10%, which would be significant? we are still in good shape from a reserve standpoint. So the short answer is we're constantly monitoring our medical loss ratios in that population. We adjust reserves as we think appropriate based on the experience we're having. And at this stage, we feel we're in pretty good shape. If you are relying on on that portion of your portfolio to generate profits, you put yourself in a more complicated situation because your reserves may be lower than you need at this point in time. So that's my explanation.

I think the only thing I'd add to that is any initial view on the PEO side is actually very active on the HR and insurance side. And we've done, I think, a very good job on the diligence, the underwriting, and that's going to certainly continue. And so we haven't seen any uptick in claims, and Efren said how well we manage that and are very tight on that to begin with. But we've actually seen a lot of interest on the HR side, obviously, with the complexity of the regulations that are coming out, both the PEO and ASO part of our business, our HR outsourcing We're the only one with 600-plus HR specialists around the country that are handling these clients, and the interest has grown very quickly. So the initial piece is there's going to be a lot of need for the HR support, not only at the beginning of this in case I have to shut down temporarily, et cetera, but how do I handle the support payments? How do I handle small business loans? What do I do with payroll taxes? You know, all of those things.

That's tremendously helpful. Thanks so much.

Okay. You're welcome.

Your next question comes from the line of Kevin McVeigh with Credit Suisse.

Great. Thank you so much. And thanks for taking a shot at 2021, obviously, in a fluid environment. Hey, Efren and Marty, just a couple of thoughts on kind of semantics. Because obviously it feels like just the shock is much more abrupt. Is there any way to think about if somebody gets furloughed versus laid off, how that impacts kind of the business model? That was my first one. And then just what type of kind of unemployment rates are you still in in that 2021, if there's any thoughts around that?

Yeah, let me start on the first one. I think it is really important. Right now, you know, we're able with our new Flex technology, we're able to actually survey clients who are in our app. And we've had a tremendous response just in the last four days asking them what's the impact to them. And we're seeing that the vast majority of small businesses and mid-sized businesses is the fact that, hey, about 50, over 50% have had minimal impact at this point. And then another 40% have basically furloughed. Our hope and our word tracks from our payroll specialists on the service side, our salespeople, are, hey, if you can stay in business and keep somehow either furlough or, you know, keep paying your employees if you can, there's going to be support. It certainly looks like there's going to be help coming, whether it be the small business loan project. That's why we pushed also to offer our assistance. We have all that information. We know the direct deposit accounts in the banks. we could quickly continue to help our clients pay their employees six weeks, eight weeks, whatever the government wants to do, and then just take that money from a government loan fund versus the client. And I think that's the quickest way to keep these businesses in business. So it is really important. And I'm seeing right now, at least the leading indicator, is that Small businesses are trying to hold it together, maybe lay off or furlough a few people, but maintain their business model so that kind of depending on how long this is going to go. And if it doesn't go too long, they'll be able to bounce back. Remember, just two weeks ago, we had full employment, and it was the biggest challenge for small businesses was finding people to fulfill the demand. I don't think that the demand in many places works. will actually change, and I think it will bounce back fairly quickly. People are going to want to get out. They're going to want to get back to restaurants and use services. They may do it a little bit differently in how they stand close to people, but I think they still want to get out and use services. And so these small businesses are trying to hold on to their employees, and that's going to make a big difference in how many clients are lost and how many checks we're cutting.

Hey, the second question, Kevin. So let me just say broadly, many of our clients, if you look at our, on the payroll side, I'm sorry, management solution side, and you ask yourself, when you look at our revenue, how much of it is based on a PIPA model? What percentage of revenue is PIPA versus subscription? In our case, and there's certain, there's a general rule of thumb, is about a third is people and two-thirds is subscription. We assume that in the next several months, the drop in pays per control will become, will be severe, will be pretty significant, I should say. I don't know, severe, you know, I know you're asking a question that everyone is. Does unemployment go to 20% to 25%? I don't have a good crystal ball, as no one else does, but I can tell you that, you know, the way we've modeled it, we see some significant contraction coming in the upcoming months. We'll see how long it lasts. We've done the modeling and think we've got at least a reasonable handle on it. So I would say significant over the next several months.

Great. Thanks again. Be safe.

You're welcome. Your next question comes from Ryan King with Deutsche Bank.

Hi, guys. Just want to ask about a bridge maybe going from the six or so percent organic growth level that we're at today down to the slightly negative growth in the fourth quarter and then for next year. Just thinking about what's in those assumptions, including bankruptcies and other things that drives it to those levels.

Yeah, our assumption is that there will be client losses in the base, that there will be lowered pays per control, and we've modeled it based on what we've seen in prior recessions. And then we've got to figure out, you know, my bad LIE analogy is just simply to figure out what's the duration of the traffic jam until that happens. that resolves, then the question is what's the sharp rebound, how sharp the rebound is, and we think it ends up coming back towards the end of the year. Brian, I can't give you a bridge that says it's 6% this, 3% that, because frankly, the modeling is early on that. All I can say is that we've looked at the client base, stressed it, assumed certain certain impacts, particularly for some of our payroll client base, compare that against what we saw in previous recessions and come up with our best estimate. But we do anticipate that there obviously is going to be an impact to the client base and there's gonna be an impact on pays per control. And I would just caveat it with one thing, which Marty said earlier. To the extent that the downturn is severe but more short duration, then our assumptions start to change. And to the extent that the downturn is both severe short-term and the government stimulus, which they're working through now, helps to keep some of those businesses in place, it also helps our projections. Don't have any way yet of being able to figure all of that out. We'll see in the upcoming days what it looks like. That could have, and I emphasize, could have some impact, but it's too early to tell.

And, of course, I already mentioned the interest rate changes is in that as well. That's a known, that's more of a known item.

Yeah, I was going to ask that as my follow-up is how did you account for the stimulus? You know, they're doing a lot for SMBs to try to prop them up and keep them alive. So is that modeled in as well, or do you just model in as if there would be no stimulus?

I think it was pretty high level. You know, Brian, we modeled some, I think we were trying to be a little more conservative on who would go out of business and on the checks because of that. But it was pretty, it's pretty high level. And you didn't know where the stimulus is going to be and how long it's going to take. I think that the thing that's so important that we try to get across, I think the government's taken some great steps very quickly. This one you know, could go faster. If you do use someone like the payroll processors, I think could be very quick. Or if you have to go through a loan program, it could take weeks. Those weeks are very important to how this happens, I think, to keep people employed and being paid and businesses in session. So I'm very hopeful that they will do something faster because of the way they've done it already and that that keeps these businesses running.

Okay, thanks for the comments. Stay healthy.

Okay, thanks. You too.

Your next question comes from the line of David Tuga with Evercore ISI.

Thank you. Appreciate the preliminary 2021 outlook. Could you dimension for us your revenue exposure to some of the most affected industries like restaurants, just broadly food service so we can, you know, think through 2021 in terms of the framework that you gave?

Yeah, let me start and then Efren can jump in. I think it's definitely, you know, I'd say restaurants in general and those groups are probably around five, you know, five or six percent of our base. And so it's not as big as some might expect. So I think that's going to be helpful. And those are the industries that you're seeing, obviously, the most impact in someplace like New York State and other states that shut down the restaurants. you know, completely. It also depends, as Efren has said a couple of times, how long does that happen? Do we try to start to open those back up in a few weeks with even the partial, you know, with a 50% rule or something else? How do you – you know, how long do you keep them in business? But I think it's around that number roughly on a client base.

Yeah, you know, David, so there's been, you know, a fair amount of talk about – how this endogenous shock is affecting industries. Marty's right that if you look at essentially hospitality and food services, that's about 6% of our client base. So obviously that's impacted pretty significantly both on the payroll side and on the PEO side, but it's 6%. If you look at everything else, for example, oil and gas is 1%. and everything else is distributed in a distribution that looks pretty similar to what the broad economy looks like. So we don't have significant exposures to one industry or the other on our payroll client base.

Yeah, one of the real positives, as Efren mentioned about our model and our financial strength, is we don't have any direct, any large clients. percentage in one industry, SIC code, you know, or region. And so that allows us a lot more diversity across the base, the type of businesses, and so forth.

Understood. Just a quick final question. You noted that the business really started to experience impacts in the second half of this month versus the first half. Can you share what you saw in the second half in terms of quantifying the impact on KPIs?

Yeah. So what we saw was, you know, so I was looking at, we were looking at people running payroll, and we weren't seeing any impacts. And it looked like clients to us were either staying at current, with their current processing routine, or in some cases they were accelerating the processing because they were in the process of either downsizing or in some cases closing. But that didn't give us enough data, so we went back into the other data that we had on time and attendance systems. We triangulated time and attendance systems, we triangulated marketing leads, sales activity, and we saw significant drops starting as the rollout of state closures or state lockdowns accelerated. So that's where we saw the impact. Now, the good thing about that is that we can see what the impact is and we can see the change in the demand environment. the question is how quickly we come up out of that. Obviously, New York is not going to come out of that quickly. The question is what happens with other states that have gone into that place.

One of the interesting things is while we've seen leads drop off on the front end, but then there's been other pieces that have picked up. So they're definitely down, but they're not like shut down. They're down double digits, but not as much as you might have even thought. So people are still looking for, and maybe because of this, looking for payroll support, HR support, insurance, you know, those kind of things. So they're also finding that, frankly, this is the time that they better go with an outsourcer and that they would want to go with somebody who's national and has the support and service teams that we have that are segregated across the entire country and that can provide great answer performance and support even with 15,000 people working from home. So I think there's some benefits to the strength of who we are in our experience level at this point in time. Thanks so much. Stay healthy. Thank you, David.

You too.

Our next question comes from the line of Stephen Wald with Morgan Stanley.

Good morning. Thanks for taking that question. I appreciate you trying to provide as much guidance as you can here. Just maybe following up on some of the conversation you just mentioned about the down double digits on the lead, but things aren't completely frozen. As we think about the developing competitive environment as we go through the trough and come out of this, How are you guys thinking about positioning that? Obviously, you've made a lot of investments on the OASIS side to get that fully staffed up from the sales side. But when we think about things like waiving fees right now to offset pressure the clients may be receiving or the fact that you may have some pricing competition from the very crowded market, how are you guys thinking about that over the next 12 months?

Yeah, you know, I think it's a lot more about are you positioned to help the clients through this difficult time? That's what they're looking for. You know, some clients – are going to be looking for, hey, can you do something to help me in the short term on price? But, you know, our prices, you know, frankly, as a cost to a small business or mid-sized business is not that big compared to the other things that they're concerned about. What we are finding is our strength in telesales, for example, is making a big difference. So, you know, we've been selling telephonically for some time, generating leads that are then picked up and handled telephonically with the conversation, the demo and the sale all being done over the phone and even to some degree when you look at your payroll online all by the client in self-service mode, we've retrained and added training to the field sales force on handling those calls remotely. So, you know, being able to talk to clients that don't want to meet in person, but to do that over the phone, to be able to demo the product, and sell and complete the sale. And of course, with some of the features that we have with document management we've had for some time, everything can be done electronically, electronic signatures, moving the documents back and forth, and of course, electronically onboarding someone to start them up, frankly, in a matter of a few hours. So I think what we're focusing on is, all right, all of our marketing and so forth is how we can help you through this. Here's the service model we can give you. Here's the product and feature set. that can help you when you think of how strong our mobile app is. We're seeing increases in mobile app utilization because many clients' employees are remote and they're able to use the mobile app. The investments that we've made are really paying off from that standpoint of mobile app learning management. They can give training to their employees online. Of course, direct deposit, pay on demand can help them if they're only part-time or they're in short shifts and they need cash. So we're positioning this as more of the value that we're providing, and then if there's, you know, something that comes up specifically, we'll talk to the client. But it's not been as much about price as it is, hey, are you the full service provider that can help me through this period of time versus someone else that I have that's not as experienced and not as strong financially.

Got it. That's helpful. And then just maybe a quick sort of two-parter. I know, Efren, you mentioned the 42-page report you have sort of running through how to think about this. If we go back to the prior downturn, I believe retention rates dropped towards the mid-to-high 70s. How are we thinking about that relative to the financial crisis? But also, someone had asked previously about the exposure to industries and how you're thinking about it versus prior downturns. If we cross-section it and say, you know, a restaurant in the Permian Basin, that's more than just being exposed to oil or gas. How are you guys thinking about this?

Yeah, so good question, Stephen. And I would say we'll go into more detailed analysis of that type as we're going through the plan process. You know, we're right in the middle of it right now. So we'll do more work in that way. And by the way, the analysis we have looks at exactly those kinds of things. But, you know, coming back to your question, when we – in previous standards, and now I'm going to go back to 08-09, we started from a retention place that was lower than – or, yeah, it was lower than where it is now. If we would have continued on the same track we were on through the third quarter, we would have had record retention. I mean, we were aiming towards a really, really significant improvement in retention through the third quarter. And if you would have said to me when I started nine years ago that we would hit that number, I would have been surprised. Because we were typically in the high 70s. So we start from a good place. So that's the first part. But you have to stress it based on the change that you saw in different environments. And we've taken our best estimate at what that will be. So... So that's where we're at right now, looking at it versus the modeling or the actual experience of previous recessions. I think we've got a good handle on dimensioning the range, and then we can overlay what'll happen by industry. But to Marty's point, I think there is an assumption that we're very exposed to restaurants. We certainly have a certain amount of those in the base, but it's not all of the clients that we service by a long shot. Now, I will say that for payroll, it's a little bit different for PEO.

Yeah, and Stephen, I guess I just – it is so determined on what Efren said about the length of how long this goes, and then is the stimulus package, you know, going to help them through the first couple of months – And then does it go another two months, three months, or so forth? You know, with the financial crisis, it went longer, certainly, I think, seven quarters or so. And so if there's something that can hold them on and they can still get business, even if it's takeout and they can furlough a few people but get support on their payroll, it could make a huge difference. So we've done some initial modeling, but we really need to see kind of how the next couple of weeks even play out.

Got it. Thanks, and stay healthy. Thank you.

Your next question comes from the line of Kartik Mehta with North Coast Research.

Hey, Efren and Morty. Hey, Efren. Thanks for at least trying to put together some kind of FY21 guidance. And I'm wondering if you could just give some of the assumptions you're making on pace for control or retention, some of the metrics that you usually talk about, to get an idea of what the backdrop is for your FY21 guidance.

Yeah. Cardick, I can't get too specific about that at this point, but I would say that generally, I'll give you kind of a framework that we're modeling drops and pays for control consistent with some of the effects that we saw in the previous two contractions. So we're using that as a guide for what at least the next three, four or so months look like. And as I said, I think we're going to have severe impacts absent whatever the buffer that the stimulus provides certainly through the summer into the early fall. So that's one, and then in terms of clients, we've used that data as a reference point for how we're trying to think about or create a framework for next year. I think many of you have that data, understand what I'm referring to when I say that. So we've incorporated that, and obviously need to have a framework as we go into next year. So that's – I would say at a general level, that's what we're using.

And then, Efren, at the beginning, you and Marty talked about the balance sheet. I think, you know, one of the benefits you have is you have an excellent balance sheet. And I'm wondering, your thoughts on share repurchase. Would you – do you feel comfortable enough that you would want to go back when it's appropriate in the market to buy back shares – Or are you at this point, want to wait and see how things progress for the next couple quarters before you would want to go in the market and buy back shares?

Yeah, Kardec. So one of the things that's challenging in an environment like this is in the absence of any other concerns, you would think that now's the time to start getting very constructive on share repurchase. Because we obviously think that... the business will bounce back, and we're highly confident that that's going to occur. So that's the one side of the thought process. And I would say, by the way, this also, my thought, the thoughts I'm expressing also apply to the portfolio. But you have to, and I've been through this before, where we had an endogenous shock in my prior life. You have to worry about making sure that there are absolutely no questions about your liquidity. And I mean absolutely. People depend on the dividend in this company. We protect that and don't want anyone to think that there is an issue there. And so shorter term, until you have a very clear perspective on where you are, you protect liquidity in the short term. you ensure that capital markets are functioning the way they should, and then you make decisions. So there are those considerations that we play through, and I would say right now we are ensuring that there are no issues on that. Not that it would be given our cash flow generation, but it also, Carter, extends to things like extending the duration of the portfolio in order to get more yield. Right now we are not assuming that we're going to do that because at this stage of the equation we put a premium on liquidity, not that we have any issues with that. I just would just reiterate we have undrawn revolver, we have almost a billion dollars worth of cash and So there's no issues there, but you've got to balance all of those pieces in terms of before you start thinking about getting constructed on share or purchase. There may be a time we'll talk with the board at the appropriate time and have that conversation. It probably is not now.

And then just one last question, Marty. Marty, when you looked at the previous recessions, was there, when we came out of it, did you see more small businesses wanting to go with, an outsource provider either because of what happened or they're looking to save money. So, in other words, as we come out of this, could you see maybe an acceleration in sales because you have businesses that are not using outsource services wanting to use the service?

I don't think we saw, you know, I don't remember seeing that much of it, Tardik, at that point. But there's a couple things that are very different in this shock that I think can help. One is the... Government stimulus packages and the regulation changes are very complex, and I think more businesses will say, if I'm going to take advantage of that or if I'm going to start my business or reignite my business and take advantage of some of the things that are out there, I cannot follow that. I need outside support. And so I think that's going to help more businesses say, if I haven't outsourced before or if I've outsourced to a small provider that can't provide that kind of guidance like we can, hey, I'm going to go with somebody. Second, it's so different from a technology perspective, as everyone knows. You know, back then it was not all of the mobile apps. Imagine where we were 10 years ago. There was no mobile apps, really. There was no remote working, very little remote working. all of the things that businesses now, and by the way, their employees are getting used to, and those that you might employ or retain are getting used to. What can you do with a mobile app? Can you provide online training? Can you provide pay on demand? Can you provide your 401K balances and loans online? Can you do all these things online, connect with your employees? It's such a different environment, and I think This is going to change the workforce permanently to say, wow, I've seen these things that I can do remotely and through self-service. I want part of that. I don't want to necessarily do old school, you know, somebody writing me a check or handing me a check even. I think all of these things are going to get people used to a whole new world, which are going to drive more people to the technology investments that we've made. So I think there's two very positive impacts here as we come out of this that could say, more new business startups and existing businesses that reignite are going to be looking for someone, you know, like us.

Thanks, Marty. I really appreciate it. Thank you, both of you.

Take care. Take care.

Your next question comes from Ryan Bergen with Cowan.

Hi, guys. Thanks for the early guidepost here. And Efren, I appreciate the LIE analogy. Thank you for that one.

All I ask all of you is to remember when I was wrong that I at least tried. I led with my chin.

There you go. I wanted to ask, just from a business mix standpoint, can you just give us some color on where you're expecting the most and the least pressure as we think about PEO and management solutions and then the various offerings within management solutions that are most and least insulated here?

Yeah. So one thing I think we should mention, I think it's been – is part of the, I guess, the backdrop. Just take off from what Marty said, build on what he said. You know, we're a very different business than we were in 08 or 09. At the end of this year, about half of our revenue or less than half of our revenue will be payroll. If you split our business, about 80% of our client base is under 20%. But our revenue is split pretty evenly below 20 and above 20, 50-50. So that's a very different animal than we were in the 08-09 timeframe. And while we do apply that thought process to how we're looking at the future, there are some differences. I think we could see, we could very well see, to Marty's point, increased demand for anything HR services related. And by the way, if I slice now the Rubik's Cube, you can't slice the Rubik's Cube. But if I slice our revenue, about 50% of our revenue is derived from HR-related products. So you could very well see an increase in demand, to Marty's point, given the complexity of what Congress is about to unleash. And let me tell you something. Emails fly every single night here about what's in the bill, what's out, what the implications are. There's lots of good things in that bill for businesses, but it requires interpretation. So I would say from an HR standpoint, you could see increased demand, which Marty's been talking about. And then where we see more stress is on the smaller businesses who, if they don't get a lifeline over the next six to eight weeks, are going to be severely impacted and stressed. So I would say in broad strokes, higher demand for HR and related services. That could include PEO, by the way, because we'd include that in. and more impact on smaller clients simply because of the depth and the severity of this correction.

Okay. And then just payroll tax holiday implications. We've gotten a question, so curious here. How should we think about the impact from a potential payroll tax holiday that might be in this final stimulus bill?

Yeah, I don't think – You know, from a standpoint of interest on client funds, you know, that we withdraw and then pay those, pretty small. Of course, we won't earn much on it anyway because there's no interest. So I don't think it'll be a very big impact at all.

Yeah, so I thought you were talking about what the business impact, whether we think that alone would drive, you know, some significant improvement. I think you're going to have to go deeper than that to really make an impact for most clients. But Marty's right. If that's a question related to interest on fund sales for clients, I think the Fed's kind of helped us there in a weird backhanded way. So it's not going to impact very much.

Okay.

Thanks, guys.

Okay. Your next question comes from the line of Andrew Nicholas with William Blair.

Hi. Good morning. I just wanted to talk a little bit about kind of the administrative challenges tied to affecting fiscal stimulus. I'm just curious, given how close you are to that market, what thoughts you might have on the most effective way for the federal government to handle that initiative? What would seemingly be a very difficult task given just the sheer number of small businesses in the U.S.? And obviously, it's important how fast it's handled. So, I'm just interested in and your thoughts on the challenges of affecting that change.

Yeah, I think if you look back at, like, 2008 and 2009, and, of course, not even close to the amount of stimulus that is being done now, you know, things took – I think the average time it took to get a check or money to small businesses was, like, 50 days. We went back and looked at it. So it was roughly a couple months. That needs to be so much faster now because of, in particular, the shutdowns that have occurred in many states of small businesses. They need to pay the rent. They need to pay employees to keep them with them because you're going to come back, I think, to a pretty good employment. You know, two weeks ago I said it's amazing. Their biggest issue was how do I find employees to fill my jobs, and now I want to keep them. So I think speed is such an essence and I do think that we could, you know, payroll processors could be such a help because we could immediately continue to pay that payroll that we paid last week or the week before and then just look for those funds from, you know, a government program, the SBA, whoever. I mean, however they do it is fine with me as long as they give that backstop and it does look like they're going to do that. to give that payroll. But if it's a long SBA loan process that takes paperwork, et cetera, et cetera, that's not going to help as many. Many you've seen have already laid off employees across the country, whether they be hotels or whatever. And I think they got to move really quick. Administratively, one of the great things with our size and our experience is that we have over 200 compliance specialists. Our compliance people have been on the phone with the federal government, Congress, the Treasury, the IRS, you know, the SBA, you name it, and are working with them not only to answer their questions about what could be done, but also trying to help say this could be the fastest way to do something and so forth. And so we're very supportive of the work that the government is doing, and we're very much in touch with them. And we think we could turn it around pretty quickly. You know, we have a lot of resources, 1,500 people in IT, And we've been talking daily, and they understand that depending on what comes out, we're going to – everything gets turned to that. Our first thing is to comply with these regulations and be sure our employees and our clients and their employees are taken care of.

Great. Thank you. That's encouraging. And then as my follow-up, obviously there's a lot of moving pieces right now, but I just wanted to get your sense for the impact social distancing and working from home may have on your sales force's ability to sell new business, particularly within PGO, where you have enough white space that maybe a material slowdown in new business starts is less of a headwind. I'm just curious if you'd expect the sales cycle to lengthen, to slow considerably, just on account of less face-to-face interaction, all else equally.

Yeah, it's kind of a mixed situation. While we said leads were down a little bit, there's still pretty strong lead flow coming in for payroll and HR. And because we've had so many years of virtual selling, we have a lot of experience in selling, which I mentioned earlier, we have now taken that training that have been used for virtual sales, which, by the way, is virtual sales is lower cost and pretty productive from a web lead perspective. And so we're now training the field sales force. Hey, here's a way if you have to do it remotely and someone doesn't want to meet, here's how we demo the product. We can use the same tools for the field sales force where they would have demoed something in person. Here's how you can do some things online. And the good news is everything can be done electronically. So you don't have to be in front of a client to have them sign something necessarily. A lot of the document management can all be done electronically. and kind of a DocuSign kind of features, and then all of that sent to remote onboarding specialists who can set up the client in a very short period of time. So it certainly has some impact in clients not wanting to focus on it right now or meet in person, but I do think that we have a vast amount of experience in a very effective virtual sales team that will continue to grow, frankly, and the field sales force is finding ways to get in touch with their clients, get in front of their clients through email, through chat, through calls, and they're very receptive to that and appreciative that we're here. It's amazing that many clients or prospects think that because you're home, they're not going to be able to reach you. That is not the case at all. We've never lost any contact with anybody, and as I said, our IT team has done a tremendous job in moving 15,000 people remote and then being able to handle it.

Great. Thanks a lot for taking the question and stay healthy. Thank you. You too.

Your next question comes from the line of Jeff Silber with BMO Capital Markets.

Thanks so much. And I really appreciated your remarks at the beginning, especially the segue from being human to talking about finance. Yeah, thank God. Just one quick question. You talked about how, I guess, your business or your customer-facing business is different now. I'm just wondering internally when we compare your business to the prior shocks or the prior recession, is there anything different? Is there more of a variable cost structure than you had before? Any color would be great.

Yeah, and I'll let Marty talk about what substantively is different in terms of how we operate. But I think, look, if you're in a service business, I said 65% people and 35% variable, which is an in-app comparison. It's 65% people and 35% other. Not all of that is variable. I would say that we've moved the cost structure in such a way that more of that cost structure supports the other parts of the business, I would say that structure, you guys who are, or you, should say you guys, but you who are analyzing it, know that that's the way most, the split of cost that most businesses have. It's distributed differently. And so the implication of that is that we don't have as many costs tied up in one part of the business that we had during the last downturn, and we've got a little bit more diversification across the cost base so that we support more business that is not purely payroll. Nothing wrong with supporting payroll, but as I said before, half of our business now is HR-related.

Yeah, and then I think just from an internal flexibility, we're on a unified, what we call unified communication system that we've installed over the last number of years. And so we can easily move calls all across the country, even to which we have never tested before. Having all of these people work from home, it's an incredible technology difference than it was in the last shock. And you have a lot of flexibility to have teams in different areas and move teams around and so forth. So there's a lot of flexibility here as to how you Control costs, how you look at your employee base and give them support tools. And we've always been good, obviously, at controlling our costs. And I think, you know, having a great focus on margin, and we'll continue to do that, and there's probably as much or more flexibility now than there ever was.

Okay, that's helpful. Thanks so much. Okay. All right, sir.

Our next question comes from the line of Samad Samana with Jefferies.

Hi, good morning, and thanks for taking all of our questions. I really appreciate it. It's running kind of long. Efren, maybe just one quick question for you. I know you guys mentioned a couple of different anecdotal comments about what you've seen in maybe the second half of March, but if I could maybe triangulate a little more precisely on a new booked business, what have you seen happen in terms of new bookings over the last couple of weeks? And then what new bookings type of assumptions are you making for fiscal 21? Thanks again for taking my questions, and hopefully everybody's families are safe and healthy.

Yeah. Hey, Samant. So we wouldn't give precise info on bookings, and then we wouldn't typically give precise bookings on what we anticipate. But I think we all know that given lead flow, bookings are down. And given what we expect in the remainder of the quarter, we also expect them to be down. Do we expect them to fall off a cliff? Absolutely not, for many of the reasons that Marty said. If the stimulus gives a jolt, it may actually be helpful. There are things in that package that may cause the businesses that are there to book other services, even if they're not booking basic payrolls. But this is a challenging environment for sure.

Maybe if I could ask just one from a competitive standpoint. It sounds like price was able to stick during the F3Q. I'm curious if you've seen a change in competitive behavior, either pricing more aggressively to capture as much business as possible before the gears start to slow down, or maybe just how are your competitors reacting from a pricing perspective in the current environment?

Yeah, not seeing – you know, there's some free months here and there, first three months of this service or that service, but not seeing too much too aggressive yet. Does it get more aggressive? It may. On the other hand, I think when you look at it, again, as I mentioned earlier, I think businesses are worried about a lot more than – you know, when you think about our average business that might pay a couple thousand dollars a year, $2,400 a year, $2,500 a year, they're looking for, you know, whether they save $200 or $500 is not that critical to them right now. It's, hey, can you give me the service and can you give me the service that I need, the service, excuse me, and the products that I need to survive in this environment. So, I'm sure we'll see a little bit more discounting here and there, but frankly, it's a little bit misguided in the fact of what clients are looking for, in my opinion.

Yeah, to Marty's point, you know, it's easy to overlook it, but when you have response times measured in seconds, I'd ask you to ask all of our competitors what their response time are. Service may not seem like it's all that important in other environments, I can tell you based on the interactions we're having, we could post all of the comments that we've gotten from clients about how responsive we've been on the website. It's going to become very, very critical. One of the things that we're very proud of, and Marty said it earlier, is that we moved everyone to work from home, and our service times have been tremendous, and our response times to clients have been tremendous, and they are asking a lot of questions. And if you can't get to them and you can't service them they're probably going to have some second thoughts about whether they continue with you.

Great. Thanks again for taking my questions. Be well. Okay. Thank you, too.

Your next question comes from the line of Pete Christensen with Citi.

Morning, gentlemen. Thank you for the update and certainly for your poignant sentiments earlier. Good news, I think we're hearing that – In the bailout so far, the stimulus is providing 10 million, up to 10 million for individual businesses and provided no layoffs. So perhaps there's some upside to the outlook here. So fingers crossed and appreciate your thoughts that the devil will be in the details. But I was just hoping if we can go back to that Rubik's Cube very quickly and We can quantify your exposure between hourly workers versus salaried workers and perhaps what you've seen earlier. And then as a follow-up, looking back to the last downturn, it looks like the dividend rate was held steady for quite a bit at risk of pulling the cart in front of the horse here. How should we think about that? Would we expect to see something similar at least over the near term? Thank you.

Yeah, Pete, I don't have much for you on hourly versus salary. I'd have to get that breakdown and figure that out. So I don't have a precise answer on that. With respect to the dividend, you know, look, our earnings amply support the dividend we have. Whether we should increase it will depend in part on the discussion that we have with the board and where we are when we present the plan. We try to peg it around 80% or so. Obviously, in some situations, it might be a little bit higher. So we'll have to go through that conversation with the board in terms of what level they want to set it at.

Thank you, gentlemen. Best of luck and be well.

Thank you. You too.

Our next question comes from the line of Lisa Ellis with Moffitt Medicine.

Hi. Good morning, guys, and thanks for keeping me in. Hi. Sure. A couple questions on workers' compensation, actually. I know we are, I guess, presumably going from an abrupt period where workers' comp claims and premiums were very low to probably the inverse of that. Yes. Can you just remind us, I know the premium going up will actually be a tailwind to your insurance business, but in general, how does that kind of dramatic shift impact you?

Yeah, it would be a tailwind to the insurance business. It would also have a modest impact on our PEO business from a revenue standpoint. Both of those would be positives. On the other hand, where we have some at-risk exposure on the workers' comp side in the PEO, we'd have to monitor that. So I think it's on balance more to the positive side of the ledger, and then you've just got to manage reserves appropriately.

Yeah, and then on that point, the follow-up, because I know we get questions about this. Can you just remind us, I was looking in the K, it looks like your reserve level on workers' comp is something like $170 million or so in total across short-term and long-term. Yeah. And then how is that capped or reinsured again? Can you just remind us, like how much actual risk exposure do you really have? Is that the way to think about it? It's kind of that number, or how does that work exactly?

I'd have to look back. I think we say in the K what we have in terms of exposure. I think it's around a million, I want to say, per case. A million-dollar workers' comp case is a very, very unusual case in my experience. It's capped there, but beyond that, by the way, That's only part of the equation. What you have to look at is the development of claims which we look at on a quarterly basis and add to reserves as they're needed. Our typical workers' comp adjustments are modest and generally we end up in a positive reserve situation. So we should be able to manage well. There'll be no change in terms of the way we manage. We don't anticipate a significant impact at this point.

Got it. Okay. Okay. And then just a quick follow-up one on the attrition. I think you've said in the past that about nine points of your attrition each year come from business is going out of business just in like a normal period. Is that about the right number? And then can you just mention how much worse that got back in 09 or after 9-11?

Yeah. So what you're doing is taking about half of the 18% that we would average. I think it's close. It's somewhere between 8 and 9%. You can, we'll see a spike. I can't call it yet, Lisa, but If we go back to 08, 09, we spiked up to about 23, 24%, but our base was about 20, 21. Most of that three to four was coming from out of business. I'm sorry, Marty.

No, that's exactly what Efren said. Most of that came from out of business. Yeah. Lisa, remember that one went longer. So this one's just kind of hard to measure because we think we're going to have, you know, depending on the stimulus, that could hold the front here for a couple months if it really could help them quickly. And then how long does it go before they open back up or give up and go out of business? So it's going to be very interesting. It doesn't feel like it's going to be as bad as 08 and 09 because that went on for seven quarters and businesses couldn't survive. These, hopefully, they could furlough, they could come back. I don't – I really – it's obviously hard to predict a few weeks into this, but I don't think it's going to be – we wouldn't expect it would be that bad. It might be more – it's going to be more of a shock in the first – probably maybe first quarter of next year, but then bounce back pretty quickly, we would think, at this point.

Terrific. Thank you. Thanks for the comment.

Okay. Thanks. You're welcome.

Our next question comes from the line of Mark McCann with FAIR.

Hi, Marty and Efren. Thanks for squeezing me in, and best wishes to you and your families. With regards to, you know, the stimulus, what elements that you've heard discussed around the stimulus are you most excited about that could potentially have a positive impact?

Well, definitely the small loan program, the small business loan program. You know, anything that, as I've mentioned, that would keep paying employees of small businesses and keep them in place is really important depending on how long this goes. If it's shorter than, you know, if it's shorter rather than longer, that could make a big difference as to whether a business goes out of business or not, and they keep their employees employed. I think also the unemployment benefits is also another way that a small business might say, hey, I'm going to furlough you. I might pay you. There's been different rules discussed about paying half. There's certain rules that are out there about sharing a job where you could – You could keep two people. Instead of laying off, you got two people. Instead of laying off one and keeping one, you could have them job share and then make it up with unemployment. That could have some impact depending on how they handle those regulations. I think anything around supporting small business and employees with their wages is the most important to me. The direct checks can't hurt, but... You know, I'm not sure what that's going to do as much as, from a business standpoint, as keeping businesses going. That's kind of how I think of it anyway at this stage based on what we've seen.

What's your level of confidence that those elements that you cited are going to go through based on all the interactions that you've had?

Pretty strong. Pretty strong. I think there has been very little disagreement on the small business loan program. There has been, we still don't know how they're going to procedurally enact it. That is important, but that's not clear yet. But I do think based on all the discussion, they're going to try to do it as quickly as possible with as little red tape as possible. And that will be very important. But feel pretty good that those things are going to get enacted. They haven't been argued much at all. It's been more the large business stimulus, you know, giving money to the airlines, et cetera, that seems to have the bigger arguments.

What sort of a marketing program could you put in place in order to take advantage of that? Because obviously your capabilities to deal with something like that would be far greater than any independent companies.

Yes, very much so. I've already positioned the marketing to even over a week ago about how we can help you. And we've had webinars that have kind of blown the doors off. from the number of people and CPAs that join those webinars because they want to know about it. So I think we're well positioned from a marketing and training perspective for our clients and prospects to take advantage of those.

Great. If I could shift gears just for the follow-up component, can you just talk about the percentage of business that you have in New York and California and the states that have gone through the shutdowns and what you ended up seeing in those states, you know, during the last days?

Yeah, it's, you know, there's a number of businesses. Not all of them are the small businesses. But I think, you know, I do think it's, you know, it might be up around the 40 or Well, New York and California alone, I don't have that. For all of the states that are shut down, which includes New Jersey, Illinois, and California, New York, of course, we kind of follow the population. So it's probably around 50% or so that are in those. But, again, they're not all small businesses that are necessarily impacted by the shutdowns and partial shutdowns that you're seeing.

Okay. And what were you seeing in the states that are shut down in terms of like the very recent trends?

Very early, but mostly we're seeing more of the, I'd say, you know, I'm furloughing, you know, I'm staying open. I'm doing like restaurants and that stuff. Again, restaurants being 5% or 6%. But that's where you're seeing the most impact. They're saying, hey, I'm going to try to furlough people. I'm going to try to keep my employees, maybe only keep, you know, three of them out of six or 10 out of 20. But I'm staying open so far. And, again, those people in flex in that survey that I mentioned early on, we've gotten a huge response on that. And it's still been 50% are minimal impact at this point. and another 40% are saying, I've done some layoffs or furloughs, but I'm continuing to run. That's all been very good news. What we don't have a great handle on yet is any losses, because you're going to see those more probably next week or end of this week if they're completely going out of business. But more the feeling is, hey, I'm going to try to hang on here, see what the stimulus is, try to furlough my employees so I keep them, and continue to do what I can with minimal staff. Great.

And then one last one. Mark, you're breaking up there. Could you try that again? This is the portfolio composition with regards to the flow balance. What are you seeing there?

You mean securities in the oil industry, Mark? Securities in the oil industry, your muni portfolio. Yes. Solid. We haven't had any issues, haven't seen any impairments of any securities. You know, obviously we invest in very highly liquid and highly safe securities. You know, we had a few in the oil industry, but we haven't had any impairments. But it's a very small part of the portfolio.

Great. Thank you. Okay. Thanks, Mark. Stay safe.

You too.

Your next question comes from the line of Tim Singhong with J.P. Morgan.

Hi, thanks so much for the hard work here. Just on the margins, just wanted to clarify, it looks like you're guiding to, I think, 35 versus the 36 this year. Is that just a function of the decremental margin of... Sorry, Efren, go ahead.

Yeah, so yeah, just want to say preliminarily we see it around 35. Yeah, what's happening, Tingen, is right now my assumption is the portfolio is down around 20 million, maybe a tad higher. That portfolio drops straight to the bottom line without a lot of expense offsets. We assume that we're going to take actions to obviously offset expenses in other areas, but it's hard in the short term at this point off of six weeks of data to say, here's how we go after replacing some of that margin. I would say we're pretty good at it. If you remember 08, 09, we took a tremendous hit on the drop in the portfolio, nowhere near as severe here. and found a way over time to make it up. But, yes, that's one component of what creates the drop in margin.

Okay, that makes sense. So you're being conservative here. If things get a little bit worse, there's room to do more, but you're just calling it as you see it, and then you can move on. Got it. And then just really quickly, I know a lot of people ask good questions on the outsourcing, what happens on the recovery. How about on PEO? I'm curious if we could see a shift there, if people want to manage their – medical side a little bit better, but also I guess there's a risk that your carriers might up prices in anticipation of higher costs, and that might price out others. I'm trying to better understand how you think about PEO here, given that you've put some more capital into that business in the last three years. Yeah.

I mean, that's a great question. So here's how, at least some preliminary thinking on that. If you have a lot of costs rippling through your health care plans, You may not feel them at first, but eventually you're going to feel them, and then your clients are going to be impacted to one extent or another. Through the course of this year, and as we have managed the integration of OASIS, what we've seen is there's a tremendous opportunity to operate a PEO-ASO hybrid model where where you have an ASO with the provision of benefits from our insurance agency, and in some ways, and sometimes, it's better for you to go through our insurance agency on the PEO instead of being on some sort of PEO master plan. So I think you're going to have to figure out some, be flexible and agile in terms of what you provide on the benefit side and what solutions you provide. either one-off through an insurance agency, a master plan, or some other arrangement. So I think what we've seen is that ASO and PEO kind of converging, and in some cases full PEO is the better model for some clients. In some cases ASO is the better model for other clients. So you could see shifts between those categories depending on what happens in each of those markets as we go through the year.

Yeah, I think that's exactly right. You brought up the right thing. We don't know what's going to happen to insurance rates. It depends on how many claims are filed and, you know, whether you have a lot of claims, there's a lot of costs that are going to be covered, you know, like the testing and so forth. So it's kind of early to tell, but it will be that balance. But as Efren said, I think then that can shift toward ASO model. But I think the PEO model will still be pretty strong. I think this is bringing an awareness of insurance plans and employees that There's going to be, you know, this fight for employees again in finding them for your businesses. And I think insurance, you know, could be an even stronger selling point now as an employer who's trying to hire people. So that may bring even more clout to the PEO. It's going to be an interesting balance as we come out of this. We're well positioned, obviously, with both ASO and PEO to do that.

Yes, you got them both. Yeah, I trust you guys will be right on that. Thank you all for the candor. It's very comforting. Thanks. Thank you. Thank you.

Our next question comes from the line of Jason Pupsterberg with Bank of America.

Hey, guys. Glad you're staying healthy. I was just curious, as it relates to revenue sensitivity to changes in certain key metrics, like ADP has talked in the past of, 1% change in client retention has about six times the revenue impact as a 1% change in bookings, just as an example. I mean, should we assume kind of similar types of relationships hold for paychecks or any specifics you'd feel comfortable sharing just so we can, you know, think about the way forward?

Yeah, hey, I would just say broadly, you know, a drop of, you know, a change in our loss rate of about 1%, you know, yields about $25 million of impact at 25, well, 2.5, I'm sorry, 2.5 million. The checks or pays per control are really the most important, so it sounds like It sounds like they're somewhat similar to what we are. But we'll see as we work through our plan.

Okay. And then I just wanted to go back, Efren, to I think answer to an earlier question. It sounded like you guys are assuming a similar amount of deteriorating tax per client and in client retention as you saw the past couple of So, is the reason you're not assuming anything deeper than that just because of the change in mix since those last recessions, like the HR and the PEO mix, or are there other factors?

Yeah, Jason, that's the impact. I mentioned earlier when just providing some color. You know, if you look at our business, 50% of our revenues are with clients that are 20 and under. 50% are clients 20 and over. That's a different mix than we had during the last recession. Of course, there's scenarios where it could get a lot worse than that, depending on how long the downturn lasts. But at this point, that's our best guess on the modeling.

Yeah, again, on the timing, you know, and obviously not knowing that timing, but you could have this, you know, larger drop in checks in the first half of the year, fiscal year, and then come back. And that's kind of how we're thinking that over that period of time, I think over the fiscal year, it might balance out what past recessions have been. So it might be a little stronger in the early part. But I think if the bounce back, you know, everybody has a different view, but if it's you know, a bounce back in the second half, it could be a pretty strong bounce back in checks.

Right, right. So maybe a deeper trough, but I hear what you're saying. And then just last one real quick. Are you relaxing or refunding certain fees to help customers stay afloat or defer price increases or anything along those lines?

Well, you know, we're looking at it. Again, I – We haven't had that much of a push from that's what they're concerned about, and we're focusing really on what they need at this point to survive and get through all of the stimulus packages and the downturn and so forth and the shutdowns. So that hasn't been that critical from a client perspective. Obviously, we're looking at the price increase, and I think it's going to be prudent to to push that out a little bit. And we'll continue to watch that as we go, you know, month to month.

Okay. Thanks again. Okay.

All right, Chase.

Your final question comes from the line of David Grossman with Stifel.

Great. Thank you. You know, I know it's pretty late here. Just one really quick question, just really, really quick. Well, that's one way to look at it, I guess. You know, just quickly on your commentary about your mix of PEPM versus subscription. I think you said one-third PEPM and two-thirds subscription. Can you just help us understand how you get at that?

How you get at that?

Yeah, how you get those percentages. Because it seems like a large percentage of your mix is really driven by the number of employees. So just... want to better understand that.

Yeah, I think it has to do with the composition of our client base, David. And when you're smaller, you tend to have more on the subscription side of the equation. For example, we don't separately disclose sure payroll, but sure payroll is purely subscription. So PEPM has no impact on it. And then It's an estimate on other clients how much of what they're getting is based on PEPM revenue, and that's what it ends up being. When you're smaller, your proportion tends to be more subscription. Larger tends to be more on the PEPM side.

So just as an example, what are the services you're including in that subscription bucket?

I just primarily, it says primarily payroll. So, but that's a big chunk of the management solutions revenue.

Got it. All right. That's it for me. Thanks again. Okay. Thank you.

Okay. At this point.

All right. Thank you. At this point, we will close the call. We do wish the best to all of yourselves and your families and good health to all of you. Thank you for participating. In this call, it will be archived for approximately 30 days. And, again, we appreciate your participation and interest in paychecks. And stay safe, everyone. Thank you.

This concludes today's conference. You may now disconnect.