Paychex, Inc.

Ladies and gentlemen, thank you for standing by and welcome to the Paychex Q2 FY21 earnings conference call. At this time, all lines have been placed in a listen-only mode. After the speaker's remarks, there will be a question and answer session. To ask a question during this time, simply press star, then the number 1 on your telephone keypad. To withdraw your question, press the pound key. Thank you. I will now turn the call over to Martin Mucey. Please go ahead, sir.

Thank you. And thank you for joining us for our discussion of the paycheck second quarter of fiscal 2021 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 second quarter ended November 30th, 2020. You can access our earnings release on our investor relations website and our form 10-Q will be filed with the SEC within the next few days. This teleconference is being broadcast over the internet and will be archived and available on our website for approximately 90 days. I will start today's call with an update on our business highlights for the second quarter. Efren will review our second quarter financial results and provide an update on our outlook for fiscal 2021, and then we'll open it up for your questions. While the first half of fiscal 2021 was affected by the economic impacts of COVID-19, we have been pleased with the results of our business and the sequential improvement over the first quarter in both revenues and earnings. Improvements in revenue occurred across the board, all lines of business. Most of our key business metrics have continued to show steady improvement, though at a more moderate pace as we entered the quarter. We have not yet experienced any deterioration related to recent surges in COVID-19 cases across the country, but we continue to monitor trends closely, especially as new restrictions are being implemented in many states. Throughout the COVID-19 crisis, our business model has proven resilient. Our client base has grown despite economic headwinds, and we continue to see good sales momentum with growth year over year in new units sold. Our digital sales remain an area of strength, and we continue to invest in digital marketing, lead generation, and sales technologies to drive growth. We also see strong demand for HR solutions and HR outsourcing, which we deliver through both our ASO and PEO models. Since the onset of the pandemic, we have seen a greater interest in the ASO model as businesses are looking for more immediate HR support. We are on track for another year of record retention as losses have declined significantly compared to the prior year. Client satisfaction scores continue to improve as we focus on providing excellent service to our customers, supporting them in this most challenging time and helping them simplify complex regulations. We have not let up on our efforts to help our clients navigate this environment, and we continue to educate clients and prospects on state and local specific regulations, which are frequently changing, including the new stimulus initiatives passed by Congress. Our retention team is proactive in reaching out to clients who may be showing signs of difficulty to consult with them regarding available options. And our clients are facing the most complex calendar year-end many have ever seen, and we are here to help them through it. We have expanded our thought leadership not only in the area of COVID-related regulations, but more recently offering information on the 2020 election results and the potential impacts to our clients' businesses. We continue to see demand for virtual events and webinars to help educate clients and prospects in this changing environment. Our financial strength allows us to continue to make investments in technology. Our fall product for launch builds on our track record of innovation and delivers on our promise to make complex business issues simple. We introduce several new offerings and enhancements that help businesses increase productivity, reduce risk, maintain compliance, and adapt to mobile and AI-driven trends. More business leaders are turning to tech solutions to increase productivity in this environment. and respond to the interest of their employees. Our Apple Watch and Google Assistant device integration now allows employees to access their HR and payroll information easily without even logging onto their phone or PC. We also added new features in our performance management system to allow for greater feedback and engagement with remote employees, critical to employee retention and development in this work-from-home environment. We continue to enhance our analytics suite and dashboards. We deliver a user experience that enables clients to define the data that is most relevant and actionable to them, which saves time, improves productivity, and supports better business decisions. We also see positive trends with double-digit increases in mobile and self-service usage as our strategy of device independence continues to gain traction with customers. We recently announced the integration of Paychex Flex with the market leading Clover point of sale platform from Fiserv. Available on the Clover app market, this gives business owners the ability to streamline payroll and time and attendance management. This is another example of our commitment to connect Paychex Flex users with some of the world's leading business tools. We are proud of these innovations and more were recognized by industry experts this quarter, most recently the Paychex Flex platform, was recognized by Human Resource Executive Magazine with an HR Tech Award for the top HR product of the year. The combination of a single device-independent application with HR services and benchmarking capabilities sets us apart from others in this category. We continue to design solutions that add value to our clients. Our new PEO Protection Plus Package helps business owners reduce risk by offering coverage related to cyber attacks and employee lawsuits. Exposure to these risks has been rapidly increasing in the COVID-19 environment, and we are the only provider offering both cyber liability and EPLI coverage as part of our PEO solution. And by leveraging the group plan model of our PEO, the coverage is significantly more affordable to businesses. The COVID-19 environment has also impacted the financial security of millions of Americans further exacerbating the issue of a lack of retirement savings in the U.S. This month, we announced that we are among the first in the retirement industry to sponsor and maintain a pooled employer plan to help businesses nationwide provide a cost-effective retirement plan option for their eligible employees. This offering is an outcome of the SECURE Act, And along with a reduced cost compared to a single employer plan, it will reduce fiduciary liability for employers and simplified plan management. As we move through this period of uncertainty, we are confident that our resilient business model, strong liquidity position, and dedicated employees who are focused on service and innovation for our clients and their employees will have paychecks emerge from this pandemic in an even stronger position in the market with our clients having experienced the full value and support that we deliver. I will now turn the call over to Efren Rivera to review our financial results for the second quarter. Efren?

Thank you, Marty. Before I begin, let me just wish everyone on the phone call a safe and a joyous holiday season. I hope you get some time off to enjoy this Covidian season. we're making of it what all of us can make of it to make it a good time. So let's start. I want to remind you that today's conference call will contain forward-looking statements. Refer to the customary disclosures. In addition, I'll periodically refer to some non-GAAP measures. Please refer to the press release and investor presentation for more information on these measures. Let me start by providing some of the key points for the quarter, follow up with some greater detail in certain areas, and then wrap with a review of the fiscal 2021 outlook. As Marty mentioned, while second quarter results continue to reflect the impact of economic conditions resulting from the COVID-19 crisis, they improved sequentially from first quarter. For the second quarter, Total service revenue of $969 million was even with the prior year. And this was moderated by a lower volume of client employees paid across our HCM solutions. Results improved from a decline of 6% in the first quarter, as you recall. Within service revenue, management solutions revenue started to increase. It was up 1% to $733 million, and PEO and insurance solutions revenue decreased 3% to $236 million. During our October earnings call, I noted that second quarter revenue was anticipated to be down mid to high single digits for management solutions and high single digits to low double digits for PEO and insurance solutions. Our results exceeded those expectations, obviously. Total revenue declined 1% to $984 million. That basically is the impact of further declines in interest on funds held for clients. Interest on funds held for clients were down 25% for the quarter to $15 million due to lower average interest rates. Average investment balances and realized gains Average balances for interest on funds held for clients declined 4% during the quarter, primarily due to lower client fund collections and changes in the client-based mix. That was offset by timing of collections or remittances and some wage inflation. Expenses decreased 3% to $629 million. The decline in expenses was driven by lower headcount, discretionary spending, and facilities costs as a result of our cost savings initiatives, operating income, of 4% to $354 million and reflected an operating margin of 36%, I'm sorry, a 150 basis point improvement from the prior year quarter. As a reminder, other expense NAF for the second quarter includes interest on our long-term borrowings, partially offset by corporate investment income, which was impacted by lower interest rates. Our effective income tax was 22.1% for the second quarter compared to 23.2% for the same period last year. Both periods reflect net discrete tax benefits related to stock-based comp payments that occur with the exercise of stock option awards. As you know, we call those out simply because it's difficult to predict when they will occur. Net income increased 5% to $272 million and adjusted net income increased 4% to $265 million for the quarter. Adjusted net income excludes one-time costs and the tax benefit from stock-based comp payments. Diluted earnings per share and adjusted diluted earnings per share both increased 4% during the quarter to $0.75 and $0.73 per share respectively. Year-to-date, I'll touch on these very quickly. They're in the press release. Service revenue declined 3% to $1.9 billion with management solutions revenue declining 2%. PEO and insurance solutions declining mid-single digits. Interest on funds for clients declined 27% as we bore the brunt of lower interest rates. Total revenue was down 3% to $1.9 billion. Operating income decreased 8% to $638 million. Adjusted operating income decreased 3% to $670 million, reflecting a margin of 35%. Adjusted operating margin, as you know, excludes one-time costs of $32 million related to acceleration of cost savings initiatives, including the long-term strategy to reduce our geographic footprint. and headcount optimization, the majority of which was recognized in the first quarter. The amount recognized in the second quarter was minimal, about $1 million or so from that amount that we had talked about when we initially released guidance. Diluted earnings per share decreased 8% to $1.34, $1.34 I should say, and adjusted diluted earnings per share decreased 4% to $1.36. Investments and income. As you know, our primary goal is to protect principal and optimize liquidity. We continue to invest in high-credit quality securities. Long-term portfolio has an average yield of 1.9%, average duration of 3.4 years. Our combined portfolios earned an average rate of return of 1.3% for the quarter, down from 2% last year. Let's talk about financial position. It remains strong with cash, restricted cash, and total corporate investments of $963 million and total borrowings of $804 million as of November 30, 2020. Funds held for clients were $3.4 billion in line with the balance as of May 31, 2020. Funds held for clients vary widely on a day-to-day basis and averaged $3.6 billion for the second quarter. Our total available for sale investments, including corporate investments and funds held for clients reflected net unrealized gains of $109 million compared with $100 million as of May 31, 2020. The increase in net gain position resulted from the declines in interest rates. Total stockholders' equity was $2.9 billion as of November 30, 2020, reflecting $447 million in dividends paid and $29 million of shares were purchased during the first six months. Return on equity for the past 12 months remained very strong at 38%. Cash flows from operations were $431 million for the first six months, a decrease from the same period last year. The decrease was driven by lower net income and fluctuations in working capital, including an increase in accounts receivable, which drives most of that. and that is parallel to our recovery in our revenue. Now I'll turn to our guidance for the current fiscal year ending May 31, 2021. It reflects our current thinking regarding the speed and timing of the economic recovery, while results for the first half of the fiscal year exceeded expectations. Uncertainty about the trajectory of the recovery over the remainder of the year remains year remains, particularly with the recent surge in COVID-19 cases. Improvements in key indicators have moderated, and our guidance reflects a steady but gradual improvement through the rest of the fiscal year, although not at the pace of the first six months. We have provided the following updates to our guidance after seeing the second quarter results. Management Solutions revenue year over year is expected to be in the range of a decline of 1% to growth of 1%. We previously got it to a decline in the range of 1% to 3%, with a bias toward the high end of that range. PEO and insurance solutions is expected to decline in the range of 2% to 5%. That is unchanged from prior guidance. Interest on funds held for clients is expected to be between $55 and $65 million. That's also unchanged from prior guidance. Total revenue expected to be in the range of a decline of 3%, too flat, or even with last year. We previously got into a decline in the range of 2% to 4%. Adjusted operating income as a percentage of total revenue is now anticipated to be approximately 36%, up from previous guidance of approximately 35%. An adjusted EBITDA margin for the full year fiscal 2021 is expected to be approximately 41%, up from approximately 40%. Other expense net is anticipated to be in the range of 25 to 30 million, previously was a range of 30 to 35 million. Our effective income tax rate is expected to be approximately 24% while we previously got it to a range of between 24 and 25% and adjusted diluted earnings per share is expected to decline in the range of 1 to 4%. We previously got it to a decline in the range of 6 to 8%. Turning to the second half of the fiscal year, we currently anticipate total revenue will be in the range of flat to up low single digits. Adjusted operating margin is expected to be in the range of 37 to 38%. Now, let me talk about the third quarter. Management solutions revenue is expected to decline in the low single digits, and PEO and insurance solution revenue would decline in mid to high single digits, impacted by lower rates for workers' compensation and state unemployment insurance. Adjusted operating margins excluding one-time costs are anticipated to be approximately 41 percent in the third quarter. Of course, all of this is subject to our current assumptions, which are subject to change. We'll update you again on the third quarter call. I will refer you back to our investor shares on our website for more information. And now, with all of that, I'll turn it back to Marty.

Great. Thanks, Efren. Operator, we'll now open the call to questions.

Certainly. And as a reminder, if you would like to ask a question, press star, then the number one on your telephone keypad. And your first question is from Ramsey Ellisall of Barclays.

Hi, guys. Thanks for taking my question this morning. Hi, good morning. I was wondering if you could let us know whether your guidance assumptions include stimulus. And I guess also as a follow-on question to that, now that you've lived through it once, what would a second round of stimulus, do you have any kind of a better understanding of how that would impact the P&L?

Yeah, so let me handle the first half and then the second half. So the short answer, Ramsey, is that no, it doesn't include the impact of any stimulus. A little bit tough to gauge, but it would be a net positive. I'll let Marty talk to kind of what we think the benefit might be.

Yeah, I think a number of benefits. Obviously, you know, a lot of clients have been kind of holding it. Some clients have been holding on, waiting for a second stimulus. What we have found is that Those who, when we surveyed our clients, those who took a PPP loan the first time, virtually 100% of them were still in business. So 99.8% or something. So obviously the stimulus, the first one, made a big difference for holding clients over until things picked back up. And I think the second one will do the same thing. And it's very targeted to small and kind of on the smaller end of mid-sized businesses, which is even better and has better parameters from what we can see at least that was signed or approved by Congress for forgiveness for loans as well. We also have done some things like made sure that we're totally connected now and with FinTech providers and lenders like Biz2Credit so we can pass our information from payroll, and clients can approve the fact that they can move information directly to a FinTech provider like Biz2Credit to get a loan. So I think everything is gonna speed up faster from a stimulus perspective. If you need a loan, you're gonna get it easier, faster. The forgiveness is gonna be even better than before, particularly if you're on the low end. And not to mention that I think payroll and HR solutions, services, software, is covered by the expenses or part of the expenses that can be covered. So I think it's going to be positive. Certainly it's going to be positive to the degree how much it's hard to tell at this point.

Great. And then I was wondering if you could also comment on or give us a little more color on the underlying drivers and management solutions for the rest of the year. It was great to see the outperformance this quarter. It looks like there's some moderation expected. Maybe a little more color on what you're seeing in your portfolio that's causing you to be a little bit conservative going forward here?

Yeah. So let me talk about first, you know, kind of what have been the drivers in the first six months and then why third quarter looks a little bit different perhaps than sequentially than other quarters. And by the way, I would just ask for other people in the queue, if there's a question that's really kind of related to what we're discussing, if you if you could just sort of keep your questions brief, because we want to try to get to everyone. So the short answer to your question on management solutions is that management solutions has HR outsourcing in the ASO model in that revenue stream. It's got retirement services in that stream. Other modules of FLEX, including, and very importantly, time and attendance in that revenue stream, and then then some other items. All of those products are doing very well. And I would highlight the fact that if you look at the year, this has been the year of demand for HR services. So if you look at our worksite employees across all of our platforms that provide HR support, our worksite employees are up. So we've seen very strong demand driving the revenue growth, or the revenue recovery. Now we're battling, as I mentioned in my comments, we're battling the fact that the number of employees paid is down, obviously because of current unemployment. But the underlying trends are very, very positive. So why as we get into Q3 does that change? In Q3, There are a number of revenue streams that are billed annually and depend on the number of employees on the payroll at that point in time. Because they are lower, we anticipate that they will be lower simply because of the number of worksite employees that are being paid. It has a moderating impact on the revenue in the third quarter. That's what's driving that result. Then as we come out of Q3, those revenue streams are no longer a factor in Q4, and we expect a rebound in Q4. So that's really what's driving what would appear to be conservatism in Q3. We'd like where the underlying trends are in all of the revenue streams on management solutions, and we see those continuing through the year into Q4.

That was super helpful, and happy holidays to you both.

Thanks, you too.

Your next question is from Kevin McVey of Credit Suisse.

Great, thanks so much. Happy holidays to you all. Hey, Averin. Hey, Marty. Hey, congratulations on the retention. Just a really, really fantastic outcome. I wonder, Marty or Averin, if It feels like based on the transition to the cloud that part of that is clearly structural. Is there a way to think about how much you can narrow it from a retention perspective and then ultimately kind of translate that into revenue relative to the cloud-based providers? Because it seems like as you've transitioned the business model to the cloud, it should clearly call for even higher levels of retention. So maybe help us understand that a little bit.

Well, I think ultimately the retention is about, as you know, about the level of service and value that you're bringing these clients. And I think the work that we've done on innovation and technology investment to the cloud has made a lot of benefits. And I think they've really shown up in this pandemic environment. One of the positives, there can be a positive in this environment for businesses, was that they could see the full value of paychecks and the service that we bring. So being on the cloud and the fact that many of them have people working from home, they could see the technology and what being in the cloud meant to them. So they could improve productivity. They could have better retention of their employees. They could still develop them, train them, onboard them. They can handle all kinds of time and attendance measures. They can do anything that I don't think they even really thought a lot about beforehand, and I don't think it's ever going to go back for them the way it was prior to that. So they understood the investments that we had made in the technology and innovations that we have. They found much more of a value from that, and the cloud is certainly a big part of that, that they don't have to rely. And there's a lot more self-service that they took advantage of and their employees took advantage of that saved them time and money and saved us this time and money as well and focus this on high-value parts of the product.

The other thing I'd add to that, Kevin, so your question is, okay, can we expect 25%, 50 basis points, 75 basis points better retention? I don't have a direct answer for that right now, but I will say this. It's very easy to envision that we have one service model that applies across the breadth of our 700,000 plus clients. The reality is that that's not correct. We have a variety of different service models that respond to the needs of the client as we understand, and I think that we have a very high degree of customer intimacy with our clients and understand what kind of service model they need. And so we have a variety of different models that are designed to ensure that the client has the highest possible net promoter score we can have. Our net promoter scores in this year are at all-time record highs, and it's in part because we've understood and have the capability, which others do not, of being able to provide hybrid services flexible service models based on what the customer desires. And so I think as we continue to refine that, as we continue to get better and better at understanding what each customer in each segment needs, whether it's no service to full service, I think you're going to see our retention continue to improve. super helpful.

I want to be respectful of time, but so I'll go back in the queue. I have another question, but I don't want everyone to get in. So thank you all. Okay. Thank you. Thanks.

Thank you. Your next question is from Jason Kupferberg of Bank of America.

Hey, thanks. Good morning, guys. Happy holidays. Hi. Thanks. Thanks. I wanted to just get your view as you head into the key selling season here. Do you think COVID is going to have an impact on competitive dynamics in the sense that, you know, perhaps fewer SMBs look to switch providers because they're consumed with just trying to keep their businesses afloat? Or is it actually possible that we see the opposite scenario with an above average amount of competitive switching as small businesses look to watch every dollar even more closely during the pandemic, or perhaps their needs have become even more complex as a result of COVID?

Yeah, Jason, what we've seen, and I would assume it's going to carry through into January in this quarter selling season, is much more of a hesitancy to switch. So our retention is certainly benefiting from that. It does make sales away from competitors a little more challenging to the degree because I think your first assumption is what we've seen as more correct, which is just that people are not focused on switching. They don't want to go through the switch right now. And they've also, at least from our perspective, they have really, as I mentioned earlier, seen the value of what we can bring at an all-time high. So they're going to be reluctant to switch because they're not focused on that. And also, I think they've also seen, we've gotten this feedback directly from clients. The way we help them with the PPP loans, the first group, the way we help them with the forgiveness, the feedback they got from their accountants, on how easy it was to file and apply for the forgiveness of loans was really a step ahead of other competitors for us. We were able to pre-populate all their reports. The forgiveness application was pre-populated and signature ready with adding just a few bits. And now that's even easier that we're going to tie them into the FinTech lenders as well. So I think it's One, a reluctance to move, but I also think they're seeing a lot more value, and that's made a big difference in our retention. And for sales, I also think that's going to help us.

Okay. The revenue upside this quarter was more pronounced in HR management and wanted to get a better understanding of which specific products were especially outperformers in the second quarter.

Yeah, I think we made mention that the ASO product, you know, really was strong. Any HR product, the need for HR, particularly when you think of so many employees working from home, some being furloughed, whether they, how do you handle the credits, the tax credits, and so forth about employee retention, all of those things helped really push HR support, and more on the ASO side than the PEO side. I think insurance was not as important to them right now from a benefits perspective as the HR support was. And so more tended to say, look, I'm not ready to switch or begin insurance, but I need the HR support pretty dramatically. Okay. Well, thanks for the answers. Have a great holiday. All right. Thank you, too.

Thank you. Our next question is from David Togut of Evercore ISI.

Hi, good morning, everyone. This is Josh Ziegler on the behalf of David Toget. Just wanted to ask my first question on business formation. So you mentioned last quarter that new business startups were up 20% year over year. How did you see those trends continue into 3Q, and can you give any projections for what you're expecting for the rest of the year?

Well, I think, yeah, nationally we've seen it continue. It's even higher than that. I think it's approaching, you know, high 30s or 40% increase in new business startups. I think what you're finding is both people shifting in the pandemic to new business opportunities and those starting new businesses. Some have been laid off from other businesses and have decided this is the time. Also, money is fairly easy to get a hold of at low cost. They have home equity where they can take loans as well at low cost to start their businesses. So that has continued. We have seen the household sales that I mentioned in the first quarter, a lot of nannies, tutors, things like that where people had their kids at home and were buying for that. We've seen a lot of other new upstart businesses get started or change what they were doing and create a new business. So it has continued. It's continued to accelerate higher than in the first quarter. And I would assume that may moderate to some degree, but we'll have to see.

Great. Thank you for the color. Next, on capital allocation, can you provide an update to your priorities and kind of what you're thinking in terms of capital allocation as we move beyond the COVID-19 environment?

Yeah, I think we haven't really changed significantly. I mean, obviously, payment of the dividend is an important part of the equation. We buy back shares to maintain share count level. But we're interested in looking at M&A and remain in the discussion for opportunities that we think could be interesting. Obviously, prices are high, but we think there's selected pockets of opportunity where it may make sense. That's where we're at.

Great. Thank you all very much, and have a happy holiday. Thanks. Same to you.

Thank you. Your next question is from Stephen Wald of Morgan Stanley.

Hey, good morning and happy holidays. Yeah, same. Thanks. Maybe just starting off on what you guys are talking about with sort of the incremental penetration, the bundles, you called out the ASO strength. It just seems like you're getting better economics relative to each client, and maybe that's part of additional market penetration and all the things you and other platforms have talked about in terms of incremental HCM demand. Just curious how big of a runway you see for that, seeing as it's already starting to show up, as well as how you think of that in terms of lowering your macro sensitivity going forward.

Well, I think there's a lot of opportunities still there. You know, when you think about time, just take products like time and attendance. Time and attendance has really been growing very strong, double digits for some time. We're seeing that with the innovation that we've put out there from the iris scan time clocks to the kiosks to punch in and punching out on your watch. All these things have driven even more demand for things like time and attendance. HR certainly has been driven a lot by the COVID environment, how different, I mean, you can understand that clients are facing for the first time challenges they've never seen before. And they're going to continue, I think, as the next big question will be, do you, you know, do you require vaccinations, for example, to bring people back to work? How do you verify that? You know, what are the rules around that? What do you do with absences? due to COVID or family or things like that. So these are all so complicated for small to mid-sized businesses who typically don't have an HR person. I think there's a great opportunity for continued demand for the services from light HR right to full ASO and PEO as well. And that includes insurance, which we think will pick up in the back half of the year.

Stephen, to the second part of your question, that's a good one. And I think, frankly, if you really disaggregate our results and we look at kind of the second level of why the performance has been what it's been, I think it's two things. The first thing is Our sales unit or our volumes on HCM have been up the first six months. We hope it continues into the back half of the year, but frankly, it's been higher than we expected. That strength of digital, strength of digital sales, marketing, and a lot of the efforts that we put into the platform over the last several years. That's part one, but I think you highlight the second part, which is important. which is when you look at that at the next level, what you realize or what you see is that we've really had strength in terms of selling other products to the base. And I would say you're seeing, in important respects, the criticality of having an HR solution in the bundle of offerings that you give to clients. And by the way, I don't mean an HR solution. in the sense of an HR administration module. Almost everyone has that. But the real ability to be able to provide counseling and consulting to clients in a very complex environment. And so we have benefited from the fact that we not only have been able to increase unit sales, but also increased penetration of services within the base. So part of that, to your point, has lessened the impact of what is obviously not a great macro environment still. We hope in the back half of the year it starts to get a bit better, and it has moderated, but I think our ability to sell within the base, the importance of HR services across the continuum of what we sell has proven out thus far this year.

And one other thing, I think it bodes well for retention. You know, sometimes when they took the HR product, they needed to set up their handbook for the first time. They needed, you know, a couple of things that they never had, employee rules and kind of benefits and so forth. But now when you think about it, there's such a continuation of this need. It's going to go on for some time. And I think that that does bode well for retention of the HR products as well.

Okay, great. I appreciate the robust commentary from both of you there. Just maybe one follow-up to, I think, something that Ramsey had asked about the sort of baking in of stimulus and other factors. You know, if we rewind the tape six or nine months, I think the way you described how you think of the upswing as sort of a gradual recovery, and I know you characterized it as the next six months are not going to be quite as robust as the last six months. But if I think about the sensitivity to the upside and downside, if stimulus added in, as you see it, is a slight net benefit, Is it also fair to think about the potential for a step back in employment or other macro factors as also not baked in so it could be possible drag to offset that? How should we think about the push and pull there?

Yeah, so that's an interesting, complex question, but I'll try to give a simple answer. I mean, it could end up having that effect. My sense is that you didn't factor in completely what the impact of a vaccine has in all of that, and that's really kind of the joker in the deck to the extent that it becomes more widespread, and now you see an uplift in employment, that's gonna be a positive. If we continue with the same environment, I think what we're assuming is gradual improvement. Unless things get much worse, I think we're in reasonable shape. If it goes backwards, We'll have to see what happens. As I mentioned, and Marty mentioned too, we have seen some moderation over the last month or so in the improvement in forward-looking trends. Will it go the other way? I don't know. Too early to call on that one, Stephen.

Okay. I just wanted to see how you were thinking about it, so I appreciate the thoughts there. Happy holidays. Thanks. Thank you, too.

Thank you. Your next question is from Andrew Nicholas of William Blair.

Hi, good morning. First, I was hoping you could provide maybe a bit more detail on the health of the PEO business specifically. Anything you can say about the growth rate in that business over the past couple of quarters. And then also, just how conducive is the market right now for starting a brand new PEO relationship? Just wondering if people are kind of stuck in their ways given the current environment or if there's still opportunities to initiate a new relationship there. Thanks.

Marty, you'll take the second. I'll come back to trends in the PEO.

So I think the second one is, you know, I think as I mentioned, there's been a much more of a demand for the HR support. And sometimes that's with the PEO, but it's been a little bit more heavy on the ASO side for us. And of course, we offer both. I think people have been a little more reluctant to change insurance providers and so forth. However, I do think that's going to start to change because I think that's been a real benefit. And we also, as I mentioned, have provided a new bundle that's providing EPLI, so Employment Practices liability protection. That's going to be very important right now. There's a lot of questions that are out there about how am I treating employees that are working from home, who have COVID, who are connected to someone who has it and they take time off. I think there's going to be, there's a lot of, as you know, of course, in the congressional discussion about liability protection for businesses, this is going to become a bigger issue as businesses the overall health concerns start to moderate, I think, with the vaccine getting out there more widespread. So I think there's going to be an increased demand for the PEO. I don't know if it's going to be in the next quarter. There's steady demand, and I think people are more open to it. Every day, people understand the PEO business a little bit better, and they're looking for the they're looking for the same concept that the PEP has for retirement. You know, it's a shared plan where we can share some of the liability protection, the fiduciary responsibility, and also get better rates and kind of better benefit packages by going with a PEO. So I think it may be quieter for another quarter, but then start to pick up a little bit more as things calm down.

With respect to your first question, Andrew, I think there's three factors driving the PEO results. The first is, in the first six months, if you look at our client base, we over-index a bit in terms of our exposure to hospitality and accommodations, and so that as we entered this year, we were more exposed than we might have been in previous years. We had a pretty sharp rebound in first quarter that continued into the second quarter, but we were coming off a lower base. So that's one. The second thing is, I called out in my comments, what we're seeing now is much lower workers comp and SUI rates. Those have an impact on revenue too. That's a trend that we're seeing. Certainly through the back half of the year, that's having an impact on revenues. And then I would say the final point is we've seen lower at-risk insurance attachment in the PEO. Part of that has been our decision on underwriting standards in this environment. So we have been a bit tighter than we have. I think in part that's helped a bit of the ASO business, but it's hurt the PEO business a little bit. And also we prefer to be a little bit more conservative on underwriting as we get into the back half of the year and we see what the environment looks like. If you look at where the guidance was, it basically maintained. There's a lot of positives on the underlying performance, but there are some headwinds that we're battling in other parts of the revenue streams in PEO.

Great. Thank you. That's really helpful. And then, Marty, you mentioned the PEP plan that you introduced a few weeks back. It seems to me like Paychex is obviously really well positioned to be able to offer a plan of that type. But I'm just wondering, bigger picture, to what extent new regulations on PEPs will impact Paychex? Does it increase the target market for retirement administration business? Does it open you up to additional competition? Just any additional color on that offering and what it means for paychecks would be great. Thank you.

Yep, sure. I think, you know, the fact that we've been in this for so long, well over 20 years in the retirement business, and that we provide more new retirement plans than anybody else in the business for at least the last eight years, I think we're well positioned. I think that also proves the point that we were the first out, I think pretty much one of the first out with the PEP plan We think it can be very competitive to opening up new market opportunities. Those small or mid-sized businesses that didn't want to get into a plan because they were worried about kind of administering the whole thing, we could be the record keeper, but they'd still have to take care of investments and would also have some other costs. This is going to lower their costs, allow it to be much more accessible to those who didn't quite step up to it. And I do think, as you said, I think Congress – is going to push more and more. The new Congress and the new president administration, I think, will push for 401ks and probably give even more credits and benefits if you start one. So I do think it opens up a market that we're already strong in, and it has great potential for us.

Great. Thank you, and happy holidays. Thank you. Same to you.

Your next question is from Brian Keene of Deutsche Bank.

Good morning. Efren, I just wanted to clarify something you said. The hit in 3Q revenues due to the number of employees on the payroll being lower, I guess, why doesn't that have that same impact in 4Q21? It sounds like it's more of just a one-time impact than in 3Q.

Yeah, because there are certain revenue streams, Brian, that are only billed in the third quarter. And so and they obey or they follow the amount of employees you have on your books at that point. Then it doesn't recur until the following third quarter. So it's basically annual. It's just an annual bill. It's somewhat unusual, but it happens every year.

Got it. That makes sense. And then, you know, when I think about You know, how we modeled it out at least, we have a little bit lower now third quarter, but a stronger fourth quarter. And just thinking about that fourth quarter now sounds to be a little bit stronger than what you kind of talked about last quarter. Just thinking about any pent-up demand in sales as we get to that easier comp in fourth quarter and how you're thinking about it.

Well, we hope it's going to be a good quarter because the compare certainly sets it up to be a good quarter. I think it's comprehended, obviously, in the guidance. You know, obviously, Brian, a lot of, as you know, a lot of it depends on the momentum we come out of the third quarter with. So if we come out of the quarter with good momentum and The macroenvironment arrows are pointing upwards, I think, at fourth quarter will be good. If the others don't pan out, then it'll be slightly different and we'll update when we get through third quarter.

Okay, great. Happy holidays, Gus. Enjoy it. Thank you. You too, Brian.

Your next question is from Karthik Mehta of North Coast Research.

Hey, good morning, Marty and Efren.

Good morning, Karthik. Hi, guys.

Marty, I wanted to ask, I know you've talked about the selling season and some hesitancy of people wanting to switch. What's the pricing environment like? Are you seeing more competition because people are trying to get market share, or has the pricing environment not been that aggressive this year compared to maybe seasons past or even the last few months?

Carter, I think it's been very consistent, which means it does get quite aggressive, particularly right now at this point, November, December. So I think we're seeing the typical same number of months free up front or over the first year kind of thing. I wouldn't say anything more aggressive than we've typically seen, and I'm not sure that that's making as much of a difference. As I said, I think there's still a hesitancy to switch. We're definitely seeing that. I think it's helping certainly our retention, and it's putting a little more pressure on sales. But right now, we're feeling pretty good going into selling season. We definitely have seen, again, a quarter of more unit growth than second quarter of last year. And that's pretty amazing to me when you think everyone is still home and they're selling from home. And we certainly have been selling inside for many years, but we also have a majority outside. And for their ability to adapt and be able to get to clients and then use the technology that we have that allows clients to search, demo, and even sign up to some degree for the service has really been good. So to see we're up units over last year in total units sold is pretty positive for us as we head into selling season this quarter.

And then Efren, just maybe this is too early, but any thoughts in changing how you're managing the portfolio You know, the yield curve is getting a little bit steeper, but have you made any changes or any thoughts on maybe the next few months?

It's funny. It's like you were looking over my shoulder when I was scribbling notes this morning before the call. You know, there are some things we can do in terms of altering duration. I would say, McCurtick, I want to see where we end up. or how things look in the spring, my sense is that interest rates start to float up a bit, not significantly, but then that level of yield curve steep, yet the level of yield curve steepness is gonna probably give us some additional opportunities to think about managing the portfolio slightly differently. The first half of the year, tended to be pretty conservative in terms of the approach we took. We wanted to see what macro environment we're in. It looks like maybe next year might be incrementally a little bit better. Perfect.

Hope you guys have a great holiday. Thank you. Thank you. Same to you, Kurt.

Thank you. Your next question is from Jeff Silver of BMO Capital Markets.

Thanks so much and happy holidays to you both as well. Thank you. Thanks. I think one of the surprises in the pandemic has been the growth in new business applications and new startups. I know it's not necessarily an area that you focus on, but I think you do have some clients there. Are you seeing any impact of that on your business?

Well, definitely. I mean, part of the unit sales on the small end in particular is have been a lot of new business starts. Now, we typically have been very successful at selling brand-new businesses on our Paychex and SurePayroll platforms, but that has continued to assist us and give us some positive benefit. So, yeah, we're seeing it. It has been amazing. I do think, as I said earlier, that cash is available that's out there, home equity. These are how new businesses start, and people also have decided – believe it or not, that this is sometimes the environment where they want to go ahead and get started because of some big change, either laid off or they see a new opportunity or their existing business does not fit under the pandemic and people have made switches to get into new things and capitalize on them. I mean, new business starts being up, I think high 30% is the last number I've seen over last year is pretty amazing.

Yeah, that's true. And if I could just ask a quick outlook question, Afrin. In looking at, I guess it's the PEO and insurance services, are you expecting growth this year in worksite employers, or is that something we won't see until next year? Thanks.

No, we expect growth this year in worksite employees for sure. I would say, Jeff, the other thing that I called out probably went in response to someone's answers. You know, we're unique in that we have both an ASO and a PEO, and we look at the worksite employees together. And if you look at the growth in worksite employees across both platforms, we're up year over year. So we're going to be up year over year on the PEO, and certainly in terms of where we ended the year. So we'll have a nice rebound there. And then when you put in ASO, we think it should be a pretty good year in terms of worksite employees served by our HR solutions to the point that Marty was making earlier. That's been a big source of demand this year.

Okay, great. And stay healthy and safe. Thanks again. Thank you.

Your next question is from Samad Samana of Jefferies.

Hi, good morning. Thanks for taking my questions. Likewise, happy holidays, as everybody else wished. Maybe the first one, I think the announcement with Fiserv Clover was interesting. Could you just maybe help us understand how a relationship like that, is that more of a technology partnership or is there an economic relationship there as well?

Well, it's got a couple of different parts to it. First, it's a referral relationship. So they, Clover, you know, what we have always found is many new businesses, and we've talked a lot about the growth of new business startups, start with, obviously, with credit card or merchant processing companies. services and so and then go to payroll and HR etc later we established you know with a leader like Fiserv we have a referral arrangement where they can refer payroll or HR needs that their clients as they sell in merchant services over to us and we have a process a pretty streamlined process to get those referrals to our sales team to be able to sell and And then there's a technology piece as well. We have a connection into the Clover system, which I think is an industry-leading system, certainly, where between our Flex platform and the Clover system, the demographic information, the employee information, for example, you add a new employee on the Clover system and you're using Flex payroll or HR, that will automatically sync with the Flex system automatically. And in addition, we saw an opportunity with Clover with time and attendance. Clover users for Fiserv use a lot of time and attendance. We have a industry leading time and attendance solutions, a number of them. You can clock in and clock out on the Clover system, but you can then look in Flex and see who's on, who's punched in, who's there, who's out. You can shift swap. You can also look and see if they're approaching overtime requirements. you can do a number of things. And we're going to continue to advance this to the point where if you're a Clover client and have signed up with Clover and you start, you can actually, you'll be able to in the future, near future, be able to sign up with Paychex in a self-service mode, just be able to sign right up for payroll yourself right over the Clover system. So it's a referral arrangement now, a technical arrangement. With Connection, it has great opportunity for us on the payroll side and time and attendance and other products as well.

Hey, thank you very much for that, guys. And maybe just a follow-up, Efren, if I think about the strong bookings commentary for the last several quarters, I know you've mentioned that digital sales have been a big contributor. How should we think about, are there any interesting dynamics that you've seen on the cohorts that have been coming through digital versus direct sales, and any interesting retention trends or the size of the average customer, just as we think about this being something that may be structurally sticking going forward as well.

Yeah, early on the retention side, so you need a year's worth of experience to really kind of get a sense of that, so we don't anticipate that it'll be different. I do think that, and I've said this to a number of you, it does skew smaller that's part of it, but that may also be a function of the environment we're in. So it may be that with this amount of new startups that Marty mentioned, you're getting a lot of the mix has shifted a little bit smaller than we would otherwise see, but it does tend to be smaller. We're hopeful, obviously, over time that in the relationship with paychecks, we can nurture them. Marty mentioned, I think in his comments, I mean, we really take a lot of care with customers, and our analytics are such that we can help a small business navigate some of the storm. Obviously, a lot of them go out of business, so you can't do that. But I would say in terms of the ability to interact with a provider, a solution provider, that can maximize your chances of doing your best, there's really kind of no finer solution on the market.

Mark Markman, Great very helpful good to see the quotes for calendar 20 and what is happening in 2021 have a happy holidays.

Mark Markman, Thank you, thank you.

Thank you, your next question is from mark markham of baird.

Mark Markman, hey good good morning and happy holidays Marty enough. Mark Markman, Thanks mark. Mark Markman, hey um so just. Following up on the bookings question, when we think about more units in terms of the smaller units that are coming through, combined with some of the pressures on some of the bigger units and less switching activity, how do you think that balances out when we think about, I fully appreciate in fiscal Q3, we're going to have some of the dynamics that you mentioned in terms of the employees within the existing accounts. But when we just think about new employees coming on from new units on the whole. How do you think that compares in fiscal Q1 relative to a year ago? I mean, fiscal Q3 relative to a year ago as we get through the selling season?

Well, it's a very interesting question, Mark. I think, you know, definitely as we've said, and I think everyone's mentioned it, and I have both, you know, the sales have skewed smaller. One, because there's a lot of brand new businesses, as we've talked about a couple times on the call. and that the mid-market is a little more hesitant. But the good news, as you look at selling season right now, I would say the pipeline looks very healthy. So while we've had presentations and there's been some hesitancy to kind of close the deal from the client perspective, I think they're a little concerned, probably waiting to see what Congress does, what kind of stimulus there is, what's happening with demand. I think between the news of the stimulus, the vaccine, and where that's standing, multiple vaccines, I do think some of these decisions will start to get closed in this quarter, and it'll still produce a pretty good selling season. We definitely saw improvement in the mid-market from Q1 to Q2 in our sales, and so while there's been smaller, you know, the small end has been strong. I do think that the mid market is picking up speed. It certainly did in the second quarter, and we expect that we'll give in the pipeline in the third quarter.

Excellent. And then can you just talk a little bit about, you know, we're still early days in terms of the reduction in terms of the geographic footprint and the office space and working from home. And it sounds like the net promoter scores just continue to go up. Can you just talk about you know, the efficiency gains that you've seen and the productivity gains that you've seen from that? And then, hate to ask this, but just any sort of commentary with regards to solar winds and, you know, what your checks have shown thus far?

Yeah, no problem at all on that. There's no, we have, none of that is in our systems at all. We've done a thorough analysis check of that. And we feel very good that, uh, you know, that has not impacted us, uh, whatsoever. Uh, and on the, yeah, that, that is great. So, um, I think the first part of the question, sorry, I jumped into this.

Yeah. The first part of Marnie was just about, uh, the efficiency. Yeah. I'm sorry.

So yeah, we've been very impressed. I mean, very impressed with the employee team. Uh, you know, on the service side in particular, we have found that, um, you know, who have had less experience working from home. We certainly had, you know, over 1,000 on the service team working from home pre-pandemic. But they have done just an outstanding job. And as Efren said, the net promoter scores have continued to increase well year to date over last year. And the productivity has been very good. So those offices that we closed, you know, will remain closed, those that were permanently closed, obviously. And we'll continue to have those service people work from home. It seems to be going extremely well. We've gotten positive feedback from the employees on the support, and I think there will be continued productivity gains to get there. So we've increased the number of clients that they've been able to handle, improved the net promoter score, and have the record-breaking retention so far this year. So I'd say it's working really well, and we'll continue to capitalize on it.

Sounds like a win-win-win.

Happy holidays. Thank you.

Same to you.

Thank you. Your next question is from Tim Willie of Wells Fargo.

Thank you. Hi, Tim. Welcome back. Yeah, thank you. Good to be back. Happy holidays to both of you. Thank you. Just a question sort of tied into the Clover Partnership. I guess when you think about all the discussion around business formations working with a platform like Clover, small business startups. And again, if you talked about this in prior calls, I apologize, but just sort of thinking about the platform concept and the ease of which people can start a business and who they sort of go to for maybe some of those initial critical functions. Should we think about more Clover-like partnerships and just any sort of thoughts about how a sales or service organization has to adapt to that kind of distribution channel, I guess, if you see that as an opportunity to acquire and build out the sales channels.

Well, I think there'll still be a number of direct sales opportunities for us, obviously, whether that's, by the way, feet on the street or telephonic or digital sales. Digital, as Efren mentioned the question a little bit earlier, digital has worked very well for us where it's going to get you know, completely to the point of self-setup is available. You can search, demo the product, and sign yourself up. That's already available with our SurePayroll platform, and Flex is moving that way as well. So finding new sales channels is always important to us, and also making sure that we're responding and even looking ahead to the way the market wants to do it. The market has changed pretty dramatically in that they're used to doing things on their own, both the client and the employees of the client. and we were glad to have the innovation that we've already done, the investments, to allow a lot of self-service, and that includes right from starting up. Connecting with Clover moved us back in the decision-making a little bit earlier, which we've always been looking at, which says that, hey, I might not be ready for payroll yet when one of our sales reps directly goes to someone, but what it does is say that, hey, I did get my merchant processing, and wow, now I see Paycheck show up on the Clover platform that I'm used to, I can transfer my information right now back and forth, and very shortly, I'll be able to set up my payroll right from that. So I do think it's always about finding new sales channels the way clients want to buy, and it is becoming much more of a client-directed, probably always was, but it's definitely much more now a client-directed decision. Self-service, do it myself when I want to do it, and we're set up very well with that, either directly with paychecks or through partnerships like that. And I think, yeah, you will see more as we find one, you know, ways to do that. Another example in the back end of that is just thinking about the new stimulus loans and the connection I mentioned earlier to business credit. You know, we're allowing a client to go in and when they're in their Flex platform doing their payroll, okay, do you want another PPP loan? Do you want to apply for one? Yes. Do you want to just move your payroll data and everything right to business credit? so that they can approve your loan probably the same day. Yes, okay, done. Never talked to anybody. Everything was all done digitally, and that's the way of the future.

Thank you very much for the insights. I appreciate it. Happy holidays to you. Thank you. Same to you, Tim.

Thank you. Your next question is from Lisa Ellis of Moffitt Nathanson.

Hi, good morning, guys, and happy holidays. A question... On this shift you're seeing with all the new business formation and then the roll off of employees within larger businesses, just a broader question as this rolls through your business, assuming it's going to persist for a period of time, are the unit economics of these smaller businesses typically more attractive, similar to the base? Is there sort of broader business structural dynamics that we should be keeping in mind?

Well, I think there's two ways to look at it. One, we certainly, you know, having been in the business a long time and serving small clients for the longest period of time, we know how to obviously make a great profit from that, as you know, from our margins. And so the small businesses we can do very profitably. And in fact, you know, probably even more so today with the digital stuff that we've been, the digital investments we've talked about. right through to self-service. We're making it so much more productive to sign up a new small client. Then when you think of the mid-market, the opportunity there is obviously for much more revenue penetration of the additional services that we offer these days. So while the cost to set up and serve may be slightly, will be maybe more, the revenue opportunity is more. So that's very profitable. So we don't see any major changing of the dynamics there. In fact, it's probably given us, you know, the investments we've made have given us an opportunity to continue to earn well. Even if prices come down a little bit on the small end due to competition, we've taken more costs out of the setup and the ongoing service that have really appealed to those clients because that's the way they want to be served. And then on the mid-market, the enhancement of the products that we offer gives us a much bigger share of revenue per client in the mid-market.

Okay, and then my follow-up is another question on the Clover partnership. Just thinking about the size of that installed customer base is probably similar in scale to your installed base. Is there an initial part of that partnership aimed at kind of cross-selling, identifying Clover clients that aren't Paychex clients and vice versa that might create like an initial pretty heavy

lift from that relationship or is it more focused on sort of should we think about it as more like incremental over time new sales oriented well lisa we're hoping we're hoping so we're obviously there's the cross-selling right off the bat so yes uh clover is reaching out to their client base uh immediately and uh and letting them know and have already started issuing uh emails to their client base to say, hey, we're connected to Paychex. This is an easy setup to go to Paychex. We will transfer data back and forth. You have Flex and Clover in sync. So we're hoping that there'll be some initial, you know, jump in success right off the bat with that. And then we're certainly excited about, on an ongoing basis, being on that Clover platform as they're, I think they've been very successful at adding new clients to it.

Terrific.

Thank you, and happy holidays, guys. Thanks a lot.

Thank you. Same to you.

Thank you. Your next question is from Pete Christensen of Citi.

Good morning. Thanks for taking my question, and happy holidays. Thank you. Two quick ones here. So, Marty, how are you thinking about the absolute level of go-to-market spending relative to other periods? How aggressive – is paychecks being right now and what are you seeing on the ROI front? And then my follow-up question is, um, on the PEP, is there a difference in, in the economics, the unit economics? Um, and how should we think about that? Thank you, gentlemen.

Sure. Uh, on the first one, I think the go-to-market spend, I, you know, we've, we've increased our marketing spend pretty consistently, uh, You may have seen we've also gotten into TV advertising, even for the brand and getting the brand out there. It was helpful to us during the beginning of the pandemic, and it has continued to be so, and I think we'll continue that. It's not a massive amount of TV advertising. I'm not sure it always is worth it. At some ROI, there's some break-even there that's hard to predict, but we are getting more leads that seem to be following the advertising that we're doing. and I think there's opportunity there. The investments that we've already made in go-to-market from the webinars, from the information, we have really enhanced that this year under COVID, and I think it has brought a lot of clients to us. If you think about a webinar on the original stimulus package, or I'm sure one coming up that we'll have on this stimulus package, those webinars used to bring, different information webinars used to bring a couple hundred clients, prospects, and CPAs, maybe 400, 500. Now they're bringing 6,000, 7,000, 10,000, you know, which gives you a lot of leads, certainly gets your brand out there and your product set, but also a lot more leads because you have that information once they signed up for the webinar. So they've been extremely successful at a pretty low cost, frankly. So I think a good ROI return on our investment there on the pep. Just quickly, I think the economics are very good there. It's a little bit lower cost. There's probably a little bit more retention to that plan because you're more involved. You're not just a record keeper, but you're the fiduciary. And I think it's going to be a lot stickier from a sale that we have on 401k. And we're very successful at selling 401k plans. And this instead of telling the client, hey, we're going to be your record keeper, but you're going to go to a financial advisor to do this or that, we can now say, look, we'll set up basically the whole thing for you with some partnerships, and we can take care of all of it at a lower cost. So the economics we feel are still going to be very good. There's always a risk of some cannibalization of single employer plans, but I think there's going to be a world for both of them that are out there, and we may capture a lot more customers prospects that have not had a 401k, but now will jump in.

Oh, thank you very much. That's great.

Your next question is from Brian Virgin of Cowan.

Hi, good morning. Thank you. First, I wanted to clarify on client retention. Are you assuming that it's going to remain at record levels in your second half outlook? And Marty, to your comments on being pleased with the sequential improvement, but at a more moderate pace near the end of the quarter, can you dig into that a little bit more? What KPIs specifically are you seeing moderate?

Yeah, so I think on the client retention, right now we expect that we'll stay at record breaking. The issue really is the non-processing clients. You know, we talked about them in the first quarter. They have come down dramatically from the first quarter, meaning that there was clients that didn't leave us, but they suspended payroll processing, but stayed with us as a client, and we worked very hard to keep them as a client, even if they were suspended. They're now paying for that service to kind of hang in there. It's dropped dramatically. In fact, it's continued to drop, but we're trying to see if this last number of non-processing clients, and it's a pretty small number compared to our base, what will happen at year-end. Are they hanging in for year-end or not? That's the only thing you know, Brian, that we're kind of watching as to whether if they all left, then we probably wouldn't hit retention. We'd still have a very strong retention number, but it wouldn't be record-breaking. I think the fact that they're still on the service, they're just kind of holding in there. You've heard of restaurants that are saying, hey, I'm going to just close till spring, you know, particularly in the northeast and kind of hang in there. So that's, I think it's going to be record-breaking through the year, but It could be close, depending on what happens with the stimulus. What I was saying with the moderation is that there was a lot of new business formation. When you think about the quarter, September, October, and November, September saw a lot of influx of new sales, particularly on the small end, because of households. So you had the start of a school year, and most school years started in September, and You had nanny payroll, you had nannies, you had tutors, you had a lot of things. So we saw a big explosion of small household sales in September. It's just starting to moderate as people are kind of fitting into a new reality of the pandemic. So it moderated some. Still growth, still seeing growth. It just wasn't quite as explosive, I guess I'd say, as the first month or two of the quarter.

Okay, that's helpful. And then can you comment on your sales headcount and just how that has progressed here in 2020?

Yeah, pretty flat. We went up a little bit in headcount, low single digits for overall sales, and we've continued to mix. Well, pre-pandemic, we continued to mix and plan for in-house sales, telephonic sales, and online sales versus feet on the street. Obviously, they're pretty much all telephonic or digital sales. Now, but, but yeah, headcounts up a few percentage points and, you know, and doing very well, particularly when you think about we've sold more units than second quarter last year, as we've mentioned, and everybody's home. It's been pretty amazing.

Thanks, guys. Happy holidays.

All right. Thanks, Brian.

Thank you. Your next question is from Tianjin Huang of JP Morgan.

Thanks so much. Just wanted to clarify on the change in the outlook. Obviously, the second quarter was better than expected. Did the composition of your second half outlook change at all? Just curious if I missed anything there.

No, I think it just got a little bit better than where we were at the last call, and I suspect we'll have more to say. When we get to third quarter, get to the selling season. So I would say it's incrementally changed.

Got it. And then just with the ASO strength you noted and to the year of demand for HR services, I think you had mentioned, Efren, do you expect to sort of maybe put a little bit more energy into selling that versus 90 days ago?

I think there's just a lot of demand, as Marty has mentioned. In some ways, we've placed a lot of emphasis on sales in that area, and the market is generating demand in that area, so you've got a good confluence of both factors.

Yeah, I think one thing I'd add to mention is that really starting last year sometime, Mark Bottini and the sales team they really put an effort out to say it's a power of 3000. So all sales were leading with that HR, you know, that HR value that we could bring. So instead of, you know, we've really moved from the traditional model of selling payroll, but then coming back with everything else. And I think, you know, that, that helped us a lot pre pandemic and really helped us with the momentum of the demand going up for HR, because anybody, if I'm in there, talking to you about retirement, I'm also telling you about ASO and PEO that's available to you and the value it brings. If I'm selling you payroll, I'm also talking about ASO and PEO. So it really has helped. And so there's been a very high energy in the sales force and opportunity for them all to sell HR, and it was perfect timing.

Yeah. No, great. Glad to see the hard work coming through. Have a blessed holiday, guys. Thank you.

Thanks. You too.

Thank you. Your next question is from Matthew O'Neill of Goldman Sachs.

Yeah. Hi gentlemen. Uh, thanks for squeezing me in. I know the call is getting long and happy holidays as well. Um, I don't mean to belabor the questions on a five servant Clover, but was curious on two fronts, a similar Lisa's question. One, when you guys were working on initiating this relationship, was there an immediate identification of a good overlap of existing paychecks and Clover clients and, providing the technological connectivity was something being asked for, or was it really more sort of, you know, offensive as far as this could be a great referral channel, you know, going forward? And then just to round out, is there any sort of two-way street element here? I understand that, you know, people are making probably a credit card processing decision potentially before a payroll decision, but are you guys able to help sell the Clover product on the other side to your existing clients? Thanks.

Yes. In fact, we've been selling merchant processing with a number of partners and Pfizer being a major one for some time. It's stayed a small part of our business because of what you just said. Typically, they have merchant processing already, but we've been able to sometimes offer them better rates. Those rates can be very confusing. And if we have payroll clients, we talk to them. We have been for a number of years talking to them about merchant processing, and we resell basically their products. So yes, there will be back and forth referral going both ways between us. And I think it was mostly offensive. We've always known there was this connection because we sold merchant as well as payroll. And so we looked for a partner. We thought that Pfizer, particularly lately, the Clover system is very strong and is very well penetrated. And I also mentioned earlier that we found that probably over 30% of their clients have time and attendance solutions that are tied in with their point-of-sale Clover equipment, and that we have very strong time and attendance solutions that can tie directly to the Clover equipment along with the Payroll Flex platform. So we felt that from an offensive perspective to pick up Referrals for payroll, it was positive. For the connection that we could make, we could also enhance what Clover offers by giving them not only a payroll platform that's tied in with the system, but time and attendance and a number of other products as well. And the demand for HR, obviously, is typically there for those who are using those point of sale systems. So a lot of wins all the way around we feel it'll bring us. Makes sense.

Thanks so much.

Okay.

You're welcome. Thank you.

Thank you. Today's final question is coming from Scott Wurzel of Wolf Research.

Good morning, guys. This is Scott on for Darren Peller. Just had one question on sort of the structural positioning for the long term. You mentioned that expenses were down this quarter related to lower discretionary spending and reduced facility costs. So kind of a mix of short and longer term cost savings. And we were just wondering if you're still if you are planning on doing more kind of cost savings on the longer term side.

Well, I think, and everyone can comment on this too. Obviously, you know, we're always looking at that, Scott. We're always looking at, you know, we've got a history of having the best margins in the business. We're really pleased that during this kind of pandemic environment that we could maintain and improve our margins. And I think that we have been successful at making changes that respond to the market but also make us more efficient. So, yes, we'll continue to look for ways to reduce costs and make us more productive and make the service and products even better. You know, I think there's a lot of opportunity for self-service that clients are looking for and their employees. We're well invested in that already with a five-star mobile app and all of our products being mobile-first designed. And I think we're going to see continued savings there as well.

Got it. And then on the revenue side, are you seeing more sustainable opportunities maybe for more sticky revenue to lift the base on the other side of the pandemic?

Well, I think the HR, yeah, I think, you know, I mentioned at the beginning of the call, I think one of the things that the pandemic has done for us and our clients is they've been able to see the full value of being with Paychex. They've been able to use products and services and count on us for more HR support than they wouldn't normally need in a non- you know, kind of pandemic situation. And so I think it's going to provide us better retention of all of the products because we've had an opportunity for them to see that we can be there in a tough situation and really support them. And frankly, get a lot of feedback from clients that we help them through the pandemic and to help their business survive. So we do feel that the products will have even better retention coming out of this because we've been able to demonstrate the full value.

Great. Thanks for taking my question, guys, and happy holidays. Thank you. You too.

Thank you, Alan. I'll turn the call back over to Mr. Musi for any additional or closing remarks.

All right. Thank you. At this point, we will close the call. If you're interested in replaying the webcast of this conference call, it will be archived for approximately 90 days. Thank you for taking the time to participate in the second quarter press release conference call and for your interest in paychecks. We do wish you a very safe and happy holiday. Thank you.

Thank you. This does conclude today's conference call. You may now disconnect.