Paychex, Inc.

Q1 2025 Earnings Conference Call

10/1/2024

spk01: Good morning and welcome to the first quarter 2025 Paychecks Earnings Conference call. Participating on the call today are John Gibson and Bob Schroeder. After the speaker's opening remarks, there will be a question and answer period. If you would like to ask a question during this time, simply press star and the number one on your telephone keypad. If you would like to withdraw your question, please press star two. As a reminder, this conference is being recorded and your participation implies consent to our recording of this call. If you do not agree with these terms, please disconnect at this time. I would now like to turn the call over to Bob Schroeder, Chief Financial Officer. Please go ahead.
spk19: Thank you for joining us for our review of Paycheck's first quarter 2025 financial results. Joining me today is our CEO, John Gibson. This morning before the market opened, we released our financial results for the first quarter ended August 31, 2024. You can access our earnings release and investor presentation on the SEC's website as well as on our investor relations website. Our Form 10-Q will be filed with the SEC in 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. Today's call will contain forward-looking statements that refer to future events and involve some risk. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ from our current expectations. During our call, we will also reference some non-GAAP financial measures. A description of these items along with our reconciliation of the non-GAAP measures can be found in our earnings release. I will now turn the call over to our CEO, John Gibson. Thank you, Bob, and good morning, everyone.
spk20: I'm going to start today's call with an update on business highlights for the first quarter and then turn it back over to Bob for a financial update. And then, of course, we will open it up for your questions. As we enter the post-pandemic era of paychecks, we are off to a good start in fiscal year 2025 with total revenue growth exceeding expectations during the first quarter. Excluding the impact of the non-recurring benefits from the ERTC program and having one less processing day in the quarter, revenue growth was 7%. As the best operators in the business, we also delivered earnings per share growth despite these headwinds through strong expense discipline. Small and mid-sized businesses remain resilient as the U.S. labor market gradually returns to its pre-pandemic level. While growth and hiring has moderated, hiring within our client base during the first quarter was positive and better than expected across our HCM and HR outsourcing businesses. We continue to make investments and transition our go-to-market capabilities and product suite to meet the post-pandemic market and drive continuous innovation in our technology and advisory solutions. We are excited to launch several new products that are specifically designed to address a constant challenge for small and mid-sized businesses, and that simply is finding and retaining qualified employees. Our Paychex Flex Engage offering, combined with Paychex Flex Perks, which was named a top HR product of the year by HR Resource Executives Magazine and the recently announced Paychex Recruiting Copilot are digitally and AI-driven solutions designed to help our clients succeed and win the war for talent in a very challenging labor market. These are examples how we are constantly looking for ways to bring enterprise solutions to the SMB market to really level the playing field. FlexEngage is a comprehensive digital solution with generative AI capabilities to help businesses manage their workflows, promote communication within the organization, and increase collaboration between employees, many of whom are remote. Since its launch, we have seen interest from businesses across the spectrum of industries and size groups. Our award-winning Paychex Perks offering is a digital marketplace that provides employees access to affordable benefits and discounted products and services. Paychex Perks is attractive to employers as it is available at no cost to the employer and the payments are processed automatically through payroll deductions by the employee. This allows us to establish a long-term customer relationship with our clients' employees. Our initial and launch includes 17 unique products ranging from voluntary lifestyle benefits to early wage access. We will continue to be opportunistic when considering adding other products and services to our marketplace. This new capability, which we have been investing in for years, allows us to engage our clients' employees with AI-driven offerings that meet their specific needs in our Flex HCM app. It also opens up an exciting new market for us and is another example of how we are helping small and mid-sized businesses compete for talent against larger companies. Recruiting, as we all know, is a costly and time-consuming process. According to a recent Paychex customer study, 80% of respondents reported that finding qualified candidates is challenging. Last year, we launched a new program in our PO called the Employer of Choice Playbook, which was designed to help our customers find qualified candidates. We are excited to add a new solution to the playbook, not only for the PO, but also all paychecks customers and non-paychecks customers, with a recent announcement of an AI-assisted recruiting tool for small and mid-sized business owners and HR professionals called the Paychex Recruiting Copilot. We believe this new solution will revolutionize the recruiting and hiring process by enabling Paychex customers to quickly find top talent instead of relying solely on traditional recruiting methods. Paychex Recruiting Copilot analyzes millions of potential employees through a natural language search engine to quickly produce an active list of qualified individuals for open positions. based upon numerous requirements and other attributes. This puts advanced technology that is often only available to enterprise-level organizations or large professional recruiting firms into the hands of small and mid-sized companies so they can more effectively compete for talent. As you know, Paychex has a long history and experience with AI, and we believe generative AI offers an entirely new set of opportunities. We have a large and growing data set, which we believe provides us with a significant competitive advantage in the years ahead. We have tens of millions of interactions with our clients and their employees every month. We have predictive and AI models deployed across the company with a focus on sales and service and the ability to deliver actionable insights based upon our vast data set to help our customers succeed. Paychex is uniquely positioned to be a leader in bringing the power of AI to small and mid-sized businesses. The breadth and quality of our solutions allows us to solve problems for business owners by leveraging our best-in-class data set and HR advisory capabilities to help them win in today's economy. We continue to gain recognition for the strength of our HCM technology innovations as well. In addition to winning a top HR product of the year for Paychex Perks, which I would remind everyone is the fourth time a Paychex solution has been named for the top HR product of the year list four of the past five years. Four of the past five years. We also earned an HR tech award for best small business focus solution in the core HR workforce category for the fifth consecutive year from Lighthouse Research and Advisory. This is an area I continue to believe we are not getting our due recognition. Paychex was also recently included in Time's inaugural list of America's best mid-sized companies based on the strength of the company's culture, business results, and corporate responsibility efforts. Paychex is uniquely well positioned to solve the problems for small and mid-sized businesses based upon our comprehensive suite of HCM solutions, our advisory expertise, and the insights gained from our large data set and constant interactions with small and mid-sized businesses. We remain firmly committed to our purpose of helping businesses succeed while also making a positive impact on our clients, employees, communities, and shareholders. I will now turn it over to Bob to give us a brief update on our financial results for the first quarter.
spk19: Thank you, John, and good morning, everyone. I'll start with a summary of our fiscal quarter financial results and then provide an update on our fiscal 25 outlook. Total revenue increased 3% to $1.3 billion in the first quarter, which reflects headwinds from the expiration of the ERTC program and having one less processing day as compared to the prior year period. These two items impacted growth by approximately 400 basis points, which is consistent with the expectation we shared with you last quarter. As John mentioned, excluding these headwinds, total revenue in the quarter grew 7%. Management solutions revenue increased 1% to $962 million. This was primarily driven by growth in the number of clients served across our suite of HCM solutions and higher client worksite employees in our HR solutions, as well as higher product penetration. Those items were partially offset by the ERTC headwinds that we previously discussed. PEO and insurance solutions revenue increased 7% to $319 million, primarily driven by higher average worksite employees and higher PEO insurance revenues. Interest on funds held for clients increased 15% to $38 million. This is primarily due to higher average interest rates and higher invested balances. Total expenses for the quarter increased 3% to $772 million, and this is primarily due to higher PEO direct insurance costs related to growth in our average worksite employees within the PO, as well as higher PO insurance revenues. We've also had continued investments in product innovation, AI, and our go-to-market strategies. Operating income grew 2% to $547 million, with an operating margin of 41.5%. I'd like to remind everyone operating income was also impacted by the expiration of the ERTC program, as well as the one less processing day during the quarter. Diluted earnings per share increased 2% to $1.18 per share, and adjusted diluted earnings per share increased 2% to $1.16 per share in the first quarter, and those items were also impacted by the headwinds that we previously discussed. Now turning to our financial position. Our financial position remains strong. We ended the quarter with cash, restricted cash, and total corporate investments of $1.6 billion and borrowings of approximately $818 million. Cash flow from operations was $546 million in the first quarter, driven by net income and changes in working capital, influenced by timing. We returned a total of $457 million to shareholders during the quarter. This included $353 million of dividends and $104 million of share repurchases, and our 12-month rolling return on equity remains robust at 46%. I'll now turn to our guidance for the fiscal year ended May 31, 2025. We have maintained our guidance pretty much in all of the categories with the exception of updates to our interest rate assumptions for the remainder of the fiscal year. Our outlook now assumes a total of 125 basis points of cuts to the short-term rate on a full-year basis, which directly impacts our interest on funds held for clients' revenue and other income. Our outlook also assumes a continuation of the current macro environment. Our current outlook is as follows. Total revenue is still expected to grow in the range of 4% to 5.5%. And I'd like to remind everyone this does include approximately 200 basis points of headwind from the expiration of the ERTC program. Management Solutions is still expected to grow in the range of 3% to 4% for the year. No changes to our PEO and insurance guidance. That is still expected to grow in the range of 7% to 9%. The two changes that we have in guidance, as I mentioned, are related to interest rates, the first being Interest on funds held for clients is expected to be in the range of $145 to $155 million. That's down from our previous guidance of $150 to $160 million. Other income net is expected to be income in the range of $30 to $35 million, and that's down from our previous guidance of $35 to $40 million. No change to our operating income margin guidance is still expected to be in the range of 42 to 43%. Our effective income tax range is still expected to be in the range of 24% to 25%. And despite the changes to the interest rates that I discussed, our adjusted diluted earnings per share guidance is still expected to grow in the range of 5% to 7% for the year. Now turning to the second quarter, provide a little bit of color. We would anticipate total revenue growth in the second quarter to be between 4% to 5%. And this, too, includes approximately 200 basis points of headwind from the expiration of the ERTC program. And then we would also expect operating margin in the second quarter to be approximately 40%. Of course, all of this is based on our current assumptions, which are subject to change, and we'll update you again when we get to the second quarter call. I will refer you to our investor slides on our website for additional information. And with that, I'll turn the call back to John. Thank you, Bob.
spk20: And we will now open the call up to your questions.
spk01: Thank you. And ladies and gentlemen, at this time, the floor is open for your questions. To ask a question, please press star 1 of your telephone keypad. To get out of the queue, press star 2. We do ask that you limit yourself to one question and one follow-up so that everyone has a chance to ask their questions. And we will take our first question from Mark Morgan with Baird.
spk18: Good morning, and thanks for taking my questions. Two questions. First, with regards to, you know, the environment that you're currently seeing, how would you differentiate the true small business market relative to, you know, the upper end of your target range, you know, companies with 50 to, say, 1,000 employees?
spk02: Yeah, Mark, this is John. How are you?
spk20: I would say this. What we're seeing pretty consistently across the board is we continue to see moderate growth both in the small and the mid-market. I would say from a demand perspective, certainly what we're seeing across the board is a lot more demand for driving efficiency or HR outsourcing. I think the pure tech play, particularly up in the mid-market, the enterprise market, I see a little bit slower decision-making going on there, but we're not seeing that in the upper end of our HR outsourcing market. So I think right now what I see across the board are businesses are trying to drive efficiency and are looking for opportunities to reduce costs in their business.
spk18: Great. And then the second question is, I had the pleasure of reviewing all of your new solutions at HR Tech, and the team there just did a tremendous job in terms of giving a really professional presentation. The solutions were very impressive. I was really struck by the recruiting co-pilot. The one thing that struck me also was that it seems like a lot of the tools, like, for example, the Flex Benefits, I think, would benefit, you know, every company. Some of the other tools, you know, seemed to be more geared towards companies that were a little bit larger and so What I was wondering is, you know, to what extent do you think you could become an even bigger player in the upper end of your market? Or how would you characterize, you know, where the tools are best, you know, best employed?
spk20: Yeah, Mark, I think, first of all, I would start with, you know, we have a very large upper mid-market business and have for decades. I think I said I don't think we get the recognition or people recognize the strength that we have there both in terms of a capability from a technology perspective and an advisory solution perspective. I think when you step back and look at the products and services that we're focused on delivering, we believe those things really apply across the spectrum of the markets that we serve. Finding qualified people is a problem that every small business is having, every mid-sized business is having. And I think what we've had a reputation of doing, whether you look at it, what we did to bring 401Ks down to the small market, you know, over 20-some years ago. When you look at what we've done to bring an efficient, you know, PNC workers' comp programs to the small market, can do that efficiently. That's always kind of been in our DNA, so I think what we're trying to do is take what are typically tools and capabilities that are reserved for large enterprises and figure out how to economically bring those down to small business owners so they can succeed. So recruiting is a big issue. We're real excited about the co-pilot product. The other thing I would tell you about the co-pilot product is that's not just for Paychex clients. You can go on Paychex.com today on our website. You can buy that digitally. You can try it for one time or you can sign up for a subscription service. So regardless of who your HCM provider may be, we want to help small businesses grow and so that's pretty important. The second thing that I think you would say is getting access to affordable benefits or providing affordable benefits both to attract and retain qualified employees is a problem that's always faced small and medium-sized businesses. So that's where you get into our Paychex PERC product. We already have a full suite of insurance products, as you know, both in terms of through our agency as well as in our PO. But the PERC product, I really like it because it gives those employers who maybe can't afford to offer benefits a means to afford it. Because basically the way that works is we've curated digitally a set of benefits for their employees that when their employees get onboarded into our Flex app, They're going through an open enrollment, and all of these benefits cost the employer nothing. So the employer can tell a new employee, if you join me, you're going to get all these benefits. And then the employee signs up for these benefits. We do the payroll deduct. Another neat thing that we've built into this is the capability that if that employee leaves that employer, they can continue their relationship with Paychex and will continue to collect a credit card for those services. So again, it opens up a new market for us. You know, look, what we see across the board is the problems of finding and attracting quality employees, getting access to affordable benefits to be able to retain and attract those employees. And then the third thing is really around the funding area and getting access to growth capital. It's continued to be a big problem, not only in the small micro market, but also in the mid market, and we're trying to address those problems.
spk18: That sounds really compelling. Are you going to advertise a little bit more? because those are compelling solutions.
spk20: Stay tuned, Mark, but I think, as you know, we're just beginning to get into our selling season, and certainly it's not a coincidence that we've launched all of these products. I would tell you we've been working on this for – we knew during the pandemic that we were going to have to – when the pandemic ended, that we were going to have to come out with a different value proposition because – You know, what one business in the last three years isn't going to win it in the next three? And it's not going to be a pure tech play. It's not going to be on bells and whistles. It's really going to be about solving problems in our estimation. And so we've been working on this for some time. You look at the Perks product. We had to really re-engineer and redesign our core products so that we could actually create the employee to be able to be a customer of ours. Never been able to do that before. These are all investments we've been making as interest rates were going up, as we were getting the benefits of the ERTC programs kind of behind the scenes, we've been making these investments. And so it's not a coincidence that now that we're in the post-pandemic era, we're launching these products, and I would expect as we go into selling season, you're going to hear us talk a lot about it.
spk18: Thanks, and congratulations on the awards. Well-deserved.
spk02: Thank you.
spk01: Thank you. And we will take our next question from Pete Christensen with Citigroup.
spk09: Good morning. Thanks for the question. Good morning, John and Bob. Just curious if there's any sense of how seasonal hiring is shaping up. I know it was a bit of an issue in the November quarter last year. Any sense of how that's trending? Appreciate it. Thank you.
spk19: Yeah, so far, Pete, I think we made reference to this in the script and the press release. Hiring within our base, both within the ATM base and then in our HR outsourcing solutions was positive in the quarter. And for the second quarter in a row, it has been slightly above our expectations. We had a couple of quarters last year where things were a little bit below where we expected them to be. We tweaked that in our forecast. Again, we didn't build our plan this year, assuming a lot of growth in those areas, but for the second quarter in a row, hiring had been positive within our base and slightly running ahead of our expectations in our plan.
spk20: I would add to that. We're working on this problem very aggressively, and what we're trying to figure out is we how do we help make sure that our clients don't have vacancies? All these things you see us doing from recruiting, we've talked about what we did in the PO last year, you mentioned where you had some seasonal softness. We actually created a program there to go out and do that. And then with this new Copia product. So, you know, we've been aggressively trying to figure out ways that we can fill every vacancy that our clients have. As you can imagine, having 740,000 clients, all of them have two or three vacancies that adds up to, to a lot of checks, and so you look at our, in our HR consulting business, our HR consultants increase their year over year interactions on both hiring and retaining by 273%. So we're packaging information, we're using analytics to identify clients that we know are having turnover problems, and then we're proactively reaching out to try to help them develop individualized strategies to fill those jobs. And so, very pleased, in this environment to continue to see that the checks and worksite employees exceeded our expectations. And we're going to continue to work on that problem.
spk09: The recruiting tool certainly sounds exciting here. Just curious if this deepens your relationship with staffing agencies. I know that's a reasonable portion of your base. Just curious if this tool has potential to broaden that exposure. Thank you.
spk20: Yeah, I don't think we designed this tool specifically for the staffing. Certainly, as you know, we do some funding in the staffing business. We have staffing companies that are on our HCM platform, as a matter of fact, and we also have some staffing companies that leverage our PEO as well. So this is for not only all of our clients, But this is for all small businesses. Again, I'll go out. This is a unique thing for Paychex. Not only is this going to allow us to have further product penetration inside our base, but this is actually a way for us to begin to have a relationship with a non-Paychex payroll customer. So anyone can go on Paychex.com today and sign up and search for a job today. We really want to encourage and help small businesses attract and retain employees.
spk09: That's great. Thank you. Nice execution.
spk01: Thank you. And we will take our next question from Kevin McVey with UBS.
spk10: Great. Thanks so much, and congrats on the quarter. Hey, if I think about the pacing of the Q1 to Q2 revenue, is that primarily less headwinds from ERTC, John, or is it maybe a little bit better than expected? client interaction or just any thoughts around that?
spk19: Yeah, Kevin, this is Bob. So when you look at the, I think the, you know, I've answered a lot of questions and talked to a lot of you over the last quarter about kind of the gating of the plan. And, you know, I think it was a little bit misunderstood. You know, probably some of that's on us as it relates to the ERTC. But when you look at the gating, of the plan this year. It's fairly evenly gated throughout the entire year. So if we go back to last year, we saw momentum in the second half of last year. We saw an acceleration of growth in the back half versus the first half. And that really continued in Q1. X, the headwinds, we mentioned revenue growth of 7%. And when you look at the gating by quarter, it's pretty much the same. I know the guide implies a ramp in performance as we move through the year, but that really doesn't have to do with this year. It has to do with the compare of last year getting easier. So the ERTC headwind was 200 bases on a full year standpoint. It was pretty large in Q1. As we move into Q2, it becomes less. I mentioned earlier, In the prepared remarks, it is about 200 basis points in Q2. It will become less in Q3, and then it's basically zero in Q4. So I have two more quarters of having to talk about an ERTC headwind, and then it's behind us. But really, there's not an assumed ramp in performance in our business. We got good momentum that started in the second half of last year. It's continued into Q1, and we expect that to continue through the balance of the year. that's super helpful and then just the adjustments on the float um where was the offset because obviously nice job being able to reaffirm that the margin targets was there any offset on that or is it just where you think you're going to fall in the range no listen i mean q1 was uh slightly better than what we expected so i think that that gives us gives us confidence in maintaining um the ranges and and we've been able to you know we rolled through the I mentioned 125 basis points of cuts. Our plan only had 25 basis points of cuts. We've now pretty much aligned with where the Fed would expect the short-term rate to be at the end of this calendar year, which is another 50 basis points worth of cuts. And then we also have another 25 basis points of cuts assumed in our back half, which is the first half of the calendar year. But just given the momentum in the business, retention was good. Losses were down year over year. John mentioned the demand environment being strong. We continue to see strong demand and performance in our HR outsourcing solutions and in our retirement business. We actually had three businesses during the quarter that were double-digit growers, the PEO, retirement, and then our funding business organically was a double-digit grower. So just based on the momentum in the business, the Q1 performance, we've been able to kind of cover the the changes to the short-term rates and really maintain guidance. I wouldn't expect guidance to be any different part within the ranges than where we were in the beginning of the year.
spk20: I think, remember, we've got a lot of things in front of us, elections, a lot of global items I think that we have to continue to monitor. We're just really getting into our selling season, as everyone knows. We're off to a good start, solid start, as Bob says. We like the setup with our products. All the stuff we've been doing to set ourselves up for the post-pandemic era are in place. We've got a lot of changes we've made to our go-to-market approach and strategies, and those investments are showing good signs early in the fiscal year. And so, like I said, there's still headwinds out there that we're trying to manage around as well.
spk02: Thank you.
spk01: Thank you. And we will take our next question from Brian Bersion with TD Cohen.
spk04: Hi, guys. Good morning. Thank you. I wanted to dig in a little bit on the Modestly Better 1Q revenue growth. You noted client hiring was better than expected. Can you comment on how bookings and retention, just how do those perform versus your clients?
spk20: Yeah, Brian, I would tell you retention was positive. It continues to be at near record levels, and particularly in our HR outsourcing business, our client retention actually was better year over year as well, both controllable and uncontrollable, the latter being a good sign relative to non-recessionary type of activities, the fact that we actually have less kind of out-of-business and financial distress losses. So retention was solid in the quarter.
spk04: Okay. And then on PEO growth, can you remind us what makes the PEO accelerate from here as you go through the year? And maybe just comment on how, from a PEO health enrollment standpoint, how the October 1 enrollment period is going versus expectation?
spk20: Yeah, so Brian, the fact of the matter is PO acceleration is going to happen by continued to see worksite employee acceleration, which we continue to see, and we have solid bookings in the first quarter. Now, as you know, PO starts off. The first quarter is important because, as you pointed out, that's a time that we roll out our new benefits plans, and I can see those plans are resonating both with our clients and with the marketplace. And we're through the first part of our enrollment, and that enrollment is meeting and slightly exceeding our expectations, both in terms of client retention as well as participant penetration as well. So please, where we are there, we still have, as you know, more to go as we finish out January. But I would say that where we are, This point right now is where we were last year at this point. I feel really good about the setup for the PEO.
spk04: Okay, very good. Thank you.
spk01: Thank you. And we will take our next question from Tensin Huang with J.P. Morgan.
spk11: Thanks, Bob. Hi, John. I just wanted to ask on the – Definitely some good product velocity echo a lot of the comments that are on the call. Just going into the selling season, would you expect some of the new products you're showcasing to impact unit growth more, or is it more about upselling and higher revenue per? I just wanted to better understand that.
spk20: Yeah, I think what we're trying to focus on, and I'll keep going back to this, is there's three core problems that we're focused on. putting our energy that we think have been consistent problems before the pandemic, during the pandemic, and accelerated in post-pandemic. That is recruiting and retaining quality employees. And we believe that the solutions that we're applying in that area not only help us drive more unit growth, but we also believe that it improves our retention. That if we're helping our clients solve that problem, then that's going to help them see the value of paychecks. And if we can provide a value proposition that says, I can help you find people you have not been able to find, we think that's going to attract new clients as well. So we think it's retentive. We think it gives us an additional upsell opportunity with existing clients to add that module on. We also think it's a way to attract new clients as well. I'll remind you on the co-pilot, you don't have to be an existing paychecks client to buy it today. And what we certainly hope is that when you come and start using our small business recruiting tool to find individuals, that you're going to get a call from one of our HR advisors and talk to you about what else we could be doing to help you engage your employees and keep them as well. So we also think that's a good thing. And then you look at the second problem that we're trying to do, which is affordable benefits. I mean, I think we still have not heard the sonic boom of the pandemic in healthcare costs. And I think a lot of the contract negotiations with hospitals and carriers, all that's coming through. And what we see from a health inflation perspective is that people are looking for someone who has the scale and the capability and the relationships to be able to help them manage costs. Now, look, we're not going to provide cheap insurance, but at least we think we can certainly help people manage over the long term their costs, and we've demonstrated that. in our PO and our agency can do that as well. And then the third thing that we're still working on, and more to come on this, is trying to help our clients gain access to growth funding. One of the things I would tell you that's been a headwind for us, it was a headwind this quarter, it's been a headwind for some time, is typically within our client base, our clients are adding new locations. And so that's why we get a natural growth, we call it client referrals, but it's really not client referrals, it's a client Again, we deal with a lot of entrepreneurs. They open a lot of businesses. The fact that they're not adding additional size has actually kind of hurt our unit growth a little bit for several years. And I think with the Fed rate going down, that's going to help. But we've also been working with FinTechs and others. And what we want to do is create an ecosystem where we can help support our clients gain access to affordable funding to be able to grow their business. Because if they're growing their business, that's going to help paychecks.
spk13: On that ladder, that's a great point because I've been attending a lot of fintech conferences. So this concept, you mentioned earlier with Jaxxis, the concept of maybe doing more of that directly versus with partners, has your view changed on that?
spk20: No, I think what we're trying to do is create a – think about it this way. Like in our app today, if you're an employee and you're going to onboard an employee, we want to create an onboarding experience like you would with a large company like Paychex. She's going to come in, you're going to give us your information, you're going to fill out your tax information for us so we can load you up, and then we're going to offer you an open enrollment experience to look at benefits that you can buy on your own. You don't need your employer chipping in. The same thing we're trying to do for the employer when they're going to run their payroll, because for most small businesses, their payroll is their largest expense. So what we're trying to do is set up an ecosystem that when it comes time to fund your payroll, We want to bring a set of partners right there in the app with your ability to say, look, you're pre-qualified for a $10,000 loan or you could potentially get access to funds if you needed to float your payroll for a period of time. So we're trying to create that ecosystem, nothing yet, but that's the vision we have in talking to our small business owners about how we can help them. We have a program called Paychecks Promise. which for a lot of our longstanding clients that have demonstrated that they're good risk, that we'll actually work with them a little bit on a payroll-to-payroll basis on what we can do. So, again, it's just one of those things that we believe that if we do that, it's going to attract more customers, it's going to retain more customers, and it's really addressing a critical need that the small business owners have.
spk11: Makes great sense. Thank you.
spk01: Thank you. Thank you. And we will take our next question from James Fawcett with Morgan Stanley.
spk05: Hi, everyone. It's Michael in Fontana for James. Thanks for taking our question. I just wanted to go back to some commentary that you provided last quarter just in terms of some of the challenges that you maybe saw just in terms of your capacity to sort of get deals across the finish line and how pricing and discounting is playing into that. Was that Sort of one time in nature, did you see any of that in the quarter, and how should we expect that to play out over the near to medium term? Thanks.
spk20: Yeah, I would say that the competitive environment is stable in terms of that. You know, certainly it's a highly competitive environment, but I'm not seeing anything relative to anything dramatically different in terms of the pricing environment.
spk05: Got it. That's helpful. Maybe just to piggyback on Brian's earlier question, just in terms of bookings composition, if you sort of had to stratify it between two buckets, payroll and HCM versus insurance and retirement, I think insurance and retirement were sort of some of the key drivers last quarter. But sort of what's driving the relative strength now? Is it fairly broad-based? And how do you think that strength is going to persist over the near term? Thanks.
spk20: Yeah, I think what I would say, I think the demand is out there across the suite. Actually, when I look at proposals, our proposals in almost all segments are up year over year. I think there are a lot of people out there kind of shopping and looking. Again, as we know, we're just entering the selling season for most of our market segments. This is when people really are making their decisions. But I do think there's a lot of people that are out there shopping and looking and and comparing providers. I've seen that. I see that in the numbers that we see. And now it's just a matter of giving them the compelling value proposition to close as we get into the selling season. So I see a very stable demand environment and feel good about how we're positioned going into the selling season. But we have a lot of work to do, and that's really what we're going to see over the second and third quarters.
spk03: Appreciate the color.
spk01: Thank you. And we will take our next question from Samad Samana with Jefferies.
spk14: Hi, good morning, and thanks for taking my questions. Maybe first, just on the new kind of benefits or financial wellness solutions, could you just remind us how the monetization works there? and what type of contribution you've embedded into the fiscal 25 outlook. And just remind us what segment it goes into as well. I'm going to have one follow-up.
spk20: Well, I'll describe. This is something we're just beginning to launch. We've been working on it. We're only eight weeks into it. I'm pleased with the initial results. We've been testing this for a while. But it basically works like this. You're an employee of our client. You get onboarded, your new employee coming on. You go through the onboarding process where you're loading your address, your information, your tax information. We then put you into a traditional open enrollment screen where you then have a menu of choices both in terms of benefits as well as earned wage access. You sign up for those and then we deduct that from your wages each payroll.
spk19: Well, just on the second part of your question, it's early innings. We do have some dollars assumed in the plan, but I would say at this point in time, it's not material. And a lot of that is insurance-related and would hit the P.O. and insurance category. But it's small dollars assumed in the plan. As John said, we're just kicking this off in its early innings, but we think it has a lot of potential.
spk20: Yeah, again, I would continue to look at these types of things as being items that we look for that are not only going to increase revenue and profit, but also are going to improve our ability to attract by differentiating ourselves for new clients and creating a retentive factor with existing clients because we're providing something that's not being offered in the market.
spk14: Gotcha. And then maybe just a follow-up. I know the last couple of quarters you guys have talked about the discounting environment and the pricing environment. So I'm curious just what you saw in this most recent quarter from a discounting perspective and the need, the frequency and magnitude that you're having to discount and just maybe what trends you've observed and if there's been any change from what you've observed over the prior couple of quarters.
spk20: No, I would say that what we're seeing is a little more stability to what we've seen over the last, you know, probably a couple quarters. It's still a competitive environment, but what I would say is it's a little more stable in terms of what we've seen. Now, I always say that we're about right in the selling season, and we'll see what things come up with. Look, I do think an interesting phenomenon is – is running itself across our industry is the thing that's called profitability. And so that tends to drive rationality as well.
spk14: Understood. Thank you again for taking my questions. Appreciate it.
spk01: Thank you. And we will take our next question from Andrew Nicholas with William Blair.
spk07: Hi, good morning. I wanted to first follow up on the last question, just specific to the PEO business, I want to make sure that you could speak to the competitive dynamics and the pricing there. It seems like some of your peers, both public and private, are talking about increased aggressiveness on the pricing front. You've had very good growth in that business now for several quarters in a row. So just curious if your comment about it being a little bit more stable also applies to that part of your business.
spk20: Yeah, like I said, I would say across each one of our business segments, I would say that that's true, and particularly the CEO.
spk07: Okay, understood. And then for a follow-up, just curious on the agency business or the insurance solutions business specifically. I know you've had some growth headwinds on the rate side over the past couple years. Just curious if there's any signs. of stabilization there or that bottoming and what that could potentially mean for growth in the back half of this year or out into future years if there's a trough in that part of the business.
spk19: Thank you. Unfortunately, Andrew, that headwind continued into Q1 on the workers' comp rate side. I think if you picked up on the comment that I made earlier as it relates to the strength of the P.O., I mean, overall, the category grew at 7%, but PEO is a double-digit grower with strong sales performance retention and just overall really good strength in that PEO business. Insurance continues to be a drag on that category. So we have factored that into the plan, so I don't see a lot of risk as we move forward to what we're calling out here from a guide standpoint. But the print numbers here that don't really do the justice for the PEO business because it's combined with insurance because it just continues to be a strong performer for us again this quarter.
spk20: And as we mentioned, we're going to continue to innovate around the insurance business. The Perks launch is one example, extending that market now to include being able to have a relationship with our clients' employees directly. And we're going to continue to look for ways that we can expand the market opportunity for the insurance business because certainly to the 3.5, the workers' comp market has been challenging for several years. We keep thinking it's going to turn around, and the macros there just are not happening. So we've got to take control of our own destiny and we're going to continue to work on that business and come up with new ways to add revenue there.
spk07: Great, thank you.
spk01: Thank you. And we will take our next question from Ashish Albajar with RBC.
spk16: Hi, this is David Page on for Ashish. Thanks for taking our question. Just a quick follow-up on what was discussed a little earlier. The five and a half percent year-over-year growth at cost of service revenues. What was the – can you provide more color on what was driving that growth year-over-year, and then I guess how should we think about that line item for the rest of the year? Thank you.
spk19: I mean, we don't specifically break that out and provide guidance on expenses. I would tell you over, you know, between the different lines, David, you know, I think as I mentioned in the prepared remarks, Expenses were up 3% in the quarter. A lot of that was driven by the performance in the PEO business in the higher insurance revenue that we've seen. I think X those higher costs, our expenses were essentially flat in the quarter. As John mentioned earlier, we spent a lot of time last year on our cost structure, getting our costs in line. knowing that we had a fairly big headwind this year from an earning standpoint and margin standpoint with ERTC. So we spent a lot of time last year and obviously we announced our cost optimization project at the end of last year to really get costs in line so we could continue to invest in the business. And I think you're seeing the fruits of those investments with a lot of the new solutions that John highlighted and that we were able to showcase last week at HR Tech and really still being able to deliver some margin expansion. You know, the midpoint of the guide assumes about a 50 basis points of margin expansion, you know, enabling us to invest and deliver margin expansion in the face of that ERTC headwind, which has a fairly significant earnings headwind as well.
spk02: Great. Thank you.
spk01: Thank you. And we will take our next question from Brian Keene with Deutsche Bank.
spk08: Hi, guys. This is Nate Svensson on for Brian. I just kind of wanted to follow up on the margin comments there. So you're expecting 2Q margins of 40%, maybe a little bit lower than you expected, and you still maintain the full year guide calling for 42% to 43%. So I know there's seasonality in the business, and, you know, the back half tends to be, stronger for you guys in terms of margin, but maybe you can talk about your confidence in realizing, I guess, some pretty material margin, sequential margin experience in the back half, particularly that looks like there's still going to be some ERTC headwinds in the third quarter.
spk19: Yeah, I mean, it's really the same story as the revenue. I mean, it's really the compare, you know, margins, X ERTC, margin expansion in Q1 was about 200 basis points of margin expansion in Q1, X ERTC. I gave you the 40% for Q2 color, which implies a slight contraction of margin versus last year. But again, if you exclude ERTC, it's between 150 to 200 basis points of margin expansion in Q2 as well. And then obviously the headwind subsides in the back half of the year, and that's where you get the margin expansion on the four-year basis. So similar to The revenue acceleration that appears to be in the plan, it's the same story with margin expansion. It really relates to the prior year compare.
spk08: Got it. That's helpful. And then for the follow-up, you mentioned updates on the go-to-market strategy a couple times in the prepare remarks. So I know last quarter we talked about maybe some rollout issues with the digital channel, but assume those are behind us now. Maybe beyond that, are you starting to see some traction on the changes you made with your go-to-market approach? Are there any lessons you've learned, maybe positive proof points on the things that you've changed and some early progress that you're seeing there?
spk20: Yeah, good question. We learn something new every day on this front, which is one of the things that we're very pleased about. So I would say when I looked at the quarter, we started in the PO a year ago. beginning some of these go-to-market, which includes a totally revised marketing and sales technology stack implementation. So think about the margin story Bob just told. We've been delivering these margins while investing significantly in preparing for the post-pandemic world. So while interest rates were going up and we were having the benefit of the RTC, we had been putting money into the business to prepare for what we knew was coming. And so I'm most pleased in the quarter with the results that we're seeing from these numerous investments that we proved in the PO that we've now extended across all of our market segments. But we've changed our marketing approach. We've changed our sales technology stack. We're exceeding our expectations in these new go-to-market teams that we've put together. We've refined our segmentation. And we're going to continue to refine that. So one of the things that we're doing digitally is, It's collecting all of our interactions, and we're looking on a daily basis about what's resonating with our clients and how our sales teams are executing. So I've been very pleased with the execution that our go-to-market transformation team has been working on. When you think about that, it's really about retooling and retraining over 3,000 sellers in the marketplace, and we've actually increased our segmentation. So I think a question was asked earlier about a little bit more in the mid and the upper market. We have a lot of confidence we can do that. We've actually added hunters in that particular segment. And given the results that we've seen in the first quarter in these go-to-market pilots that we've done across the various other segments, we are actually accelerating sales hiring. So we're going into the selling season not only fully staffed, but Given the results we've had, we're going to be accelerating higher into this new go-to-market strategy.
spk18: Great call. I appreciate it.
spk01: Thank you. And we will take our next question from Ramsey Ellisol with Barclays.
spk06: This is Owen on for Ramsey. I appreciate you taking our question this morning. You just touched on kind of your sales team and wanted to get an update on sort of the growth drivers within management solutions. Just wondering if the focus has shifted a bit from new client wins to further penetration in your existing client base with the additional HCM services. Any of your expectations going forward, given all the new product rollouts, which you expect to lean into more one versus the other, any insight there would be helpful. Thanks.
spk20: No, and I would say, look, our growth formula hasn't changed. It's, you know, grow clients. drive further penetration of new products, continue to innovate so we have more products to drive into the client base, and continue to provide value to our clients so that we have pricing capacity, the ability to pass price on. And I would say that's been Paychex's 52-year history, and that's what we're going to continue to work against.
spk06: Got it. And just on cost of service revenues, you touched on that a bit early in the call. Just also interested on the benefits side, if any increase in cost is associated with kind of the utilization in kind of claims costs, any color there and kind of expectations going forward would be helpful as well. Thanks.
spk19: Yeah, just to add to my comment, you know, overall I think what you're seeing there is cost being driven by not so much higher claims but really worksite employer and higher insurance attachment that we've seen over the last year. So, you know, worksite employee growth in the PEO was strong. You know, that's what we're focused on is driving worksite employer growth and I think when you do that, coupled with the insurance attachment, you get some wage inflation and medical inflation, then you're able to put together a PO business that's growing in the double-digit range like ours did this quarter and has, you know, for the past couple quarters. And that's what's really driving the higher costs is just the performance of the business, not so much unfavorable claims history or anything like that.
spk06: Understood. I appreciate the clarity there. Thanks. Yep.
spk01: Thank you. And we will take our next question from Kartik Mehta with North Coast Research.
spk15: Hey, good morning, John and Bob. Hey, John. Hey, just getting your thoughts on acquisitions versus buyback. You know, you've talked a lot about some of the new products you have, maybe a change of what businesses want and need. And so I'm wondering, you know, as you look forward to, Just your thoughts on maybe what you're trying to prioritize and how you might allocate capital.
spk20: Yeah, I would say, Carter, thanks for your question. I hope you're doing well. I would say that we are constantly and have always been looking, we talked about the growth formula, grow our clients, increase our product penetration, provide value so that we can get a proper price for what we deliver for our clients, and then tuck in inorganic growth on top of that. That's always been kind of what we've looked at. I think we've talked several times. The market, I would say, over the last 12 months has changed a little more rational of what we're seeing. I would tell you that our pipeline is robust at this point in time, and I think there's more rationality coming in to the industry at this point in time in terms of a willingness to to look at potential combinations. I can just see it in our pipeline and the way deals are coming together. But what we're looking at hasn't really changed. We're looking at opportunities at scale in our existing markets where we can drive our advisory and really the full breadth of our services. Remember, we're just not a tech company. We have a ton of other products and services that we can bring to those markets. We're looking for opportunities to expand our product suite so ways in which we can continue to add products and services that we can sell to all of our clients. We're continually looking at digital capabilities where we can add that into our business and then looking for adjacent growth platforms. So all of those right there, what I told you, I would have said three years ago we had a lot of interest and prices were unreasonably high for the value and we're very, as you know, very conservative in looking at deals that we're going to do. What I've seen over the last two years is more rationality. The last 12 months, even more rationality. And now I think more and more individuals are going to have serious conversations. And so again, we're out there, we're looking, but we're going to make sure it's a smart deal and one that is going to be accretive for our shareholders long term.
spk15: And just one follow-up, Bob, I think when you initially gave guidance, you anticipated kind of flat pace for control. Seems like things are going a little bit better than you expected. Any thoughts in terms of, you know, kind of as you look out, if those expectations need to be changed or maybe feel better about the guidance for pace for control?
spk19: Yeah, I would say it's more the letter card. We feel better. Again, it wasn't assumed in the plan to be a big contributor to growth. We had it, I would say, in the checks per client part of the business on the HCM side. We had assumed it was going to be flattish on a full-year basis, and it trended a little bit more positive there. So I think that gives us confidence in the guide. And again, we're maintaining the guide. in the face of some interest rate headwind on the top line as well. And then when we look at our bigger client sizes, particularly our HR outsourcing models, we did assume a little bit of growth there in the plan. Again, not a huge contributor to growth, but certainly expected it to be positive. And it was slightly better than where we expected it to be in Q1. And I think that gives us confidence and kind of maintaining the guide in where we're at. But again, neither one of them were big contributors to revenue growth on a full year basis.
spk15: Thanks, Bob, John. I appreciate it.
spk01: Yep. Thank you. And we will take our next question from Jason Kopferberg with Bank of America.
spk17: Thanks, guys. Good morning. I wanted to start on the management solution. Can you give us a sense of what you expect for our second quarter? growth there. I know you will still have the ERTC headwind, but you won't have the processing day headwind. And then just any comments on visibility on the second half acceleration and plot and the guide. It doesn't sound like you're assuming any real improvement in underlying performance, but just any other color on that aspect too. Thanks.
spk19: Yeah, Jason, I think you might have asked me a similar question last quarter. I could be wrong. But I don't want to get into giving quarterly guidance, particularly on the splits. We're trying to maintain our approach, which is to provide annual guidance and provide updates quarterly. I try to give you guys a little bit of color on the next quarter to help you out with your models, but I don't want to get into the specifics. As I mentioned, we'd expect the Q2 to be 4% to 5%. The headwind is in management solutions. It's ERTC. It's 200 basis points on total revenue. I'd like to stick to that. Again, I'll just reiterate my prior comments as it relates to the acceleration in the back half. When you look at the gating by quarter and you exclude the ERTC headwind, the gating by quarter from a growth standpoint is very consistent quarter to quarter and is in line with where we were exiting last year, which again was an acceleration versus where we were in the first half of the business. So again, we feel like we got a lot of positive momentum in the business. Lots of great things to talk about, certainly from new product and solution introductions that have rolled out here in the last month or so. And we expect that momentum to continue through the balance of the year. But there really is not an acceleration assumed. It's really the compare last year that makes it look like the growth accelerates in the back half.
spk17: Okay, understood. Just on operating margins, I think you came in above the guide for the first quarter. Were there any expense timing dynamics there or other factors? I mean, I know you're in the full year.
spk19: Yeah, I mean, I'd say a couple of things. I mean, revenue was a little bit favorable to our expectations, so that certainly helped. And, hey, we put together a plan and, you know, You know, when we look at expenses, we have investments that we want to make, you know, headcount that we're adding, and maybe that takes us a little bit longer than what we assumed in the plan. Like, you know, we thought we were going to get it in the first month, and it takes a little bit longer. So I'd say, you know, we had a little bit of expense favorability, a little bit of revenue favorability, and those two things combined, you know, provided a little bit better margin than what we had gotten to.
spk17: Okay. Thank you, Bob. Yep.
spk01: Thank you. And we will take our final question from Scott Wurzel with Wolf Research.
spk12: Hey, good morning, guys. Thanks for squeezing me in here. Just wanted to touch on the two-key margin guidance a little bit more. I know we touched on sort of the cadence for the full year, but just kind of looking, obviously guidance implies a similar year-over-year change, I guess, relative to what you reported in first quarter, but we have a little bit of an improving or better BRTC balance Edwin, just wondering if there's any kind of items we should think about with respect to the two-key margin. I understand we're getting into the selling season. If there's any items around that or others that we should be contemplating.
spk19: Yeah, I think if you look at the gating of the margin throughout the year, it's not exactly the same quarter by quarter. I think someone had referenced it's higher in the back half. It's typically higher in Q3 because of some of the year-end processing that is high margin that occurs there. in that quarter. But I would say nothing specific to call out, Scott, other than the guide implies a slight contraction versus prior year. But again, that's really coming from the headwind from ERTC. When you exclude that, you're seeing good margin. We'd expect to see good margin expansion in Q2 between 150 and 200 basis points, I think, if you did the math. that's what you would get to exclude the ERTC headwind. But nothing specific to call out. Yes, we're going into selling season. I want to make sure we're gearing up and we feel like we're in a good position, fully staffed and making the investment so we're going to have a successful, you know, so we can have a successful selling season.
spk12: Got it. And just as a follow-up, I mean, I'm just looking at the presentation you called out, you know, high single-digit growth and HR outsourcing WSEs, which, you know, seems pretty impressive and, you know, I just want to maybe understand the drivers there a little bit better, and if you can talk about maybe some of the growth that you saw in the ASO business during the quarter would be very helpful.
spk20: Yeah, I would say that what's driving that is the power of the value proposition. Like I said, I don't think what won the last three years in our industry is going to be what is going to win in the next three years. And I think it's not about the bells and whistles, and I think when you look at our comprehensive HR outsourcing offering and the assistance that we provide that's beyond just the tech play. That seems to be resonating, and I do think the outsourcing message of our PO is, once again, we're tilting back. If you remember a page where ASO was a little more tilted than PO, we now see that tilt back to the PO value proposition, and the team has done a great job of putting together a powerful a set of, I think, benefit offerings and execution in the P.O. market. So that's been what's driving this exciting program.
spk02: Got it. Thanks, guys. Thanks. Is that it?
spk01: And there are no further questions at this time.
spk20: Okay. Well, listen, thanks, everyone. At this point, we're going to close the call. If you're interested in a replay of the webcast, it will be archived for approximately 90 days. Again, I want to thank you for your interest in paychecks and hope everyone has a great day.
spk01: Thank you. That concludes today's first quarter 2025 Paychecks Earnings Conference call. You may now disconnect your lines at this time and have a wonderful day.
Disclaimer

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