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Paychex Inc
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Ladies and gentlemen, thank you for standing by and welcome to Paychex First Quarter Earnings Call. At this time, I will turn the conference over to your host Martin Mucci. Please go ahead.
Thank you. Good morning, everyone. Sorry for our slight delay there. Just a little bit of issues on conferencing, but we will get started now. Thank you for joining us for our discussion for the Paychex first quarter fiscal 2019 earnings release. Joining me today is Efrain Rivera, our Chief Financial Officer. And this morning before the market opened, we released our financial results for the first quarter ended August 31, 2018. You can access our earnings release on our Investor Relations webpage and our Form 10-Q will be filed with the SEC within the next few days. This teleconference is being broadcast over the Internet, will be archived and available on our website for about 1 month.
On today’s call, I will review the business highlights for the first quarter. Efrain will review our first quarter financial results and discuss our guidance for fiscal 2019. Then we will open it up for your questions.
We have had a good start for fiscal 2019 and our financial results reflect growth across our major product lines. Our total revenue growth was a solid 9% for the first quarter. Beginning this quarter, we are changing from our traditional disclosures, as Efrain talked about last quarter, of the service revenue categories of payroll and human resource services and are now reporting service revenues as management solutions revenues or PEO and insurance services revenues. This new revenue disaggregation provides a better representation of how our business has evolved to the selling of more bundled products and Efrain will provide more information about this in his commentary.
You may recall last fiscal year we implemented certain go-to-market strategies for sales, which began to gain momentum in the back half of the year. That momentum has continued for the first quarter, especially to HR outsourcing services both in our PEO as well as our traditional ASO/HCM service bundle. We have also continued to add to our sales force and are fully staffed as we head into our upcoming peak selling season.
With regards to the client retention in the first quarter, we are very pleased with the continued increase in this metric for retention as well as our strong client satisfaction performance. August 18 was the anniversary of our acquisition of HR Outsourcing Holdings, Inc., or HROI, a national PEO. HROI continues to perform well and has integrated very well into the existing PEO sales and service organization of Paychex. We also acquired Lessor Group, a payroll and HR services provider headquartered in Denmark at the end of February 2018. Lessor is performing well and we are enthusiastic about the growth opportunities that these acquisitions provide us. At the HR Tech Conference in September, we premiered our Paychex brand refresh, which focuses on the power of simplicity. This renews our commitment to our customers to make their lives easier by alleviating the complexity of payroll, HR, benefits, and insurance.
Paychex has over four decades of experience working with businesses to solve their complex challenges. And everything we do is focused on making it simpler for our clients to run their businesses through a combination of our leading technology, our breadth of product offerings and our personalized service options. At HR Tech, we also introduced Paychex Learning Management, a web-based learning management system that provides employers with a simple and affordable learning tool. Paychex Learning Management features access to hundreds of preloaded learning modules, allows clients to create their own new materials, and upload existing training material specific to their industry or workforce. It is also integrated with our performance management solution, which recently underwent a user experience update.
In our current environment of record low unemployment and award for talent, employers need every advantage they can to get for recruiting and retaining employees and our comprehensive suite of HR products can help employers recruit with attractive benefit package and our new LMS offering helps with the retention of talent by providing ongoing engagement and professional development. We also showcased additional new enhancements and features within our HR product suite. We now offer tablet-enabled facial recognition for time and attendance and the new Paychex Flex Assistant, a chatbot for commonly asked HR related questions. These are examples of our ongoing commitment to continually introduce advancements in technology that evolves and enhances our clients’ experience and makes it more valuable to them across all of our services.
We are pleased with our progress in retirement services for the eighth consecutive year. Paychex was named by PLANSPONSOR Magazine as the leader in total number of defined contribution plans as we now serve well over 80,000 plans. Paychex Retirement Services meets the needs of businesses of all sizes by delivering next level efficiency with full Paychex HCM integration, fee transparency, plan accessibility across devices, flexibility in investment options and fiduciary solutions and personalized participant support. We also ranked number 20 as the 20th largest business insurance agency in 2018 in their top list of 100 brokers in the U.S. This is up 1 spot from last year. This is our eighth time on this list as well and is a testament to our best-in-class insurance agents who continue to deliver customized solutions to meet the evolving needs of business owners and their employees. Value-rich insurance coverage plays a key role in both hiring and keeping key talent.
I would also like to note that for the sixth consecutive year, we were recognized by Selling Power Magazine as one of its 50 best companies to sell for, in fact ranking number 3. We have been making significant investments in our sales force, including new technology support tools and more sophisticated demand generation to improve the quantity and quality of the sales leads to support our sales force and their success.
We continue to also provide value to our shareholders. Our quarterly dividend is currently at $0.56 per share, with a last increase of 12% this past April.
In summary, our state of art technology full suite of integrated HCM product offerings and personalized service is a powerful combination that positions us for sustainable growth in our markets. Our employees make this combination successful with their hard work and commitment to our clients each and every day.
I will now turn the call over to Efrain Rivera to review our financial results for the first quarter. Efrain?
Thanks, Marty and good morning. I would like to remind everyone that today’s conference call will contain forward-looking statements. Please refer to our earnings release that includes a discussion of forward-looking statements and related risk factors. In addition, I will periodically refer to some non-GAAP measures such as adjusted net income and adjusted diluted earnings per share. These measurements include certain discrete tax items and one-time charges. Please refer to the press release and investor slide presentation for a discussion of these measures. The investor slide presentation should be up and it’s got a lot of supplemental information on it.
As mentioned previously, effective for this fiscal year, we have adopted a new revenue recognition guidance in ASC Topic 606. We have adopted under the full retrospective method. So prior year results have been restated to conform with this guidance. After our previous earnings call in June, you’ll recall that I held a supplemental call to introduce the impacts of this new guidance on our financial results. On our IR page, we have published an updated presentation from that call and that gives quarterly information on the financial impacts of ASC 606 and other non-GAAP adjustments for the past 2 years.
Overall, the changes from adoption of the accounting standard are not significant, but they do have a modest effect on the quarterly periods. This presentation also reflects the impact of tax reform and non-GAAP measures. In connection with the adoption of the new guidance, the categorization of our service revenues is evolving. In prior years, we disaggregated service revenue into two buckets, payroll service revenue and human resource services revenue. As our business has evolved to selling more bundled products, this disaggregation has become less meaningful. ASC 606 requires disaggregation of revenues to reflect how the nature, amount, timing and uncertainty of revenue and cash flows are impacted by economic factors. Given how we manage our business and the risk inherent in various services, we have decided that a more meaningful presentation is the categories of management solutions revenue and PEO and insurances revenue. Management solutions revenue includes payroll and HR and employee benefits products that are better reflective of offerings in our product bundles. So, this presentation includes our previous category of payroll services together with retirement services and HR administration solutions, including our comprehensive ASO service bundle. This presentation represents our integrated HCM services.
PEO and insurance services revenues have similar operational economic characteristics. Both involve the provision of insurance benefits to clients. PEO revenues also reflect a gross up for certain of our insurance offerings to PEO clients. During this transition period, I want to emphasize this will provide information on service revenues under both our previous and new classification. So, you will have that information. You will have the ability to adjust your models as you go forward. And there is information on our Investor Relations site. It provides both as reported disaggregation of revenue, payroll and HRS and the revised disaggregation of revenue management solutions and PEO and insurance services for the past few years.
Now with that preface out of the way, I will provide some of the key highlights for the quarter and then provide greater detail in areas. And as usual, I will touch briefly on the results and wrap up with the review of fiscal ‘19 outlook. Total revenue and services grew 9% for the first quarter to $863 million and $846 million respectively. The growth was aided by the acquisitions of HROI and Lessor, more to come on those. Expenses increased 14% for the first quarter. The acquisitions of HROI and Lessor together contributed approximately 6% to the total expense growth for the first quarter. Accelerated investment in sales, marketing and product development as part of tax reform investments and PEO costs were major factors in expense growth.
Operating income increased 1% to $320 million. Operating margins were 37.1% for the first quarter. Margins were impacted by acquisition expenses, increased investment initiatives, higher growth and PEO costs and the composition of payroll processing days. Our effective income tax rate was 24.5% for the first quarter compared to 34.1% for the respective prior year quarter. The significant decline year-over-year in the effective tax rate is of course due to tax reform legislation. We anticipate that the effective tax rate will be approximately 24% for the remainder of the year. Net income increased 16% to $244 million for the first quarter and adjusted net income increased 18% to $242 million. Diluted earnings per share increased 16% to $0.67 for the first quarter and adjusted diluted earnings per share increased 18% to $0.67.
I will provide some additional color now in selected areas and start with a discussion of service revenues and we will discuss results under our previous categories and our new service revenue categories. Under our previously reported categories of service revenue, payroll services revenue growth was 1% for the first quarter in line with our expectations. Organic growth related to pricing for the first quarter was offset by the impact of client size mix and the composition of payroll processing days within the quarter. If you recall in June, I indicted that payroll revenue growth for Q1 would be below the low end of the range of our guidance. HRS revenues grew 18%, approximately 12% excluding the HROI acquisition. This growth is due to the growth in clients across our HR products, in particular Paychex HR Services, ASO and PEO, and retirement services.
Now, let’s talk about management solutions revenue. This includes as I discussed previously payroll service revenue together with other HCM products included in many of our product bundles. Management solutions revenue increased 3% to $688 million for the first quarter. This increase was driven by growth in client bases across our HCM services, including payroll, ASO, retirement services, and time and attendance solutions. Retirement services revenue also benefited from an increase in the asset value participants’ funds. The acquisition of Lessor contributed less than 1% to this growth. The growth was partially offset by the impact of unfavorable composition of payroll processing days in the first quarter compared to the prior year quarter, same thing that I mentioned on payroll.
PEO and insurance services revenue increased 39% to $158 million for the first quarter. We acquired HROI near the end of the first quarter of fiscal 2018. The incremental impact of HROI accounts for approximately one half of this growth. The remaining growth was primarily driven by continued strong demand for our combined PEO services as we continue to experience strong growth in the number of client worksite employees. In addition, our insurance services revenue benefited from growth in the number of applicants.
Interest on funds held for clients grew 25% for the first quarter to $17 million primarily as a result of higher average interest rates earned. And just to pause there for a second, we have assumed that there would be Fed rate increases in this fiscal – there will likely be more, but we only included two in our plan. The first occurred this or last month I should say and we anticipate there will be one more at least that’s what’s contemplated in our plans. As we get to midyear, we will talk a little bit more about what our expectation is based on where the Fed is at that point.
Turning to our investment portfolio, our goal as always is to protect principal and optimize liquidity. And the short-term side, primary short-term investment vehicles were bank demand deposit accounts and variable rate demand notes. In our longer term portfolio, we invest primarily in high credit quality municipals bonds, corporate bonds, and U.S. government agency securities. Our long-term portfolio has an average yield of 1.9%. Average duration is 3.1 years. Our combined portfolios have earned an average rate of return of 1.8% for the first quarter, up from 1.4% last year. Average balances for interest on funds held for clients were down modestly for the first quarter, primarily driven by the impacts of tax reform and client employee withholdings partially offset by wage inflation.
I will now walk through our thoughts on our financial position. It remains strong with cash and total corporate investments of $788 million as of the end of the quarter. Funds held for clients were $3.8 billion compared to $4.7 billion as of May 31, 2018. Funds held for clients vary widely as you know on a day-to-day basis and averaged $3.7 billion for the first quarter. Our total available-for-sale investments, including corporate investments and funds held for clients, reflected net unrealized losses of $36 million as of August 31, 2018 compared with $38 million as of May 31, 2018.
Total stockholders’ equity was $2.4 billion as of August 31, 2018 reflecting $201 million in dividends paid and $33 million of shares repurchased during the first quarter. Our return on equity for the past 12 months has been a stellar 45%. Please note that our return on equity calculation was adjusted to reflect the impacts of the adoption of ASC 606. At fiscal 2018 year end, we reported 46% return on equity, which would be actually 44% on a restated basis, because of those changes made by ASC 606. Cash flows from operations were $274 million for the first quarter. It was a decline versus the prior year quarter. The change was primarily a result of timing impacts within working capital largely related to income taxes and our PEO payroll and related unbilled receivables for payrolls not yet processed as of the reporting date offset by higher net income.
Fiscal 2019 guidance. Now, I will turn to guidance for the upcoming fiscal year ending May 31, 2019. I will remind you that our outlook is based upon our current view of economic conditions continuing with no significant changes. Our guidance for fiscal 2019 is unchanged from what was provided in June, which was given reflecting adoption of ASC 606. Under our previous revenue categories, there is no change to payroll revenue guidance in the range of 2% to 3% and HRS revenue guidance in the range of 10% to 11%. Payroll services revenue was below the low end of the range in the first quarter as anticipated due to the composition of payroll processing days. Growth in payroll revenue will be at or above the high end of the range for Q2 and Q3 and Q4 is anticipated to be within the range. HRS revenue growth for the first quarter was significantly higher than the range due to the timing of the HROI acquisition. Growth for Q2 and Q3 is anticipated to be within the range. For Q4, growth is anticipated to be below the low end of the range due to a more challenging compare caused by the strong growth in the PEO in the latter part of fiscal 2018.
We will also provide you with revenue guidance under our new categories as we transition to this approach in the future. Management solutions revenue is anticipated to grow by approximately 4% for fiscal 2019 as compared to fiscal 2018. Our Q1 results were obviously lower than this due, as I mentioned before, to the composition of payroll processing days. We anticipate that Q2 and Q3 will be above 4% and we anticipate that Q4 will be in line with the full year guidance.
PEO and insurance services revenue is anticipated to grow in the range of 18% to 20%. Growth in the first quarter was obviously significantly higher due to the timing of the HROI acquisition. We anticipate that growth for Q2 and Q3 will be in the range of 15% to 17% and for Q4 in the range of 11% to 13% due to the factors that I mentioned before, i.e., a challenging comparison with strong PEO growth in the latter part of fiscal 2018. All other guidance remains unchanged.
Finally, just as a reminder, we have provided on our IR website a presentation entitled service revenue disaggregation, which reflects historical revenues as originally reported and as they would be under the new categories. We have also published an updated presentation entitled impacts of ASC 606 and other items that reflects the impacts of adoption of 606 and other non-GAAP adjustments for fiscal 2017 and fiscal 2018. And with that, I will turn it now back to Marty.
Alright. Thank you, Efrain. Operator, we will now open up the call to questions please.
Okay. [Operator Instructions] Our first question will come from the line of Bryan Keane with Deutsche Bank. Please go ahead. One moment. Please go ahead, Mr. Keane.
Hi, guys. Can you hear me now?
Yes, we can, Bryan.
Yes, solid results. Just want to ask about the margins, they came in a little bit better than expected and wondering if they had to do with some timing of investments, because I think the full year operating margins were reiterated?
Yes, Bryan, I would say that investments in Q1 were a little bit lower – they were planned that way, so this wasn’t different, investments were a little bit lower in first quarter than they will be in subsequent quarters. That was one. And then revenue was a little bit better than we had originally anticipated in the quarter, so the combination of those two drove margins a bit better than we anticipated.
Okay. And then just in particular on ASO and PEO strength, it looks like that those trends continue, in particular, just curious if there are any callouts? And then Efrain, when we get towards the end of the year, I know it gets a little more challenging on comps. So does that mean that 11% to 13% is a more normalized range for the PEO business and insurance business as we go forward past this fiscal year?
Bryan, I knew when I put out that number in those ranges just so everybody could be centered I would get that question. I don’t know the answer to that at this point. I think I will talk to that as we get closer to Q2 and Q3. We had an exceptionally strong back half of the year. So I will have to see we have some momentum in PEO and we have a degree of conservatism in the way we look at the information. So, I will hold out on commenting whether that’s the run-rate going into next year. Your first question was any callouts on PEO I will just let Marty.
Yes, I think just – Bryan just that we continue as we said – as Efrain just said we had a strong back half of last year that continued right into the first quarter. We are finding a lot of success with the PEO and ASO both from an HR outsourcing perspective and the integration with HROI has gone very well and frankly has complemented us and our teams and the leadership I think very well. So, we have really picked up, continue to have some great momentum in the first quarter. So right now, the callouts are that there is a great need for the PEO and the ASO products and we are capturing the sales for that need. So, we are very pleased with the work that those guys have been doing.
Okay, helpful. Thanks for taking the questions.
Sure. Thanks.
Our next question comes from the line of David Grossman with Stifel. Please go ahead.
Thank you. Good morning.
Hi, David.
Thanks for taking my question. I am wondering if you could go back to the PEO for a minute and I don’t know if you can break just focus on the PEO excluding the other insurance business, but can you help us understand the components of the growth that you are anticipating for this year broken down, how much of that is unit growth versus pass-through versus maybe pricing and other items that maybe impacting the growth rate year-over-year?
David, here is what I’d say, the – what we are experiencing is strong growth in worksite employees that continued in the first quarter. So, it’s not primarily pricing-driven, it’s really much more driven by volume of clients. So we’re not – and we’re not anticipating any significant stat up – step-up, I’m sorry, in the rate of attach on healthcare. So it’s not that getting a little bit more contribution from pass-throughs, it’s really more volume-driven. And I got a lot of calls or we got a lot of questions about whether our worksite employee growth was real or how real it was and how sustainable more than that not how real, and we had strengthened the back half of the year and that that’s continuing as we start the year.
Yes. I think you can really see it in the – because when you think about it, the worksite employee growth is double digits as well, so it’s continued to be very strong, not only the sales of – from new sales, but also the existing basis is continuing to grow. So, we’re getting a little uptick on the economy from those slightly larger businesses, I guess I’d say mid-market size PEO client.
And David one of the thing that I’d like to add because this is probably not what was true five or six years ago. We get a lot of PEO clients outside of the base. So, when you see the growth, a lot of that’s coming from outside the Paychex PEO bay – sorry, Paychex payroll base. So, we’re winning both inside the base and outside the base.
And just to confirm since you – the way you just disclosure is set up, the actual of this WSE growth that you’re quoting now is actually an organic number, right, because you had HROI at the end of last – from fiscal first quarter last year as well, correct?
WSE growth or revenue growth?
Worksite employee growth.
Yes.
Yes.
WSE growth.
Yes, I’m sorry.
The organic is double-digits.
Yes, yes, correct.
Right, got it. Okay, great. And then just to – you gave us some good guidance on the growth and the cadence as the year goes by. Do processing days normalize at all as the year goes on or is that just this year or one quarter-ish with no real impact through the balance of the year?
Well, we never recover that one heavy processing day and the impact on payroll services revenue is about $5 million from that one day. So we never recover it and then you have kind of the normal ups and downs you might have in a given quarter, which is why the other quarters looks so different from Q1.
Alright. So just 1Q is the $5 million and nothing else through the balance of the year?
Yes, just to be clear since I get this question. We’re not saying there is one less day, it’s really just the composition of a heavier processing day in Q1 that we lost and then the rest of the year is normal, which will mean you got some a little bit more in one quarter, a little bit less in other quarters and – but it will look like a normal year.
Got it. And then just one last quick question on the competitive dynamic. You know one of kind of non-traditional competitor came out with a kind of revised payroll solution during the quarter, I think it’s been out there, so it’s really not terribly new. But, I guess the reason I bring it up is that in the past point-of-sale usually goes in the small business before payroll and I’m just curious whether how you’re thinking about that if in fact the point-of-sale competitor comes in with a stronger solution and how that may impact you given that typically is the – the cash register if you will goes in before the payroll system?
Yes, David, this is Marty. You’re absolutely right. I mean that that’s how it’s always been and of course other competitors have been out there with those solutions for a while. This one is not a new one, a lot was made about it, and – but it’s a mobile version of something they’ve had for a number of years. It doesn’t support all the states, it’s not as complex obviously as close to our offering, you have to do payroll many days ahead. So, I don’t at least in this instance I don’t see it as any big change from a competitive standpoint. And you’re right that in kind of that point-of-sale typically because we’re selling – we are also selling through a partner those solutions, payment solutions. We find that, that is something that they take upfront and then payroll comes along a little bit later. So, we have experienced that ourselves. So, we can be selling it. We actually unseat more payment solutions, because they already have them before they ever talk about payroll with us. So, we don’t see that as a big change at this point. Again, a number of competitors have been out there and this one really wasn’t that big of a change or anything close to the competitiveness that we have. It’s a mobile payroll solution. It doesn’t, I don’t believe, even have employee access, which is what many companies are looking for now on a mobile basis.
And if I just more concretely beyond what – adding building on what Marty said, look, I mean, we have a really competitive offering in the micro-enterprise space and we will be talking as we go through the year about some really significant enhancements of that product that we think will put us certainly at the forefront of what’s happening on the low end of the DIY SaaS part of the market. We are doing really well in that part of the business. It was really, really surprising to us, what the reaction that occurred as a result of that, because we don’t see any of that in our numbers. As a matter of fact, in the past 6 months, we have been building momentum in that part of the market. So, everyone is entitled to make their own opinion as to what a press release makes. Unfortunately, from the standpoint of the facts, we are not seeing any impact. And so, I just want to make that very clear.
Thanks for that. But I guess the follow-on related to that is does this change at all your appetite to be in the merchant acquiring business or has that really not changed?
No. I mean, we are selling and our sales have done very well. We have an inside team that sells through a couple of partners now and has continued to do well. But as far as getting into a full-fledged – doing the processing itself of the payments, I don’t think so, there is not a great interest there. As you know, the company dynamics are very different. The financials are very different. And I don’t think it makes a huge difference from the payroll side on the front-end. Frankly, we have had better experience with having the payroll and then unseating an existing competitor in the payment space, because those rates constantly are changing and we can give them a little bit better product. And frankly, sometimes it offsets the cost of payroll or other products. So, we are in it, but I think we are in it at the right level right now.
Alright. Got it, great. Thanks very much.
Thanks, David.
Our next question will come from the line of Tim McHugh with William Blair. Please go ahead.
Thanks. I guess two questions on the PEO business. I guess one is just somewhat of a follow-up. I guess, the WSE growth had double-digits versus the 19% I guess organic growth. It seems double-digits doesn’t sound quite as high as 19%, so what’s the kind of revenue per WSE, maybe talk about that in terms of that I guess driving incremental growth? I mean, I will top there first.
Yes. So we don’t disclose the revenue per WSE number, Tim. We will talk to that as we go through the year. It doesn’t sound impressive, because when we said organic was 19%, remember that the base now, including HROI, increases the number of WSEs. It’s still pretty strong. So, I wouldn’t take that as an implication that growth is somehow decelerating, because now when we talk about organic, we are talking about the inclusion of HROI in the base, which adds more WSEs. And so we are talking about a more apples-to-apples comparison. And then as we walk through the year, we will talk more about revenue per worksite employee.
Is the implication of that last comment that I guess HROI wouldn’t be growing as fast as your organic? Is that what you are saying now that it’s rolled in…
No, the implication of that is that now you have got a larger base on which to calculate growth. So, the 19% was on the Paychex business itself. That was the organic comparison. And now we roll in the HROI base to our clients and so the growth rate obviously is a little bit lower, because you have a bigger base on which you are calculating the growth.
Yes. And we didn’t really mean to imply that double-digits means at the low end of double-digits.
Yes.
Okay. And then, I guess a broader question just you are breaking PEO and insurance out into separate segment. I get it’s somewhat driven by the revenue disclosures, but also even just this call, a lot of discussion of this business and you have talked about a lot of momentum in it. So, yet it’s still a smaller piece relative to your business. I know it’s been clearly an area of expansion. I guess should we read anything into I guess how important this is going to be strategically to Paychex in terms of your focus and where the investment dollars are going over the next 3 years given all those factors?
Well, I think you certainly could read into it that we think that’s an important part of our business going forward. The HR Outsourcing has been very important and the PEO has picked up momentum really the last 2 or 3 years in particular even from the client standpoint from accepting what a PEO is and understanding. The competition that’s out there I think has also helped drive that, understanding that what a PEO is and how that can assist them. The changes in insurance have driven that. So, yes, I think you will see us continue to make investment in that business and we do think – we wouldn’t break it out as a segment with insurance unless we thought it was certainly a significantly growing piece of the business. And it has different dynamics obviously to the financials that we like to call out as well.
Okay, thank you. Maybe actually one more on that, the dynamics part, sorry to raise the question, just the margins on that side of the business, can you comment at all? Is it different versus the other segment as we think about the growth of that side of it?
Hey, Tim. So, we will talk more as this is the first quarter reporting on it. But obviously, because PEO is bundled with insurance or not bundled with insurance, but presented with insurance and PEO has pass-through costs, it’s lower than the overall company margin and management solutions is higher. We will have to go through the year and kind of see where rates normalize, but it’s fair to say it is lower than overall company margins.
Okay, thank you.
Okay.
Our next question will come from the line of James Fossett with Morgan Stanley. Please go ahead.
Thanks very much. I just wanted to follow-up on the question related to kind of the crossover and you have made it clear that you feel like merchant acquiring, etcetera, is a different business. But I am wondering if there is opportunity or how you think about like the selling motion to continue to make sure that Paychex has the best opportunity to win the business where you do want it, especially as the way people are setting up new businesses, etcetera, seems to be changing?
I hope I got the question. You mean specific to the payment business, payment with payroll?
Yes, just as people are starting to think about it as they setup new business, especially smaller businesses that maybe looking for a one stop shop. And I can understand what you are talking about in terms of where merchant acquiring maybe doesn’t fit within Paychex, but I think perhaps what people are expressing some concern about is like what that selling motion looks like or needs to look like, so you can get the best opportunity to win new business?
Yes, I think – one, I think we are very much at the front-end. I would just say our experience has been that, with the payment solutions that we do a payment solution through two partners. We are I think very effective at it. That sales team has grown. It’s all an inside team. So, we get referrals from the field and we have of course one of the largest field base selling teams out there in payroll and HR. And so when we run into brand new clients, we can certainly refer them back to that team to sell payment now and then build a relationship to payroll. But we also more times than not have payroll first and then unseat the payment solution. On the other hand, I would tell you that a lot of the work that we are doing now on the front-end is to be able to get at those clients where they come to us on the web. So, you are seeing a lot more web-based coming in through the web and then selling them whatever they need at that point, whether that’s payment, payroll or a combination of that with HR. So, I think we are well positioned very much to get those businesses at the very much the front-end of when they are searching. And more of our dollars frankly have shifted to marketing and to web development and demand generation than any time in our history, because of that, because of the way the whole sales approach is. And Efrain mentioned, SurePayroll, a component of ours out of Chicago, obviously is also we are working on some things that we will be releasing and talking about the next quarter or two that I think will help that even more.
The other thing, as you know we have been involved with merchant services over the past 5 years and I think we have got a pretty good understanding of the dynamics of how that sale occurs and how it occurs with payroll. So, I think between SurePayroll and what we do on the merchant side, we are in a position to see if that starts to tilt or to tip and take the appropriate action. Right now though I just want to emphasize that we are not seeing that and a lot of the dynamics that we saw 5 years ago still remain and what happens in the future where we will monitor and see what’s going on.
Great. That’s really reassuring. And I guess on your kind of online customer acquisition and referral efforts and what you are putting in there, any even qualitative color you can share with us about the effectiveness of that versus traditional sales force and maybe how that has been changing and what kind of further improvements you maybe able to make at least on what those metrics look like? Thanks.
Yes, sure. I think it’s been a very significant change over particularly over the last year. We have moved more leads to a virtual team inside for the smallest of clients. Those were starting up 1 to 4. We use more of the virtual teams or telephonic sales, because that’s the way the client in those small areas in particular, their leads come in, they want to be addressed very quickly. We have really become much more sophisticated in our lead generation in the way we are scoring leads and then communicating with prospects, who aren’t ready to buy yet. Those used to all be kind of in the bucket with all the leads being the same that is not the way it’s done anymore. We know when someone just comes in. We know where they start and stop looking at our product. They know if we have been compared to somewhere else. We know if they looked at pricing or not. And we can respond telephonically much faster with much better data targeted right at that client and we are setup to demo and sell over the phone or through chat very quickly. So the dynamics have changed quite dramatically, particularly for the inbound web search and low end client. And I think we have really – last year we kind of started this towards the beginning of the year actually in the fourth quarter of the year before and we really have picked up momentum in the last 6 months and I think we have really fine tuned the store, it’s working very well.
That’s great color. Thanks guys.
Okay.
And our next question will come from the line of Jim Schneider with Goldman Sachs. Please go ahead.
Good morning. Thanks for taking my question. Maybe Marty, if you could talk through, I think you have touched on some of them, but maybe talk through the remaining product and service initiatives you have got underway for the fiscal year? And maybe share what goals you might have in terms of retention rates exiting this fiscal year, if you could give us any color to that? That will be great.
I will start with the latter. Certainly, our goal is always to be at the best we have ever been. I think we are approaching that from a client retention level. First quarter doesn’t make the year, but we certainly have seen continuous improvement in our net promoter scores and our satisfaction surveys, which have been translated into even better retention and we went through a pretty big service kind of realignment 2 years ago that really settled out through last year and we really feel like all of that is behind us now and has worked very effectively and how we are servicing clients in different ways with different teams. We have also added a lot of technology for the retention. So, we have put in a whole new unified communications system across all of our branches and locations. We collect a lot more data. I know lot more about the clients, what they are looking at, what their history has been before I ever talk to them when they are calling in. And of course, we have continued to use a lot of data analytic models to anticipate if a client is possibly going to leave us or not and then do proactive calling to them. So, our goal is certainly to have the best retention ever in our history and we hit that peak about 2 years ago, 2.5 years and we are slightly below that and aiming for more. From a product standpoint, Jim, we are very proud that HR Tech, just a few weeks ago we released as I mentioned the learning management, Paychex Learning Management that type training into development. So now we have kind of a fully bundled development. So we are helping, you can think about it all the way from acquiring new employees for our clients, we can do all of that paperless in a paperless fashion right from the recruiting to the on-boarding of the client so nothing, there is no paper necessary. Once they are in the system, now we’ve been much more full-featured as far as training them, developing them, giving turnover data analytics of what’s going on in the environment. I think the data and the enhancements have never come faster. And then adding more self-service, so where the other thing we’re seeing is a lot of clients wanting self-service, so meaning that if they have questions or their employees have questions or their employees want to make changes that we allow them to do that in the app whether mobile or on the desktop. They can make changes, they can ask questions, we’ll be introducing a chatbot that we showed at HR Tech that will basically service up 50 or 60 answers the questions, all you have to do is where is my W-2 or where do I find this or how do I do that and that will pop up and you will see that continue to evolve throughout the year.
That’s helpful. And maybe a corollary question to that is, are you seeing those initiatives now starting to translate to higher bookings at this point, and I know you don’t give the precise bookings figures, but is there a way to quantify how much higher bookings were this quarter than say a year ago quarter?
Now without giving it to you, but a good try anyway. But – we’re – I would just say we had some momentum going into the last half of last year, we feel like that has continued. So, hey selling season is the peak and we’re fully staffed up on our sales team. We did that very quickly. Well we added some additional sales. We have added more to virtual, to telephonic as well, both field and telephonic. And I think we’re well positioned for a peak selling season, product wise and sales wise. And they have a lot – by the way I didn’t even mention the sales team has a lot more tools as well. So when you think about the use of sales force and how sophisticated sales force has now become for them, it’s just – it’s amazing the tools that are at their disposal and the ability to train and get them to use it is coming much better too because they’re seeing that when they give us data on a prospect that maybe didn’t close this time, they’re getting a lot more information back the next time they got out and talk to CPAs, current clients et cetera. So, it’s starting to translate. We didn’t quite call it the year yet but because we got to get through that peak selling season, but we’re feeling really good about where we are now.
Well, I had this right. Thanks very much though.
Okay, alright.
Our next question will come from the line of Tien-tsin Huang with JPMorgan. Please go ahead.
Thanks, Tien-tsin.
Good morning. Thanks for the slides. It’s all very helpful. Just a couple of quick clarification questions and I have a strategic question. Just within the PEO side, I heard you mention it’s more new rather than existing, but I’m curious, are you taking pre-existing PEO clients and converting to your own or these first time PEO clients? Just trying to understand the end-market dynamics?
Yes. I don’t have a good split between previous – obviously the – that the – you get a lot outside the PEO who have – who know PEO. So, we’re doing well there and the split as to new to PEO, I don’t know, my suspicion is it’s more people who know about the PEO model to start with.
Okay.
But I do want to say just reiterate Tien-tsin what you said which is as we looked at the data we always had a certain amount of PEO clients outside the base, but that trend has certainly been accelerating.
Got it. Now it seems that way. Within – then within core payroll I know the segmenting is changing, but just as we go into 2Q, 3Q, you mentioned it will be at the high-end or above the range. Is that just a function of the processing days or are there any other drivers pricing, units, retention that you might see?
Yes. It is a function of the days, but our assumption is that through the year we build in terms of sales units and sales volume as we progress through the next three quarters. And as Marty said we’re off to a decent start this year.
Okay, got it. So, backlog conversion, okay, great. And then last one just for you Marty just if you don’t mind, just a high-level question on freelancers and that whole market. I’m curious if that’s an area of focus for you to potentially go after that freelance market?
Maybe I’m not sure.
1099 gig.
Oh, I’m sorry, like the gig economy.
The gig economy, sorry.
That’s alright.
It’s a trendier word to use.
It’s I think we are well prepared for that. We have been building out a number of the products I am looking at it from a strategy standpoint of how do we look at from an insurance, retirement, savings and payroll, but even more so from the benefit side, how do you look at ways to let that follow the employee as opposed to being so client focused, the employer focused. And I think we will have some things to talk about in future quarters as we are rolling that out. We are not seeing a big impact from that right now. I think it was a little bit overstated last year, but we are certainly preparing for that. And I think already with the mobile app and the way we are building out the data by employee, you are going to see much more of a shift toward the employee and how they can carry information with them. And we will be prepared to react to that as it continues to grow.
Very good. Thank you.
Great. Alright.
Thanks.
And our next question will come from the line of Jeff Silber with BMO. Please go ahead. Mr. Silber, maybe of your mute button on. We will move on to the next question. It comes from the line of Jason Kupferberg with Bank of America. Please go ahead.
Thanks. Good morning, guys. How are you?
Good morning, Jason.
Good. So, I just had a question to follow-up on Core Payroll. Thanks for continuing to give the disclosure there. I just wanted to try and break down the pieces, because it seems like there is a few moving parts. So, I guess it seems like the tailwind from Lessor was more or less offset by the one less processing day. So if that’s right, you have got about this 1% underlying revenue growth. And it does sound like pricing is still a tailwind. I know it had been running around 2%. So, I was just trying to figure out the implications for organic client count, because qualitatively it doesn’t sound based on what you are saying that, that metric would be down year-over-year, but what are the other pieces here? Is this a average client size issue or is organic client comp down?
No, no, no. No, it isn’t.
Okay.
And I don’t typically give quarterly, but I can say no. No, it’s really client size and that abates as we go through the year. We anticipate that it will abate in addition to all of the other factors changing as we go through the year. We have another day. We assume better unit and volume growth, all of those and mix abates a bit. So, it’s those factors.
Are you running at about 16 on the average client size now?
We are between I think 15 and 16 is where we ended up the client base last year.
Okay, okay. Can you just talk a little bit about what the differences maybe in the pricing trends between renewals of existing clients versus pricing for new clients that you are bidding on? And just I guess at a high level, are you still running at around a 2% pricing uplift?
Yes. You want to take that?
No, go ahead.
I think yes, that would be – our anticipation is still 2 to 3, we have always said kind of 2 to 4, but tend to recognize a little on the lower end of that. I think on new clients what you are seeing is some discounting there upfront, but we are able to get to roll that off very effectively and pretty quickly through using a lot of data analytics. We started this a number of years ago, but instead of leaving it to kind of individual branches to decide how to roll off discounts, we do it on a much more automated basis and it’s done with data analytics. So we know based on the history of the client whether we can roll off more of a discount or less of a discount and that has been very effective for us at bringing the price, the discount back off. So, you are still seeing pretty much the same level of competition upfront, which drives a little bit more of the discounting or the same level of discounting, but we are able to roll that off. And I think between the service levels, the additional products we offer, all of that allows you to bring – getting drive more revenue per client kind of after you have the client. And once you have the client, the price increase seems to stick pretty well. So, the more of that discounting is more upfront to get the client in a competitive environment, but not as much once you are going forward.
Okay. Thanks for the commentary, guys.
Sure.
You are welcome.
Our next question comes from the line of Rick Eskelsen with Wells Fargo. Please go ahead.
Hi, good morning. Thank you for taking my question.
Sure.
Just one for me. I am just wondering if you can talk about the Talent Acquisition, you did mention Marty in your script about how you are fully stepped up on the sales headcount increases you were looking for, but just in general across your organization how has it been finding talent and maybe if you could spend a little time on finding sales talent as you upped your investments? Thanks.
Yes. Interesting question, I think it’s still been pretty good as far as finding. I know there is shortages that are difficult to find based on the work that we do in the overall market as well as Paychex itself. It’s more in the IT side and we have actually have been very successful there too. That’s where when you get into certain disciplines of IT, security and so forth, that’s been difficult. Sales has not been too difficult. I think one there – we are attracting good solid sales folks who are – who typically we still look for that some sales experience already and they are seeing the level of products and success that we are having. They are seeing growth opportunities that when they come into the company they could start and frankly in virtual telephonic they can grow to the field payroll, they can advance the mid-market, they can grow into HRS. In fact we just came back from our sales conference two weeks ago and just tremendous enthusiasm and a lot of good employee referrals. So we are really not having an issue of getting fully stepped. In fact we got fully stepped faster than we expected in the first quarter because of the success in the recruiting and the retention is improving across virtually every sales organization. So the retention is getting back in line where we were historically as well. I think that’s all about them feeling like they have got the right tools, sales force, the enhancements we have made to that, the lead generation that they are getting, the leads and that they can be successful. All of that equates well to acquiring and retaining the talent.
Thank you.
Thanks.
And our next question will come from the line of Jeff Silber with BMO. Please go ahead.
Can you hear me?
Yes. Good Jeff, we were worried about you.
Thank you so much. This is going to be really quick. I know you are not directly impacted by all the noise regarding tariff wars etcetera. Are you seeing though any hesitation from your clients that might be impacted that could indirectly impact you?
Not at this point. We are not seeing much. There are specific small and mid-size businesses that are impacted whether they are supplying the automobile industry and so forth, but we have not seen much of an impact on our client base at all. And when you think about also when we saw the storm impacting awful lot of businesses in South Carolina and North Carolina we didn’t – we haven’t seen too much of an impact there yet either. So, so far retention is in very good shape as I mentioned earlier and we are not seeing an impact either from regulation and tariff changes or the hurricane.
Okay, great. Thanks for squeezing me in.
Sure.
Our next question comes from the line of Samad Samana with Jefferies. Please go ahead.
Hi. Thanks for taking my question this morning. A couple of follow-ups to some of the answers, you mentioned a lot of new tools for the sales organization, I was wondering maybe dig deeper into what those are and how much you are factoring in productivity increases from these tools into the forecast for this year and then I have one follow-up?
Yes. I think when you think about like sales force, we have had sales force for some time but we have really added a team that has really worked with the sales team to say what to encourage them to find it to be much more useful. And so we have gotten a lot more into the analytics of sales force and we have also profiled the clients and the leads that they are getting much better. So let me start with the leads, when the leads come in, in the past as I mentioned they were in kind of one big bucket. So all the leads that came in that had interest kind of went out to the sales force and they may have been of different quality. We started with a new leader in marketing and with a lot of experience in demand generation started making these much more sophisticated. We are scoring the leads now. At the front end we have a team that has been talking to leads for some time taking them through the web, etcetera and now scoring them and if they don’t score high enough they were put kind of back into system to get – to really get worked and continue to provide information and details to prospective clients before we send a sales person out to them.
And so we are seeing that the quality of the leads to the sales team is much better. But as the sales team continues to use sales force and gives us more data on their prospects that goes back into data analytics that is then helps us profile the clients, also profile the CPAs and give you more data on the CPAs and what’s the last time that they referred us, who referred us, how they referred us, what they referred us, all of giving the sales rep much more data to go out and approach either a prospective client or current client for referral, a CPA or other lead referral source. And you’re also evolving into giving them a lot more data on their mobile phone as to where their next appointments are, how they make the best use of their time and how they can then get data off of social media on those prospects, so then when I walk into a prospect I know a lot about them already from our internal resources and combining that with external resources. So the level of sophistication and the tools that we give them has increased dramatically just even in the last six to 12 months. And we are starting to see some benefits from that one I think better retention of the sales force and certainly we’re looking for an improved productivity as well and it’s a little early in the year to talk about that, but so far as we have said number of times we think we’re off to a good start.
That’s very helpful. And then maybe if I could just ask a follow-up with that in mind and then some of the commentary about non-traditional competitors and customer acquisition, I am curious if you’ve seen a change in your customer acquisition cost as you move more to virtual and/or your non-traditional competitors try to spend aggressively and building their merchant base? I am just curious what you’ve seen in your customer acquisition cost trends?
Yes. I would say first of all not in the merchant base, I mean I think again it seems like they’ve got an awful lot of play and we just haven’t seen that there and I think it’s – that’s not really much of an impact at least at this time. What we have seen is that the shift of dollars have definitely gone toward marketing. So, where you would necessarily shift – put dollars more into sales, we continue to put dollars into sales, but I have to say some of it has shifted earlier in the process. So redesigning our web, redesigning the whole lead-flow that I just talked about, data analytics and the work in building those support systems, more money goes into and investment goes into the marketing side. And overall that probably does raise the cost of acquiring a client to some degree certainly, but you’re also getting more productive on the sales side or that’s your hope. So, you are getting more revenue and more success and higher close rate as a result of that, but you’re definitely doing more upfront in the spend as much more upfront to get that. This is the way they’re searching. Most clients’ prospects today are 60% of the way through the sales process before we even get contacted, that’s very different than in our past and we think we’re very much ready for that.
That’s very helpful. Thanks again for taking my questions.
Sure.
You’re welcome.
Our next question comes from the line of James Berkley with Wolfe Research. Please go ahead.
Thanks guys. Appreciate the time. On the service revenue disaggregation slide, I think you put out earlier this week, the last week rather, I was just wondering if you could speak to the drop off in growth for the restated HR Management Solutions revenue from fiscal ‘17 and ‘18 end, goes from what 6.1 to 2.9?
Yes. I just make that really quick. So, what happens there is that because we bundle into that revenue the impacts from modules related to Affordable Care Act, you didn’t see that growth in that number, so that number started to tail off just – we penetrated the base and that part of the module which a couple of years earlier started at basically zero didn’t grow very much, so that dropped off in growth. And then the second thing was the impact to payroll services revenue growing more slowly as seen in that number. You will see if you look at the numbers that we’re projecting in terms of growth for the remainder of the year that we bounced back off that number that we had last year and we start to see better growth in the back half of this year, but those are the reasons, growth and payroll growth in that one category was muted.
Okay, thanks. And just a quick follow-up, I know last quarter you guys talked about organic growth guidance being like 1.5% for payroll and then 9% to 10% for HRS. Are you able to provide those numbers for the new segmentation?
We repeated it. It should be on the website. So, we breakout management solutions and PEO and insurance and then we just reaffirmed the guidance that we provided for the full year, so…
On an organic basis?
On an organic basis. Yes, I think what we said, James, was that Lessor would be about 1% of payroll growth.
Okay. Alright, thank you very much.
Okay.
Our next question comes from the line of Kartik Mehta with Northcoast Research. Please go ahead.
Hey, good morning, Efrain and Marty.
Good morning.
I wanted to go back to I think, Efrain, you were talking about client growth. And I am just wondering if you can talk about maybe is there a difference in the client growth you are seeing between your traditional payroll and SurePayroll? And so in essence, are you seeing client growth in both and is one greater than the other?
We don’t breakout the client base between them anymore, Kartik. But I think both are growing. You certainly see, as Efrain said, on the low end of both companies you are seeing a stronger growth. We really feel like that has picked up a lot of momentum, particularly on the low end. And I think that’s a lot of the things that we have been talking about, the demand generation, the virtual sales team, the faster response to leads, doing it with chat and selling over the phone much more. So, I think both of them are doing well. Certainly, Sure has continued to see good growth as well, really pleased with the team there.
And just lastly, on the PEO side, any thoughts on maybe price competition, it seems like that business is really growing well. So I am assuming it’s attracting all of the competitors into that space. So, any worries on that becoming a little bit more price competitive as we go through this fiscal year?
Always some concern with that. But I think right now, what you see in those kind of clients that are taking a PEO solution is they are much more interested in the service that they are getting and the support for the insurance in particular. And they are looking at those costs and do you have the right insurance plans and do you have the right service with the HR generalist and we have 500 of those out there that are supporting PEO and ASO. Do they have the right experience? It’s really much more of a value play. So frankly I worry less about that price competition than I would small business payroll, which is much more competitive. And so the more that we grow toward the PEO side from a price standpoint, I think that the value is much stronger to say, hey, we hear plenty of clients that say to us this was having a strong HR person and this insurance plan was very valuable to my business and they probably pay more.
Thanks, Marty. I appreciate it.
Okay, Kartik.
And the last question that we have in queue comes from the line of Matt O’Neill with Autonomous Research. Please go ahead.
Hi, Matt.
Hi, guys. Thank you for taking my question. It’s actually already been answered. So I thank you for the time.
Yes. Okay, thank you.
And we have no further question in queue at this time.
Alright. Thank you. And at this point, we will close the call. If you’re interested in replaying the webcast for this conference call, it will be archived for approximately 30 days. Thank you for taking the time to participate in our first quarter press release conference call and for your interest in Paychex. We very much appreciate it and have a great day.
Ladies and gentlemen that does conclude today’s conference. Thank you for your participation. You may now disconnect.