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Paychex Inc
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Welcome and thank you for standing by. [Operator Instructions] This call is being recorded. If you have any objections, you may disconnect at this point. Now, I will turn the meeting over to your host, Martin Mucci, President and Chief Executive Officer. You may begin.
Thank you. Thank you for joining us for our discussion of the Paychex second quarter fiscal 2019 earnings release. Joining me today is Efrain Rivera, our Chief Financial Officer. This morning before the market opened, we released our financial results for the second quarter ended November 30, 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 and will be archived and available on the website for approximately 1 month.
On today’s call, I will review the business highlights for the second quarter and Efrain will review our second quarter financial results and discuss our guidance for fiscal 2019. And then we will open it up for your questions.
Financial results for the second quarter of fiscal 2019 reflect good progress against our objectives in growth across our major product lines. Our total revenue growth was 7% for the second quarter, management solutions revenue grew a solid 5%, and PEO and insurance services revenues grew a strong 15% compared to the prior year quarter. Sales momentum has been positive. We have added to our sales force and are fully staffed for our peak selling season and we have implemented a number of tools and strategies that are aiding in that momentum.
With respect to client retention, we continue to be pleased with current trends and our strong client satisfaction performance. On November 26, 2018, we announced an agreement to acquire Oasis Outsourcing Group Holdings, L.P. for $1.2 billion. Oasis is the largest privately held PEO in the U.S. and an industry leader in providing HR outsourcing services. This acquisition is anticipated to close in this quarter. Oasis is a good fit with our PEO growth strategy adding to our scale, expanding relationships with new insurance partners, creating up-sell opportunities into the existing Oasis customer base and augmenting our leadership talent with the addition of an Oasis experienced leadership team. This acquisition will significantly advance our leadership position in HR outsourcing and when close Paychex and Oasis combined will serve more than 1.4 million worksite employees through our various HR outsourcing services.
We expect to finance this acquisition with $800 million of new debt along with cash on hand. Our Paychex IHS Markit Small Business Employment Watch shows the light labor market continues to create a challenging hire environment for many of our clients. The workplace has been evolving partly due to this tight labor market and as a result of technology advances. In August, we were named one of the world’s most innovative companies by Forbes, and in this vein, we continue to focus on enhancing our products and technology to increase efficiencies for our clients. Recent enhancements to features and functionality in Paychex Flex will simplify the complexity of finding and retaining talent, optimize HR and overall business performance and remove obstacles that stand in the way of our client’s productivity. We have enhanced our HR dashboard, creating the functionality that will make it the destination for clients looking to manage and develop their workforce. This dashboard includes advanced analytics, seamless access to Paychex learning and a state-of-the-art performance management process. New workflows and approval functionality in Paychex Flex ensure proper checks and balances occur with employee self-service activities, which have also increased. The use of self service will drive greater efficiency for our clients.
During this summer, we introduced live reports with turnover and headcount data allowing clients to view consolidated data to quickly identify trends and gain meaningful insights into their business and we are now adding the ability for clients to compare turnover rates – employee turnover rates with similar companies through our benchmarking live report. These significant technology product enhancements in the last quarter support our clients in recruiting, on-boarding, training and developing their employees in a market, where it is increasingly difficult to find and retain employees, particularly for the small and midsized companies.
In addition to our technology, our team of over 500 HR specialists around the country serve our clients growing HR needs as states have increasingly made it more difficult and challenging to run and grow their businesses without this expertise. We also continue to evolve our Paychex Flex APIs to give clients the ability to add new worker using our API. This allows us to continue to develop new partnership opportunities with third-parties that our clients engage.
I would like to congratulate our Paychex Insurance Agency, which has been named in the Business Insurance Magazine’s list of best places to work in insurance for the fourth consecutive year. This ranking improved one spot to number 12 this year, I am very proud of the Paychex culture that fosters engagement and growth among our employees. I will conclude by saying that our state-of-the-art technology, our 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 everyday.
I will now turn the call over to Efrain Rivera to review our financial results for the second quarter. Efrain?
Thanks, Marty. Good morning. I would like to remind everyone that today’s conference call contains forward-looking statements that refer to future events and such involve risks. Please refer to our earnings release that includes a discussion of these 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 measures exclude certain discrete tax items and one-time charges. Please refer to our press release and investor slide presentation for a discussion of these measures and a reconciliation in the second quarter to their related GAAP measures.
I will start by providing some of the key highlights for the quarter and then follow up with some greater detail in certain areas. I will touch briefly on results and wrap with a review of our fiscal 2019 outlook. Total revenue and total service revenue both grew 7% for this second quarter to $859 million and $841 million respectively. The acquisition of Lessor Group accounted for less than 1% of the growth in service revenue. Expenses were up 10% for the second quarter to $552 million, Lessor accounted for approximately 2% of this growth. The remaining growth related to accelerated investment in sales and marketing, product development as part of our tax reform investments, together with growth in PEO direct and insurance costs. In addition, we incurred some one-time expenses relating to the Oasis acquisition. Operating income increased 1% to $307 million. Operating margin was about 36% for the second quarter. Margins were impacted by accelerated spending and growth in the PEO.
Our effective income tax was 23.8% for the second quarter compared to 34.8% for the respective prior year quarter. The significant decline year-over-year on the effective tax is due to tax reform legislation. We anticipate that effective tax rate will be approximately 24% for the remainder of the year. Net income increased 19% to $236 million for the second quarter and adjusted net income increased 20%. Diluted earnings per share increased 18% to $0.65 for the second quarter and adjusted diluted earnings per share increased 20%.
I will now provide some additional color in selected areas. Management solutions revenue, which includes our payroll service revenue, together with our HCM products included in many of our product bundles increased 5% to $685 million for the second quarter. This increase was driven by growth in client bases across our HCM services, including payroll, ASO, retirement services and time and attendance solution. Retirement services revenue also benefited from an increase in the asset value of participant funds. PEO and insurance services revenue increased 15% to $155 million for the second quarter. In August, we anniversaried the acquisition of HROI, growth was primarily driven by continued strong demand for combined PEO services, which along with WSE growth in our existing client base resulted in double-digit growth in client worksite employees served. Our insurance services revenue benefited from growth in the number of health and benefits applicants.
Interest on funds held for clients, it increased 31% for the second quarter to $18 million, primarily as a result of higher average interest rates earned. Investments and income, our goal as you know is to protect principal and optimize liquidity. On 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 municipal bonds, corporate bonds and U.S. government agency securities. Our long-term portfolio has an average yield of 2% and average duration of 3.1 years. Combined portfolios have earned an average rate of return of 1.9% for the second quarter, up from 1.5% last year. Average balances for interest on funds held for clients were relatively flat for the second quarter primarily driven by the impacts of wage inflation offset by lower client employee withholdings resulting from tax reform.
Year-to-date let me briefly summarize the 6-month period. Management solutions revenue increased 4% approximately 1% was contributed by Lessor. PEO and insurance services revenue increased 26%, 17% on an organic basis. Interest on funds held for clients increased 28% driven by interest rate increases. Total revenue up 8%, operating margins were 36.4%, tempered somewhat by accelerated investments in the business and growth in PEO direct and insurance costs, net income increased 70% and adjusted net income increased 19%, diluted earnings per share increased 18%, and adjusted diluted earnings per share increased 19%.
I will now walk you through highlights on our financial position. It remains strong with cash and total corporate investments of $769 million as of November 30, 2018. Funds held for clients as of November 30 were $3.7 billion compared to $4.7 billion as of May 31, 2018. Funds held for clients as you know vary widely on a day-to-day basis and averaged $3.7 billion for the second quarter and 6 months.
Our total available-for-sale investments including corporate investments and funds held for clients reflected net unrealized losses of $45 million as of November 30, 2018 compared with $38 million as of May 31, 2018. Total stockholders’ equity was $2.4 billion as of November 30, 2018 reflecting $403 million in dividends paid and $33 million worth of shares repurchased during the first half of fiscal 2019. Our return on equity for the past 12 months is a very respectable 45%. Cash flows from operations were $497 million for the 6 months, a decrease of 4% from the same period last year. The decrease was driven by working capital fluctuations related to timing around collections and related tax payments for our combined PEO business and a decrease in accrued liability balances in connection with the termination of certain licensing agreements. Other impacts on non-cash adjustments were offset within working capital fluctuations.
Fiscal 2019 guidance. I remind you that our outlook is based on current view of economic conditions continuing at no significant changes that will give guidance excluding any anticipated impacts from the Oasis acquisition and then follow with the anticipated impact of Oasis on our results. We have tightened some of the guidance we have previously provided. The revised guidance is as follows. Interest on funds held for clients is anticipated to grow 20% to 25%. We assume no interest rate rises after this anticipated December raise. We will see if that occurs today. Investment income net is anticipated to be in the range of $10 million to $15 million. Net income and diluted earnings per share anticipated to grow approximately 4% and adjusted diluted earnings per share anticipated to increase now in the range of 11% to 12%.
Other aspects of our guidance remain unchanged from what we have previously provided. The guidance is reiterated as following. Management solutions revenue is anticipated to grow by approximately 4% for fiscal 2019. PEO and insurance services revenue is anticipated to grow in the range of 18% to 20%. Total revenue is anticipated to grow in the range of 6% to 7%. Operating income as a percent of total revenues is anticipated to be approximately 37%. The effective income tax rate for fiscal 2019 is expected to be approximately 24%. And adjusted net income for non-GAAP expected to increase again in the range of 11% to 12%.
I will now provide you with a little additional color on the second half of the year. We anticipate that management solutions revenue growth in the second half of fiscal 2019 will be approximately 4% with Q3 at or above this rate and Q4 below this rate due primarily to the anniversary of the Lessor acquisition. For PEO and insurance services, revenue growth in the first half was significantly higher due the timing of the HROI acquisition. We anticipate growth for Q3 to be in the range of 15% to 17% and for Q4 to be in the range of 10% to 13% due to the challenging compared with strong PEO growth in the later part of fiscal 2018.
Assuming the completion of Oasis, the Oasis acquisition which we expect to occur in the future, we anticipate that Oasis will have an incremental impact on revenue in the range of $155 million to $175 million for the balance of the year. We expect that approximately 45% of this incremental revenue will occur in Q3 and the remainder will occur in Q4. Excluding one-time costs related to the acquisition, we anticipate that Oasis will have minimal impact on our diluted earnings per share for the year. With one-time acquisition costs, we anticipate that the acquisition will be approximately $0.03 dilutive for fiscal 2019 primarily due as I said to the acquisition costs.
And now with those comments, I will now hand it back to Marty.
Great. Thanks Efrain. Operator, we will now open the call to questions please.
Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from the line of Kevin McVeigh from Credit Suisse. Your line is now open.
Great. Thank you.
Hi, Kevin.
Hey, how are you?
Good.
Just real quick. Really good results. Obviously, there has been a lot of unevenness in the market. Any change at the margin in terms of the client discussions, I mean it seems like the payroll really scaled up nice, so really nothing in the fundamentals. But anything you would call out just given obviously some of the noise that’s been occurring since you last reported?
No. I think what we are finding is that we are getting – we are seeing momentum on the sales side and we are seeing retention numbers that are very positive and heading back toward our all time best on the client retention. So we are feeling good about the momentum in the first half of the year. Of course, we are heading into selling season, we are in selling season, which is really an important time for us and we are feeling good at this point. We are seeing business kind of environment pretty good and certainly in need of HR outsourcing in particular, because of all the things that are going on with state regulations in particular. And I think that’s really helping what you are seeing is kind of that double-digit growth on worksite employees, particularly in the PEO business. So we are seeing a good need for the HR services and all of our products.
And just Marty, following up on that client retention at an all-time high, what’s been driving that? And are you seeing any kind of trends in the smaller businesses as opposed to larger, just really nice job there and should we expect that to continue?
Yes. I think as I said we are heading kind of – we are getting closer to that all time high in retention we had. I think that we are still seeing the same kind of number of businesses going out of business. I think we are seeing an improvement in those that left for service or price. I would say the competitive environment is about the same. There is always some pressure there, but we seem to be doing very well from a retention standpoint and from a selling standpoint. We have got some momentum there. So I don’t think we are seeing a lot different in competition and I think we are really holding our own and showing some momentum on the sales side.
Great. Thank you.
Okay.
Thank you. Our next question comes from the line of James Berkley from Wolfe Research. Your line is now open.
Good morning and thanks guys and congrats. How are you doing?
Good.
Just a quick question on Oasis, could you just talk about what you expect the accretion to look like there on a cash basis just given that you tend to accelerate D&A for tax purposes. I would think it looks even more attractive on the cash side, but just wanted to hear your thoughts?
Yes. James, I’ll hold that a little bit. We do expect it on a cash basis for it to be accretive. Their margins are at or above our margins on PEO. So that will be a positive going forward. We will talk more once we have closed the acquisition in Q3, but we think it’s going to be a nice add from a cash basis.
Okay, thanks. And then obviously that was the largest private PEO provider in the U.S. and if you could just comment on what other M&A opportunities you see and your thoughts on timing, your comfort level with leverage and just how you think about your broader PEO strategy going forward? That would be really helpful.
Sure. I think from an acquisition, we are always looking at a number of opportunities. I think certainly there is a number of other PEO opportunities there and we are looking – and Oasis was pretty active. As a private company, they were pretty active on the acquisition side, particularly on the smaller ones and being able to integrate those in. So we think that gaining scale in the PEO business is very good. Obviously that was part of this move is it gains us more scale with the insurance carriers. It picks up new markets. And we have been able to do some thing – we will be able to do some things, I think with Oasis clients that if they don’t fit in the underwriting, we can get them to our insurance agency which is the 20th largest insurance agency in the country right now. So we feel there is a lot of opportunity on the PEO side. In other areas, there are some acquisitions as well. I think we have been closed on a few, not too worried about, I mean we are always watching for the leverage, but from a debt perspective, but this was – I think we will be very successful in getting a good debt placement here. And I think that given our balance sheet and cash flows that we will have other opportunity to do more if we need to do it. We are always watching for that shareholder return and be sure that we are using cash obviously in the best way for our shareholders. And I think we have got a long track record of that, but acquisitions are certainly always on the table and we are looking at a number of things.
Thanks a lot. Appreciate the time.
Okay, thanks.
Thank you. Our next question comes from the line of Jason Kupferberg from Bank of America/Merrill Lynch. Your line is now open.
Hey, thanks, guys. Good morning. Happy holidays. How are you?
Thanks.
Good, good. So I just wanted to circle back, if we think about last quarter, you guys had given some kind of quarterly layout on payroll, what you were thinking about the respective growth rates? And I think for Q2 and 3Q, the expectation was to be at, at least 3%, if I am not mistaken, because that’s the high end of the full year 2% to 3% guide. And I think you came in at 2.8% in Q2. Are you still thinking Q3 will be at least 3% or any changes around the edges in the thought process there?
Yes. Jason, I don’t see any reason why that wouldn’t be the case. So, we feel pretty comfortable about where things are. And just to add a little bit of color about why we feel comfortable, Marty mentioned, I think sales process has – we have seen some momentum there. Retention has been good and then pricing has been stable. So I think all of those three say we should be certainly in that range.
Okay. And just want to go little deeper on some of the macro dynamics, but I know you guys do fairly regular surveying of the small business base. So, just in terms of confidence and sentiment and sort of forward-looking indicators like it sounds like everything was fine in this latest quarter, but as you head into the new calendar year, are you detecting any changes at all just in terms of hiring intentions or prospects for new business creation?
Jason, I think the interesting thing is the one thing we keep hearing is it’s just tough to get employees. And so for small to midsized businesses, it’s tough for them to recruit and retain employees. And one of the positives for us, because of that is they are looking for more benefits. They are looking to offer insurance. They are looking to be able to have better benefit enrollment kind of opportunities, better technology, self-service type of technology for their employees. And so generally, I think you still look at like the NFIB optimism, the business indexes are all near – still near historic highs and consumer optimism is high – consumer confidence. And so everything is high, but there is this concern about can I get the employees and we have heard where some small to midsized businesses have – and some of our surveys have actually said, hey, I have turned down some business, because I just can’t get enough employees to do it. But there is still – the good news is there is optimism that there is work to do. It’s just with a low unemployment rate, can I attract enough employees to get the work done.
Okay. And just last from me, in terms of reinvestments, I just wanted to catch up on that topic at least for [ESR] [ph] model your margins came in better than expected. I know you are not changing the full year forecast. So quarterly cadence of reinvestments, just commentary there for the back half and then just your latest thinking on whether or not you think these reinvestments could cause a little bit of uptick in underlying revenue growth as we start to think ahead to next fiscal year directionally?
Yes. I would say this, so we did have a little bit lighter spending than we had guided in the quarter. It won’t affect the back half of the year. Our perspective is if it wasn’t spent, it wasn’t spent. But I think the other part of the margin story was that revenue came in a little bit better than our plans had anticipated and so that dropped down to the bottom line. So we see strength, we will see what happens in the back half of the year, but it was a combination of both.
Okay, thank you.
Okay.
Thank you. Our next question comes from the line of Ramsey El-Assal from Barclays. Your line is now open.
Thank you for taking my questions. I wanted to ask about the Fed in the path of rate hikes. I know you only have a single additional raise contemplated in your guidance, but would a slower pace of increase by the Fed cause you to change any internal plans about business investment or timing of investments or headcount additions or is there any other business impact or is your internal plans very much aligned with your sort of external guidance?
It’s pretty much aligned with the external guidance, Ramsey. It really wouldn’t change. I think when we came into the year, our thought process was we look at the same data you all look at. And we looked at the probability of raises, they were talking about 3 and 4 in calendar ‘19, we weren’t buying it at the moment. And I think now that’s become a little bit more uncertain, but it doesn’t – it further raises are more uncertain. But it doesn’t affect what we do. And I would say it’s interesting that the macro backdrop has been uncertain and volatile. A lot – if you look at the vectors in our business, they are pointing up, not down, they are not pointing neutral, they are pointing up. And so when we look at the wealth of data that we have everything from business bankruptcies to the clients who go out of business to sales to new clients, it looks positive to us. So, now we are in a situation where things can change rapidly, but nothing that we are seeing says there are clouds on the horizon certainly in the back half of our fiscal year.
Yes, that’s great to hear. And it doesn’t mean that we can’t tuck ourselves into a recession. It would do the same. On another topic, I wanted to ask you about sort of the sales process and strategy in PEO. I mean you just rolled up Oasis. There is a handful of larger players out there like yourselves, there is a bunch of smaller folks out there as well. From the standpoint of a prospective customer, how do you close that sale, is there a big price discovery process? Is it expectation of service levels? What is it that gets them to go into your camp rather than to one of your competitors?
Yes. I think it’s always – it’s not as much price I think it’s going to be really the value of the technology and the service. And what we have been in this – Paychex has been in this for 20 years the outsource – HR outsourcing through both PEO and ASO and we have 500 HR specialists around the country that are dedicated to helping small and midsized business clients with their needs. So, you have good technology that they can use to enroll benefits and help their employees enroll in benefit, good insurance options for them particularly on the PEO side, the larger you get the more options you’re going to have from carriers and those are really important benefits right now as I said earlier on, because of the competitiveness of attracting and retaining employees and then it’s going to be that service piece, so from a client’s perspective, it is getting more challenging every day whether it’s marijuana use and whether it’s legal or not, whether to do drug testing, how to handle drug testing, immigration, minimum wage, paid family leave, you need an HR support as a small to mid-sized business New York just came out with the need for a non-harassment training, that has to be done by the pretty much of the middle of next year for a company of any size basically I mean, these are a lot of needs and that’s how you sell the HR outsourcing ASO or PEO. And PEO is becoming much more comfortable and things that well, it’s not just limited to Florida and Texas it’s a real need, and in this competitive environment for employees, that’s how you sell that is your service and your technology.
A related and a final question for me, a brief one you basically also called out this Flex API and increased kind of capability to plug into potential partners QuickBooks integration, you talked about Facebook integration with social component in the last call are you going to lean deeper into sort of a partnership strategy to enhance the client bundle of a value proposition? Or is this just is this a trend? Or is this more just sort of a string of kind of one-offs?
Yes, it’s a great question I think we’ve always had kind of the value of Paychex has been, I can offer you that full suite of products on our Flex system, everything fully integrated, real-time, mobile first design, single employee record kind of thing and we still offer that, however, you do find particularly in the mid market is more clients who say, hey look, I’m used to having this record keeper for my retirement services or I’m used to this time and attendance solution and I’m just not ready to get off of all of that yet and switch to you so what we have found over time is particularly in that mid-market, we’re opening up more and more APIs to say, hey look, you can stay with who you have if you wanted and of course, partnerships are always powerful from if you pick the right ones, to grow your base and do what you do best and things like QuickBooks were good fit particularly for the small and some of the lower end of the mid-sized for us so it’s just a way of broadening out, whatever clients want, they can get from us, however, the real value I think we bring still is that on Flex, you can have the full suite of products, you can have retirement, nobody else provides the suite of products that we provide with a single employee record in the technology and service.
Great. Thanks so much.
Thank you. Our next question comes from the line of Brian Keene from Deutsche Bank. Your line is now open.
Hi guys. Good morning. I want to ask about Oasis, just what’s the organic revenue growth profile of the company? And then what do you expect going forward? Is there any synergies between the two companies that could push it higher?
Yes, Brian, it’s a upper single digit grower they also did some inorganic, we think that’ll be part of the mix, which can drive that organic growth higher there are certainly synergies between the Oasis business and our existing PEO business as we add two of them, that will be working on aggressively the thing that we’re in the process of looking at also is, look there’s as you’ve seen our results over the last certainly, three to four quarters, PEO is growing pretty rapidly and what we want to do is fuel growth not necessarily cut costs out of the business it’s not one of those acquisitions, and one of the issues that we’re looking very closely at is, do we add more sales people to get even greater coverage than we currently have so we’re looking we’re trying to balance the cost savings with additional investments to fuel even faster growth for Oasis.
Yes, I think, Brian that when you this is a kind of perfect timing from a market standpoint the need for HR and the acceptance of PEO in particular, now you’ve got two teams as I said we’ve been doing this for 20 years, we’ve got a very experienced team they’ve got a very experienced team they’ve been doing acquisitions of smaller PEOs they’ve got insurance carrier relationships that we haven’t had they’ve got other markets where they’ve got more scale that we haven’t had it’s a good combination at a good time in the market to really grow and obviously through the double digit worksite employee growth, we’ve already been doing pretty consistently we expect this has really got a lot of more, as Efrain said, more revenues and top line synergies this isn’t so much about cost cutting as it is about growing the business been a perfect time in the market.
Okay that’s helpful. And then just curious to get an update, Marty, I know you talked about increasing the sales force, just trying to see if you can quantify that going into the selling season here?
I think we’ve been fully staffed, pretty much for this year so we’re up, I think 3% to 4% maybe closer to 5%, if you put all sales teams in there and we’re feeling very good about that we have been able to fill those spots particularly in mid-market and in the PEO and ASO services, and they’ve got some nice momentum as we go into this as we’re in this peak selling season.
Okay great. I will leave it there. Happy holidays guys.
Thanks same to you.
Thank you. Our next question comes from the line of Lisa Ellis from MoffettNathanson. Your line is now open.
Hi thanks. Good morning guys. So a question on Oasis and HROI I mean, as you guys know we’d love these businesses but I know historically concerned factor you guys have raised about doing acquisitions in the space has been around getting comfortable with the insurance risk in the underlying book so can you just talk about how with a company like Oasis you manage that and get comfortable with that? And I guess building on the experience with HROI?
Yes, sure. I think obviously the due diligence, we’re very careful on that and how we look at the company, they have not taken risk, and we felt based on some not only our own but some third-party analysis, that they were in very good shape from a book of business and so we are careful about who we pick, but we’re very pleased with how Oasis look to us in the way they’ve been doing business and what their book of business look like.
Yes, and the other thing, Lisa, that I want to add to that is, they while they do attach healthcare like all PEOs do, all of their business is based on guaranteed contracts so compared to other acquisitions that we have looked at, they’re not taking risk on the healthcare side so that made it attractive to us especially given how they had built the business and how they were growing.
Got it. Okay, thank you. And then a question just to follow up related to the macroeconomic environment can you just describe on how if and when we ever do see a slowdown in the U.S., that impacts Paychex’s business and sort of a second order basis meaning, of course, and slowdown in employment is not good, but I mean do you does that end up driving additional demand for things like PEO and ASO when you’re in a downturn I’m just curious kind of what the second order impacts are in your business?
Yes, obviously as you said, the first order is fewer businesses more going out of business that kind of thing but in second order, you’re right I think particularly in the environment we’re in now versus even 10 years ago, there’s a much bigger need now when there’s a downturn, how do I attract and retain employees? Do I have the right technology, so can my employees use mobile apps? Can I be so when can I be more productive and use my employees to be more productive to help me be more productive? They’re going to look for ways to cut costs, and using our technology and a lot of the self-service is going to help them to be more productive on the other side, they’re going to have to attract and retain more employees or if they may have to lay off or do something like that, they’re going to want to know how to do those things and do them right so that they don’t face legal consequences I think more than 10 years ago and that’s going to be an HR need for PEO, for ASO, time and attendance, you name it, I think those things will improve so second order, while there’s certainly a first order hit of businesses out of business, loss of jobs and so forth, that second order is okay, it’s more complex now, I need more help in other services.
Terrific. Thank you. Thanks guys. Happy holidays.
Thank you.
Thank you. Our next question comes from the line of Tien-tsin Huang from JPMorgan. Your line is now open.
Hi good morning. Happy holidays upfront here. You guys went through a lot already I just curious just maybe bigger picture question on Oasis why now do a deal of this size? I know this has been around for sometime, just curious why you felt like now was the right time to do such a large deal?
Well, I think I do think that timing is by view we’ve certainly known them for a long time and been an had an eye on the PEO, we felt that our own PEO was particular with HROI now with our PEO, we’re really at a very mature level of leadership and sales performance and underwriting so we felt really good about where we were now than Oasis where it is right now, and the need in the market again as I’ve said a couple of times that HROI need is really picked up and PEO is not just a Florida, Texas kind of thing, it is really taking off now with the need for HR support and the acceptance of PEO of the PEO business has really taken off so I think we gained more experience, we felt more comfortable with how strong our existing team was, the integration of HROI and how well that’s gone and now it was time to take on the largest private PEO and make ourselves the second largest PEO, and frankly, the second largest HR outsourcer by worksite employees.
Got it. That makes sense. I am just curious then with Paychex now going after growth here, especially on the PEO side, and then also investing as you’ve talked about in the past will we be able to break out or appreciate or evaluate the impact of margins from Oasis as well as the impact of margins from your investments, and then the subsequent benefits you might be getting from those investments? Just trying to understand, how if there’s a way that we’ll be able to evaluate the return on investments that you’re making away from Oasis? Does that makes sense? Efrain, I know we’ve talked about this.
Yes, so short answer Tien-tsin is yes, we’ll give more information as we go through the year through the year so that people can make those judgments on what’s going on so and you’re right there are there are value enhancing investments that we’re doing in the management solutions side, that over time we would expect improved margins there and there’s acquisitions that we are doing on the PEO and insurance side that will help to fuel revenue growth and over time also improve margins there so we’ll give more color as we go through.
Great. Thank you both.
Okay.
Thank you, our next question comes from the line of Tim McHugh from William Blair. Your line is now open.
Thanks. Just a follow-up on that, I know you said Oasis margins are similar to your PEO margins I guess can you give us color on what that would be I guess as we roll this in?
Tim, I’ll leave for now the discussions of specific margins I think we called out where we’re going to be for the balance of the year, but from a PEO perspective, I just leave it right now, that Oasis is pretty comparable to where we are from a margin standpoint on PEO and actually in some cases a little bit better, because they don’t take any risk on health insurance we’ll update more once we close the deal and then can provide more definitive information going forward.
Okay given the way they structure their contract, is there as much passthrough revenue?
No so I mean that’s a good point, and that’s one reason why we’ll talk more once the deal is closed so because and as you know, Tim, because you know the space pretty well everyone accounts for PEO revenue differently, in our case, if it’s a guaranteed contract, we don’t run that through revenue, we were running through revenue the healthcare costs that we’re taking risk on because Oasis doesn’t do any healthcare, any take any risk on healthcare, that revenue does not run through their revenues they obviously have work comp revenue that they take risk on that runs through their revenues, but so there’s differences in terms of a little bit of difference between their revenues and ours because of that, where we have guaranteed contracts we don’t run it through the P&L either so margins actually that’s why I say margins on an apples-to-apples basis are at or above our PEO margins.
Okay. And then going back to I think the comment earlier was the sales force can depend how you want to count and up 3% to 5% do you mind how does that compare to last year and the year before, I guess, how much more resources are you going into the selling season with versus what we’ve seen in the last couple of years?
Yes, Tim, we typically be up around 2% to 3% and I think this is 3% to 5% is more like you’re adding the other work other sales forces in as well, so pretty much have grown across the board as we’ve talked about, we’ve moved some into what we call virtual for the – on the payroll, particularly, the small in payroll side we have moved inside in tele-sales, but we’ve also added a number of sales people on the PEO, ASO side, the mid-market side is pretty strong as well, and because we took a little bit of a dip last year, but we’re feeling good about the fact that we’ve got good momentum in the first half of the year, and we’re fully staffed as we’re in this peak selling season.
Okay great. Thank you.
Thank you. Our next question comes from the line of David Grossman from Stifel Financial. Your line is now open.
Thank you. Good morning. There is obviously a lot of discussion about the PEO and you’ve changed your revenue segmentation, and I guess what I’m curious about is if you could give us some insight into the changing business mix in new sales how much of these new sales are standalone payroll versus the bundle products compared to where we were maybe two or three years ago?
Yes, I would say it’s different bundles I would say it’s more of a bundled product these days and kind of taking that full, looking for a full product on a very low end, you’re still seeing, hey, I’m looking for basic payroll to help me get started in the business and that one to four or even one to two employees size but above that five employees size, you’re definitely seeing a larger interest and need for time and attendance solutions, HR support etcetera. we don’t necessary breakout percentages, but it’s definitely trended up, and that’s one of the reasons to expand on the HR and the PEO side is that where 5 years ago, David, you’d see, you needed 25 or 30 employees to really say hey I’m interested in PEO or in HR outsourcing, now that is honestly 10 to 15 employees, sometimes need that support, because of the legal issues today, the requirements of the States, the minimum wage changes if you’re multi-state employer, it is really tough even if you’re small, and these rules don’t apply to hey, you have to be 25 and above it’s typically like this harassment – non-harassment training that’s needed in New York, it’s like one employee and above, you have to do this training by the middle of next year so they’re seeing a lot more need so you’re getting much more of the approach, the go-to-market approach and sales is much more about the full package, and the HR, you’re leading much more with HR or a time and attendance solution etcetera. and the payroll is kind of yes it includes payroll, but the need is for much more of a fully comprehensive solution.
And it’s just shifted to bundles.
Right. I was just kind of thinking pricing aside, unit sale, how is that trended over the past couple of years in terms of what kind of revenue you’re getting per unit sale versus what you’re getting a couple of years ago?
I think you’re talking about revenue per client, or.
Right revenue per client on the unit sale.
Yes, revenue per client has been growing you look over I afraid I’ve said, last three years, you’re up in the 5% 6% range.
Okay. And then just a follow up, I think Marty, actually both of you had mentioned this that the scale of Oasis relative to Paychex in certain geographies may help you can you give us sense of what percentage of your payroll installed base is in those geographies?
Yes, I would say that’s an interesting question I don’t have the number of the top of my head. I can tell you that our PEO is certainly covered, probably where the majority of our payroll population is but we definitely have scale of payroll clients and other products in those areas, where they are and we don’t have PEO so we think about it more as, there is in these markets that we’re expanding and probably 10 different new markets, where they have some scale and we have not built it up, it’s because we haven’t built up the PEO in those in those areas and we haven’t had the relationship with the carrier, the insurance carrier, who are the strongest in those markets and now we’ll have scale with that carrier in those markets, and we certainly have enough clients existing to be able to sell PEO into and remember, we sell PEO directly as well so we sell to brand new clients, and as we just talked about that’s a growing need, is they’re interested in PEO right up front they are interested in HR outsourcing right up front, they’re not it’s not just the payroll base that we’re selling to so while we have clients there I’d say the majority of our client base payroll client base, we have covered with PEO, but these new markets, we certainly have thousands of clients that we can sell into, but again, we sell the PEO directly to brand new prospects.
And our PEO, David, as we’ve talked before, it’s predominately a California and Texas and Florida gain, and this gives us strength outside of that so I don’t have a exact percentage for what California, Texas and Florida represent there, but this gives us access to a lot of markets that or at least strength a lot of markets we really weren’t strong in before.
Right and then just one last question, I would say there’s been a lot of kind of headlines about the ACA the last week so the ACA was obviously a big catalyst for this industry a couple years ago, and obviously, we’ve kind of anniversary and we’ve kind of seen the reverse impact of that so any thoughts on directionally what the possibilities maybe for the PEO based on the outcome, what’s going on right now?
Yes, I think I see, it’s been very interesting, I think even there’s so much confusion in the marketplace among everybody, of course, as to whether it’s in or out we have actually there’s still been plenty of notices that have gone out to clients and non-clients of ours that have said, hey, you have a penalty, and you have to respond to this and so even though, it feels like it’s people aren’t sure whether it’s on or off, clients are still getting penalties from previous years, saying that, they owe significant sums of money we have been very successful in helping not only our clients, we’ve also offered a service, where if you weren’t a client of ours, but you have a penalty notice and you want to come and talk to us, we’ve been able to help a number of clients and have abated a significant millions and millions of dollars of potential penalties for them so it still is a very much a talking point to new clients and a retention point to existing clients that they need to report, they need to keep the information to report, and that they may get letters from the government saying, you owe something and you’re going to need support on how to get out of it.
But the other part I build on from what Marty said, the tailwind we see for PEO, really has something to do with I think it got turbocharged by Affordable Care Act but really much more – it’s much more now that integrated HR and benefit play and we saw strength, we saw strength starting two years or so ago, and that strength has continued and some of it has to do with ACA related issues, but a lot of it is really more HR than technology related.
And the point I made you made earlier that in the on in such a low unemployment rate, these small and mid-sized companies are really looking to someone to help them have better insurance benefits, offer insurance benefits, help them enroll their employees in these benefits, because they’re having to compete with really large companies and what their benefit plans are.
Thanks for that and happy holidays.
Thank you. Our next question comes from the line of Samad Samana from Jefferies. Your line is now open.
Hi good morning. Thanks for taking my questions. First, I was wondering on Oasis, so are all of their customers’ PEO, the 270,000 WSEs, and I know that Paychex historically has included both ASO and PEO clients in their WSE cap could you give us maybe an apples-to-apples number of what the PEO WSE cap looks like following the Oasis acquisition?
Well, we don’t breakout separately we’ll do that as we close the acquisition when we give you the $1.4 million WSEs, there is a significant amount of those that obviously are ASO employees when they when you’re using the 270 figure, they have some ASO employees included in that, they are between 200 and 300 closer to the midpoint on PEO clients, so some of their clients on the numbers that are floating around really are ASO, so we would count them as ASO clients.
Great thanks for that clarification and that’s why I asked. And then I know that Oasis, I think they were using a third-party software vendor called Prism HR I’m curious if you’re factoring in the opportunity to migrate those customers over to Paychex Flex or if that’s something that’s further down the road and maybe help us understand if there’s a revenue or margin opportunity and the magnitude of that?
I think yes, certainly will be looking at that and looking at how what Prism, the flexibility in the offering of Prism, which we think has been very solid for their clients and certainly Flex is for ours so we’ll be looking at the two platforms and it will be further down the road, that is not a necessarily a big savings or anything a synergy that we’re counting on there, because this is more of what provides the best client service and technology for their clients for our clients, and we’ll be looking at that, but that’s not a big part of the synergy is to try to save and that we want to make sure it’s a great experience for the clients no matter what platform they are on.
Great. And maybe just one last one retention was mentioned a couple of times on the call and improving, and I’m curious if you could just remind us what the peak retention rate was before? And do you think with PEO now and the mix and that being more strategically valuable for customers, holding all else equal, do we think that retention can kind of eclipse the prior highs going forward, maybe just some color on that would be helpful?
Yes, I think the all-time best was around 82% and as I said we’re approaching that best. I think you make a good point that certainly as you take more products that’s always been part of our model, as you take more products and particularly HR, that drives better retention. But you still have to keep in mind that 80% of our clients are under 20 and many of those still take payroll only and so that will make it more difficult to get that retention much above that kind of all time high we’re always looking to do that there is certainly the possibility is there if they take more products and that their client and that their employees are more tied into things like our mobile app and the technology but I think it’s a little bit tough given the dynamics still at the base.
Great thanks very much for my questions and next quarter guys. Happy holidays.
Thank you, our next question comes from the line of James Faucette from Morgan Stanley. Your line is now open.
Hi good morning Efrain and Marty. I just had most of my questions have been answered but I was looking for a little bit of color on a couple of things that you’ve talked about in addition to strong attention, you’ve also mentioned new bookings in payroll anything to call out by market or are you seeing any differences in behavior among mid-market or micro-enterprise, among your customer base within whether it’d be retention and new bookings at all?
Well, it’s always hard to say before we get through kind of this next this current quarter this third quarter, because the selling season is such an important part of it but we are feeling momentum kind of across the board, whether it’s on the small end of payroll, the mid-market, we’re feeling momentum pretty consistently certainly as well as we’ve talked a lot about the PEO and ASO, time and attendance, retirement, really seeing pretty consistent momentum across the board.
Great. And then second question is just as it relates to your partnerships and wondering if it’s if we’re far enough along to see a trend of middle market clients that were exposed to you through partnership transition to complete solutions or how and if they’re mixing and matching with partners? And I guess just trying to get a sense of how you’re managing that potential channel conflict besides looking at incremental opportunities?
Yes, I think definitely, the sale is about what’s best for the client and what where do they see the most value we certainly try to make sure that we demonstrate to them that, the vast majority of our clients are still taking a full service, full Flex offering, because of the great benefit of a single employee record, a unified user interface that whether you have retirement you’re on one platform no matter how much you grow for payroll and HR, and that it’s fully integrated so when you’re taking Flex, when you just think of what we just offered in the last quarter, the learning management system, the Flex learning management is giving you training, we are building that into some of the bundles, some low – free training and then you can build and design your own training to tie that into performance management, that ties to your payroll, that ties to your workflow for HR. So I would say the vast majority are still sold as the full bundle, but you do find in the mid-market, there are clients that say, hey, I am just not ready to make a full switch, if I am already up with a retirement provider or a time and attendance solution and okay, if that’s the way you want to do it, we will go with an API and we think that’s efficient. But in the future that also gives us an opportunity to go back to them and say, hey, this would be even better if you bought more services on the Flex platform.
Great. That’s really helpful. Thank you very much.
Thank you. Our last question comes from the line of Jeff Silber from BMO. Your line is now open.
Hey, guys. It’s Henry Chien calling for Jeff. Thank you for squeezing me in. So lot of stuff was covered. I just wanted to ask sort of big picture question on the Oasis acquisition. So, as we think about the PEO business, I know you touched on it a little bit. What are the kind of synergies that you get from combining sort of two PEO businesses, I know you mentioned there are the carrier relationships, but how does that translate into growth in your business as that let you offer better insurance rate or better products, just sort of what are the benefits of combining two PEO businesses?
Yes, sure. And it’s very much about again that top line as we have talked about that really the revenue synergy, the growth synergy. So when you talk about like a carrier relationship, we have had very good carrier relationships, but not with all carriers, because of the markets that they are in and we are in. And now when you go into new markets and you have a strong carrier relationship and now you – let’s say, you double the size or you increase the size tremendously. Now, when you go to those carriers, they are much more interested in giving you more attention to say, hey, let’s give you the best benefit packages, let’s give you some more support as far as the integration with the carrier, you are dealing with the carrier customer support from the carrier, you are just a larger customer and they are going to give you a lot more support therefore you can offer necessarily more benefit options, packages to clients to be able to give to their employees and a better benefit enrollment experience. And so just think of it from that sales perspective. And then just when you think about all of the various markets and then – so there is that – that are just additional markets, where they are in that we are not as Efrain said. We have been in primarily Florida, California, Texas and Georgia and they are in different markets. And now we have some clients there, but we weren’t scaled enough necessarily to deal with those carriers. Now we are going to be scaled between the two of us to be larger in those markets that opens up a great possibility. And also you are dealing with a PEO that didn’t have an insurance agency with it. We have an insurance agency that top – the 20th largest insurance agency. And when you don’t fit the underwriting profile for PEO, they couldn’t go anywhere else for that. We now take these clients and say, hey, if we can underwrite you as a PEO client, I have an insurance agency product that I can offer you for insurance. So now, you have just opened up a whole new opportunity for them and their PEO clients can now buy retirement services from us, they can buy time and attendance solutions from us and a lot of things that were much larger at that they didn’t necessarily offer to a large variety of their customers.
Got it, okay. No, that’s really helpful. And maybe just final question, what’s your sense of the – I mean, it sounds like that the PEO and sort of these combined HR services are really starting to inflect in your view. I mean, what sort of innings or stage you think of adoption you think PEO is in right now?
It’s pretty – I think it’s pretty early, because I don’t see the – I don’t see the requirements from states or federal government frankly getting that much easier, particularly the states. And I think that more and more clients – and then as the economy has gotten more, it’s gotten tougher from an unemployment. So, unemployment has gotten lower, harder to find workers, you have gotten a lot of companies, who for the first time have said, okay I really have to offer benefits now. I have to really be sure that I have benefits that I make it easy for my employees to get them or I am not going to track the employees. And by the way, I also have to offer more technology and make it easier for employees to do self-service, to talk, to do things on their mobile phone, to enroll in their benefits, change their benefits and so forth. So I think actually, it’s pretty early innings from adoption of a PEO or frankly any HR outsourcing. Remember that, we are very large in both markets, so PEO is great, ASO is great also and we have over 500 HR people. We are one of the largest obviously and the second largest we will be in this space and that gives us a lot of clout to get in front of clients with technology and service.
Okay, great. I really appreciate that. Thanks.
Thank you. At this time, we don’t have any more questions on queue. You may proceed.
Alright. At this point, we will close the call. If you are interested in replaying the webcast of this conference call, it will be archived for approximately 30 days. I thank you for taking the time to participate in our second quarter press release conference call and for your interest and investment in Paychex. We hope you and your families have a joyful holiday season. Thank you.
That concludes today’s conference. Thank you all for participating. You may now disconnect.