Good day and thank you for standing by. Welcome to the Paychex Third Quarter Fiscal Year 2021 Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that today's conference is being recorded. [Operator Instructions]. I would now like to hand the conference over to your speaker today, Martin Mucci. Please go ahead.

Thank you. And thank you for joining us for our discussion of the Paychex third quarter fiscal '21 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 third quarter ended February 28, 2021. You can access our earnings release on our Investor Relations website, and our Form 10-Q will be filed with the SEC within the next few days. This teleconference is being broadcast over the Internet, will be archived and available on our website for about 90 days. I will start today's call with an update on the business highlights for the third quarter and then Efrain will review our third quarter financial results and provide an update on our outlook for fiscal 2021. We will then open it up for your questions. It is hard to believe that it's been over a year since the beginning of the mass shutdowns in response to COVID-19. This past year has been different from any other that we've experienced before. You know, new challenges have forced us to find innovative ways to connect with our clients, prospects, and our own employees. I'm very proud of how the Paychex team embraced these challenges and took a leadership role throughout this pandemic as evidenced by the newly released Sapient Insights Group Annual HR Survey just coming out this week that ranked Paychex Flex, our SaaS-based cloud application, number one among all solution providers as rated by their Voice of the Customer report in both user experience and client satisfaction scores. Our results for the third quarter reflect strong retention in client based growth across all of our lines of business, most notably in our ASO HR outsourcing business. We completed the selling season with strength in…

Thanks, Marty. Hello, everyone, on the call. Good morning. I'd like to remind you that today's conference call will contain forward-looking statements. You know where to look for those disclosures. And please refer to them. In addition, I'll periodically refer to non-GAAP measures such as adjusted operating income, adjusted EBITDA, et cetera. Please refer to our press release again and our investor presentation for more information on these measures. I will start by providing some of the key points for the quarter. And then I'll follow up with some greater detail in certain areas and then I'll wrap with a review of our fiscal 2021 outlook. And some initial thoughts on fiscal 2022. Our third quarter results reflect the impact of economic conditions resulting from COVID. For the third quarter, service revenue of $1.1 billion decreased 2% compared to the prior year, largely due to a lower volume of client employees paid across our HCM solutions. As a reminder, our third quarter includes certain annual revenue streams that declined due to lower employment. Total revenue declined 3% to $1.1 billion, impacted by decline in interest on funds held for clients. Within service revenue, Management Solutions revenue was even at $847 million and PEO and Insurance Solutions revenue declined 8% to $250 million. Interest on funds held for clients decreased 29% for the quarter to $15 million due to lower average interest rates and realized gains. Average balances for interest on funds held for clients were consistent with the prior year. Expenses were down 4% to $643 million. The decline in expenses were driven by lower discretionary spending, reduced facilities costs, and lower amortization of intangible assets. Operating income was flat at $469 million and reflected an operating margin of 42.2%, a 100 basis point improvement from the prior year quarter.…

Thank you, Efrain. Operator, at this point, we will open it up for questions.

[Operator Instructions]. Our first question comes from the line of David Togut of Evercore ISI.

Two questions, please. First, if you could quantify some of the key performance indicators a little bit more, for example, client retention. Marty, you I think referred to some delays in sales cycles. Can you kind of walk through the booking trends you saw in the quarter? And then, my follow-up is really around the receivables balance, which was up 81% versus the May balance sheet. And perhaps, Efrain, you can talk a little bit more about kind of the purchased accounts receivables, what are the terms around that?

Let me talk to that, David. As many of you know, we have a business that provides funding for staffing firms. And those of you who cover the staffing industry, there's a number of you that know that in the last quarter of the year, let's call it April, May, and June, basically, staffing was flat on its back. What happened was that we weren't providing any lending because there was no lending to be provided to staffing firms, and as a consequence, the receivables balance was very low. Our cash flow was very high in the last quarter. What's happened is that trend persisted through the first half of the year, and then staffing came roaring back, starting in January. And in particular, really in the month of February, as there was a ramp up in a number of areas in staffing including healthcare. So, at the end of the quarter, we had purchased significantly more receivables than we had anticipated when the year started. But on an average basis, we're only about 4%, 5% above where we were last year. So, it's a little bit of an artifact of the decline in staffing followed by a sharp rebound. That number will come down significantly in the fourth quarter. So, that's what's happening on receivables. So, you had three questions there. I think the other ones were retention and bookings growth.

David, on the sales side, yeah, I think what we've seen is an improvement, particularly toward the end of the quarter, which has continued now into March on sales opportunities. So, we’re getting in front of clients for presentations. What we've seen throughout the first half of the year and into the selling season was really a lot of no decisions. So, we get in front of clients, but they're just not ready to make a move. And so, we're starting to see now a little bit of that open up in the last month or so. And so, we’re getting good opportunities in front of clients. Actually, our win rates, where they make a decision, we're doing better against competitors than we have in the past, and sales results kind of year-to-date are pretty much on track for the year as to kind of what we expected, but I think that we're seeing improvements now and things starting to open up. One of the tough things that played against that was just not getting more enough face to face with clients. Certainly, always put a little bit of a dampening effect on – particularly on the selling season where we have so many units that come in that way. The positives have been digital. We increased our marketing and got a lot more digital sales, so coming in over through the web, selling telephonically, selling online. So, we've seen that and that's helped. That's been really helped by new business starts, which are up I think double digits year-over-year, and so we're taking advantage of that. So, everything is improving, but it did have some dampening effect on selling season not getting in front of people. We're now opening that up and getting out with prospects face to face…

Our next question comes from the line of Ramsey El-Assal of Barclays.

Thanks for the early view on fiscal 2022. That's super appreciated. Can you help us think through kind of the key drivers of PEO performance next year? What are the sort of pressure points in that business that need to lift to see it return to a sort of a more normalized growth profile? I think you just mentioned a reticence for customers to change providers. I think in the past, you've mentioned some hospitality over-indexing in that industry vertical. Sort of what the end market conditions have to be in order to see that segment return to a more normalized growth profile?

I think, one, it is indexed a little higher on the hospitality side and particularly on the Oasis acquisition that we did and concentrated in, of course, southern states. And so, I think as you see the hospitality come back, the stimulus that are out there now and that are picking up, the new grants, in particular, for restaurants and bars, hotels, et cetera, that are out there, these grants, not loans but grants, are going to be given out. I think all these things are going to help kind of bring hospitality back. And of course, just the opening up of more states and more restaurants to either expanded capacity or full capacity, I think, will bring that back, and that will drive, certainly, more of the PEO who tend to go – those clients tend to go that way. The other thing is I just think more comfort in getting their employees back into the business place. Now, they're going to be interested in, 'okay, how do I get employees back? How do I retain them? How do I recruit them?' Benefit plans are going to become very interesting again for them. And I think the more complexity of those benefit plans and how competitive they are is going to be very important to them. So, I think the stimulus, the opening and the bounce-back in hospitality, which is coming toward the later end of some of the stimulus, and the need to have very strong benefit plans, I think we'll start to see the PEO pick back up and a lot of interest from prospects.

A follow-up for me is, I wonder if you could kind of update us on the relative importance in the business now of kind of cross-selling to existing customers versus signing up new ones. Has the model kind of evolved in the context of the pandemic to being more reliant on expanding wallet share rather than signing up de novo clients simply because there's been a lot of pressure in that area in the economy?

It's an interesting question. We've gone the last number of years, two to three years, with really talking about the power of 3,000 sales reps, which is our reps across all divisions, and our traditional model of selling payroll and then coming back in after has changed quite a lot in our go-to-market strategy. We saw that we were leaving money on the table and value for our clients on the table. So, we sell HR complete benefit packages upfront or at least make sure that they're aware of that, and that hasn't changed all that dramatically during the pandemic. It's been harder to get full interest. So, I think we've been good about coming back around and selling other products, but I think leading with HR actually was very important during the pandemic. And you can see that in, really, the double-digit growth that we've seen in the sales of ASO because you could go in and talk – if we were just going in and pushing payroll first over the last year during the pandemic, I don't think we would have been as successful as – that we've been trained to have our salespeople talk about HR and how we can help them completely, not just with payroll, and that has really helped us. So, I'd say that, actually, we stayed with the full HR value, and that has been a lot of our success during the pandemic because that was the real need for our clients and our prospects.

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

Marty, you talked about an increase in win rates against competitors. Maybe can you help us kind of understand that a little bit, maybe how much of that is just a better service through the pandemic versus more competitive product? And is there any part of the client base you'd call out in terms of, obviously, towards the lower end or kind of midmarket? Just any thoughts on that because that's an interesting development.

Kevin, I think what we've seen is, first of all, the innovation in the product. We have such a complete product set now in the SaaS-based cloud Flex platform. And I think our document management has been very popular. And we've seen the big increase in. The mobile app being five-star, continues to be five-star, and an increased use of that in self-service by our clients. And I think selling, going back to the go-to-market of selling HR completely, I think if you went back two years, they still saw selling payroll upfront versus our competitors selling an integrated HR and payroll and the HR focus that we've put the last two years has really positioned us very well. We've also done more using sales engineers in the midmarket to demo the product and have experts demoing the product earlier in the process. And I think that also has shown the full value of Flex. And then just on top of it, I just think our employees' response, both in our IT, our product development, our marketing, to COVID and how we've helped clients has really positioned us well versus some of our competitors who are just not as large and as fully capable. You go back to that number, we've helped our clients get $60 billion in PPP loans. That was all responding to stimulus like the day it was out or the day after it was out, partnering with Biz2Credit and other financial players who could get them the loans quickly. I think clients really saw the strength of a Paychex brand through all the things that we're doing like that. And that has helped us against competitors that, hey, may have been selling technology, but certainly didn't have the compliance or the experience and the wherewithal that our resources have.

Efrain, real quick, if you think about the margin – and thanks for the preliminary 2022 – does that dial in some normalization of cost? Or how should we think about maybe some structural cost savings coming out of COVID? Or does that, again, assume some uptick of costs coming back into the business? Or is there any way to think about that?

Kevin, I get that question on a fairly frequent basis. So, yes, it does contemplate that some of the variable costs that came out of the business will go back in. So, that's part of our thinking already. But I think we've done a pretty responsible job this year, and I think that we've already started to add back costs, actually, back half of the year to normalize our cost structure, so that next year wouldn't be quite as big an impact as it otherwise would be. So, we've taken that into account. But I would say this. And I think one of the great lessons of this year, not only for us but for everyone, is that there are pockets of costs that won't come back and that we don't need. And they're not coming back and they're not needed and they won't be in the P&L. So, I think that's why you see – we exceeded expectations, our own expectations and, certainly, external expectations, on margins. As I said, a lot of the revenue that we were looking at was marginal revenue [technical difficulty] beat that number. And going into next year, we're expecting to leverage further. So, I think that we're comfortable with that cost structure moving forward. It does include continued savings from actions that we took this year, but we've added back some costs.

I think just to add to that, one of the things that we were already doing before the pandemic and had helped us a great deal because some of the calls coming into payroll specialists and HR specialists that we have were very complex. We've been able, the last two years, to really drive a lot of easier task back to the client who wanted to do them anyway in a self-service perspective. So, when you think about – we've talked about chatbots. 50% of the service questions that come in online for us are now handled by an automated chatbot that respond to that. Now, 7 by 24 by 365, personal is political, but that has been a tremendous help. The other thing, when you change your direct deposit number or address changes, over 80% of those changes are now done by clients or their employees online through the mobile app or on the desktop. And that has made a tremendous amount of difference in driving operational costs down, and that's the innovation of our operations team, and driven them to the client who wants to do them anyway. So, it's freed up our people to do a lot more and it's reduced cost.

Any sense, if you can answer it, what percentage of clients are totally DIY this quarter?

Our total DIY?

Yeah.

It's certainly over 50%. And I think the way we think about it is you don't have to be totally DIY to be largely in a DIY service setting. So, probably the number is higher than that.

Our next question comes from the line of Bryan Bergin of Cowen.

Curious, how are you thinking about the PPP impact on potential future switching behavior due to the reg and reporting requirements? So, is there any dynamic that can leave the base potentially stickier for an extended period of time? Are you planning for a more normalized switching behavior in fiscal 2022 that you were seeing pre-COVID?

Great question. I think we're planning for more switching behavior just because I think we have found that many clients, just because of our sales experience, as well as client retention, to be fair, is that people are just kind of buttoned down and not making changes while they've got other things to worry about. But I do think that there's been, certainly, as I mentioned earlier, a great value that clients have seen that they wouldn't normally have been able to see from us, how we facilitated their help or how we facilitated helping them through the innovation of Flex to really pre-populate information, file for their loans, and be able to help them through difficult times. I think that is definitely going to have some retention impacts because we see it in the client satisfaction scores being at an all-time high, great feedback from clients, awards that we've won, the help center online that we've produced. So, I think there will be some stickiness, but we also know that there's just the ability that people are more comfortable and they will now focus on, 'do I need something else, do I grab a discount option to get three months free,' or something like that. That's probably going to happen as people are more comfortable.

Let me just add one other thing because I think you raise a good point. Those of you who've followed us for a while know that we tend to err on the side of being a bit conservative in terms of what we say and try not to get over our skis too much. But I would say this, if you look through the first three quarters, and Marty mentioned that our net client gain was the highest that certainly it's been in recent memory in the third quarter, if you look through three quarters, we're on a pace to really smash our retention records. Significant improvements that, frankly, nine years ago, I would never have thought was possible. But let's leave that to the side. Right now, as we speak, our rate of revenue retention, ignore client retention, is verging on 90-plus percent. That's a number, given our client base, which is really pretty extraordinary. So, when I looked at those numbers and I say, 'why is that,' it's all of those small actions, seemingly small, in helping clients that have driven them to stay with us. Now, will we end the year there? I would say, we have to see what happens in the fourth quarter. But we're on record-setting levels from the standpoint of both locking down the client base on units and also in terms of revenue retention through the first three quarters of the year. So, we're feeling pretty good. We expect some slippage as we get into the summer. That's to be expected. But we've set ourselves up pretty well. So, if we can continue to derive benefit from all of the actions that are occurring and all of the packages that have been released and continue to serve clients well, we're well positioned for next year.

Bryan, one other point, just to be very clear on it too on the question that you had, when you think about it, they will need – they will look for our support to file for forgiveness, loan forgiveness, as well as these – a lot of the stimulus things move through into our next fiscal year. So, I do think it will have specific retention benefits based on the fact that they'll need support on loan forgiveness that we have automated into the Flex system that makes it easy for them to apply and also for things like the employee retention tax credits, if they have to refile quarterly returns or file them correctly or go back and get data. I think it will certainly help us. There will be a little bit of a tail on some of the stimulus piece of it.

Just as a follow-up, I wanted to dig in a little bit more around the demand improvement by client size. So, we heard the continuation of strong performance on the small end. Can you quantify anything around short payroll? And then on your upper end, anything around mid-market that you're seeing different?

Payroll, the low end, has continued to be strong. Not as strong as it was in the first half. There was a big bounce there for household employers like nanny payrolls, things like that. That demand isn't as strong. But the demand coming in from a digital perspective through marketing and on the website and sales from a digital continue to be strong and consistent and persistent, I would say. On the mid-market side, that's probably been more affected by the no decision. So, we're getting in front. As I mentioned earlier, the key metrics of getting in front of more clients, winning when there is a decision made against competitors is better. I wouldn't say we're as strong as we want it to be in the mid-market, more because of no decision, not because of losing to a competitor.

Our next question comes from the line of Andrew Nicholas of William Blair.

Given the demand dynamics around the ASO and PEO businesses, I'm wondering how we should think about the likelihood of an ASO client eventually opting for the insurance benefit via the PEO offering? What type of upsell frequency have you historically experienced? And then, if you could give any color on what the economics look like when a client transitions from ASO to PEO, that would be helpful.

I'll start with the demand for it. And remember that we kind of go in and can offer both upfront. And many times, if they're not a good insurance risk or fit the underwriting, the ASO is a stronger platform for them or we can take them through our agency. I think that there's always availability of upsell ASO to PEO later, but it's not always as strong. We make that available to them. We always are ready to offer that to them. And we keep an eye on that through the HR generalist that service them, that if they have benefit and insurance needs where we can supplant their ASO offering with a plan,we can do that. But I would say that we do a pretty good job upfront of identifying, for the client, whether the better value is to go PEO or ASO and offer those options to them. You want to catch on the economics, Efrain?

There's a revenue uplift if you go from PEO to ASO. Just to kind of build on what Marty said. This has been an extraordinary year in terms of the growth in the ASO offering. And I think that what happened, Andrew, this year – we'll see how this trend plays out – was that because people were so interested in getting HR support quickly, they opted for what ended up being the solution that gave them that support the quickest. We do think there's an opportunity for ASO to PEO conversion and there's revenue uplift in two areas. One, because the admin fee is higher; and second because, of course, the attachment of insurances would boost revenue. So, we think there's an opportunity there. And I think we'll wait for the dust to settle in the fourth quarter, see where that opportunity is and then see how we go after attacking that. For now, as Marty's been saying over the last three quarters, clients have a desire to get an HR solution in place quickly because of the changing landscape of regulations and our HR specialists have been terrific in guiding clients through that. So, more to come on that.

For my follow-up, I was wondering if you could just speak to how healthcare utilization and claim costs are trending in your risk-based plans? And also, whether your experience over the past 12-plus months has impacted how you're thinking about risk-taking in the PEO business broadly, if at all? Thank you.

Short answer is really not much of a significant change. I think that what you're continuing to see, to be fair, I'd like to claim it was all superior management, and I would say to my colleagues in the PEO, of course, it was superior management for them. But the reality is also that there's a market component here where people continue to defer elective surgery – elective medical procedures, not just surgery. So, costs have been very contained. And I would say that's across a wide range of plans that we have. It doesn't change our perspective on risk on healthcare. I think properly managed, if you underwrite it correctly and you have a strong underwriting group, which we do, I think that our appetite for risk on healthcare remains unchanged. So, I think that that will continue. And as Marty said earlier, the value prop of healthcare, we think that that will start to come back next year as conditions change, the pandemic abates, and people are looking at a little bit more normalized environment. So, that's where those things stand.

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

First, I just wanted to ask, can we just get the latest update on what you're seeing in different parts of the market, just in terms of pricing, in terms of promotional offers, discounting, things like that?

I think it's been pretty consistent with what we've seen. I don't think there's been any major changes from that. We still feel like we have pricing power and can do the things that we normally do. We do offer various competitive pricing tactics to win clients over, but I don't think things have changed all that drastically out there.

Just a question on the early view you provided on fiscal 2022. Firstly, I appreciate you providing that view, but maybe you could share just some of the underlying assumptions that are embedded in that guidance? Just things like US unemployment rate, GDP growth, or new business formation, just what you expect from the competitive environment, things like that.

I would say that our outlook at this stage embodies a continued gradual recovery into next year. We're not expecting super sharp decrease in unemployment. We are wrestling with that. We're wrestling with the current environment. Now, I would say that fourth quarter is trending close to what we expected from a macro standpoint, but we're not expecting it to be dramatically different, probably doesn't change – you don't start to see a significant change until end of year, beginning of next year calendar 2021 into 2022. So, the macro doesn't change significantly. We are benefiting, I would say, especially as other competitors not so much, from a very robust environment in terms of new business formation. So, our new business sales are up significantly. That benefits more the lower end than the mid-market and expect that it will continue positive. From an interest rate standpoint, it looks like we've had a sharp move upwards. We don't expect it to be that significantly different. And so, I think that we're expecting the trends that you start to see in the fourth quarter that we're experiencing already in March, are going to continue, but it will be more gradual.

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

You talked a lot about what you've been doing for clients with some of the stimulus funds that's been pushed into the economy over the past year. Last week, we had an announcement of an infrastructure plan. I don't know if you're going to be benefiting or your clients are benefiting it from directly, but is there anything in there that you might be able to participate in?

I think probably more indirectly. I think if you think about a lot of the infrastructure going to construction, we benefit from constructionwhen there is more construction, whether it'sin homebuilding or road construction or other facilities,everything kind of around that – there's a lot of small business around that, small and mid-sized businesses. And I think, definitely, it provides more jobs and then we'll benefit from that. I don't see it directly, but indirectly, I think, certainly, any boost like that to construction, to everything around it will be a positive for us. Still early to see exactly how that's going to play out and how long it takes to get that money into the economy, but we should be a benefactor of it.

Efrain, I guess, the implied guidance for the fourth quarter is somewhat wide. Can you just give us any framework? What should we expect on the high end and the low end? And also, what share count is embedded in that guidance? Thanks so much.

Jeff, I think that shares will move slightly lower than where they are right now, but not a significant change. The service revenue, I thinkI called it out at 7% to 9% for fourth quarter. I would just add a little bit of color to that, which is to say that Management Solutions will grow faster than PEO in the fourth quarter. So, I think that's enough to kind of add the points together to get you to where you need when you couple it with the year guidance. I would say, look, it will be good to talk about growth. We've had pockets of growth in the last three quarters, but it will be good to resume a period of more normalized growth in the fourth quarter. So, that's what we're expecting at this stage.

Our next question comes from the line of Kartik Mehta of Northcoast Research.

I wanted to ask a little bit about payroll, and I think you alluded to this a little bit, Marty, but when COVID was originally occurring last year, one of the issues that you had was not doing price increases or not putting that burden on your customers. Where we stand today, do you think you'll go back to the normal cycle or how do you think that environment looks in terms of the ability to get some price increases?

I think the ability is there. In fact, Kartik, I think during this year, as a lot of things that we've talked about, we've shown a lot of value to our clients and I think we're probably in as good or better position than we've ever been. One of the opportunities, while it's difficult on us and on our clients, is the ability to show how strong we are as a company and what we add to our clients and help them through a very difficult time. So, I think the pricing power is very consistent and I think you'd see a more of a normalized move in that regard.

Just the second question – Efrain, last question. Any change in thoughts on how you'll manage the float [ph] portfolio? I know you kind of gave guidance for FY 2022, but I'm wondering, considering what's happening with rates, how you might change the management of that?

I've got a long meeting to discuss various scenarios. And so, the short answer is we're looking at that. The shape of the yield curve presents opportunities that wouldn't have been there several years ago. So, we're looking at a range of options there to see if we can squeeze a bit more out of the portfolio. I wouldn't expect anything significant, but we're looking at opportunities to optimize it, given the fact that we now have a steeper yield curve and looks like longer-term rates may be heading higher. I don't have a complete answer yet. We'll build that obviously when we get to the fourth quarter.

Our next question comes from the line of Eugene Simuni of MoffettNathanson.

I have two that I'll ask upfront, both related to M&A. So, you closed the Oasis acquisition about two-and-a-half years ago. So, one question is, is the integration of that acquisition fully completed now? I know, obviously, you went through the crisis and maybe there was some pause there. Or is there synergies left that might help the recovery in the PEO of the next 12 months or so? And then I'll ask the second one right away. Just more broadly, as we're coming out of the crisis, has M&A been a consideration? If so, what kind of assets could be attractive to you guys?

I think the Oasis integration, yeah, it's gone very well particularly lately. We've been in the PEO business for a long time, so that integration made sense. We made sure at the beginning – when you think back now, almost two years, we had some bumps in the road from a combination of the sales teams and their compensation policies and all that stuff. But we're past that and I think that we've continued to see good synergies that we expected. Unfortunately, the pandemic obviously put a damper on some of that from a sales perspective as you can see. And so, a little disappointing there. But generally, I think we were on a good – we were heading on a good path until the pandemic hit now over a year ago. I do think there's always still synergies that we can look for there as we combine kind of our traditional – our PEO business with Oasis and we continue to do that from a platform perspective and look at the platform, look at the way we're selling, how we sell ASO to both markets and those things. So, I think there are still some things there we can do. But we're very high on the PEO market and the ability of where it's going to come back as we come out of the pandemic. Again, all the things we talked about earlier, a little bit higher indexed than hospitality in some states and some areas of the states that were hit a little bit harder, I do think we have some opportunity to see that bounce back. On M&A, I think we've continued through the pandemic to continue to look at opportunities that we see. So we'll still have the same kind of ideas in mind for that. That can be the PEO business. We're obviously interested in, from a product standpoint, if there's things we need, but we don't see a big need there right now. Always looking at payroll HR and anything else that we can do there. In international, we picked up a small acquisition that we think will add to the product set internationally as well. We did that kind of under the radar, kind of as a small one. But we think that could have some impact too. So, yeah, we're still very interested in M&A. Obviously, we're in a good position from a cash standpoint if that opportunity comes up and we'll continue to watch for good valuations that make sense, particularly coming out of the pandemic.

Our next question comes from the line of Pete Christiansen of Citi.

Marty, I was wondering if you can talk about the decision delay discussion that we've been having here. Has it been a regional issue,given that some of the southern states have opened up where there is a lot of PEO business there? I was just curious if that's been a factor certainly impacting face-to-face meetings, so on and so forth. And as a follow-up, Efrain, I was wondering if can you talk about expectations for go-to-market spending in 2022 and if that is factored in in the margin outlook? Thank you.

I would say, yeah. I mean, as more businesses open up, they're getting more comfortable with the ability to have a rep come in and talk to them. I do think as we look back at the year, we transitioned very quickly to virtual selling, all telephonic. Of course, we've been selling telephonic for many years and really maximizing the use of our marketing spend to bring more leads into the website and into telephonic sales. So, I think that really helped us kind of hone our skills very quickly because we'd already been on that path and actually got us there even faster. But I think, yeah, we're really looking forward to where more businesses are comfortable. We've already started to open that back up to say that we're available for face-to-face meetings. We do want the rep and the client have to be comfortable with it. But I think you're going to see that pick up quite quickly as you're seeing the states open up and people just get more comfortable with it from that standpoint, that I think will drive an increase in certainly in close rate. And then just the comfort level that customers are coming back. Our business, our clients, customers are coming back. I think now they'll be more open to making a decision as to what they need. And I think Paychex has a full suite of products that can help them grow in this as we come out of the pandemic.

With respect to go-to-market spending, we, in the face of the pandemic, actually increased our marketing spend. Going into next year, we'll continue to spend against the opportunities that we see. And so, don't anticipate that that's going to get clawed back. There is an opportunity in California on retirement services. Not a business we talked about a lot, but a business that has done well and which we think there's an opportunity. Marty mentioned PEP, but there's also a mandate in California around providing retirement services. We think that could be a nice opportunity and we're looking at ways to optimize that opportunity going into fiscal year 2022. So, we'll continue to spend at a good clip to be able to address the market needs that we see.

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

Maybe a follow up to the last question around go-to-market. Efrain, how should we think about maybe the incremental cost to acquire a customer and how that's trended? So, not just the absolute spending, but the CAC for customers, especially with most of you and your competitors having to sell virtually still in this environment, are you seeing the per-unit costs go up or have they stayed relatively consistent? Could you give us some color on that?

It depends on the channel, Samad. So, I would say that where those leads are driven through our digital channels, while – I would say we've spent more, we actually have gotten good economies of scale in our spending. And I would say the marketing group has done a fantastic job of optimizing our marketing spend. So I think, in that sense, that's been good. So I see, as we pivot our field based resources into more digital or virtual, we end up realizing a savings that we then plough back into marketing. And I think that we can make that equation work with some net savings with respect to the other channels. It's about the same. It's not dramatically different from what it was. But as the business pivots more toward digital, and it will continue to do that, I think what you're going to see is an ability to optimize spend and to get better economies of scale in that trade.

Similarly, on the retention side, the number you called out was quite high. Any trends now that we're a year in on the retention of customers acquired more through the digital channels throughout the last year or so versus maybe the historical basin and if there's any dispersion in the retention trends there?

Two things. I'll answer a question you didn't ask and I'll answer the question you asked. So first, the question you asked. The short answer to the question is the smaller the client, the more the propensity to churn. So that hasn't changed. So we would expect that we'll see a bit more churn as we get into next year simply because the survival rates on clients that are under four are typically not terrific. But we haven't seen any significant increases in bucket of clients and we're certainly handily outselling losses either through SurePayroll or through our virtual sales. So that's been a positive. And we expect that a lot of those trends will continue into next year. Will it lockdown to the extent – and by lockdown, I mean will we have less churn in the way we've experienced this year going into next year? That's to be seen. I would certainly expect in the first half of the year, we're going to see continued positive news on retention. We'll see what happens in the back half of the year when things start to open up. The second thing I'd say is that one of the things that we looked at very closely is, in terms of clients who now have taken our HR solutions, how are they churning or not churning in the base? And the short answer to that is they're not. So they see a lot of value in what we're providing. That's a big revenue for us. And I think that's helping to drive what are really good revenue retention numbers. Then I will update as we get into next year.

Our next question comes from the line of Tien-tsin Huang of J.P. Morgan.

I'm just trying to think about some of the answers you've given around the client and decisions. And I'm just trying to summarize in my head. Is it more structural or cyclical? It sounds like it's both, but I just want to make sure it's not one more so than the other, if that makes sense.

I think the no decision – if I get your question right, Tien-tsin, I think it's just – honestly, I think it's just focus. I think they're interested in the presentation. So our presentations are up, our end user presentations, and we're feeling very good about that. But what's happening is that the client is deciding, well, I'm just not ready to decide yet. There's just too many things going on. Either they'remaybe getting a loan, they're finding out new ways to get employee retention tax credits. They've got a lot going on. And I thinkwhat you're finding is that it's a no decision, not a – or I'd say not right now decision, let me put it that way versus a no decision. It's not losing to competitors. As I said, what we're seeing is better competitor win rates when they are making a decision. So, we feel good about from that standpoint. So, I think it's more of a timing of what we're getting – the feedback we're getting and we're seeing as it's more of a timing thing than anything. So we're hoping for a pickup. It's just that it's a big number in the selling season to produce. Andthat's a tough one when you're not getting as many decisions being made. And it's a little bit more obviously on the mid-market side where they have more complexity to their business that they're working on.

I know the retention results have been great. And I'm sure you're not standing by from a sales perspective. But given what you've learned on selling so far, do you anticipate changing your traditional versus digital sales investments from a mix perspective going into fiscal 2022 or is it more you're just going to be ready to catch it in the net here as things open up?

I think it's one of those things that's going to continue to evolve. We were doing that beforehand. Where you're going to see more – as Efrain said, you're going to see more spend – the shift in marketing and sales, you're going to see more spend in marketing as we've already seen this year. It's justthe way things – clients and prospects have gotten more used to saying, hey, I don't know if I have to see somebody in person, right? So, I can sell. I don't want to give you the impression that we – we're pretty much year-to-date where we thought we would be on sales. Soit's worked, this pivot of going and selling remotely has worked pretty well. So, we're not going to go back to the full model, but we'll certainly go back to more of the selling face-to-face, but we found a lot of new tools and a lot of new training and ways to sell online. Frankly, it's more effective. And you can spend more in marketing, but you're going to spend a little bit less in sales, doing sales kind of thing. I don't think it's not going to go back to where we were. It'll continue to evolveas we need to, to sell the product.

Our next question comes from the line of Mark Marcon of Baird.

I'm wondering with regards to the win rates, the improvement that you're seeing, who is that primarily coming against? Do you have any sense?

You'd know them very well. They're the major competitors in the mid-market space, would be most of them. That'sthe ones that we're seeing. And it's pretty consistent. It's not just one of them. It's beenthe top players in there that you would know very well and cover.

With regards to your assumptions for next year, how do you thinkit's going to end up trending in terms of the clients being distracted? Initially, they're distracted because of,obviously, COVID and the unprecedented nature. Now, it looks likewe're going to end up havingpotentially a lot of stimulus combined with COVID fading. Are they going to get overwhelmed with business and too busy to think about things? Or do you think if they're really super busythat could actually be a spur to increasing decisions?

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And with regards to the micro end of the market, are you seeing any impact from a large competitor introducing a micro solution?

We have not yet. And I thinkit's going to be interesting. We're going to watch it, obviously.It's a very basic product andyou're going to get what you pay for. It's very basic. There's not going to be personal support, I don't believe.As we've said, we've moved a lot to self-service. But at the same time, we're always ready7/24/365 to provide that support. And we've found that to be very critical to our clients during the pandemic, in particular. If they get hung up on something and they need to talk to someone, they don't want to wait for a text back or someone to answer an email when they can't talk to a live person. Just like how many of us find software support these days? So, it's going to be as good until you need something different and then it could be a frustration. So, haven't seen the impact yet, but we'll watch it.

With regards to two things, just the PEO, under what conditions do you think that really does transition where people will say ASO is great, but PEO is really what would be better. Like how confident are you in terms of seeing that? And then the second question is just on the service footprint, does as you cut back on the geography – and it seems like retention is doing extremely well. So, it seems like your client satisfaction must be really doing well. But are you seeing any sort of – are there any negatives with regards to the – the cutback with regards to the geographic footprint on the service side?

I have not seen a lot of it, Mark. It's a tribute to our operations leadership team and how we've handled that. Many of those tenured employees that were in the offices that we closed are working from home. So, the clients have not seen that disruption from losing their payroll specialist that they've had for many years. We've been able to transition to that work-from-home environment which was accelerated by the pandemic. We had already planned on doing some of that over the next few years, but accelerated it. And frankly, my hats off to the technology teams here, the operations, leadership that have really done a very good job in making sure that that continue to be handled. And they've also positioned clients into the right service centers. So, if they were normally calling in, we're transitioning them to different service centers that can handle them from that standpoint. So, I think we've done a really good job and have not seen a fallout on that. On the PEO question, I think, again, it's going to come back to – as clients feel a little bit morethings are calmed down, now it's going to be again, how do I recruit, retain, and really make sure I get the employees that I need while there's still some disruption to the employees. I think even through the summer with childcare, with unemployment having an additional higher rate of payment to them, so they're going to be interested in, hey, what are the benefit plans that I can offer them, how am I going to be able to provide those benefit plans, are they good benefit plan? I think the PEO interest will pick back upas we get into the second half of the calendar year. And into our next fiscal year, we expect that that will start to pick back up again.

Last one for me, just Clover, how has that partnership worked? Have you seen much of an impact or do you expect to see more of an incremental impact over the coming year?

It's going to have more of an impact coming up. We've finished this integration where the app, the Flex app is on the Clover platform. So, I'm a Clover customer, I fire up my point-of-sale terminal and I've got the marketplace from Fiserv's Clover there. Paychex is right there as a preferred app. And once they realize that if they're a Flex customer from Paychex and a Fiserv point-of-sale Clover customer, they can now have all of that information integrated, the time and attendance will automatically populate from the point-of-sale terminal. I think all of that integration has recently kind of gotten done now. And so, I think that we'll see more of an impact in the next fiscal year as that gets out there more and they start to see the combined benefits of being together, Clover and Flex.

Your next question comes from the line of David Grossman of Stifel.

Just a couple of really quick ones. So, there's a lot of noise in the market right now. I think it's fair to say retention is going to be up for everybody in the industry. Increased complexity definitely plays into the outsourcing theme and you've got really difficult comps this year transitioning, obviously, to more favorable comps next year. We all appreciate the fiscal 2022early look. However, at the risk of sounding greedy,perhaps you could help us sort through how to do more normalized growthwhen you get past these distortions from the reopening and the compares?

You mean what our expectation is, Dave?

Yeah. I don't want to ask you yet too granular, obviously. But just a way to think about what a more normalized growth…

What I say when I get asked that question is, pre-pandemic, Management Solutions growing about 6%. We certainly expect Management Solutions will grow in mid-single digits, maybe here faster. We'd want it to grow faster than that. And then, we expect PEO to grow double-digit or around there. Insurance, it's a little bit of a drag at this point. Unfortunately, the workers' comp market has not recovered. But that's what we expect. And frankly, in some ways, if you look at the guidance next year, that's sort of what you're seeing, right? Could we do better? Sure. There is a possibility, as we get through Q4, that we come out of it even stronger than we expected. But I think as a reasonable starting point, that's where we're at right now, yeah.

On the PEO, obviously, you're underperforming with peers right now and you gave us some of those reasons. How impactful are the insurance and the SUI versus the over-indexing to hospitality? Can you help us think through the relative impact?

I think it's a mix of that and I think the insurances haven't helped. You put your finger on it. SUI is going to be an impact into Q4. And that's going to be an impact. Workers' comp has an impact too. So, I think you've got a mix, a mélange of, say, of different issues there. But I think we start to anniversary those as we get into next year.

You mentioned one other interesting thing about self-service characteristics of the platform. And I think you mentioned it in the context of your costs going down. I guess my question is really more competitively since that's one of the biggest criticismsthroughout the spectrum of client size ofkind of your model versus a software model. So,am I reading too much into that or is there more to come here and where may we be on that journey or that transformation ofembedding more self-service characteristics to give the client more control and just give them the services when they need it?

It's been very important to us. It's actually something – that innovation, we've been on a path for that for some time. And it's really an ability of getting the client and the client's employees to see how easy it is to do those things. I think the pandemic has helped in the fact that while employees were away from many worksites,it forced the clients to say, hey, you can do this yourself or I can do it for you. But we're not together, so we can't be passing paper round and there's no longer a need for that. So, as I mentioned,over 80% of changes like direct deposit changes, address changes, things like that are done by the clients or their employees now and we see that continuing. The movement will continue to be self-service even in sales itself and setting up, the client allowing themselves to be set up. Much of that is done with SurePayroll now and that'll continue on the Flex platform. Hey, are you there? We're always going to be available to them if they need us. But definitely, there is not only us cost-saving, but even probably more important, there's a value to the client that want to do it themselves when they want to do it. And we've been on that track for some time. We just probably haven't talked about it as much from that standpoint. But I think we're well on that continuum and that will continue as an offering to clients. But always leaving that, hey, if you want – if you have an issue, you can get to us any time to be able to get you through it if you need it.

The other thing I'd say, David, is we're proudly a tech services firm. You cannot win the awards that we won. Those aren't paid awards. We didn't pay anyone to give us those awards unless independent third parties look at your platform and your service and say, yeah, you know what, they do what they're going to do and clients agree with that. Look at those awards. I would just say to people, look at that. The prevalence of the model, the strength of the model is shown by our retention numbers and the service we were able to deliver to clients. I would say this, of course, there's an opportunity for pure-software players in the market. But if everyone drops out and provides no service, that's great for us because, you know what, we'll be there to catch those clients because a lot of clients, especially in the SME market, need some element of service. So, we're not going to run away from that. How we deliver it? That can change. And frankly, over the last – since tax reform, many of you know, we made significant investments to accelerate the opportunity. You want a low-end solution where you don't talk to anyone and you can onboard yourself? By the way, let's talk about reality. Ask our competitors who can do that. We can. Ask them if they can do it end to end. I think you're going to get some funny stares on that. My point is, we don't cede our tech chops to anyone. We're as good as anyone else. But what we do is we also give you value-added service. And this year was a year where you saw the benefit of that. And what we're seeing, the reason we're seeing our retention numbers and revenue retention numbers at the levels they are is because we did it with excellence.

Our last question comes from the line of James Faucette of Morgan Stanley.

I wanted to follow up just on that last comment. Obviously, you guys have been very successful in adding capabilities. Not just evidenced by the awards, but also by other capabilities and new products, et cetera. How are you feeling now about kind of the pace of innovation in the industry? And what are you feeling in terms of what Paychex needs to do to match that or exceed that both from an R&D perspective? It seems like you're pretty comfortable from that perspective. But is there some supplementation you're looking at from an M&A where it makes sense to go out and acquire capabilities or technologies? Or do you feel like most of what you're seeing and what you need to do can be handled through internal development?

I think most of it can be done by internal development. Just following up on Efrain's passionate speech there, I think we under – probably undersold the technology side of us over the years because we're so proud of the service side as well. And when you think about things like the loans, when that stimulus – when the CARES Act first came out, the next day, we introduced a product that said all of your information is pre-populated in Flex. If you're a client of ours, all of your payroll information is in there, you can apply for the loan. And then we shortly said, you can now send your information to Biz2Credit and it will automatically apply. All you have to add is a few things and we have signature-ready forms for you to apply for forgiveness as well. So, I'm very proud of the fact of what our IT and the technology team have done. I think we've added those things over the years that we needed. Time and attendance, we bought as a very small add-on product and have now turned it into a very large business, growing extremely strong now as part of a revenue stream for us. And we've integrated that into the SaaS cloud-based Flex product. The mobile app, as I mentioned a few times, still a five-star app that is getting increased usage and has a lot of ways to go. So, I'm very comfortable. Now, we're always looking – probably from an M&A standpoint also – or even partnership standpoint like the Clover example. We have the technology, but when you integrate that now with a point-of-sale platform that's best in the business, now you really have some additional power that you're putting the technology. So, I've got a point-of-sale, but boy, now I've got a great time and attendance solution and a payroll solution that's all integrated with seamless connection, that's really powerful. So, it's probably more partnership than it is even M&A. But we're always interested in that, but we've built out most of our technology and we're very proud of it.

My last question here is just you've talked about, over the course of the last year, some variances from geographies in terms of pace of recovery, et cetera. Does that continue to be the case? And what key things are you watching for to measure and try to forecast that recovery, particularly in maybe some of the regions if there are differences that are a little bit behind?

Well, our own small business index that Paychex puts out with – i.e. just market every month, we've seen this last month, we saw the best one-month gain in jobs in about eight years, and it was across all regions. So, that's very positive. The South has been the strongest as you'd expect. They're lower wages, but they've had more growth. Just exodus to the South and just more construction, commercial and residential. But right now, in March anyway, we saw growth in every region, and I think 18 out of the 20 states that we look at for the best growth. So, we're seeing pretty – growth across that we use our own metrics that way. We're seeing that and we're seeing a bounce back in employees a little bit. But it's going to be interesting through the summer. I think you're really going to see the bounce in September as people start saying, okay, schools are back in, people are coming back full time into work. There may be still flexible work conditions, but that's when I thinkas you see the summer and I guess be ready for all of that, our clients are going to start picking up on the decision making. That's all the questions, right, operator?

That's correct sir.

All right. At this point, we will close the call. If you're interested in replaying the webcast of this conference call, it will be archived for about 90 days. Thank you for taking the time to participate in our third quarter press release conference call and your interest in Paychex. We greatly appreciate it. I hope you all continue to remain safe and healthy. Thank you very much.

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