Good day, everyone, and welcome to today's Paychex Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, you will have the opportunity to ask questions during the question-and-answer session. [Operator Instructions] Please note, this call will be recorded, and I will be standing by if you should need any assistance. It is now my pleasure to turn the conference over to Mr. John Gibson. Please go ahead, sir.

Thank you, Todd. Thank you, everyone, for joining us for our discussion of the paychex third quarter fiscal year '23 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 third quarter ending February 28. You can access our earnings release on our Investor Relations website. Our Form 10-Q will be filed with the SEC within the next day. This teleconference is being broadcast over the Internet and will be archived and available on our website for approximately 90 days. I'm going to start the call today with an update on the business highlights and then Efrain will review our financial results and outlook for fiscal year '23. We'll then open it up for any of your questions. As you saw in our press release, we delivered solid financial results for the third quarter with total revenue of 8% and adjusted diluted earnings per share growth of 12%. Thanks to the outstanding efforts of our employees we completed a successful selling and calendar year-end season with strong sales volumes and revenue retention for the quarter. We continue to see a stable macro environment and demand for our solutions. Our unique value proposition is clearly resonating in the market. Small and midsized businesses continue to show remarkable resilience as seen in our job at index in the last two months as they contend with a constantly changing labor market, inflation, increasing regulations and rising interest rates. Before we get into the third quarter results, I want to take a minute to address the recent volatility in the U.S. banking market as a result of two highly publicized bank closings. We have no cash, restricted cash and investments deposited within Silicon Valley Bank or Signature Bank, and…

Thanks, John. Good morning to everyone on the call. I'd like to remind you the customary things I remind you that during these conversations, we're going to talk about forward-looking statements. Items like EBITDA, non-GAAP measures, please refer to our press release for more information on these topics. I'll start by providing some of the key points for the quarter and finish up with a review of our fiscal 2023 outlook. Total revenue for the quarter, as you saw, grew 8% to $1.4 billion. Total service revenue increased 7% to $1.3 billion. Obviously, we're benefiting from increase in interest rates. Management Solutions revenue increased 7% to $1 billion, driven by additional product attachment, HR ancillary services. It's largely what we've discussed previously, our ERTC product and price realization, we continue to see strong attachment of our HR solutions, retirement and time and attendance products. Demand for our ERTC service remains strong and contributed approximately 1% to revenue growth in the quarter. Demand for this product along with our internal execution, have continued to exceed our expectations, while ERTC has been a tailwind, and we expect demand to continue into fiscal year '24. It will eventually become -- will eventually moderate and become a headwind as we progress through next year -- next fiscal year. Beyond Insurance Solutions revenue increased 6% to $321 million, driven by higher revenue per client and growth in average worksite employees. The rate of growth was impacted by factors previously discussed, including lower medical plan sales and participant volumes, along with the mix shift to ASO as John called out. We expect these trends to normalize as we progress through fiscal 2020, meaning a little bit more of a balance between PEO and ASO. Interest on funds held for clients increased significantly to $35 million in…

Thank you, Efrain. With that now being complete, Todd, we'll open up the call for any questions people have.

[Operator Instructions] Our first question comes from Kevin McVeigh with Credit Suisse.

Congratulations. Just really, really strong results here. I don't know, John or Efrain, maybe -- and I know it's preliminary Efrain, but the 2024 looks pretty similar to '23, and there's a lot of crosscurrents from a macro perspective. And you folks tend to be pretty conservative. Maybe help us understand some of the puts and takes? Is it maybe there's a little bit more pricing and just any base underlying assumptions around unemployment because, again, just really, really outcome. I'm just trying to understand maybe that a little bit more.

Yes. Let me -- I'll let John talk a little bit more to kind of what our thinking is from a macro perspective. But Kevin, just to kind of address some of the higher level assumptions that go into the plan. I called out the fact that ERTC is not going to be the headwind -- I'm sorry, the tailwind that it was this year. We called that out last year, but definitely going to happen next year or I wouldn't say definitely. I will say, we have a very high degree of belief that we won't see it. However, you're going to see that more in the second half of the year than the first half of the year. So, that's the first thing, thing I'd say. If we look back at where we started this year, we're getting a nice macro uplift from employment as we started the year. That seems to have run its course. It is not going the other way. But at this stage, what we're seeing is that there's been a pretty significant moderation in terms of employee adds and that's happened as we progress through the year. So, those two things are -- will become headwinds as we go through the year. Interest rates I called out. The first half of the year, I think we've got some sense of where we are. So, where we're at, the market does too, what is really hard to understand what happens in the second half of the year and whether we start going in reverse on interest rates. We're taking steps to position the portfolio to be able to deal with that. That's what happens. But no one1 knows there. Now that's all the stuff that's headwind. No positives. We think HR continues to be strong. We think as John pointed out, we think retirement continues to be strong, where we think that HCM continues to proceed well. We think PEO, which has been a little bit of a tailwind to growth this year. It does do better next year. The Insurance business that we call out PEO, a lot of the moderation on the growth rate in PEO insurance coming from insurance, we think that starts to improve as we go into next year. And then we have the normal level of cost discipline in the business that drives the results that we're anticipating in 2024. So that's a broad overview of, Kevin, numbers we've put together. I'll let John talk to macro and any other parts of the business we need to call out.

Yes. Yes. Kevin, keep in mind that we've certainly seen a reference and really expected to see some moderation. I mean, we don't expect another 4.5 basis points increase in interest rates that we don't expect the type of hiring that we saw from the HCM. It's hard to believe that the great resignation was just last year, a year away. So certainly, we've had the benefit of staffing up. But we're not seeing any contraction moderation. And in fact, if you look at our job index, which has been a great indicator of kind of small business health and what we've seen in both January and February that we've reported, it's actually an increase in the index. And we have not seen that through all of this fiscal year. So these are the really first two months where we've seen an increase in the index and also saw some moderation in wage inflation as well. So, we're certainly not seeing it. We haven't reported March yet, but I can tell you we continue not to see anything there. Demand for our products, the HR products, the online products that we're offering HCM products of the 401(k) effort is really, really strong. I mean, we had a strong sales quarter in the second quarter and the third quarter was actually better than that even on a relative basis quarter-to-quarter from prior periods. So, we're seeing good demand in what I would say, moderation stabilization. We're certainly closely watching all of the indicators, but we're not seeing things. We've got a very -- the other thing I would point out on a macro basis, there's a lot of noise in the system. And I think it's important to say, we have a very diverse client base. And I think it's fair…

Thank you. Our next question comes from David Togut with Evercore ISI.

Just to dig into fiscal '24 guidance a bit more. Could you walk through some of the underlying drivers of Management Solutions revenue growth for next year and a little greater depth? And in particular, if you could let's say, start with the critical year-end selling season, which you've just gone through, you've indicated it was strong. If you could kind of walk through kind of what parts of the bookings were particularly strong within your client base, small end like sure payroll versus kind of more of the core payroll processing business, and then in addition to that, if you could comment on your expectations for client revenue retention next year and also for pricing?

Okay. Let me break it into two pieces, and then do let John comment on the selling season. So David, look, to put the revenue plan together for Management Solutions. I'd say you've got to -- you've got to get several dimensions reasonably right. The first is obviously what we expect from a client growth perspective, and John can talk to what we saw during the selling season. What I mean is unit growth in terms of sales. The second part is what do you expect from a pricing standpoint, too early to talk exactly what we're going to do. But those two components, both client growth and also -- and also pricing or part of our assumptions going into next year. You want to get attachment, continued growth on the ancillary products in the bundled suite fluting time and attendance, HR administration. And then increasingly, within Management Solutions, retirement and HR drive a lot of growth. And we're assuming strong years within both of those products, partly on the return side based on what John said. So you put all those together, and that forms the basis of our thought process around Management Solutions. And then PEO and insurance, we expect to grow faster than we've seen this year in part because of some of the headwinds we feel will abate as we get into next year, although that may still be evident in Q1. You framed the question correctly in the sense that if we come out of the selling season, and we haven't felt like we've had some of our objectives, it becomes a little bit more challenging to put the plan for '24 together, but John called out the fact that we thought we had good performance in the selling season. We obviously are not giving percentages at this point. We think after Q4, we gave you a lot of detail about client base, et cetera, and we'll talk about that. But I'll let John talk to what we were seeing during the selling season.

Yes. No, I think, David, the key point was is we had both strong revenue production -- new revenue production and good volume production across the core business and then really just continue to see this accelerated level. I mean, we were growing our HR businesses. We're growing a good healthy clip before the pandemic and when the pandemic hit, we started to come out and they accelerate. And we're really seeing strong growth there, strong growth in retirement services, our online services, time and attendance, the other bundles that we're offering retention insights. We're just seeing a lot of traction in our products and services and we saw it in the third quarter. And I said the third quarter was a step-up from the second quarter, we felt pretty good about the second quarter. So -- and it was a very highly competitive environment. I would say there's a lot of aggressive competitors out there, and I think our products and our sales team did a great job on executing. Also, the other thing I feel good about in that quarter is we sell a lot of our business, only 50% of our new clients come to us from strategic partnerships, and we had a good year-over-year increase there. And again, I think what's going on there, not only as our products and services resonating, but I think people that are advising clients are beginning to put a preference on, hey, if I'm going to advise my clients were to go, maybe they need to be in a nice safe place where I don't have to have worries about whether or not their employees are going to get paid. So, I think that's also helped us in the third quarter as well.

Just pivoting to the float Efrain. How are you positioning the float if the Fed is almost done raising short-term interest rates?

So, that's an interesting point, David. I wonder whether they're almost been raising short interest rates. I tend to agree with you, but I'm not so certain about it. But the levers you have there is what percentage you have long term versus what percentage you have short term? And where do you lock -- where you lock long-term rates and over a period of time, so you can manage what happens on the downside of the cycle. So, we're starting to extend duration now because we're of the conviction that interest rates seem to be getting close to some sort of peak. Having said that, my prognostication skills on this or not anything anyone should take to the bank, but I do think from a portfolio management perspective, it's probably better to start going longer now for us. We were shorter earlier in the year.

Thank you. Our next question comes from Ramsey El-Assal with Barclays.

Efrain, can I ask you control down a little bit in terms of the factors that are giving you confidence that the insurance side of PEO will improve next year. Just curious about the drivers or sort of reasoning behind that expectation.

Yes. So, two things, Ramsey, it's interesting. It's been an unusual year in the sense that we've seen softness in insurance inside the PEO, and we've seen softness in insurance particularly health care insurance, in our agency. I'd start with the kind of obvious point that -- at some point, people do need health insurance. And at some point, as clients grow within the PEO, we add more clients. We're going to get more health care attachment. What's happened this year is that in the PEO in particular, you have renewals that occur in the fall and then you have renewals that occur at the beginning of the year. And if in that cycle, you don't get what you expected. You basically have to wait for some period of time if we start all of that process a little over again. So, we -- as we went through the year -- in the first half of the year, but okay, we're going to come out of the year with robust insurance as we get to the end of the year, it was better, but it wasn't what we expected. On the agency side, it's been moderating as we've gone through the year. And we've gone through cycles like this over seems attachment is lower and then it picks up. So part of it is almost a new reversion phenomenon that we think will occur. But the second part is we put a number of different initiatives that don't bear immediate fruit, but we think we'll bear fruit as we go into next year. One thing that's really interesting final point on that, John, just to highlight something John said, which is this preference for ASO versus PEO is a permanent preference for many clients eventually that want a PEO solution because they want the benefit of and we're expecting that we're going to see more of that as we head into next year. So while PEO performance, I would just highlight the PEO performance has been lower than what we anticipated during the year. It's still been growing at a decent clip. It's being somewhat attenuated by the insurance business, which has been very, very sluggish through the year.

Yes. I would add to that, I think it's important to understand that particularly on the insurance attachment side in the PEO, remember, that's a lot of pass-through revenue, not a lot of margin. But it's a big dollar number. So a small percentage change in any direction has probably an over-weighted impact on the revenue in the PEO, right? And so extra 1% or 2% and then another 1% or 2% participation within the base, I think, is critical. And to Efrain's point, you have this opportunity to reset your insurance portfolio every open enrollment, and you're hoping that you have the right portfolio of cost and the type of plans that people can afford and they want to gravitate to and what they're going to do. And that cycle comes up every fall and into the winter. So certainly, we're taking a lot of data. We're doing a review of every market for the PEO and looking at our health insurance line up, making sure it's competitive. We're taking an affordable for clients. We're talking to our clients. We're already in the process beginning to reset that and talk about that reset. So, we're confident that we'll have the right lineup and the right opportunity, and then as Efrain said, historically, most of Paychex PEO sales really prior to our acquisition of Oasis was coming from upgrading ASO clients into the PEO business, a lot of inside the base. Now it's far more outside the base, but we still have that capability inside the base. So, we think there's additional opportunity inside our client base to upgrade them to PEO and that not only increases the revenue, but it also increases the lifetime value of the customer to us, it's the right thing to do for the business, and we'll be looking at plans to do that as we go into next year as well.

Let me sneak one follow-up, you called out higher revenue per client as a driver in the quarter. And I'm just curious, over time, have you seen the kind of overall growth algorithm of the business shift more such that, that higher rev per client metric is sort of more important. I guess the underlying question is, do you expect sort of ongoing gains there to sort of persist or is it -- was there something a little more lumpy about it that we should be aware of?

No. For sure, I mean, if you look at -- if you parse all the data, I'm not sure you get it from all of the public fiscal you get pretty close. You've seen persistent growth in revenue per client. So I think we've been very skillful at finding new opportunities, both with product attachment, but also the ability to create new products and services within our client base to drive that revenue higher. So yes, we can talk about an algorithm that's about units and price, or we can talk about an algorithm that's really around revenue per client and revenue per client has become more important, certainly in the last five years.

I think it's important, Ramsey, keep in mind, we're in states where we're driving more value to the customer and both through our technology as well as our advisory services and that value is driving retention. It's driving pricing power, and it's driving an openness to add additional products and services over time. So the old traditional model we've always had, which is we've always been able to drive price increases over time to cover our cost increases. We've been able to go into the base and drive attachment. I would lay on top of that because we focus so much on the HR value proposition and driving customers up our kind of value continuum, that the other benefit we're seeing here is revenue retention. And now they're looking at us as their trusted adviser and they're saying, I want my 401(k) with Paychex, I want my time in time and attendance with Paychex. I want my other digital offerings from Paychex. I want my insurance from Paychex.

Thank you. Our next question comes from Andrew Nicholas with William Blair.

This is Daniel Maxwell on for Andrew today. Sort of similar to the last question, but specifically on WSE growth in the PEO and ASO client base, if you can break apart, how much of that is coming from existing clients versus new clients and attrition? And any color on why there has been a preference for ASO over PEO and the reasons you expect that balance to normalize? Is that just coming from increased confidence in up-selling to PEO? Or is there anything else in there?

Yes, Daniel. So, we've seen healthy growth in WSEs across ASO and PEO. We don't separately break them out, but both have been growing. So, we're seeing positive results on that side of the equation, splitting it out between new adds versus existing base. The reality is that because the existing base is so large, it dwarfs the impact of new adds from a WFE perspective, especially when you consider loss. And so, we've seen good growth on WSE that makes us, as John said, more positive about the general value of our HR advisory services like both cross ASO and PEO. I'll let John talk through shifting preferences in a given year between ASO and PEO.

Yes, Daniel. I think that what you're seeing is -- and again, some of this is just speculation on our part, but when we see clients that had our insurance and we go through enrollment and where they had 25 employees that bought the insurance, now they have 22 or you see clients that had your insurance in the PEO and decide that they no longer going to have insurance or offer insurance for your employees. I just think you're in a position where given some of the uncertainty, people being cautious of adding a benefit. Now it's interesting, they know they need to have benefits to attract or retain employees. So, 401(k) is doing very, very well. It's a lower cost benefit. It's a lower commitment. And now when we take the SECURE Act 2.0, technically, if you're a 20 to 50 million company, a person company, you now can basically get a 401(k) setup and have all of the setup costs and the annual cost covered through tax credits. So, those are things they're adding. But the health insurance, because of the size of the expenditure and the fact of matter is once you start offering it. It's a pretty long-term commitment you're making. I think there's a degree of hesitance to that. And again, as I said, I think there's more we can do in going out and looking for more innovative product sets that gives access, affordable access to health care for our employees and our teams are working on that. As we go through the new enrollment. But again, the issue you'll have there, that's going to be enrollment, we get into the fall of this calendar year and into the second quarter of our fiscal year. Does that help?

Yes, that's helpful. And then just generally on capital allocation, anything on the attractiveness of buybacks going forward or any M&A opportunities that have become more attractive in the last few months in the pipeline?

Look, with respect to buybacks, I think we've talked about what our philosophy is in general. And at this stage, we're evaluating a range of opportunities from an M&A perspective and if the right opportunity, I'll let John talk to that, what we're looking at. But the right opportunity comes along. We obviously have the dry powder to be able to make something happen.

Yes. I think Daniel, I think, our position has changed on this. I think the market conditions are changing and have changed and I think we're going to continually be on the lookout for opportunities that accelerate our position from an HR leader and the technology leader and continue to position us as the leading digital HR human capital management provider. So I would say some -- we've seen some valuations starting to come down. I'm sure the recent disruptions in the financial markets may create additional opportunities. And as Efrain said, we stand ready if the right opportunity comes around to pull the trigger. It's not that we haven't wanted to do something but we also are not going to overpay for something. So we're going to be -- you're going to see the same financial discipline you've continued to see from Paychex. What we believe that the market conditions are more conducive to us moving forward on the M&A front, but we'll see if that actually transpires.

Thank you. Our next question comes from Samad Samana with Jeffries.

Maybe one, just as I think about that comment about the number of new customers coming through strategic partnerships, how should we think about maybe how that impacts kind of customer acquisition costs those tend to be slightly larger, smaller, more profitable, less profitable? How should we think about where you're acquiring the customers from and what the impact of that is to the financials?

So I wouldn't think anything about it. I would just really more commenting that's been Paychex for 50 years. Over 50% of our new clients have always come from strategic alliances we have. We're a respected partner with the association is been the CPAs. And so they've always been a big source of ours. It doesn't do anything to our cost of acquisition. I just think they tilted certainly during the selling season, we saw a good uptick in how they were referring Paychex over other options that they have. That was my comment.

Okay. Great. And then as we think about the bookings in the quarter, anything to call out between the different kind of customer sizes so think about it as very down market and maybe more micro customers versus your average customer size. Just any trends or pockets of strength or weakness?

Well, actually, what I would say is we have good strength. I think, across the board. And actually, what I would tell you is that we actually saw a little more strength up market, not just the small start-up, 1s and 2s and on the digital side, which is during the pandemic, that's where we saw a lot of growth. We know business starts through the roof crazy levels they've subsided that they're still at high levels in comparison to pre-pandemic. So at that time, when all these start-ups were happening, also, we do a lot of managed payrolls, insure payrolls. So as you can imagine, a lot of people were hiring household staff during the pandemic. We saw a lot of escalation in the very micro end of that space. I would say that's balanced out. It's gotten back to a more balanced world and what we saw in the third quarter was strength in the more traditional segments for Paychex.

Thank you. Our next question comes from Bryan Bergin with TD Cowen.

It's actually Jared Levine for Bryan today. How does the 3Q PEO revenue and worksite employees come in relative to your expectations? And then what is the expectation for 4Q in terms of how worksite employees and at-risk health insurance revenue will compare to 3Q?

Yes. Jared, I won't get into that level of granularity at this point. And -- so we will report as we get through the quarter and year-end, I'm not ready to dive into specific operational metrics for the PEO at this point. We called out that revenue was going to be lower in Q4. That's a function of the topics that we've been talking about relative to insurance. But yes, I won't go any further than that. We'll have more to say as we get to Q4.

Okay. And then the 25 to 50 basis points of potential margin expansion for FY 24, can you discuss what the primary drivers of that expansion would be?

Yes. I mean it's a -- it's an emphasis that the Company has had. We're going through the budget process, frankly, after this call, we've done, we'll start the process of putting our budget together. But -- we just have a mantra to get more efficient where we can get more efficient. And some of it comes from operations. Some of it comes from sales. Some of it comes from G&A. It's really across the business and where we see an opportunity to become more efficient. Not simply massivley just cut costs, obviously, that's important, but also deploy technology where appropriate, to become better at doing what we're doing. We do it. I would say that many of the technologies that you read about in that here, we don't trump it, but we use. And we think that advances in things like AI can be of tremendous help to tech angle services businesses. So we're excited about the potential, to understand the risk and are actively looking at how we can deploy those technologies to get more efficient, get better at serving the clients.

Thank you. Our next question comes from Jason Kupferberg with Bank of America.

So I guess there's a school of thought out there that just one of the byproducts of the banking crisis could be some tightening of credit, small businesses find it harder to get loans. They tend to bank with a lot of the regionals, et cetera. I'm just wondering what your take is on that as we start to look into fiscal '24. It doesn't sound like you guys are really assuming a recession per se in this preliminary outlook for next year. So, I just want to get a reaction to that to start.

Yes, Jason, I think I kind of mentioned it in my remarks and some other questions. I don't think there's any doubt. I mean, prime at 8% for small and midsize business centers and you talk to a regional bank that I've heard, and there's going to be some tightening of credit. That's part of the reason why we've seen a lot of our customers engaging us on our ERTC product. So it was interesting, I would say as we approach some of our clients, some of our clients like, I really don't need that. A lot of our clients don't -- again, we're Main Street small business owners. They're not -- they're not looking for a handout and they're probably sometimes a little gun shy to get out -- there's been a lot of talk about auditing this stuff. We had a bunch of clients that have come back to us and said, "Hey, I can use this money. And on average, it's $180,000 per client. So we've been doing that. We created partnerships with fintechs during the PPP during the pandemic, and we're also helping our clients from that perspective as well because we've really become a trusted source for our clients to help them when they're trying to figure out how to take advantage of tax programs of government programs. When you look at the PPP loans, 9% of all of the PPP loans in the U.S. was placed by Paychex. That was more than JPMorgan and Bank of America, you guys combined. And so I think we're continuing to support them and help them, and we'll continue to look for ways that we can help them access non-traditional funding sources. And I think that's another part of our value proposition that our customers and our CPA partners are appreciating.

Okay. Understood. As a follow-up, I just wanted to ask on the float side of things, maybe a two-parter there. the first part just being, obviously, the unrealized losses have increased with the rates going up, but just wanted to confirm, you guys can comfortably meet all the float obligations just short-term component? I know you said so far to date, obviously, that's been the case. But I just wanted to make sure we shouldn't expect any material amount of realized losses? And then just any thoughts on Fed -- now coming this summer, do you see any potential impacts on float if it's adopted by enough banks? And maybe just talk about how your float income breaks down between payroll and tax pieces.

Yes. Let me take the first part. Yes, Jason, obviously, one, as John mentioned earlier in the call, when you have interest rates rising 450 basis points at the pace it did and you're holding very high-quality securities, but our interest rates at 1.5%, you're going to take going to take -- you're going to see some of the unrealized losses that you see in the portfolio. We hold our securities to maturity. So that really doesn't represent an issue. We've had swings from plus $100 million plus now obviously to this point, had nothing to do with credit. So, there's really no issues there. Understand why you ask and understand all of the all of the concerns that others had. So, those securities will roll the portfolio as they mature, just to remind people on the call, our average duration is around 3.5 years or so. So this is relatively quick. So no issues there. High quality, we really only typically in A or above and no concerns there. The second part of your question, I didn't catch. I was focusing too much on the first part, Jason.

Yes, sorry, I was just asking about Fed now with those real-time rails coming out this summer. Just any thoughts on how that could, if it all impact float balances, float income obviously like we'll see how many banks adopt it, right, but -- and then anything just on your float income, how it breaks down between the payroll and the tax pieces? Because I know, obviously, some of the float you hold a lot longer. So...

Yes. Yes. Good question. So yes, we've been anticipating that at some point, what the current landscape of payments, certainly ACH windows, which provides some measure of the float that we have is one to narrow. But you, of course, you know business very well. A lot of our float income is not coming necessarily from overnight payroll, is coming from taxes and that should not be impacted significantly under the Fed rules. The other part that I would say flip around there is that we stopped and there's not been a lot of conversations really as much lately about real-time payments. We do think that there will be opportunities in the future and that may be an opportunity to monetize even if you lose some element of the float income. Final point, just the advertorial since this is my 12th year now, as you know, Jason, there was a point when our business was heavily depend on float 27% or so of net income. We're in a different world right now. We'll manage through it even if it doesn't materialize quite the way we expect it to. But that's the breakdown of the three pieces that I think will impact us going to in the future.

Thank you. Our next question comes from Kartik Mehta with Northcoast Research.

Efrain, I wanted to go back to your comment on Management Solutions, payroll and pricing. Do you think it's fair to assume that considering the inflationary environment we're in and obviously, that's impacting your costs as well that the pricing on the payroll side will be higher than normal, maybe not as high as it was last year, but higher than normal?

So, I'll turn it over to for John some comments on pricing because I think that I think we need to distinguish between pure pricing and value delivered to customers. So -- but let me answer your question. So as you know, Kartik and everyone on the call knows, we typically have said that pricing is in the 2% to 4% range on a realized basis. So maybe it could be a little bit higher for some clients, but frequently or sometimes it's discounted. I don't want to talk too much to the specifics around pricing next year. I think the pricing environment will not be quite the same as it was this year. I think it was somewhat of an unusual situation given inflation. Having said that, I just want to limit that comment to the issue of pricing and not include value. I do think there's always an opportunity to think about how to add more value to a customer and then charge them for that because they're willing to accept that. I'll let John comment on some of the things that we think about in that respect.

Yes. We certainly don't want to talk about future pricing on this call. But I think it's fair to say that we have gotten far more scientific and precise about the ability and willingness of our customer base to pay based upon a series of attributes about the way that they consume our services, the way they want to be served, and what products that we attach, we see better stickiness and price elasticity. So a lot of AI, a lot of data science, a lot of modeling for us to be very precise in that regard. And then as Efrain said, I think we try to talk a lot more about value and about how we engage them in the utilization of our products and services. We approached over -- for the first time in third quarter over 100 million mobile uses interactions with our Paychex Flex product. And a vast majority of those are employees engaging the product. And we've been doing a lot to really introduce that to not only our clients, but their employees, but now they're getting accustomed to the notification, the way Paychex, the way they can make changes in real time. And what we're seeing is people that we can do that with actually see that as a higher value. And as you can imagine, it's a higher -- it's a better customer experience, and there's also some service and margin benefit there at the same time. So that's been another lever that we understand as well that we're pushing on. So, I think what you're going to see is us continue to understand what things we need to engage the customer around that if we engage them on those items, it's going to increase the value they get from Paychex. And because of our competitive position, allow us to, I think, generate more value to the bottom line at the same time.

Fair. And then just -- we've talked a lot about, obviously, PEO and ASO. And I'm just wondering if you could give a little bit of context as to revenue per client PEO versus ASO?

Yes. I'd say, Kartik, the way to think about it is ASO does not, in general include insurances. And so, what you end up getting in a little bit of price on PEO on the base product is the added revenue that comes from benefit attachment, typically, workers' comp and also healthcare. Not all clients take health care, but when they do, then the revenue can be significantly higher.

Thank you. Our next question comes from Bryan Keane with Deutsche Bank.

Just a clarification on the preliminary outlook for fiscal year '24, it doesn't sound like you expect the U.S. recession in that guidance. Is that correct? And I guess if we do see a U.S. recession, how would it show up in the numbers, Efrain, because there's definitely a lag impact to where it shows up in the actual financials?

Yes. So Bryan, a good point, and obviously, we all hear the same chatter everyone is hearing. So let me just move to the answer to that. That's a little bit more new. At this point, I can only tell you what we see right now. And I can say, as we said we've repeated earlier, we see signs of moderation that we've been seeing progress since the fall after Q1, but we don't see any significant signs of slowing. So we just got through the last three months, John gave an overview of kind of what was happening from the selling season, that would have been to a signal that, hey, maybe something going on here that we needed to pay attention to and incorporate. At this point, through the selling season, we haven't seen signs of a slowdown. Again, I've seen signs of moderation and we've incorporated that in our thinking. To the extent that we saw a slowdown, obviously, we'd see it by July, and we've incorporated that in our thinking, we come back and say, guess what, things are slowing down. I don't think that things will occur that way, but it could. The way we think about the year is really -- and I've said this probably for the last three or four years, it's in two halves. So I think that are confident in terms of what we expect to see in the first half is at this stage, decent win by thesis. I mean, we've got enough trending to say something should not fall off the cliff in the first half of the year. The Fed is tight. And John said, our clients are going to be much more impacted by rate increases in the prime rate than anything else. And at this…

Yes. And I would -- yes, Bryan. I'd just point you to our Paychex IHS job index reports on our website and look at January and look at February, we released it every month. Both months, the job index improved. We didn't see that in any other consecutive months in the prior fiscal year. So certainly, we don't see as Efrain already said, and I can reiterate what Efrain said, but even the benchmarks that we would see that would be signed, we've been doing this for a while. And we have a lot of historical models of what it looks like leading into a recession. And we're just not seeing those. And what we hear from our clients in terms of the labor market, in terms of their employment, again, moderation, stabilization. They're not signing up for any big pieces. And I understand the challenge, and I try to put it in perspective is saying, how can you hear all this on the TV and the lease papers of what's happening and then rationalize that with what I walk into the office in here every day. And I do think in some respects, I said it in earlier comments and the way I've rationalized it is we -- there's two different small business worlds. And I think there's a lot of money put into a lot of tech companies, a lot of people that didn't have to make money to spend money, could pay whatever they needed to, could hire as many people even if they didn't have stuff for them to do. I think that bubble is bursting and you're seeing that being digested. I don't see the foundation of Main Street small business at this point, having those same type of dynamics that you're reading in the paper. I just simply can't put it any other way, but we're just not seeing it in the numbers. Now is there going to be a trickle down. And certainly, the banking thing last week was certain concerning because that gets contagious. Hopefully, the policymakers and individuals can do things to continue to help support Main Street small businesses from being impacted to being impacted from this kind of irrational actors that are doing things that don't make sense. But I'll get off that soapbox.

Thank you. Our next question comes from Peter Christiansen with Citi.

Just wondering if we can get a sense for the health of the top of the funnel, if we were to exclude the ERP side of things, what are you seeing from new business formation and also perhaps some share shift from regional sell filers, that kind of stuff would be helpful color there?

Yes. Peter, again, I'll go back. What we see is on business applications, business starts, again, they're back to pre-pandemic levels. So I was always trying to explain to people that when you look -- when I look at it because we're doing our budget points, I'm looking back almost five fiscal years now and fiscal year '19 stands out because then you see all this entity going on in the other fiscal years. Business starts are down from where they were historically. And that's why when I even look at some of our retention in the small end, that doesn't surprise me because even in good times or bad times, a small business that starts two years later, most of them aren't in business. So when I look at it, there's a good new business starts. When I looked at our sales from the third quarter, they were strong across the board, not just in ERTC but across the board. And so I really -- again, I'll go back. I'm not seeing anything on a macro level that would indicate to me that there are macro issues or there are demand issues relative to the products and services that we're offering.

Thank you. Our next question comes from Mark Marcon with Baird.

A couple of questions. One is basically in terms of the margin guide or the preliminary thoughts with regards to margins for next year. To what extent would you expect to see any sort of improvement in terms of the margins ex the impact of float income? And how are you thinking about that?

Yes, it's a good question. Mark, I don't think float will play as big an impact on margin expansion as it did this year. I will hold the answer to that question. And so I've gone through the budget process because it will depend on where I end up in terms of float income for next year. We anticipate that it will grow so that will have a modest impact on the -- it will exert a positive impact on margin next year. But remember, Mark, one other thing is that we called out ERTC as moderating, that's going to exert a countervailing force. So when I pull those two together, I'll figure it out and answer on Q4. But I don't think -- I think there will be at the end of the day, likely real improvement in operating margin when all is said and done.

Do you think there will or will not be?

Will, that's my expectation. But I haven't done.

But ex quote, we should see some margin improvement. And then -- and then with regards to -- I know you're in the budget process now, but are you anticipating an increase in terms of the sales force and in terms of the overall headcount within the business? Or are the technological innovations that you're making sufficient to basically continue to drive the business with the same headcount?

Yes. Good question. I'll answer it in two ways and then let John give his commentary because I'm sure he will be scrutinizing every headcount in the sales budget. But the short answer is that we're where it makes sense to add headcount to drive greater sales, we are likely to do that, and I'll let John talk to that. But I think you rightly identify something that has been the feature of the Company, which is increasingly if you look at not only in the U.S. but also in Europe, where we also have a growing business, a lot of our sales are done digitally and do not require at least at a minimum the level of sales involvement that our field sales force provides. So you're going to have a mix. And I don't think that we know quite yet whether there are adds, but I would be careful I know our competitors tout their headcount adds as a precursor or a driver of growth that is not necessarily where we are at. We can grow without adding headcount, although there are places where we may use do that. I'll let John talk to that.

Yes. I don't tell adding expense to the business very frequently. So I think that we're constantly looking to make sure that we have the right go-to-market strategies and the right go-to-market coverage. We are certainly focused on using our vast data sets and analytics and digital engagement as much as we can. As Efrain said, I went back five years ago, our digital, if you think about just in the U.S., I mean, including international paychex.com and surepayroll.com, probably a 20-point improvement in the percent -- 20 percentage point improvement. And what we're getting there. We're driving analytics to make our sales force more productive instead of just cold calling across the market or inside and client base, we're using data analytics and models and triggers of behaviors of people engaging our systems to give them active risk. So, I think there's opportunity for productivity. And we're doing a lot more digital engagement inside our applications and actually creating digital experiences to drive more attachment of ancillary products and services. So, I think when we're sitting down for the budget, we're certainly going to add sales reps engaging our strategic partners, doing things that we need to do to cover the market and the market opportunity we have, but we're equally balanced on making sure we're making the investments in digital engagement and driving productivity and using the data analytics we have to make sure we're making every rep as productive as they can be.

Fantastic. And then one last one. Did you say what your -- how much pace per control ended up increasing over the course of this quarter or this year on a year-over-year basis? I've got some investors that are under the impression that your pace per control might be up by 300 bps and then they're factoring in the ERTC and looking at the underlying growth and I'm not sure that the numbers are right. So just what did you see in terms of pace per control for this last quarter?

So, we didn't talk about it, but I will say that through the year. We have seen increases in pay per control or we would say, checks, and it's moderated as we've gone through the year. So that -- in some ways, it's been a tale of two cities, the first half is port end up being different than the second half of the year.

And Mark, just keep in mind, remember, we're Main Street small business was a year ago in terms of their ability to hire people. They were understaffed, desperate to get people. So you've got the benefit of that hiring up. It's not that there's a deceleration. It took -- this has been an interesting year in terms of people getting and that's helping them getting staffed up. Now they're staffed up. I'm not expecting that they're going to have another -- a big group of employees, regardless of whether or not there was a recession or not, right? I mean they're fully staffed. And we would expect a moderation of the growth in the number of employees in our clients.

Thank you. Our next question comes from Eugene Simuni with Masset Makinson.

I just have one quick question to follow up on the comment on you made on Secure 2.0. always very interesting to hear about how kind of regulatory developments can help you guys. So can you elaborate a bit specifically on what the opportunities for Paychex might be from that act? And then what is the time frame for when we might see that flow into your financial results?

Yes. Yes. So as we said, we're in our budget and we're really in our planning stages to figure out how we want to approach the SECURE Act 2.0. We started some education, certainly within our base and we're trying to figure out in scope the size of the opportunity across the market and determine what investment we're going to do that. And that's something I think we'll talk about more in the next call. We're doing a lot of surveys trying to get where people are in their understanding of what it means. There's a huge education effort that I think has to go on, but I think it's a pretty powerful value proposition. Like I said, I think the secular labor problem is going to continue. I don't -- even we get to a recession, we just simply don't have enough people working. The labor participation rate is just not big enough to meet even a lower demand were at 3.4%, 3.5% unemployment. And so, I think the simple fact is small and midsized businesses needing to compete against large employers, we typically have richer benefit plan. It's going to be a secular trend that's going to continue, and I think we're well positioned to do that. And I say that because that's going to create the opportunity for a 401(k) plan. And the SECURE Act 2.0, just to give you an idea, pretty much if you're an importer with between 20 and 50 employees, we could provide you and start up a 401(k) plan, and you would pay Paychex literally nothing because you pay us for a startup fee. You pay us for the other fees that we would have there. But you'd get all that back through tax credit. So it's -- basically, you can add the plan. And then if you want to contribute up to $1,000 to each employee, you can get that $1,000 as a tax credit as well in many circumstances. So I think there's not a lot of awareness. Look, we found the same thing with the ERTC. They're just a lot of small and midsized business owners not even where these programs exist and then they have reluctance to participate because whether we want to like it or not, they have some skepticism about government programs and being on some government list. And we're really positioning ourselves as kind of this trusted adviser to help them and help facilitate that. And so we're doing a lot of studies on it. We're trying to figure out how big the opportunity is and certainly, we think it's a great thing for small, midsize businesses. And again, I applaud the Congress and all the partisanship that goes on in Washington. It's great to see them have a program like this, and I hope there's more programs like this in the years to come to support Main Street small business owners.

Thank you. Our next question comes from James Faucette with Morgan Stanley.

Just a couple of questions from me. First and I know we've talked a little bit about this both in previous quarters, but now, but can you recap for us a little bit why you think ERTC outperformed what you thought it would do during the course of this fiscal year? And then kind of how that contributes to you thinking that it could slow a little bit in next?

I'll just start, John can take the here. Yes, Jim, I think that when we entered the year, we thought that there was widespread understanding and knowledge of the program such that as we went further and further into the base, clients would have already themselves of the service. What we actually found was that they were anxious to hear and to be educated with respect to the program and the way it works and our ability to facilitate their access to the program made them constructive about wanting to participate the level of understanding a little lower than we anticipated. John talked about that for many reasons, and it turned out that there would be a much bigger opportunity coming into this year than we had realized. As we get into next year, more and more time has elapsed the ability to access the programs is running out. One, it relates to a period of time that now will have in 18, 24 months ago. And so as we round the next year, into the beginning of calendar '24, we think that the opportunity both within our base and in general, will have moderated. So the back half of the year, we don't anticipate that there will be as much demand or opportunity. And any you want to...

Yes. No, again, I would just reiterate, I think this is a good example of how we're trying to approach helping our clients. I think when the program was first announced, we did a lot with the PPP loan program. I talked about that 9% of all of them paired with fintech companies to be able to facilitate that. And we've really developed a muscle there to build an automated simple solution and an educational package and program for both our strategic partner CPAs and for our clients to go through. When the ERTC program came out, I think, we thought they kind of knew about it and were just trying to do general education. I think what we learned early on is that was just not resonating. And a lot of people either thought they didn't qualify or weren't sure, or quite frankly, by some of the just hassles and other challenges of participating in to some other government programs, they felt like, Hey, I don't need this right now, and I just can't tolerate. I think we had two things kind of happen. One is our data science team began to look at actual data models and we started to be able to pinpoint accuracy, be able to go to a client and say, we actually know from our data that you qualify and this is how much we're talking about. So now you're saying, hey, I can get you a check for $180,000 and what you had to do with education. There was some more information and then we made it a very simple process. So one was we were now instead of broadcasting to all of our clients, we were going with a specific database analysis to a specific client and saying, we have a high…

That's really helpful color. And then just last thing for me is, Efrain, you talked about that at least initial planning stages, you think margins next year can expand some. If I reflect back on where you've talked about your margin targets in the past, we were kind of getting towards the upper end of that. Are we at a stage we can start completing that maybe the margin structure can even move above what you've talked about in the past? Or what would have to happen for that to be the case?

That's a good question, James. So -- and that's the benefit of listening to what I've said over a period of time. If you would have said to me persistently, we could be above 40%. And I would have urged caution because I didn't know whether we had all of the set of initiatives that could drive us there. The short answer to that is I don't have a great answer. I have a sense of when we're probably getting closer to the ceiling, I do think that you're right in saying that it's been reset a bit, and it's been reset a bit because of technology. So technology keeps giving us opportunities to automate things that we -- if you would have said seven years ago, is that a chatbot could be as good or better than in answering 275 questions that are 90% of what clients want to know, I would have said -- I don't know about that. And short answer now is -- that number is not 275, it's probably 375 or 400 question. So short answer is technology is going to set the limit especially in the tech services business. And so I think we probably have developed some more headroom with some of the actions that we have taken. And it's not just pure technology, but I think we wanted to become more automated efficiently. A lot of the initiatives that John started years ago have paid these dividends.

Thank you. Our last question will come from Andrew Polkowitz with JPMorgan.

just wanted to -- just wanted to ask, you mentioned earlier that it was a fairly competitive selling season. So I just wanted to ask if you could share where that competition is coming from, whether it's new or entrance usual suspects like the regional and if there is anything to call out different from history regarding balance of trade?

I wouldn't say any new entrants, it's the same suspects. I think what we found was just everyone was more aggressive in trying to go after and grab market share, and I'm very proud of our sales team for really outcompeting the competitive metrics were very strong for the quarter and I think in a very aggressive market. And I would say every one of our market segments all that. And I think that's going to continue. Look, I think very proud of where we are and where we're positioned. I'm sure a lot of our smaller competitors and those that are maybe a little more focused in niches that aren't doing as well as the traditional small business market is doing. We'll maybe get more aggressive, but I feel good about where our value proposition is. And I think what we're finding is, as I said, I think our strategic partners, our clients, and I think prospects are beginning to put a premium on, hey, I want to be somewhere where you know what they're doing. They're doing it right and they're stable, and they're going to be able to have the financial capability to continue to invest in their products and services over the long term. And so I think there may be a little less chasing shiny objects as we go forward.

Got it. And I just had one follow-up on op margins. I mean for the quarter, this quarter, it came out a little bit ahead of the 40%, 43% you laid out three months ago. Just wanted to ask if there is anything that came out better than you expected three months ago relating to the expense line?

Well, I think revenue, obviously, was a little bit higher than we expected a lot of the flow-through and drove higher margins and our expenses were in line with maybe a little bit better than we anticipated. The combination of that is really what drove better margin performance in the quarter.

At this time, I have no further questions in queue. I'll turn the call back over to John Gibson for any additional or closing remarks.

Well, thank you very much, Todd. I appreciate it. At this point, we'll close the call. If you're interested in a replay of the webcast, it will be archived for approximately 90 days on our website. I want to thank everybody for your interest in Paychex. And everybody have a great day.

This concludes today's call. Thank you for your participation. You may disconnect at any time.