沛齊 (PAYX) 2019 Q2 法說會逐字稿

Welcome and thank you for standing by.

(Operator Instructions) This call is being recorded.

If you have any objections, you may disconnect at this point.

Now I'll turn the meeting over to your host, Martin Mucci, President and Chief Executive Officer.

You may begin.

Thank you, and thank you for joining us for our discussion of the Paychex Second Quarter Fiscal 2019 Earnings Release.

Joining me today is Efrain Rivera, our Chief Financial Officer.

This morning, before the market opened, we released our financial results for the second quarter ended November 30, 2018.

You can access our earnings release on our Investor Relations webpage.

And our Form 10-Q will be filed with the SEC within the next few days.

This teleconference is being broadcast over the Internet and will be archived and available on the website for approximately 1 month.

On today's call, I'll review the business highlights for the second quarter and Efrain will review our second quarter financial results and discuss our guidance for fiscal 2019 and then we'll open it up for your questions.

Financial results for the second quarter of fiscal 2019 reflect good progress against our objectives and growth across our major product lines.

Our total revenue growth was 7% for the second quarter.

Management solutions revenue grew a solid 5%.

And PEO and insurance services revenues grew a strong 15% compared to the prior-year quarter.

Sales momentum has been positive.

We added -- we have added to our sales force and are fully staffed for our peak selling season, and we have implemented a number of tools and strategies that are aiding in that momentum.

With respect to client retention, we continue to be pleased with current trends in our strong client satisfaction performance.

On November 26, 2018, we announced an agreement to acquire Oasis Outsourcing Group Holdings, L.P. for $1.2 billion.

Oasis is the largest privately held PEO in the U.S. and an industry leader in providing HR outsourcing services.

This acquisition is anticipated to close in this quarter.

Oasis is a good fit with our PEO growth strategy adding to our scale, expanding relationships with new insurance partners, creating upsell opportunities into the existing Oasis customer base and augmenting our leadership talent with the addition of an Oasis experienced leadership team.

This acquisition will slightly -- will significantly advance our leadership position in HR outsourcing.

And when closed, Paychex and Oasis combined will serve more than 1.4 million worksite employees through our various HR outsourcing services.

We expect to finance this acquisition with $800 million of new debt along with cash on hand.

Our Paychex | IHS Markit Small Business Employment Watch shows the tight labor market continues to create a challenging hire environment for many of our clients.

The workplace has been evolving partly due to this tight labor market.

And as a result of technology advances, in August, we were named one of the world's most innovative companies by Forbes.

And in this vein, we continue to focus on enhancing our products and technology to increase efficiencies for our clients.

Recent enhancements to features and functionality in Paychex Flex will simplify the complexity of finding and retaining talent, optimize HR and overall business performance and remove obstacles that stand in the way of our clients' productivity.

We have enhanced our HR dashboard creating the functionality that will make it the destination for clients looking to manage and develop their workforce.

This dashboard includes advanced analytics, seamless access to Paychex learning and a state-of-the-art performance management process.

New workflows and approval functionality in Paychex Flex ensure proper checks and balances occur with employee self-service activities, which have also increased.

The use of self-service will drive greater efficiency for our clients.

During the summer, we introduced live reports with turnover and headcount data allowing clients to view consolidated data to quickly identify trends and gain meaningful insights into their business.

And we're now adding the ability for clients to compare turnover rates, employee turnover rates with similar companies through our benchmarking live report.

These significant technology product enhancements in the last quarter support our clients in recruiting, onboarding, training and developing their employees in a market where it is increasingly difficult to find and retain employees, particularly for the small and midsize companies.

In addition to our technology, our team of over 500 HR specialists around the country serve our clients growing HR needs as states have increasingly made it more difficult and challenging to run and grow their businesses without this expertise.

We also continue to evolve our Paychex Flex API -- APIs to give clients the ability to add new worker using our API.

This allows us to continue to develop new partnership opportunities with third parties that our clients engage.

I would like to congratulate our Paychex Insurance Agency, which has been named in the Business Insurance magazine's list of Best Places to Work in Insurance for the fourth consecutive year.

This ranking improved 1 spot to #12 this year.

I'm very proud of the Paychex culture that fosters engagement and growth among our employees.

I'll conclude by saying that our state-of-the-art technology, our full suite of integrated HCM product offerings and personalized service is a powerful combination that positions us for sustainable growth in our markets.

Our employees make this combination successful with their hard work and commitment to our clients each and every day.

I will now turn the call over to Efrain Rivera to review our financial results for the second quarter.

Efrain?

Thanks, Martin.

Good morning.

I'd like to remind everyone that today's conference call contains forward-looking statements that refer to future events and such involve risks.

Please refer to our earnings release that includes a discussion of these statements and related risk factors.

In addition, I'll periodically refer to some non-GAAP measures, such as adjusted net income and adjusted diluted earnings per share.

These measures exclude certain discrete tax items and onetime charges.

Please refer to our press release and investor slide presentation for a discussion of these measures and a reconciliation of the second quarter to their related GAAP measures.

I'll start by providing some of the key highlights for the quarter and then follow up with some greater detail in certain areas.

I'll touch briefly on results and wrap with a review of our fiscal 2019 outlook.

Total revenue and total service revenue both grew 7% for the second quarter to $859 million and $841 million, respectively.

The acquisition of Lessor Group accounted for less than 1% of the growth in service revenue.

Expenses were up 10% for the second quarter to $552 million.

Lessor accounted for approximately 2% of this growth.

The remaining growth related to accelerated investment in sales and marketing, product development as part of our tax reform investments together with growth in PEO direct insurance cost.

In addition, we incurred some onetime expenses relating to the Oasis acquisition.

Operating income increased 1% to $307 million.

Operating margin was about 36% for the second quarter.

Margins were impacted by accelerated spending and growth in the PEO.

Our effective income tax was 23.8% for the second quarter compared to 34.8% for the respective prior-year quarter.

The significant decline year-over-year on the effective tax is due to tax reform legislation.

We anticipate that effective tax rate will be approximately 24% for the remainder of the year.

Net income increased 19% to $236 million for the second quarter and adjusted net income increased 20%.

Diluted earnings per share increased 18% to $0.65 for the second quarter.

And adjusted diluted earnings per share increased 20%.

I'll now provide some additional color in selected areas.

Management solutions revenue, which includes our payroll service revenue together with our HCM products included in many of our product bundles, increased 5% to $685 million for the second quarter.

This increase was driven by growth in client bases across our HCM services, including payroll ASO, retirement services and time and attendance solution.

Retirement services revenue also benefited from an increase in the asset value participant funds.

PEO and insurance services revenue increased 15% to $155 million for the second quarter.

In August, we anniversaried the acquisition of HROI.

Growth was primarily driven by continued strong demand for combined PEO services, which, along with WSE growth in our existing client base, resulted in double-digit growth in client worksite employees served.

Our insurance services revenue benefited from growth in the number of health and benefits applicants.

Interest on funds held for clients, it increased 31% for the second quarter to $18 million, primarily as a result of higher average interest rates earned.

Investments and income.

Our goal, as you know, is to protect principal and optimize liquidity on the short-term side, primary short-term investment vehicles were banked demand deposit accounts and variable rate demand notes in our longer-term portfolio.

We invest primarily in high credit quality municipal bonds, corporate bonds and U.S. government agency securities.

Our long-term portfolio has an average yield of 2% and average duration of 3.1 years.

Combined portfolios have earned an average rate of return of 1.9% for the second quarter, up from 1.5% last year.

Average balances for interest on funds held for clients were relatively flat for the second quarter, primarily driven by the impacts of wage inflation, offset by lower client employees' withholdings resulting from tax reform.

Year to date.

And let me briefly summarize the 6-month period.

Management solutions revenue increased 4%, approximately 1% was contributed by Lessor.

PEO and insurance services revenue increased 26%, 17% on an organic basis.

Interest on funds held for clients increased 28%, driven by interest rate increases.

Total revenue, up 8%.

Operating margins were 36.4%, tempered somewhat by accelerated investments in the business and growth in PEO direct insurance costs.

Net income increased 70%.

And adjusted net income increased 19%.

Diluted earnings per share increased 18%.

And adjusted diluted earnings per share increased 19%.

I'll now walk you through highlights on our financial position.

It remained strong with cash and total corporate investments of $769 million as of November 30, 2018.

Funds held for clients as of November 30 were $3.7 billion compared to $4.7 billion as of May 31, 2018.

Funds are held for clients, as you know, very widely on a day-to-day basis and averaged $3.7 billion for the second quarter and 6 months.

Our total available-for-sale investments including corporate investments in funds held for clients reflected net unrealized losses of $45 million as of November 30, 2018, compared with $38 million as of May 31, 2018.

Total stockholders' equity was $2.4 billion as of May -- as of November 30, 2018, reflecting $403 million in dividends paid and $33 million worth of shares repurchased during the first half of fiscal 2019.

Our return on equity for the past 12 months is a very respectable 45%.

Cash flows from operations were $497 million for the 6 months, a decrease of 4% from the same period last year.

The decrease was driven by working capital fluctuations related to timing around collections and related tax payments for our combined PEO business and a decrease in accrued liability balances in connection with determination of certain licensing agreements.

Other impacts of noncash adjustments were offset within working capital fluctuations.

Fiscal 2019 guidance.

I remind you that our outlook is based on current view of economic conditions continuing, no significant changes that we give guidance, excluding any anticipated impacts from the Oasis acquisition and then follow with the anticipated impact of Oasis on our results.

We have tightened some of the guidance we previously provided.

Revised guidance is as follow.

Interest on funds held for clients anticipated growth 20% to 25%.

We assume no interest rate rises after this anticipated December raise.

We'll see if that occurs today.

Investment income net is anticipated to be in the range of $10 million to $15 million.

Net income and diluted earnings per share anticipate to grow approximately 4%.

And adjusted diluted earnings per share anticipated to increase now in the range of 11% to 12%.

Other aspects of our guidance remain unchanged for what we have previously provided.

The guidance is reiterated as follow: management solutions revenue is anticipated to grow by approximately 4% for fiscal 2019; PEO and insurance services revenues anticipated to grow in the range of 18% to 20%; total revenue is anticipated to grow in the range of 6% to 7%; operating income as a percent of total revenues is anticipated to be approximately 37%; the effective income tax rate for fiscal 2019 is expected to be approximately 24%; and adjusted net income, non-GAAP, expected to increase again in the range of 11% to 12%.

I'll now provide you with a little additional color on the second half of the year.

We anticipate that management solutions revenue growth in the second half of fiscal 2019 will be approximately 4%, with Q3 at or above this rate and Q4 below this rate, due primarily to the anniversarying of the Lessor acquisition.

For PEO and insurance services revenue, growth in the first half was significantly higher due to the timing of the HROI acquisition.

We anticipate growth for Q3 to be in the range of 15% to 17% and for Q4 to be in the range of 10% to 13%, due to a challenging -- compared with strong PEO growth in the later part of fiscal 2018.

Assuming the completion of Oasis, the Oasis acquisition, which we expect to occur in future, we anticipate that Oasis will have an incremental impact on revenue in the range of $155 million to $175 million for the balance of the year.

We expect that approximately 45% of this incremental revenue will occur in Q3 and the remainder will occur in Q4.

Excluding onetime cost related to the acquisition, we anticipate that Oasis will have minimal impact on our diluted earnings per share for the year.

With onetime acquisition cost, we anticipate that the acquisition will be approximately $0.03 diluted for fiscal 2019, primarily due, as I said, to the acquisition cost.

And now with those comments, I will turn it back to Marty.

Great.

Thanks, Efrain.

Operator, we'll now open the call to questions, please.

(Operator Instructions) Our first question comes from the line of Kevin McVeigh from Crédit Suisse.

Yes, just real quick -- really good results.

Obviously, there's been a lot of unevenness in the market.

Any change at the margin in terms of the client discussions.

I mean, it seems like the payroll really scaled up nice, so really nothing in the fundamentals.

But anything you'd call out just given obviously some of the noise that's been occurring since you last reported?

No, I think what we're finding is that we're getting -- we're seeing momentum on the sales side.

And we're seeing retention numbers that were very -- that are very positive and heading back toward our all-time best on the client retention.

So we're feeling good about the momentum in the first half of the year.

Of course, we're heading into selling season.

We're in selling season which is really an important time for us.

And we're feeling good at this point.

We're seeing business kind of environment pretty good and certainly in need of HR outsourcing in particular because of all the things that are going on with state regulations in particular, and I think that's really helping what you're seeing is kind of that double-digit growth in worksite employees, particularly in the PEO business.

So we're seeing a good need for the HR Services and all of our products.

And just, Marty, following up on that client retention at all-time high.

What's been driving that?

Are you seeing any kind of trend in the smaller businesses as opposed to larger?

Just really nice job there.

And we -- should we expect that to continue?

Yes, I think, as I said, we're heading -- kind of we're getting close to that all-time high in retention we had.

I think we're still seeing the same kind of number of businesses going out of business.

I think we're seeing an improvement in those that left for service or price.

I would say, the competitive environment is about the same.

There's always some pressure there but we seem to be doing very well from a retention standpoint and from a selling standpoint.

We've got some momentum there.

So I don't think -- we're seeing a lot different competition, and I think we're really holding our own and showing some momentum on the sales side.

Our next question comes from the line of James Berkley from Wolfe Research.

Just a quick question on Oasis.

Could you just talk about what you expect the accretion to look like there on a cash basis?

Just given that you tend to accelerate D&A for tax purposes.

I would think it looks even more attractive on the cash side.

But just wanted to hear your thoughts.

Yes.

I -- James, I'll hold that a little bit.

We do expect it on a cash basis for it to be accretive.

Their margins are at or above our margins on PEO.

So that will be a positive going forward.

We'll talk more once we have closed the acquisition in Q3.

But if -- we think it's going to be a nice add from a cash basis.

Okay.

And then obviously, that was the largest private PEO provider in the U.S. And if you could just comment on what other M&A opportunities you see and your thoughts on timing?

Your comfort level with leverage and just how you think about your broader PEO strategy going forward?

That will be very helpful.

Sure.

I think from an acquisition, we're always looking at a number of opportunities.

I think certainly there's a number of other PEO opportunities there, and we're looking in.

And Oasis was pretty active.

As a private company, they were pretty active on the acquisition side, particularly on the smaller ones in being able to integrate those in.

So we think that gaining scale on the PEO business is very good.

Obviously, that was part of this move.

It gains us more scale with the insurance carriers, it picks up new markets.

And we've been able to do something -- we'll be able to do some things, I think, with Oasis clients that if they don't fit in the underwriting, we can get them to our insurance agency, which is the 20th largest insurance agency in the country right now.

So we feel there's a lot of opportunity on the PEO side.

In other areas, there's some acquisitions as well.

I think we've been close on a few, not too worried about.

I mean, we're always watching for the leverage but from a debt perspective but this was -- I think we will be very successful in getting a good debt placement here, and I think that given our balance sheet and cash flows, that we'll have other opportunity to do more if we need to do it.

We're always watching for that shareholder return and be sure that we're using cash obviously in the best way for our shareholders.

I think we've got a long track record of that.

But acquisitions are certainly always on the table.

And we're looking at a number of things.

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

So I just wanted to circle back.

If we think about last quarter, you guys had given some kind of quarterly layout on payroll, what you were thinking about the respective growth rates.

And I think for Q2 and 3Q, the expectation was to be at, at least 3%, if I'm not mistaken, because that's the high end of the full year 2% to 3% guide.

And I think you came in at 2.8% in Q2.

Are you still thinking Q3 will be at least 3%?

Or any changes around the edges in the thought process there?

Yes, Jason, I don't see any reason why that wouldn't be the case.

So we feel pretty comfortable about where things are.

And just to add a little bit of color about why we feel comfortable.

Martin mentioned, I think sales process has -- we've seen some momentum there.

Retention has been good.

And then pricing has been stable.

So I think all of those 3 say we should be certainly in that range.

Okay.

And just wanted to go little deeper on some of the macro dynamics.

But I know you guys do fairly regular surveying of the small business base.

So just in terms of confidence and sentiment in sort of forward-looking indicators like it sounds like everything was fine in this latest quarter but as you head into the new calendar year, are you detecting any changes at all just in terms of hiring intentions or prospects for new business creation?

Jason, I think the interesting thing is -- the one thing we keep hearing is it's just tough to get employees.

And so for small to midsize businesses, it's tough for them to recruit and retain employees.

And one of the positives for us because of that is they're looking for more benefit, they're looking to offer insurance, they're looking to be able to have better benefit enrollment kind of opportunities, better technology, self-service type of technology for their employees.

And so generally, I think you still look at like the NFIB optimism, the business indexes are all still near historic highs.

And consumer optimism is high, so -- consumer confidence.

And so everything is high.

But there is this concern about can I get the employees.

And we have heard where some small to midsize businesses have -- and some of our surveys have actually said, hey, I've turned down some business because I just can't get enough employees to do it.

But there's still -- the good news is there's optimism that there is work to do.

It's just, with the low unemployment rate, can I attract enough employees to get the work done.

Okay.

And just last for me.

In terms of reinvestments, I just wanted to catch up on that topic.

At least for ESR model, your margins came in better than expected.

I know you're not changing the full year forecast.

So quarterly cadence of reinvestments, just commentary there for the back half.

And then just your latest thinking on whether or not you think these reinvestments could cause a little bit of uptick in underlying revenue growth as we start to think ahead to next fiscal year directionally?

Yes.

I'd say this.

So we did have a little bit lighter spending then we had gated in the quarter.

We -- it won't affect the back half of the year.

Our perspective is if it wasn't spent, it wasn't spend.

But I think the other part of the margin story was that revenue came in a little bit better than our plans had anticipated.

And so that dropped down to the bottom line.

So we see strength.

We'll see what happens in the back half of the year.

But it was a combination of both.

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

I wanted to ask about the Fed and the path of rate hikes.

I know you only have a single additional raise contemplated in your guidance.

But would a slower pace of increase by the Fed cause you to change any internal plans about business investment or timing for investment or headcount additions?

Or is there any other business impact?

Or is your internal plans very much aligned with your sort of external guidance?

It's pretty much aligned with the external guidance, Ramsey.

It really wouldn't change.

I think when we came into the year, our thought process was -- we look at the same data you all look at.

And we looked at the probability of raises.

They were talking about 3 and 4 in calendar '19.

We weren't buying it at the moment.

And I think now that's become a little bit more uncertain.

But it doesn't -- it -- further raises are more uncertain.

But it doesn't affect what we do.

And I would say, it's interesting the macro backdrop has been uncertain and volatile.

A lot of -- if you look at the vectors in our business, they're pointing up, not down.

They're not pointing neutral, they're pointing up.

And so when we look at the wealth of data that we have, everything from business bankruptcies to the clients who go out of business to sales to new clients, it looks positive to us.

So now we're in a situation where things can change rapidly.

But nothing that we're seeing says there are clouds on the horizon certainly in the back half of our fiscal year.

Good.

That's great to hear.

And doesn't mean that we can't talk ourselves into a recession.

Yes.

It would do the same.

On another topic, I wanted to ask you about sort of the sales process and strategy in PEO.

I mean, you just rolled up Oasis.

There's a handful of larger players out there like yourselves.

There's a bunch of smaller folks out there as well.

From the standpoint of prospective customer, how do you close that sale?

Is there a price -- a big price discovery process?

Is it expectation of service levels?

What is it that gets them to go into your camp rather than to one of your competitors?

Yes, I think it's always -- it's not as much price, I think.

It's going to be really the value of the technology and the service.

And what -- we've been in this -- Paychex has been in this for 20 years, the outsource -- HR outsourcing through both PEO and ASO.

And we have 500 HR specialists around the country that are dedicated to helping small and midsize business clients with their needs.

So you have good technology that they can use to enroll benefits -- help their employees enroll in benefit.

Good insurance options for them, particularly on the PEO side.

The larger you get, the more options you're going to have from carriers.

And those are really important benefits right now.

As I said earlier on -- because of the competitiveness of attracting and retaining employees.

And then it's going to be that service piece.

So from a client’s perspective, it is getting more challenging every day whether it's marijuana use and whether it's legal or not whether to do drug testing, how to handle drug testing, immigration, minimum wage, paid family leave, you need an HR support as a small to midsize business.

New York just came out with the need for a non-harassment training that has to be done by pretty much the middle of next year for a company of any size basically.

I mean, these are a lot of needs.

And that's how you sell the HR outsourcing ASO or PEO.

And PEO is becoming much more comfortable.

And things that -- well, it's not just limited to Florida and Texas, it's a real need.

And in this competitive environment for employees, that's how you sell it as your service and your technology.

A related final question for me, a brief one.

You basically also called out this Flex API and increased kind of capability to plug into potential partners.

The QuickBooks integration, you talked about Facebook integration, social component on the last call, are you going to lean deeper into sort of a partnership strategy to enhance the client bundle, the value proposition?

Or is this just -- is this a trend?

Or is this more just sort of a string of kind of one-offs?

Yes, it's a great question.

I think what we've always had -- kind of the value of Paychex has been I can offer you that full suite of products on our Flex system, everything fully integrated, real time, mobile-first design, single employee record kind of thing.

And we still offer that.

However, you do find particularly in the mid-market is more clients who say, hey, look, I'm used to having this record keeper for my retirement services or I'm used to this time and attendance solution and I'm just not ready to get off of all of that yet and switch to you.

So what we have found over time is particularly in that mid-market we're opening up more and more APIs to say, hey, look, you can stay with who you have if you want it.

And of course, partnerships are always powerful from -- if you pick the right ones to grow your base and do what you do best and things like QuickBooks were a good fit particularly for the small and some of the lower end of the midsize for us.

So it's just a way of broadening out whatever clients want, they can get from us.

However, the real value, I think, we bring still is that on Flex, you can have the full suite of products, you can have retirement.

Nobody else provides the suite of products that we provide with a single employee record in the technology and service.

Our next question comes from the line of Bryan Keane from Deutsche Bank.

I wanted to ask about Oasis.

Just what's the organic revenue growth profile of the company?

And then what do you expect going forward?

Or is there any synergies between the 2 companies that could push it higher?

Yes, Bryan, it's an upper single-digit grower.

They also did some inorganic.

We think that will be part of the mix which can drive that organic growth higher.

There are certainly synergies between the Oasis business and our existing PEO business as we got 2 of them that we'll be working on aggressively.

The thing that we're in the process of looking at also is look, there is -- as you've seen our results over the last certainly 3 to 4 quarters, PEO is growing pretty rapidly.

And what we want to do is fuel growth not necessarily cut cost out of the business, it's not one of those acquisitions.

And one of the issues that we'll -- we're looking very closely at is do we add more sales people to get even greater coverage than we currently have.

So we're looking -- we're trying to balance the cost savings with additional investments to fuel even faster growth for Oasis.

Yes, I think, Bryan, when you -- this is a kind of a perfect timing from a market standpoint, the need for HR and the acceptance of PEO in particular.

Now you got 2 teams.

As I said, we've been doing this for 20 years.

We got a very experienced team.

They have got a very experienced team.

They've been doing acquisitions of smaller PEOs.

They've got insurance carrier relationships that we haven't had.

They've got other markets where they've got more scale that we haven't had.

It's a good combination at a good time in the market to really grow.

And obviously, through the double-digit worksite employee growth, we've already been doing pretty consistently.

We expect this has really got a lot of more, as Efrain said, more revenues in the top line synergies.

This isn't so much about cost cutting as it is about growing the business in a perfect time in the market.

Okay.

That's helpful.

And then just curious to get an update.

Marty, I know you talked about increasing the sales force.

Just trying to see if you can quantify that going into the selling season here?

I think we've been fully staffed pretty much for this year.

So we're up, I think, 3% to 4%, maybe closer to 5% if you put all sales teams in there.

And we're feeling very good about that.

We have been able to fill those spots particularly in mid-market and in the PEO and ASO services.

And they've got some nice momentum as we go into this -- as we're in this peak selling season.

Our next question comes from the line of Lisa Ellis from MoffettNathanson.

So question on Oasis and HROI.

I mean, as you guys know, we'd love these businesses.

But I know historically, concerned factor, you guys have raised about doing acquisitions in the space that's been around getting comfortable with the insurance risk and the underlying book.

So can you just talk about how, with a company like Oasis, you managed that and get comfortable with that and, I guess, building on the experience with HROI?

Yes.

Sure.

I think, obviously, the due diligence, we're very careful on that in how we look at the company.

They have not taken risk.

And we felt based on some not only our own but some third-party analysis that they were in very good shape from a book of business.

And so we are careful about who we pick.

But we are very pleased with how Oasis look to us and the way they've been doing business and what their book of business look like.

Yes, and the other thing, Lisa, that I want to add to that is, they -- while they do attach healthcare, like all PEOs do, all of their business is based on guaranteed contracts.

So compared to other acquisitions that we have looked at, they are not taking risk on the healthcare side.

So that made it attractive to us, especially given how they had built the business and how they were growing.

Got it.

Okay.

And then a question to follow up related to the macroeconomic environment.

Can you just describe on how -- if and when we ever do see a slowdown in the U.S. that impacts Paychex's business in sort of a second-order basis, meaning, of course, slowdown in the employment is not good but I mean, do you -- does that end up driving additional demand for things like PEO and ASO when you're in a downturn?

I'm just curious kind of what the second-order impacts are in your business?

Yes, obviously, as you've said, the first order is, fewer businesses more going out of business, that kind of thing.

But in second order, you're right.

I think particularly in the environment we're in now versus even 10 years ago, there's a much bigger need now when there is a downturn, how do I attract and retain employees, do I have the right technology, so can my employees use mobile apps, can I be -- so when can I be more productive and use my employees to be more productive to help me be more productive.

They're going to look for ways to cut cost, and using our technology and a lot of the self service is going to help them to be more productive.

On the other side, they're going to have to attract and retain more employees or if they may have to lay off or do something like that, they're going to want to know how to do those things and do them right so that they don't face legal consequences, I think more than 10 years ago.

And that's going to be a HR need for PEO, for ASO, time and attendance, you name it.

And I think those things will improve.

So second order, while there's certainly a first-order hit of businesses out of business, loss of jobs and so forth that second order is, okay, it's more complex now.

I need more help in other services.

Our next question comes from the line of Tien-tsin Huang from JPMorgan.

You guys went through a lot already.

I'm just curious, just maybe bigger-picture question on Oasis.

Why now do a deal of this size?

I know Oasis has been around for some time.

Just curious why you felt like now was the right time to do such a large deal?

Well, I think -- I just think that timing is by view.

We've certainly known them for a long time and been an -- had an eye on the PEO.

We felt that our own PEO was -- particularly with HROI now with our PEO, we're really at a very mature level of leadership and sales performance and underwriting.

So we felt really good about where we were now than we -- Oasis where it is right now and the need in the market, again, as I've said a couple of times, that HR need has really picked up.

And PEO is not just a Florida, Texas kind of thing, it is really taking off now with the need for HR support.

And the acceptance of PEO -- of the PEO business has really taken off.

So I think we gained more experience.

We felt more comfortable with how strong our existing team was, the integration of HROI and how well that's gone and now, it was time to take on the largest private PEO and make ourselves the second largest PEO and frankly, second largest HR outsourcer by worksite employees.

Got it.

No, that makes sense.

I'm just curious then with Paychex now going after growth here, especially on the PEO side and then also investing, as you've talked about in the past, will we be able to break out or appreciate or evaluate the impact of margins from Oasis as well as the impact of margins from your investments?

And then the subsequent benefits you might be getting from those investments.

Just trying to understand how -- if there's a way that we'll be able to evaluate the return on investments that you're making away from Oasis?

Does that make sense?

Efrain, I know we've talked about this.

Yes, so short answer, Tien-tsin, is yes, we'll get more information as we go through the year so that people can make those judgments on what's going on.

So -- and you're right, there are value-enhancing investments that we're doing in the management solutions side that over time, we would expect improved margins there and there is acquisitions that we are doing on the PEO and insurance side that will help to fuel revenue growth and over time also improved margins there.

So we'll give more color as we go through.

Our next question comes from the line of Tim McHugh from William Blair.

And just a follow-up on that.

I know you said Oasis' margins are similar to your PEO margins.

I guess, can you give us a color on what that would be, I guess, as we roll this in?

Tim, I'll leave for now the discussions of specific margins.

I think we called out where we're going to be for the balance of the year.

But from a PEO perspective, I just leave it right now that Oasis is pretty comparable to where we are from a margin standpoint on PEO.

And actually, in some cases, a little bit better because they don't take any risk on health insurance.

We'll update more once we close the deal and then can provide more definitive information going forward.

Okay.

Given the way they structure their contracts, is there as much pass-through revenue?

No.

So I mean, that's a good point.

And that's one reason why -- we'll talk more once the deal is closed.

So because -- and as you know, Tim, because you know the space pretty well, everyone accounts for PEO revenue differently.

In our case, if it's a guaranteed contract, we don't run that through revenue.

We -- we're running, through revenue, the healthcare costs that we're taking risk on because Oasis doesn't do any healthcare, any -- take any risk on healthcare.

That revenue does not run through their revenues.

They obviously have work comp revenue that they take risk on that runs through their revenues.

But -- so there's differences in terms of -- a little bit of difference between their revenues and ours because of that, where we have guaranteed contracts.

We don't run it through the P&L either.

So margins actually -- and that's why I say, margins on an apples-to-apples basis are at or above our PEO margins.

Okay.

And then going back to -- I think the comment earlier was the sales force kind of depend how you want to count it, up 3% to 5%.

Do you mind -- how does that compare to last year and the year before, I guess?

How much more resources are you going into the selling season with versus what we have seen in the last couple of years?

Yes, Tim, we've typically be up around 2% to 3%.

And I think this is -- 3% to 5% is more like you're adding the other sales forces in as well.

So pretty much have grown across the board.

As we've talked about, we've moved some into, what we call, virtual for the -- on the payroll, particularly, the small in payroll side.

We've moved inside in telesales.

But we've also added a number of sales people on the PEO, ASO side.

The mid-market side is up pretty strong as well and -- because we took a little bit of a dip last year.

But we're feeling good about the fact that we've got good momentum in the first half of the year.

And we're fully staffed as we're in this peak selling season.

Our next question comes from the line of David Grossman from Stifel Financial.

There's obviously a lot of discussion about the PEO.

And you've changed your revenue segmentation.

And I guess, what I'm curious about is, if you could give us some insight into the changing business mix in new sales?

How much of the new sales are standalone payroll versus a bundled product compared to where we were maybe 2 or 3 years ago?

Yes, I would say, it's different bundles.

I would say, it's more of a bundled product these days in kind of taking that full -- looking for a full product.

On the very low end, you're still seeing, hey, I'm looking for basic payroll to help me get started in a business in that 1 to 4 or even 1 to 2 employee size.

But above that 5 employee size, you're definitely seeing a larger interest and need for time and attendance solutions, HR support, et cetera.

We don't necessarily break out percentages, but it's definitely trended up.

And that's one of the reasons to expand on the HR and the PEO side is that where -- 5 years ago, David, you'd see you needed 25 or 30 employees to really say, hey, I'm interested in PEO or in HR outsourcing.

Now that is honestly 10 to 15 employees sometimes need that support because of the legal issues today, the requirements of the states, the minimum wage changes.

If you're a multistate employer, it is really tough, even if you're small.

And these rules don't apply to, hey, you have to be 25 and above.

It's typically like this harassment -- non-harassment training that's needed in New York, it's like 1 employee and above, you have to do this training by the middle of next year.

So they're seeing a lot more need.

And clearly, you're getting much more of the approach.

The go-to-market approach in sales is much more about the full package, and the HR, you're leading much more with HR or a time and attendance solution, et cetera, and the payroll is kind of, yes, it includes payroll but the need is for much more of a fully comprehensive solution.

And it's shifted to bundles.

Right.

I was just kind of thinking pricing aside, the unit sale.

How has that trended over the past couple of years in terms of what kind of revenue you're getting per unit sales versus what you were getting a couple of years ago?

You're talking about revenue per client or sale?

Right.

Revenue per client on the new unit sale.

Yes, revenue per client has been growing.

You look over probably the last 3 years, you're up in the 5%, 6% range.

Okay.

And then just a follow-up.

I think, Marty, actually both of you had mentioned this that the scale of Oasis relative to Paychex in certain geographies may help you.

Can you give us a sense of what percentage of your payroll install base is in those geographies?

Yes, I would say -- that's an interesting question.

I don't have the number off the top of my head.

I can tell you that our PEO is certainly covered probably where the majority of our payroll population is.

But we definitely have scale of payroll clients and other products in those areas where they are and we don't have PEO.

So we think about it more as there is -- in these markets that we're expanding and probably in 10 different new markets where they have some scale and we have not built it up, it's because we haven't built up the PEO in those areas and we haven't had the relationship with the carrier, the insurance carrier who are in -- who are the strongest in those markets.

And now we'll have scale with that carrier in those markets and we certainly have enough clients existing to be able to sell PEO into.

And remember, we sell PEO directly as well.

So we sell to brand-new clients, and as we just talked about, that's a growing need is they're interested in PEO right up front.

They're interested in HR outsourcing right up front.

They're not -- it's not just the payroll base that we're selling to.

So while we have clients there, I'd say the majority of our client base, payroll client base, we have covered with PEO.

But these new markets, we certainly have thousands of clients that we can sell into.

But again, we sell the PEO directly to brand-new prospects.

And our PEO, David, as we've talked before, is predominantly a California, Texas and Florida game.

And this gives us strength in thinking outside of that.

So I don't have exact percentage for what California and Texas and Florida represent there, but this gives us access to a lot of markets that -- or at least strength in a lot of markets we really weren't strong in before.

Right.

And then just 1 last question.

Obviously, there's been a lot of kind of headlines about the ACA the last week.

So the ACA was obviously a big catalyst for this industry a couple of years ago.

And obviously, we've kind of anniversaried and kind of seen the reverse impact of that.

So any thoughts on directionally what the possibilities may be for the PEO based on the outcome of what's going on right now?

Yes, I think ACA has been very interesting.

I think even there is so much confusion in the marketplace among everybody, of course, is to whether it's in or out.

We have actually -- there's still been plenty of notices that have gone out to clients and nonclients of ours that have said, hey, you have a penalty and you have to respond to this, and so even though it feels like it's people aren't sure whether it's on or off, clients are still getting penalties from previous years saying that they owe significant sums of money.

We've been very successful in helping not only our clients, we've also offered a service where if you weren't a client of ours but you have a penalty notice and you want to come and talk to us, we've been able to help a number of clients and have abated a significant millions and millions of dollars of potential penalties for them.

So it still is a very much a talking point to new clients and a retention point to existing clients that they need to report, they need to keep the information to report and that they may get letters from the government saying, you owe something and you're going to need support on how to get out of it.

But, David, the other part I've build on from what Marty said, the tailwind we see for PEO really has something to do with.

I think it got turbocharged by Affordable Care Act.

But really much more -- it's much more now that integrated HR and benefit play.

And we saw a strength.

We saw a strength starting 2 years or so ago, and that strength has continued.

And some of it has to do with ACA-related issues.

But a lot of it really is more HR benefits...

Yes, definitely.

And technology related.

Yes.

And that point I made, you may have heard earlier that in the -- in such a low unemployment rate, these small and midsize companies are really looking to someone to help them have better insurance benefits, offer insurance benefits, help them enroll their employees in these benefits because they're having to compete with really large companies in what their benefit plans are.

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

First, I was wondering, on Oasis, so are all of their customers PEO, the 270,000 WSEs?

And I know that Paychex historically has included both ASO and PEO clients in their WSE cap.

Could you give us maybe an apples-to-apples number of what the PEO-WSE cap looks like following the Oasis acquisition?

Well, you want to -- go ahead.

Well, we don't break out separately.

We'll do that as we close the acquisition.

When we give you the 1.4 million WSEs, there is a significant amount of those that obviously are ASO employees.

When they -- when you're using the 270,000 figure, they have some ASO employees included in that.

They are between 200,000 and 300,000, closer to the midpoint on PEO clients.

So some of their clients on the numbers that are floating around really are ASO.

So we would count them as ASO clients.

Great.

And that's why I asked.

And then I know that Oasis, I think, they were using a third-party software vendor called PrismHR.

I'm curious if you're factoring in the opportunity to migrate those customers over to Paychex Flex?

Or if that's something that's further down the road?

And maybe help us understand if there is a revenue or margin opportunity and the magnitude of that?

I think, yes.

Certainly, we'll be looking at that.

And looking at how -- what Prism -- the flexibility in the offering of Prism, which, we think, has been very solid for their clients.

And certainly, Flex is for ours.

So we'll be looking at the 2 platforms.

And it'll be further down the road.

That is not a necessarily a big savings or anything, a synergy that we're counting on there because this is more of, hey, what provides the best client service and technology for their clients, for our clients and we'll be looking at that, but that's not a big part of the synergy is to try to save on that.

We want to make sure it's a great experience for the clients no matter what platform they are on.

Great.

And maybe just 1 last one.

Retention was mentioned a couple of times on the call and improving.

And I'm curious if you could just remind us what the peak retention rate was before?

And do you think with PEO now in the mix and that being more strategically valuable for customers, holding all else equal, do we think that retention can eclipse the prior highs going forward?

Maybe just some color on that would be helpful.

Yes, I think the all-time best was around 82%.

And as I said, we're approaching that best.

I think you make a good point that certainly, as you take more products, that's always been part of our model.

As you take more products and particularly HR, that drives better retention.

But you still have to keep in mind that 80% of our clients are under 20.

And many of those still take payroll only.

And so that will make it more difficult to get their retention much above that, kind of all-time high.

We're always looking to do that.

The -- certainly, the possibility is there as they take more products and that their employees are more tied into things like our mobile app and the technology.

But I think it's a little bit tough given the dynamics still of the base.

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

I just had -- most of my questions have been answered.

But I was looking for a little bit of color on a couple of things that you've talked about.

In addition to strong retention, you've also mentioned new bookings in payroll.

Anything to call out by market?

Or are you seeing any differences in behavior among mid-market or micro enterprise among your customer base within whether it be retention and new bookings at all?

Well, it's always hard to say before we get through kind of this next -- this current quarter, this third quarter because the selling season is such an important part of it.

But we are feeling momentum kind of across the board, whether it's on the small end of payroll, the mid-market.

We're feeling momentum pretty consistently certainly as well as we've talked a lot about the PEO and ASO, time and attendance, retirement.

Really seeing pretty consistent momentum across the board.

Great.

And then second question is just as it relates to your partnerships and wondering if it's far enough along to see a trend of mid-market clients that were exposed to you through partnership, transitioning to complete solutions or how and if they're mixing and matching with partners?

And I guess, just trying to get a sense of how you're managing that potential channel conflict besides looking at incremental opportunities?

Yes, I think definitely, the sale is about what's best for the client and what -- where do they see the most value.

We certainly try to make sure that we demonstrate to them.

The vast majority of our clients are still taking a full service, full Flex offering because of the great benefit of a single employee record, a unified user interface that whether you have -- you're on 1 platform, no matter how much you grow for payroll and HR and that it's fully integrated.

So when you are taking Flex, when you just think about what we just offered in the last quarter, the Learning Management System, Flex learning management is giving you training, we're building that into some of the bundles, some low free training and then you can build and design your own training to tie that into performance management that ties to your payroll, that ties to your workflow for HR.

So I would say, the vast majority are still sold as the full bundle, but you do find in the mid-market that there are clients that say, hey, I'm just not ready to make a full switch if I'm already up with a retirement provider or a time and attendance solution and, okay, if that's the way you want to do it, we'll go with an API and we think that's efficient.

But in the future, that also gives us an opportunity to go back to them and say, hey, this would be even better if you've bought more services on the Flex platform.

Our last question comes from the line of Jeff Silber from BMO.

It's Henry Chien calling for Jeff.

So a lot of stuff was covered.

I just wanted to ask sort of big-picture question on the Oasis acquisition.

So as we think about the PEO business, and I know you touched on it a little bit, what are the kind of synergies that you get from combining sort of 2 PEO businesses?

I know you mentioned there are the carrier relationships.

But how does that translate into growth in your business?

Is that let you offer better insurance rate or better products?

Just sort of what are the benefits of combining 2 PEO businesses?

Yes, sure.

It's -- and it's very much about, again, that top line as we've talked about that really the revenue synergy, the growth synergy.

So when you talk about like a carrier relationship, we've had very good carrier relationships but not with all carriers because of the markets that they are in and we're in.

And now when you go into a new markets and you have a strong carrier relationship, and now you, let's say, you double the size or you increase the size tremendously, now when you go to those carriers, they're much more interested in giving you more attention to say, hey, let's give you the best benefit packages, let's give you some more support as far as the integration with the carrier, you're dealing with a carrier customer support from the carrier, you're just a larger customer and they're going to give you a lot more support.

Therefore, you can offer necessarily more benefit options, packages to clients to be able to give to their employees and a better fit -- a better benefit enrollment experience, and when you -- so just think of it from that sales perspective.

And then just when you think about all of the various markets -- so -- and then so there's that, then there's just additional markets where they're in that we're not, as Efrain said.

We've been primarily Florida, California, Texas, Georgia and they're in different markets.

And now we have some clients there but we weren't scaled enough necessarily to deal with those carriers.

Now we're going to be scaled between the 2 of us to be larger in those markets.

That opens up a great possibility.

And also you're dealing with the PEO that didn't have an insurance agency with it.

We have an insurance agency, the 20th largest insurance agency.

And when you don't fit the underwriting profile for PEO, they couldn't go anywhere else for that.

We now take these clients and say, hey, if we can't underwrite you as a PEO client, I have an insurance agency product that I can offer you for insurance.

So now you've just opened up a whole new opportunity for them.

And their PEO clients can now buy retirement services from us, they can buy time and attendance solutions from us and a lot of things that we're much larger at that they didn't necessarily offer to a large variety of their customers.

Got it.

Okay.

No, that's really helpful.

And maybe just final question, what's your sense of the -- I mean, it sounds like that the PEO and sort of these combined HR Services are really starting to inflect in.

In your view, I mean, what sort of innings or stage, you think, of adoption, you think, PEO is in right now?

It's pretty -- I think it's pretty early.

It's -- because I don't see the requirements from states or federal government frankly getting that much easier, particularly the states, and I think that more and more client.

And then as the economy has gotten more -- has gotten tougher from an unemployment.

So unemployment has gotten lower, harder to find workers.

You've got a lot of companies, who, for the first time, have said, okay, I really have to offer benefits now.

I have to really be sure that I have benefits that I make it easy for my employees to get them or I'm not going to attract the employees.

And by the way, I also have to offer more technology and make it easier for employees to do self-service, to talk -- to do things on their mobile phone to enroll in their benefits, change their benefits and so forth.

So I think actually it's pretty early innings from adoption of a PEO or frankly any HR outsourcing.

Remember that we're very large in both markets.

So PEO is great.

ASO is great also.

And we have over 500 HR people.

I -- we're one of the largest obviously.

And the second largest we will be in this space.

And that gives us a lot of clout in -- to get in front of clients with technology and service.

At this time, we don't have any more questions on queue.

You may proceed.

All right.

At this point, we will close the call.

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I thank you for taking the time to participate in our second quarter press release conference call and for your interest and investment in Paychex.

We hope you and your families to have a joyful holiday season.

Thank you.

That concludes today's conference.

Thank you all for participating, you may now disconnect.