Ladies and gentlemen, thank you for standing by and welcome to the Paychex Q2 FY 2021 Earnings Conference Call. At this time, all lines have been placed in a listen-only mode. After the speakers’ remarks, there will be a question-and-answer session. Please follow the operator's instructions for the question-and-answer session. Thank you. I will now turn the call over to Martin Mucci. Please go ahead, sir.

Thank you, and thank you for joining us for our discussion of the Paychex second quarter of fiscal 2021 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, 2020. You can access our earnings release on our Investor Relations website and our Form 10-Q will be filed with the SEC within the next few days. This teleconference is being broadcast over the Internet and will be archived and available on our website for approximately 90 days. I will start today’s call with an update on our business highlights for the second quarter. Efrain will review our second quarter financial results and provide an update on our outlook for fiscal 2021 and then we will open it up for your questions. While the first half of fiscal 2021 was affected by the economic impacts of COVID-19, we have been pleased with the results of our business and the sequential improvement over the first quarter in both revenues and earnings. Improvements in revenue occurred across the board, all lines of business. Most of our key business metrics have continued to show steady improvement, though at a more moderate pace as we ended the quarter. We have not yet experienced any deterioration related to recent surges in COVID-19 cases across the country, but we continue to monitor trends closely, especially as new restrictions are being implemented in many states. Throughout the COVID-19 crisis, our business model has proven resilient, our client base has grown despite economic headwinds and we continue to see good sales momentum with growth year-over-year in new units sold. Our digital sales remain an area of strength and we continue to invest in digital marketing, lead generation and sales technologies to drive growth. We also see strong demand for HR solutions and HR outsourcing, which we deliver through both our ASO and PEO models. Since the onset of the pandemic, we have seen a greater interest in the ASO model as businesses are looking for more immediate HR support. We are on track for another year of record retention as losses have declined significantly compared to the prior year. Client satisfaction scores continue to improve as we focus on providing excellent service to our customers, supporting them in this most challenging time in helping them simplify complex regulations. We have not let up on our efforts to help our clients navigate this environment, and we continue to educate clients and prospects on state and local specific regulations, which are frequently changing, including the new stimulus initiatives passed by Congress. Our retention team is proactive in reaching out to clients who may be showing signs of difficulty to consult with them regarding available options. Our clients are facing the most complex calendar year-end many have ever seen and we are here to help them through it. We have expanded our thought leadership, not only in the area of COVID-related regulations, but more recently offering information on the 2020 election results and the potential impacts to our clients’ businesses. We continue to see demand for virtual events and webinars to help educate clients and prospects in this changing environment. Our financial strength allows us to continue to make investments in technology. Our fall product launch builds on our track record of innovation and delivers on our promise to make complex business issues simple. We introduced several new offerings and enhancements that help businesses increase productivity, reduce risk, maintain compliance and adapt to mobile and AI-driven trends. More business leaders are turning to tech solutions to increase productivity in this environment and respond to the interests of their employees. Our Apple Watch and Google Assistant device integration now allows employees to access their HR and payroll information easily without even logging on to their phone or PC. We also added new features in our performance management system to allow for greater feedback and engagement with remote employees, critical to employee retention and development in this work-from-home environment. We continue to enhance our analytics suite and dashboards to deliver a user experience that enables clients to define the data that is most relevant and actionable to them, which saves time, improves productivity and supports better business decisions. We also see positive trends with double-digit increases in mobile and self-service usage as our strategy of device independence continues to gain traction with customers. We recently announced the integration of Paychex Flex with the market-leading Clover point-of-sale platform from Fiserv. Available on the Clover app market, this gives business owners the ability to streamline payroll and time and attendance management. This is another example of our commitment to connect Paychex Flex users with some of the world’s leading business tools. We are proud of these innovations and more were recognized by industry experts this quarter. Most recently, the Paychex Flex platform was recognized by Human Resource Executive magazine with an HR Tech Award for the Top HR Product of the Year. The combination of a single device-independent application with HR services and benchmarking capabilities sets us apart from others in this category. We continue to design solutions that add value to our clients. Our new PEO Protection Plus Package helps business owners reduce risk by offering coverage related to cyber attacks and employee lawsuits. Exposure to these risks has been rapidly increasing in the COVID-19 environment and we are the only provider offering both cyber liability and EPLI coverage as part of our PEO solution. And by leveraging the group plan model of our PEO, the coverage is significantly more affordable to businesses. The COVID-19 environment has also impacted the financial security of millions of Americans, further exacerbating the issue of lack of retirement savings in the U.S. This month, we announced that we are among the first in the retirement industry to sponsor and maintain a pooled employer plan to help businesses nationwide provide a cost-effective retirement plan option for their eligible employees. This offering is an outcome of the SECURE Act, and along with a reduced cost compared to a single employer plan, it will reduce fiduciary liability for employers and simplify plan management. As we move through this period of uncertainty, we are confident that our resilient business model, strong liquidity position and dedicated employees who are focused on service and innovation for our clients and their employees will have Paychex emerge from this pandemic in an even stronger position in the market with our clients having experienced the full value and support that we deliver. I will now turn the call over to Efrain Rivera to review our financial results for the second quarter. Efrain?

Thank you, Marty. Before I begin, let me just wish everyone on the phone call a safe and joyous holiday season. I hope you get some time off to enjoy this COVID-19 season. We are making the most of it. Let’s start. I want to remind you that today’s conference call will contain forward-looking statements; please refer to the customary disclosures. In addition, I’ll periodically refer to some non-GAAP measures. Please refer to the press release and investor presentation for more information on these measures. Let me start by providing some of the key points for the quarter, follow up with some greater detail in certain areas, and then wrap with the review of the fiscal 2021 outlook. As Marty mentioned, while second quarter results continue to reflect the impact of economic conditions resulting from the COVID-19 crisis, they improved sequentially from the first quarter. For the second quarter, total service revenue of $969 million was even with the prior year. This was moderated by a lower volume of client employees paid across our HCM solutions. Results improved from a decline of 6% in the first quarter, as you recall. Within service revenue, Management Solutions revenue started to increase; it was up 1% to $733 million and PEO and Insurance Solutions revenue decreased 3% to $236 million. During our October earnings call, I noted that second quarter revenue was anticipated to be down mid to high single digits for Management Solutions and high single digits to low double digits for PEO and Insurance Solutions. Our results exceeded those expectations, obviously. Total revenue declined 1% to $984 million; that basically is the impact of further declines in interest on funds held for clients. Interest on funds held for clients were down 25% for the quarter to $15 million due to lower average interest rates, lower average investment balances and realized gains. Average balances for interest on funds held for clients declined 4% during the quarter, primarily due to lower client fund collections and changes in the client base mix. That was offset by timing of collections and remittances and some wage inflation. Expenses decreased 3% to $629 million. The decline in expenses was driven by lower headcount, discretionary spending and facilities costs as a result of our cost savings initiatives. Operating income was up 4% to $354 million and reflected an operating margin of 36%, a 150 basis point improvement from the prior year quarter. As a reminder, other expense now for the second quarter includes interest on our long-term borrowings, partially offset by corporate investment income, which was impacted by lower interest rates. Our effective income tax rate was 22.1% for the second quarter, compared to 23.2% for the same period last year; both periods reflect net discrete tax benefits related to stock-based compensation payments that occur with the exercise of stock option awards. We call those out simply because it’s difficult to predict when they will occur. Net income increased 5% to $272 million and adjusted net income increased 4% to $265 million for the quarter. Adjusted net income excludes one-time costs and the tax benefit from stock-based compensation payments. Diluted earnings per share and adjusted diluted earnings per share both increased 4% during the quarter to $0.75 and $0.73 per share, respectively. Year-to-date, I’ll touch on these very quickly; they are in the press release. Service revenue declined 3% to $1.9 billion with Management Solutions revenue declining 2% and PEO and Insurance Solutions declining mid single-digits. Interest on funds held for clients declined 27% as we bore the brunt of lower interest rates. Total revenue was down 3% to $1.9 billion, operating income decreased 8% to $638 million and adjusted operating income decreased 3% to $670 million, reflecting a margin of 35%. Adjusted operating margin excludes one-time costs of $32 million related to acceleration of cost savings initiatives including the long-term strategy to reduce our geographic footprint and headcount optimization, the majority of which was recognized in the first quarter. The amount recognized in second quarter was minimal, about $1 million or so from that amount that we had talked about when we initially released guidance. Diluted earnings per share decreased 8% to $1.34 and adjusted diluted earnings per share decreased 4% to $1.36. Investments and income: as you know, our primary goal is to protect principal and optimize liquidity, and we continue to invest in high credit quality securities. The long-term portfolio has an average yield of 1.9% and average duration of 3.4 years. Our combined portfolios earned an average rate of return of 1.3% for the quarter, down from 2% last year. Let’s talk about financial position. It remains strong with cash, restricted cash and total corporate investments of $963 million and total borrowings of $804 million as of November 30, 2020. Funds held for clients were $3.4 billion, in line with the balance as of May 31, 2020. Funds held for clients vary widely on a day-to-day basis and averaged $3.6 billion for the second quarter. Our total available for sale investments, including corporate investments and funds held for clients, reflected net unrealized gains of $109 million compared with $100 million as of May 31, 2020. The increase in net gain position resulted from the declines in interest rates. Total stockholders’ equity was $2.9 billion as of November 30, 2020, reflecting $447 million in dividends paid and $29 million of shares repurchased during the first six months. Return on equity for the past 12 months remained very strong at 38%. Cash flows from operations were $431 million for the first six months, a decrease from the same period last year. The decrease was driven by lower net income and fluctuations in working capital, including an increase in accounts receivable, which drove most of that, and that is parallel to our recovery in our revenue. Now, I will turn to our guidance for the current fiscal year ending May 31, 2021. It reflects our current thinking regarding the speed and timing of the economic recovery. While results for the first half of the fiscal year exceeded expectations, uncertainty about the trajectory of the recovery over the remainder of the year remains, particularly with the recent surge in COVID-19 cases. Improvements in key indicators have moderated and our guidance reflects a steady but gradual improvement through the rest of the fiscal year, although not at the pace of the first six months. We have provided the following updates to our guidance after seeing the second quarter results. Management Solutions revenue year-over-year is expected to be in the range of a decline of 1% to growth of 1%. We previously guided to a decline in the range of 1% to 3% with a bias toward the high end of that range. PEO and Insurance Solutions is expected to decline in the range of 2% to 5%; that is unchanged from prior guidance. Interest on funds held for clients is expected to be between $55 million and $65 million; that’s also unchanged from prior guidance. Total revenue is expected to be in the range of a decline of 3% to flat with last year; we previously guided to a decline in the range of 2% to 4%. Adjusted operating income as a percentage of total revenue is now anticipated to be approximately 36%, up from previous guidance of approximately 35%. And adjusted EBITDA margin for the full year fiscal 2021 is expected to be approximately 41%, up from approximately 40%. Other expense net is anticipated to be in the range of $25 million to $30 million; previously it was a range of $30 million to $35 million. Our effective income tax rate is expected to be approximately 24%, while we previously guided to a range between 24% and 25%. Adjusted diluted earnings per share is expected to decline in the range of 1% to 4%; we previously guided to a decline in the range of 6% to 8%. Turning to the second half of the fiscal year, we currently anticipate total revenue will be in the range of flat to up low-single digits. Adjusted operating margin is expected to be in the range of 37% to 38%. Now, let me talk about the third quarter. Management Solutions revenue is expected to decline in the low-single digits and PEO and Insurance Solutions revenue is expected to decline in mid to high single-digits, impacted by lower rates for workers' compensation and state unemployment insurance. Adjusted operating margins excluding one-time costs are anticipated to be approximately 41% in the third quarter. Of course, all of this is subject to our current assumptions which are subject to change. We’ll update you again on the third quarter call. I will refer you back to our Investor Relations site on our website for more information. And now with all of that, I will turn it back to Marty.

Great. Thanks, Efrain. Operator, we will now open the call to questions.

Certainly. Please follow the operator's instructions to register a question. And your first question is from Ramsey El-Assal of Barclays.

Hi, guys. Thanks for taking my question this morning.

Hi, good morning.

Hi, good morning. I was wondering if you could let us know whether your guidance assumptions include stimulus. And I guess also as a follow-on question to that, now that you’ve lived through it once, what would a second round of stimulus — do you have any kind of a better understanding of how that would impact the P&L?

Yes. So let me handle the first half and then the second half. The short answer, Ramsey, is that no, it doesn’t include the impacts of any stimulus. It’s a little bit tough to gauge, but it would be a net positive. I’ll let Marty talk to kind of what we think the benefit might be.

Yes. I think a number of benefits: obviously, a lot of clients have been kind of holding — some clients have been holding on waiting for a second stimulus. What we have found is that those who took a PPP loan the first time, virtually 100% of them were still in business, so 99.8% or something. So obviously, the first stimulus made a big difference for holding clients over until things pick back up. And I think the second one will do the same thing and it’s very targeted to small and mid-sized businesses, which is even better and has better parameters from what we can see, at least what was approved by Congress for forgiveness for loans as well. We also have done some things like made sure that we’re totally connected now with fintech providers and lenders like Biz2Credit so we can pass our information from payroll and clients can approve the fact that they can move information directly to a fintech provider like Biz2Credit to get a loan. So I think everything is going to speed up faster from a stimulus perspective. If you need a loan, you’re going to get it easier and faster. The forgiveness is going to be even better than before, particularly if you are on the low end. And not to mention that payroll and HR solution services software is covered by the expenses or part of the expenses that can be covered. So I think it’s going to be positive. Certainly, it’s going to be positive to the degree how much — it’s hard to tell at this point.

Great. And then I was wondering if you could also comment on or give us a little more color on the underlying drivers in Management Solutions for the rest of the year. It’s great to see the outperformance this quarter. It looks like there is some moderation expected. Maybe a little more color on what you are seeing in your portfolio that’s causing you to be a little bit conservative going forward here?

Yes. So let me talk about first what have been the drivers in the first six months and then why third quarter looks a little bit different perhaps sequentially than other quarters. And by the way, I would just ask for other people in the queue, if there is a question that’s really kind of related to what we are discussing, if you could just keep your questions brief, because we want to try to get to everyone. The short answer to your question on Management Solutions is that Management Solutions has HR outsourcing and the ASO model in that revenue stream. It’s got retirement services in that stream. Other modules of Flex, including, and very importantly, time and attendance in that revenue stream and then some other items. All of those products are doing very well. I would highlight the fact that if you look at the year, this has been the year of demand for HR services. So if you look at our worksite employees across all of our platforms that provide HR support, our worksite employees are up. So we’ve seen very strong demand driving the revenue growth or the revenue recovery. Now we are battling, as I mentioned in my comments, the fact that the number of employees paid is down, obviously because of current unemployment, but the underlying trends are very positive. So why as we get into Q3 does that change? In Q3, there are a number of revenue streams that are billed annually and depend on the number of employees on the payroll at that point in time. Because they are lower, we anticipate that they will be lower simply because of the number of worksite employees that are being paid. It has a moderating impact on the revenue in the third quarter. That’s what’s driving that result. Obviously, then as we come out of Q3, those revenue streams are no longer a factor in Q4 and we expect a rebound in Q4. So that’s really what’s driving what would appear to be conservatism in Q3. We like where the underlying trends are in all of the revenue streams on Management Solutions and we see those continuing through the year into Q4.

That was super helpful and happy holidays to you both.

Thanks. You too.

Your next question is from Kevin McVeigh of Credit Suisse.

Great. Thanks so much. Happy holidays to you all. Hey, Efrain. Hey, Marty. Hey, congratulations on the retention, just really, really fantastic outcome. I wonder, Marty or Efrain, it just — it feels like based on the transition to the cloud that part of that is clearly structural, is there a way to think about whether how much you can narrow it from a retention perspective and then ultimately kind of translate that into revenue relative to the cloud-based providers? Because it seems like as you’ve transitioned the business model to the cloud, it should clearly call for even higher levels of retention. So maybe help us understand that a little bit?

Well, I think ultimately, the retention is about, as you know, the level of service and value that you are bringing these clients. And I think the work that we’ve done on innovation and technology investment to the cloud has made a lot of benefits. I think they’ve really shown up in this pandemic environment. If one of the positives, there can be a positive in this environment for businesses is that they could see the full value of Paychex and the service that we bring. So being on the cloud and the fact that many of them have people working from home, they could see the technology and what being in the cloud meant to them. They could handle — they could improve productivity, they could have better retention of their employees, they could still develop them, train them, onboard them; they can handle all kinds of time and attendance measures. They can do anything that I don’t think they even really thought a lot about beforehand and I don’t think it’s ever going to go back for them to the way it was prior to that. So they understood the investments that we had made in the technology and innovation that we have. They found much more value from that and the cloud is certainly a big part of that. They don’t have to rely on internal infrastructure and there is a lot more self-service that they took advantage of and their employees took advantage of that saved them time and money and saved us time and money as well and focuses on high-value parts of the products.

The other thing I would add to that, Kevin: your question was, can we expect 25% or 50 basis points, 75 basis points better retention? I don’t have a direct answer for that right now, but I will say this. It’s very easy to envision that we have one service model that applies across the breadth of our 700,000 plus clients. The reality is that that’s not correct. We have a variety of different service models that respond to the needs of the client as we understand. I think that we have a very high degree of customer intimacy with our clients and understand what kind of service model they need. We have a variety of different models that are designed to ensure that the client has the highest possible net promoter score we can have. Our net promoter scores this year are at all-time record highs and it’s in part because we have understood and have the capability, which others do not, of being able to provide hybrid, flexible service models based on what the customer desires. As we continue to refine that and get better and better at understanding what each customer and each segment needs — whether it’s no service to full service — I think you are going to see our retention continue to improve.

Super helpful. I want to be respectful of time, so I will go back into queue. I have another question, but I don’t want to really get into a long follow-up. Thank you all.

Okay, thanks.

Thank you.

Your next question is from Jason Kupferberg of Bank of America.

Hey, thanks. Good morning guys. Happy holidays.

Thank you. Same to you.

Thanks. I wanted to just get your view as you head into the key selling season here. Do you think COVID is going to have an impact on competitive dynamics in the sense that perhaps fewer SMBs look to switch providers because they are consumed, just trying to keep their businesses afloat, or is it actually possible that we see the opposite scenario with an above average amount of competitive switching as small businesses look to watch every dollar even more closely during the pandemic or perhaps their needs have become even more complex as a result of COVID?

Yes. Jason, what we have seen — and I would assume it’s going to carry through into January selling season — is much more hesitancy to switch. So our retention is certainly benefiting from that. It does make sales away from competitors a little more challenging to the degree, because they — I think your first assumption is what we have seen is more correct, which is that people are not focused on switching. They don’t want to go through the switch right now. They have also, at least in our view, really seen the value of what we can bring at an all-time high. So they are going to be reluctant to switch because they are not focused on that. Also, I think they have also seen — and we’ve gotten this feedback directly from clients — the way we helped them with PPP loans the first time, the way we helped them with forgiveness; the feedback they got from their accountants on how easy it was to file and get forgiveness or apply for forgiveness was really a step ahead of other competitors for us. We were able to pre-populate all their reports, the forgiveness application was pre-populated and signature-ready with adding just a few bits and now that’s even easier that we are going to tie them into fintech lenders as well. So I think it’s one a reluctance to move, but I also think they are seeing a lot more value and that’s made a big difference in our retention. And then for sales, I also think that’s going to help us.

Okay. The revenue upside this quarter was more pronounced in HR management and I wanted to get a better understanding of which specific products were especially outperformers in the second quarter?

Yes. I think we noted that the ASO product really was strong. Any HR product — the need for HR, particularly when you think of so many employees working from home, some being furloughed — how do you handle the credits, the tax credits, employee retention, all of those things helped really push HR support and more on the ASO side than the PEO side. I think insurance was not as important to them right now from a benefits perspective as the HR support was, so more tended to say, look, I am not ready to switch or begin insurance but I need the HR support pretty dramatically.

Okay. Well, thanks for the answers. Have a great holiday.

Alright. Thanks. You too.

Your next question is from David Togut of Evercore ISI.

Hi, good morning, everyone. This is Josh Schimmer on behalf of David Togut. Just wanted to ask my first question on business formation. You mentioned last quarter that new business startups were up 20% year-over-year. How did you see those trends continue into Q3 and can you give any projection for what you are expecting for the rest of the year?

Well, I think nationally, we have seen it continue; it’s even higher than that. I think it’s approaching the high 30s or 40% increase in new business startups. I think what you are finding is both people shifting in the pandemic to new business opportunities and those starting new businesses. Some have been laid off from other businesses and have decided this is the time. Also, money is fairly easy to get a hold of at low cost. They have home equity where they can take loans as well at low cost to start their businesses, so that has continued. We have seen household services that I mentioned in the first quarter — a lot of nannies, tutors, things like that — where people had their kids at home and were buying for that. We have seen a lot of other new upstart businesses get started or change what they were doing and create a new business. So it has continued. It’s continued to accelerate higher than in the first quarter. And I would assume that may moderate to some degree because — but we will have to see.

Great. Thank you for the color. Next on capital allocation, can you provide or update your priorities and kind of what you are thinking in terms of capital allocation as we move beyond the COVID-19 environment?

Yes. I think we haven’t really changed significantly. Obviously, payment of the dividend is an important part of the equation. We buy back shares to maintain share count level, but we are interested in looking at M&A and remain in discussions for opportunities that we think could be interesting. Obviously, prices are high, but we think there are selected pockets of opportunity where it may make sense. So that’s where we are at.

Great. Thank you all very much and have happy holidays.

Thanks. Same to you.

Your next question is from Steven Wald of Morgan Stanley.

Hey, good morning and happy holidays.

You have the same. Thanks.

Maybe just starting off on what you guys are talking about with sort of the incremental penetration, the bundles, you called out the ASO strength. It just seems like you are getting better economics relative to each client and maybe that’s part of additional market penetration and all the things you and other platforms have talked about in terms of incremental HCM demand. Just curious how big of a runway you see for that seeing it’s already starting to show up as well as how you think of that in terms of lowering your macro sensitivity going forward?

Well, I think there is a lot of opportunities still there. When you think about time, and just take products like time and attendance, time and attendance has really been growing very strong double-digits for some time. We are seeing that with the innovation that we have put out there from the iris scan time clocks to the kiosks to punching in on your watch. All these things have driven even more demand for things like time and attendance. HR certainly has been driven a lot by the COVID environment; how different — I mean, you can understand that clients are facing, for the first time, challenges they have never seen before and they are going to continue. The next big question will be, do you require vaccinations, for example, to bring people back to work? How do you verify that? What are the rules around that? What do you do with absences due to COVID or family or things like that? So these are all so complicated for small to midsized businesses, who typically don’t have an HR person. I think there is a great opportunity for continued demand for the services from light HR right to full ASO and PEO as well and that includes insurance, which we think will pick up in the back half of the year.

Hey, Steven. To the second part of your question, it’s a good one. If you really disaggregate our results and look at the second level of why the performance has been what it’s been, I think it’s two things. The first thing is our sales unit volumes on HCM have been up the first six months. We hope it continues into the back half of the year, but frankly it’s been higher than we expected. That strength of digital sales, marketing and a lot of the efforts that we put into the platform over the last several years — that’s part one. The second part, which is important, is when you look at the next level, you realize we have had strength in selling other products to the base. I would say you are seeing the criticality of having an HR solution in the bundle of offerings that you give to clients. By that I don’t mean an HR administration module — almost everyone has that — but the real ability to provide counseling and consulting to clients in a very complex environment. We have benefited from the fact that we not only have been able to increase unit sales, but also increase penetration of services within the base. Part of that has lessened the impact of what is obviously not a great macro environment.

And one other thing: I think it bodes well for retention. Sometimes when they took the HR product, they needed to set up their handbook for the first time; they needed a couple of things they never had like employee rules and benefits. Now, when you think about it, there is such a continuation of this need, it’s going to go on for some time, and I think that does bode well for retention of the HR products as well.

Okay, great. Appreciate the robust commentary from both of you there. Just maybe one follow-up to something Ramsey had asked about, the sort of baking in a stimulus and other factors. If we tape six or nine months, I think the way you described how you think of the upswing is sort of a gradual recovery. I know you characterized it as the next six months are not going to be quite as robust as the last six months, but if I think about the sensitivity to the upside and downside if stimulus is added in, as you see it is a slight net benefit. Is it also fair to think about the potential for a step back in employment or other macro factors that has also not been baked in, so this could be a possible drag to offset that? How should we think about the push and pull there?

Yes. That’s an interesting, complex question, but I will try to give a simple answer. It could end up having that effect. My sense is that you didn’t fully factor in the impact of a vaccine and that’s really kind of the joker in the deck. To the extent that it becomes more widespread and you see an uplift in employment, that’s going to be a positive. If we continue in the same environment, I think what we are assuming is gradual improvement unless things get much worse. I think we are in reasonable shape. If it goes backwards, we will have to see what happens. As I mentioned and Marty mentioned, we have seen some moderation over the last month or so in the improvement in forward-looking trends. Will it go the other way? I don’t know; it’s too early to call.

Okay. I just wanted to see how you were thinking about it. So appreciate the thoughts there. Happy holidays.

Thanks.

Thanks. You too.

Your next question is from Andrew Nicholas of William Blair.

Hi, good morning. First, I was hoping you could provide a bit more detail on the health of the PEO business specifically. Anything you can say about the growth rate in that business over the past couple of quarters? And then also just how conducive is the market right now for starting a brand new PEO relationship? Just wondering if people are kind of stuck in their ways given the current environment or if there are still opportunities to initiate a new relationship there? Thanks.

Marty will take the second. I will come back to trends in the PEO.

So I think on the second question, I think there has been much more demand for HR support and sometimes that’s with the PEO, but it’s been a little bit heavier in the ASO side for us, and of course, we offer both. I think people have been a little more reluctant to change insurance providers and so forth. However, I do think that’s going to start to change, because I think that’s been a real benefit. We also have provided a new bundle that’s providing EPLI, employment practices liability protection, which is going to be very important right now; there are a lot of questions about how am I treating employees that are working from home, who have COVID, who are connected to someone who has it and may take time off. I think there is going to be a bigger issue about liability, and I think as the overall health concerns start to moderate, with vaccine distribution, there will be increased demand for the PEO. I don’t know if it’s going to be immediate next quarter. It may be quieter for another quarter and then start to pick up more as things calm down. People are more open to PEOs everyday; they understand the concept that the PEO offers shared plans where we can share some of the liability protection and the coverage and get more affordable benefits packages. So I think it may be quiet for another quarter, but then start to pick up more.

Yes. With respect to trends in the PEO, Andrew, there are three factors driving the PEO results. The first is that in the first six months, our client base over-indexes a bit in exposure to hospitality and accommodations, so as we entered this year we were more exposed than we might have been in previous years. We had a pretty sharp rebound in the first quarter that continued into the second quarter, but we were coming off a lower base. That’s one. The second thing is, I called out in my comments that we are seeing much lower workers' comp and state unemployment insurance rates. Those have an impact on revenue too. That’s a trend we’re seeing and certainly through the back half of the year that’s having an impact on revenues. Finally, we’ve seen lower at-risk insurance attachment in the PEO; part of that has been our decision on underwriting standards in this environment. We have been a bit tighter than we have been historically. In part that’s helped a bit of the ASO business, but it’s hurt the PEO business a little bit. We prefer to be a little more conservative on underwriting as we get into the back half of the year and we see what the environment looks like. If you look at where the guidance was, we basically maintained it. There are a lot of positives on the underlying performance, but there are some headwinds that we’re battling in other parts of the revenue streams in PEO.

Great. Thank you. That’s really helpful. And then Marty, you mentioned the PEP plan that you introduced a few weeks back. It seems to me Paychex is obviously really well positioned to be able to offer a plan of that type. But I’m just wondering, bigger picture, to what extent new regulations on PEPs will impact Paychex? Does it increase the target market for retirement administration business? Does it open you up to additional competition? Just any additional color on that offering and what it means for Paychex would be great. Thank you.

Yes, sure. I think the fact that we’ve been in this business for so long, well over 20 years in the retirement business and that we provide more new retirement plans than anybody else in the business for at least the last eight years, I think we’re well positioned. I think that also proves the point that we were one of the first out with the PEP plan; we think it can be very competitive in opening up new market opportunities. Those small or mid-sized businesses that didn’t want to get into a plan because they were worried about administering the whole thing, we could be the record keeper but they still had to take care of investments and other costs. This is going to lower their costs and allow it to be much more accessible to those who didn’t quite step up to it. I do think, as you said, it opens up a market that we’re already strong in, and it has great potential for us.

Great. Thank you and happy holidays.

Thank you.

Thank you. Same to you.

Your next question is from Bryan Keane of Deutsche Bank.

Good morning. Efrain, I just wanted to clarify something you said. The hit in Q3 revenues due to the number of employees on the payroll being lower — why doesn’t that have that same impact in Q4? Is it a one-time impact then in Q3?

Yes, because there are certain revenue streams, Bryan, that are only billed in the third quarter, and so they follow the amount of employees you have on your books at that point; then it doesn’t recur until the following third quarter.

Got it.

It’s just an annual bill. It’s somewhat unusual, but happens every year.

Got it. That makes sense. And then, when I think about how we modeled it out, at least we have a little bit lower now in third quarter, but a stronger fourth quarter. Just thinking about that fourth quarter, now it sounds to be a little bit stronger than what you talked about last quarter. Just thinking about any pent-up demand in sales as we get to that easier comp in fourth quarter and how you’re thinking about it?

Well, we hope it’s going to be a good quarter because the compare certainly sets up to be a good quarter. I think it’s comprehended, obviously, in the guidance. A lot, as you know, depends on the momentum we come out of the third quarter with. If we come out of the quarter with good momentum and the macro environment arrows are pointing upwards, I think Q4 will be good. If the others don’t pan out, then it will be slightly different. We’ll update when we get through the third quarter.

Okay, great. Happy holidays, guys. Enjoy it.

Thank you.

You too, Bryan.

Your next question is from Kartik Mehta of Northcoast Research.

Hey. Good morning, Marty and Efrain.

Good morning, Kartik.

Marty, I wanted to ask: I know you’ve talked about the selling season and some hesitancy of people wanting to switch. What’s the pricing environment like? Are you seeing more competition because people are trying to get market share, or has the pricing environment not been that aggressive this year compared to seasons past?

Kartik, I think it’s been very consistent, which means it does get quite aggressive, particularly right now at this point, November and December. So I think you’re seeing the typical same number of months free upfront or over the first year kind of thing. I wouldn’t say anything more aggressive than we’ve typically seen and I’m not sure that that’s making as much of a difference. We’re definitely seeing the typical negotiation dynamics. As I said, there is still hesitancy to switch which is helping retention and putting a little more pressure on sales. Right now, we’re feeling pretty good going into selling season. We have seen a quarter of more unit growth than the second quarter of last year, which is pretty amazing when you think everyone is still at home and they’re selling from home. We’re strongly positioned and the ability to adapt and get to clients using technology that allows clients to search, demo and even sign up to some degree for the service has really been good. So seeing units up over last year in total units sold is pretty positive for us as we head into selling season.

And then, Efrain, just maybe this is too early, but any thoughts on changing how you’re managing the full portfolio? The yield curve is getting a little bit steeper; have you made any changes or any thoughts on maybe the next few months?

It’s funny, it’s like you were looking over my shoulder when I was scribbling notes this morning before the call. There are things we can do in terms of altering duration. I want to see where we end up or what happens in the spring. My sense is interest rates may start to float up a bit, not significantly, but on that level of yield curve steepness it probably gives us additional opportunities to think about managing the portfolio slightly differently. The first half of the year we tended to be pretty conservative in our approach. It looks like next year might be incrementally a little bit better.

Perfect. Hope you guys have a great holiday. Thank you.

Thank you.

Thank you. Same to you, Kartik.

Your next question is from Jeff Silber of BMO Capital Markets.

Thanks so much and happy holidays to you both as well.

Yes, thank you.

Thank you.

I think one of the surprises in the pandemic has been the growth in new business applications and new startups. I know it’s not necessarily an area that you focused on, but I think you do have some clients there. Are you seeing any impact of that on your business?

Definitely. Part of the unit sales on the small end in particular have been a lot of new business starts. We typically have been very successful at selling brand new businesses on our Paychex and SurePayroll platforms, and that has continued to assist us and give us positive benefit. We’re seeing it and it has been amazing. New business starts being up, I think high-30% is the last number I’ve seen over last year, is pretty amazing.

If I could ask a quick outlook question, Efrain: in looking at the PEO and insurance services, are you expecting growth this year in worksite employees or is that something we won’t see till next year? Thanks.

No, we expect growth this year in worksite employees for sure. I would say the other thing I called out is we are unique in that we have both an ASO and a PEO and we look at the worksite employees together. If you look at growth in worksite employees across both platforms, we’re up year-over-year. So we’re going to be up year-over-year on the PEO and certainly in terms of where we ended the year. When you put in ASO we think it should be a pretty good year in terms of worksite employees served by our HR solutions.

Okay, great. And stay healthy and safe. Thanks again.

Thank you. You too.

Same to you.

Your next question is from Samad Samana of Jefferies.

Hi, good morning. Thanks for taking my questions. Likewise, happy holidays. Maybe first one: the announcement with Fiserv Clover was interesting. Can you help us understand whether that is more of a technology partnership or is there an economic relationship there as well?

It’s got a couple of different parts to it. First, it’s a referral relationship. Clover — what we have always found is many new businesses start with credit card or merchant processing services, and then go to payroll and HR later. We established a referral arrangement where Clover can refer payroll or HR needs that their clients have to us and we have a streamlined process to get those referrals to our sales team to be able to sell. Then there is a technology piece as well. We have a connection into the Clover system, which is an industry-leading system, where demographic information and employee information sync. For example, you add a new employee on the Clover system and if you’re using Flex payroll or HR, that will automatically sync with the Flex system. In addition, we saw an opportunity with Clover on time and attendance. Clover users often use time and attendance tied to their point-of-sale equipment and we have industry-leading time and attendance solutions. You can clock in and clock out on the Clover system, but you can then look in Flex and see who is punched in or out, do shift swaps, see if they’re approaching overtime and do a number of things. We will continue to advance this so that if you’re a Clover client and have signed up with Clover and you start, you will be able in the near future to sign up with Paychex in a self-service mode right over the Clover system. So it’s a referral arrangement now and a technical integration with connection. It has great opportunity for us on payroll, time and attendance and other products as well.

Thank you very much. Maybe a follow-up: you mentioned strong bookings and digital sales being a big contributor. How should we think about cohorts coming through digital versus direct sales? Any interesting retention trends or the size of the average customer? Is this structurally sticky going forward?

Early on the retention side you need a year’s worth of experience to really get a sense of that, so we don’t anticipate it will be different. I do think it skews smaller; that may also be a function of the environment we’re in with a lot of new startups. The mix has shifted a little bit smaller than we would otherwise see, but it tends to be smaller. We’re hopeful over time that in the relationship with Paychex we can nurture them. Marty mentioned we take a lot of care with customers and our analytics are such that we can help a small business navigate some of the storm. In terms of the ability to interact with a solution provider that can maximize your chances of doing your best, there is really no finer solution on the market.

Great. Very helpful. Good to see the growth for calendar 2020 and into 2021. Have a happy holiday season.

Thank you.

Thank you.

Your next question is from Mark Marcon of Baird.

Hey, good morning, and happy holidays, Marty and Efrain.

Yes, thanks.

Thanks, Mark.

Following up on the bookings question, when we think about more units in terms of smaller units coming through combined with some pressures on bigger units and less switching activity, how do you think that balances out? For new employees coming on from new units on the whole, how do you think that compares in fiscal Q3 relative to a year ago as we get through the selling season?

It’s an interesting question. The sales have skewed smaller because of new businesses and the mid-market being a little more hesitant. The good news is the pipeline looks very healthy heading into selling season. While there has been hesitancy to close deals — clients are waiting to see what Congress does, what kind of stimulus there is and what’s happening with demand — the news of stimulus and vaccine progress improves closure rates. We saw improvement in the mid-market from Q1 to Q2 in our sales and expect that to continue; the pipeline is strong for the third quarter.

And can you talk a little bit about the reduction in geographic footprint and office space and working from home? It sounds like Net Promoter Scores continue to go up. Can you talk about the efficiency and productivity gains that you’ve seen so far?

We’ve done thorough checks and have not seen adverse impact from the changes. On the service side, employees have adapted very well to working from home. We had over 1,000 service employees working from home pre-pandemic and they have done an outstanding job. Net Promoter Scores have continued to increase and productivity has been very good. The offices we closed will remain closed and many service people will continue to work from home. That has increased the number of clients each employee can handle, improved Net Promoter Scores and supported record retention so far this year. It’s working really well and we’ll continue to capitalize on it.

Sounds like a win-win-win. Happy holidays.

Thank you. Same to you.

Yes.

Your next question is from Tim Willi of Wells Fargo.

Thank you, and good morning.

Hi, Tim. Welcome back.

Good to be back. Happy holidays to both of you. Just a question tied into the Clover partnership: when you think about business formations and small business startups, should we expect more Clover-like partnerships? And do you see this as an opportunity to acquire and build out distribution channels? How does the sales and service organization adapt for that distribution channel?

We see opportunities across multiple channels. Digital sales and self-service are already available; SurePayroll allows complete self-service and Flex is moving that way. Finding new sales channels is important and we are responding to how clients want to buy, which is often client-directed and self-service. Partnerships like Clover move us earlier into a client’s decision process. For example, with fintech lenders, clients will be able to transfer payroll data directly to lenders for quick PPP loans. We will continue to pursue partnerships and channels that meet client preferences.

Thank you very much for the insights. Appreciate it. Happy holidays.

Thank you.

Thank you. Same to you, Tim.

Your next question is from Lisa Ellis of MoffettNathanson.

Hi. Good morning, guys, and happy holidays. A question on the shift you’re seeing with all the new business formation and the roll-off of employees within larger businesses: as this flows through your business, assuming it persists for a period of time, are the unit economics of these smaller businesses typically more attractive, similar to the base? Is there broader structural dynamic we should keep in mind?

I think there are two ways to look at it. We have been serving small clients for a long time and know how to be profitable there. The small business economics can be very favorable, especially with digital and self-service investments that make acquisition and servicing more efficient. The mid-market presents opportunities for more revenue penetration and therefore higher revenue per client. The cost to set up and serve may be higher, but revenue opportunity is greater. So we don’t see major negative changes; our investments have improved margin and given us the ability to earn well even if prices come down a little on the small end due to competition.

And then a follow-up on the Clover partnership: should we think about the partnership generating initial cross-selling of existing clients and vice versa, potentially creating an initial lift, or is it more incremental over time?

We’re hopeful for both. Clover is reaching out to their client base to say we’re connected to Paychex and this is an easy setup. We expect some initial lifts from cross-selling and ongoing opportunities as Clover adds clients. There will be both near-term and longer-term benefits.

Terrific. Thank you and happy holidays.

Thank you. Same to you.

Your next question is from Pete Christiansen of Citi.

Good morning. Thanks for taking my question and happy holidays.

Hi, Pete.

Two quick ones. Marty, how are you thinking about the absolute level of go-to-market spending relative to other periods? How aggressive is Paychex being right now and what are you seeing on ROI? And my follow-up: on the PEP, is there a difference in unit economics and how should we think about that?

On go-to-market, we’ve increased marketing spend fairly consistently. We’ve also used targeted TV advertising to build brand awareness; it’s not a massive amount but it helps generate leads. Webinars have been extremely successful and low cost — attendance has grown from a few hundred to thousands, producing many leads. So we are seeing good ROI from these investments. On the PEP, the economics are very good. It may be a little lower cost per plan versus some single-employer plans, but it can be stickier because we are more involved as a fiduciary and administrator. There may be some cannibalization of single-employer plans, but we think it will expand the market of employers offering retirement plans and that is a big opportunity for us.

Thank you very much. That’s great.

Okay, Pete.

You are welcome.

Your next question is from Bryan Bergin of Cowen.

Hi, good morning. Thank you. First, I wanted to clarify on client retention: are you assuming that it’s going to remain at record levels in your second half outlook? And Marty, you mentioned being pleased with sequential improvement but at a more moderate pace near the end of the quarter — can you dig into what KPIs specifically you’re seeing moderate?

On client retention, right now we expect we’ll stay at record-breaking levels. The key watch is the number of non-processing clients — clients that suspended payroll processing but stayed with us as a client. Those numbers have come down dramatically from the first quarter and are a small portion of the base. We’re watching whether those remaining non-processing clients hang in through year-end. If they all leave it would reduce the record level, though retention would still be strong. On moderation in the quarter: September saw a big influx of new sales, particularly on the small end due to household services like nannies and tutors as schools started. That was an initial surge and it moderated as people settled into new reality. So growth continued but at not quite the explosive pace earlier in the quarter.

Okay, that’s helpful. And can you comment on sales headcount? How has it progressed through 2020?

Headcount is pretty flat. We went up a few percentage points in overall sales headcount and continued to mix in-house, telephonic and digital sales versus field. Pre-pandemic we had a majority outside sales; during the pandemic many have moved to telephonic or digital. Headcount is up low single digits and performance has been strong.

Thanks guys. Happy holidays.

Alright. Thanks Bryan, you too.

Thank you.

Your next question is from Tien-tsin Huang of JPMorgan.

Thanks so much. Just wanted to clarify on the change in the outlook: the second quarter was better than expected. Did the composition of your second half outlook change at all?

No, I would say it just incrementally changed. It’s a little better than what we discussed at the last call. I suspect we’ll have more to say when we get to the third quarter season.

Got it. And with the ASO strength you noted and the year of demand for HR services, do you expect to put more energy into selling that versus 90 days ago?

There’s a lot of demand and we have placed emphasis on sales in that area. The market is generating demand and we have sales efforts focused there.

I’d add that last year Mark Bottini and the sales team put an emphasis on leading with HR value. That helped pre-pandemic and it helped position us well for the demand increase. Sales have been energized to lead with HR and that was perfect timing.

Great. Glad to see it coming through. Have a blessed holiday.

Thanks. You too.

Your next question is from Matthew O’Neill of Goldman Sachs.

Hi, gentlemen. Thanks for squeezing me and happy holidays as well. Two quick Clover questions: when you initiated the relationship, was there immediate identification of good overlap of existing Paychex and Clover clients and was technical connectivity being asked for? Also, is there any two-way element where you help sell the Clover product to your existing clients?

We have sold merchant processing with partners including Fiserv for some time. It was somewhat offensive: we knew the connection could get us earlier into client decisions. Clover is well penetrated and many of their clients use time and attendance tied to point-of-sale equipment. We can add value by offering payroll and time and attendance integrated with Clover. There will be two-way referrals and cross-selling; we resell merchant products in some cases. So yes, both offensive and reciprocal elements and the partnership enhances what Clover offers by providing Paychex payroll, time, attendance and HR solutions.

Makes sense. Thanks so much.

Thank you.

Today’s final question is coming from Scott Wurtzel of Wolfe Research.

Hi, good morning, guys. This is Scott on for Darrin Peller. Just one question on structural positioning: you mentioned expenses were down this quarter related to lower discretionary spending and reduced facility costs — a mix of short and longer term savings. Are you planning more long-term cost savings?

We’re always looking for ways to reduce costs and become more productive while improving our service and products. We have a history of strong margins and we’re pleased to have maintained and improved margins during the pandemic. We’ll continue to look for efficiency gains and capitalize on investments in self-service and mobile-first design to improve productivity.

Got it. And on the revenue side, are you seeing more sustainable opportunities for sticky revenue coming out of the pandemic?

Yes. I think the pandemic has allowed clients to see the full value of Paychex. They have used more products and services and counted on us for HR support in ways they hadn’t before. That demonstrable value should lead to better retention across products after the pandemic.

Great. Thanks for taking my question and happy holidays.

Thank you. You too.

I will now turn the call back over to Mr. Mucci for any additional or closing remarks.

Alright, thank you. At this point, we will close the call. If you’re interested in playing the webcast of this conference call, it will be archived for approximately 90 days. Thank you for taking the time to participate in the second quarter press release conference call and for your interest in Paychex. We do wish you a very safe and happy holiday. Thank you.

This concludes today’s conference call. You may now disconnect.