Good day, everyone, and welcome to today's Paychex First Quarter Fiscal '22 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, you will have the opportunity to ask questions during the question-and-answer session. Please note, this call may be recorded and I will be standing by should you need any assistance. It is now my pleasure to turn today's call over to President and Chief Executive Officer, Martin Mucci. Please go ahead.

Thank you. And thank you for joining us for our discussion of the Paychex first quarter fiscal year 2022 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 first quarter ended August 31, 2021. You can access our earnings release on our Investor Relations website, and our Form 10-Q will be filed with the SEC within the next few days. This teleconference is being broadcast over the Internet and will be archived and available on our website for approximately 90 days. I will start today's call with an update on the business highlights for the first quarter, and Efrain will review the financial results for the quarter and provide an update on fiscal '22 guidance. We will then open it up for questions. Fiscal '22 is off to a very strong start with Q1 results above our expectations. Total revenue increased 16% with double-digit growth in both Management Solutions and PEO and Insurance Solutions while total expenses declined by 1%. Adjusted diluted earnings per share increased 41%. While results benefited from the comparison to a pandemic-impacted first quarter last year and improvements in the economy, our internal execution has been strong with continued momentum in sales, marketing, and client retention. During the first quarter, positive macroeconomic trends continued. This was evident in the growth in checks per payroll and net increase in worksite employees within our existing base of HR outsourcing clients, particularly with our ASO offering. Our client retention remains near record levels, reflective of both the resilience of small businesses and the value provided by our unique blend of software solutions and HR expertise. Our sales momentum continued with strong first quarter sales performance as measured by new annualized revenue, reflecting solid performance in digital sales, mid-market sales, and our HR outsourcing divisions. Our unique value proposition of combining the most comprehensive human capital management software platform with our deep HR expertise continues to resonate with prospective clients. We continue to invest in our sales force and support them through increased digital marketing and lead generation initiatives. We are well positioned for the upcoming selling season. We continue to leverage our investments in research and development to expand the capabilities of our industry-leading software, Paychex Flex. Our investments in self-service, artificial intelligence and machine learning, analytics, payments, wearables, and voice recognition allow us to offer cutting-edge technology, specifically designed to deliver automation and efficiency to both administrators and their employees. Our recent Pulse of HR survey identified hiring retention and software automation to gain efficiencies as the top industry trends facing businesses of all sizes. Our fall release introduces a series of software enhancements to further strengthen the power of Paychex Flex. We currently offer two options for clients in their search for talent, a fully integrated API connection with Indeed, the world's largest job board for clients who are looking for a pool of applicants; and a comprehensive recruiting and applicant tracking offering called Flex Hiring for businesses looking for integrated technology to manage the entire recruiting process. We made enhancements both to provide clients with tools they need to post jobs, attract candidates, and allow new hires to digitally self-onboard via our Flex mobile application. With employee retention being a significant issue in this challenging environment, we've introduced several enhancements to provide our clients with insights and offerings designed to help them in making informed decisions and retain their workforce. The introduction of retention insights, our first client-facing predictive analytics, was designed to identify employees who may be at risk of leaving, for example. Second is pay benchmarking, which allows employers to compare performance ratings and compensation details by position to ensure top performers are paid equitably. With our advanced technology, employers can easily compare individual employee compensation against national averages provided by the Bureau of Labor Statistics to confirm the impact of compensation on retention. We're excited also to announce a new offering called Paychex Pre-Check to further automate the payroll process for employers and provide their employees the opportunity to review their gross-to-net calculation before payroll is officially processed. With Paychex Pre-Check, employees are notified through their channel of choice, whether it be their phone, tablet, smart watch, or smart speakers, that they have a pending pay period to review. The employee leverages Paychex Flex to either confirm the amount of their check or report an issue. Issues are routed electronically to allow clients to focus on exceptions and proactively address issues prior to payday. Paychex Pre-Check leverages our industry-leading Flex payroll and time and attendance offerings, HR Connect offering, our digital employee case management tool, our advanced analytics module, our five-star rated mobile app, and expands our conversational UI capabilities, including our integration with Amazon Alexa, Google Assistant, and Siri Shortcuts. With these additions, Paychex Flex is the first HCM application to offer integration with three of the major voice assistant platforms. Paychex Pre-Check was recently recognized by HR Executive Magazine in the HR Tech Conference and Exposition with the Top HR Product of the Year Award, an award that spotlights innovation driving the HR technology market. This is a three-peat for us, marking the third consecutive year that Paychex has been recognized as a top HR product innovator by HR Tech. In addition to our innovative technology, the expertise and advice we can provide clients on HR matters really sets us apart. Our HR professionals have been very important in helping ASO and PEO clients navigate through the pandemic and handling the current uncertainty around COVID with the recent uptick in transmission rates, return-to-office plans, and potential vaccine mandates. We are very proud of the work our HR professionals do, and we're honored to be recognized by winning a gold Human Capital Management Excellence Award from the Brandon Hall Group in the category of best use of a blended learning program for our HR Services Excellence Academy training program. This training program prepares our new HR professionals to provide exemplary consulting services to the company's HR outsourcing clients and was recognized for combining instructor-led training with technology-based activities. The expertise we offer our clients also expands by providing resources to assist them with their many compliance obligations. Our COVID response continues with near real-time updates to our COVID-19 help center, where businesses can access key information regarding changing regulations, including the recent Biden administration proposal and vaccine mandates. We assisted our clients in receiving over $65 billion in Paycheck Protection loans. That's 9% of the total PPP loans provided. Our industry-leading PPP forgiveness tools and reports have been accessed over 500,000 times since their release, with over 90% of businesses now reporting their initial loan has been forgiven. We have also been instrumental in helping clients secure over $4 billion in stimulus funds available through the employee retention and paid leave credits. We recently launched an enhanced offering, the Paychex Employee Retention Tax Credit Service, to help businesses retroactively identify tax credit eligibility based on wages already paid and file amended returns to claim the credit. On average, Paychex clients are claiming over $150,000 in tax credits, a substantial amount for a small or midsized business, that is helping them survive and thrive in this pandemic. The pandemic has only exacerbated the retirement crisis in America. In response, a growing number of states have introduced state-mandated retirement programs, and our Pooled Employer Plan, or PEP offering, as well as traditional plans have helped our clients handle new state mandates in ways that make financial sense for the employer and employees. For the 11th consecutive year, Paychex has earned the distinction as the largest 401(k) record keeper by a total number of 401(k) plans, serving more than 96,000 plans. We have seen continued success in helping clients find retirement plans that suit their employees' needs and help them attract and retain clients. We are very proud of our performance during the first quarter but remain vigilant about the rest of the fiscal year given the uncertainty around the macroeconomic environment and the COVID-19 variants. Our strong start in sales, continued client base growth, best-in-class operating margin, and increased investment in marketing, lead generation, and product development have us well positioned for continued financial and operating success during the remainder of fiscal year '22 and beyond. I'd like to close my comments by recognizing again the company's 50th anniversary. From our founders' start with $3,000 and a few clients, we have transformed into a comprehensive, technology-driven human capital management software company with over 710,000 clients across the U.S. and Europe. In addition to paying one in every twelve American private sector employees, we are the country's largest 401(k) record keeper, a top 30 U.S. insurance agency, and among the largest providers of HR outsourcing in the U.S., supporting over 1.7 million worksite employees. While the size and breadth of the company have changed, we remain true to our original mission of serving the unique needs of small and midsized businesses. That mission was all the more important during the challenges faced over the past 18 months. I'd like to thank and commend our employees for their tireless dedication to innovation and commitment to serving our clients. They have driven our growth over these 50 years. And our shareholders, we thank them for their investment with us along the way. I will now turn the call over to Efrain Rivera to review our financial results for the first quarter.

Thank you, Marty, and good morning to everyone. I want to remind you that today's conference call includes forward-looking statements, so please refer to the customary disclosures. I will move through my comments quickly to allow time for your questions. Throughout my remarks, I will reference non-GAAP measures such as adjusted operating income and EBITDA. For more details on these measures, please check our press release and investor presentation. I'll begin by highlighting some key points for the quarter and then provide more details in specific areas. I will conclude with an overview of our fiscal 2022 outlook, which has been revised upward. The first quarter showed strong internal execution, an improved economic environment, and favorable comparisons to the prior period. Both service revenue and total revenue rose 16% to $1.1 billion, benefiting from higher employment levels and increased client counts across all our solutions. Growth rates were aided by easier comparisons to a prior year that was affected by the pandemic. As Marty mentioned, strong execution also played a key role this quarter. In service revenue, Management Solutions rose 17% to $805 million, while PEO and insurance revenue grew 14% to $263 million. Interest on funds held for clients decreased 3% this quarter, as lower average interest rates and realized gains were partially offset by higher average investment balances. We'll see how interest rates trend for the rest of the year as they have started to increase. Total expenses dropped 1% to $640 million, but when excluding one-time costs of $31 million from the first quarter of fiscal 2021, expenses increased a modest 4%. The rise in expenses was driven by higher PEO direct insurance costs, increases in fringe benefits, and ongoing investment in product development and information technology. It's worth noting that when comparing to the first quarter of 2020, our performance remains strong, demonstrating the company's transformation over the last two years. Operating income for this quarter increased 56% to $443 million, with an operating margin of 41%. The adjusted operating margin was also 41% this quarter compared to 33.8% the previous year, reflecting a significant expansion. The effective income tax rate was 24.9%, up from 23.4%, impacted by an increase in state tax provisions. Both periods included net discrete tax benefits related to stock-based compensation, which we exclude from our adjusted calculations. Adjusted net income rose 42%, and adjusted diluted earnings per share increased 41% to $323 million and $0.89 per share, respectively. Regarding our investments, our primary focus remains on protecting principal and optimizing liquidity. We continue to invest in high-quality securities, with our long-term portfolio yielding an average of 1.8% and an average duration of 3.4 years. Our combined portfolios achieved an average return of 1.1% for the quarter, a decrease from 1.3% last year. Now, let's assess our financial position, which remains strong, with restricted cash and total corporate investments exceeding $1.2 billion. Our borrowings were $805 million as of August 31. Cash flow from operations reached $386 million in the first quarter, marking an impressive 79% increase from the same period last year. Free cash flow generated was $354 million, up 83% year-over-year, driven by higher net income and changes in working capital. We paid quarterly dividends of $0.66 per share, totaling $238 million in the first quarter. Our 12-month rolling return on equity was an impressive 42%. Looking ahead to guidance for the current fiscal year ending May 31, 2022, this outlook reflects the current macro environment, which saw improvements particularly in June and July. Despite the first quarter results exceeding projections, there remains uncertainty about the trajectory of the upcoming quarters, influencing our expectations for the remainder of the year. Management Solutions is now expected to grow approximately 8%, revised from 7%. PEO and Insurance Solutions are anticipated to grow in the range of 8% to 10%, consistent with prior expectations. Interest on funds held for clients is expected to remain flat year-over-year, while total revenue is projected to increase around 8%, again up from the previous estimate of 7%. Adjusted operating income is anticipated in the range of 38% to 39%, revised from roughly 38%. Adjusted EBITDA margin is expected to be approximately 43%, an increase from earlier guidance of about 42%. Other income and expense net is projected between $23 million to $26 million, a decrease from the previous range of $33 million to $37 million, due to some non-operating income recognized during the first quarter. We also invested in a technology fund, resulting in income recognition from investments in early-stage tech companies. Our effective income tax is expected to be between 24% to 25%, and adjusted diluted earnings per share is forecasted to grow by 12% to 14%, compared to prior guidance of 10% to 12%. For the second quarter, we anticipate total revenue growth of 7% to 8%, and the adjusted operating margin is expected to range between 36% to 37%. It's important to note that our statements are somewhat conservative due to the unpredictability of the macro environment and our aim to create an all-weather forecast. As always, all of this is subject to current assumptions, which can change according to the prevailing environment. We will provide updates during the second quarter call and additional information will be available on our investor slides on the website. Now, I will turn it over to Marty.

Thank you, Efrain. Ashley, we will now open the call for questions, please.

We will now take our first question from David Togut with Evercore ISI.

Very nice results. Duly noted on the conservatism for the rest of the year, but the first quarter revenue and earnings outperformance actually exceeds the increase in the annual guidance by about $18 million in revenue and adjusted EPS by $0.03. So can you flesh out your thinking on the remaining three quarters of the year, perhaps talking about your outlook for employment bookings and any other factors besides conservatism that might be keeping the next three quarters, let's say, below where they might have been given the first quarter outperformance?

Yes. Let me handle that, David. I think there's two pieces to the way we look at the year, what we see in the first half and what we see in the back half. So I would say with respect to the EPS, we've factored into our assumptions additional hiring as the year progresses, which will add a bit to expenses. So I think that's the first part of the equation. The second part is that we do not, at this point in our guidance, contemplate that the unemployment picture is going to change significantly. So to the extent that it does, that it is improved from where we are, that would be upside to our case. We simply are at a point where we had in the first quarter a nice rebound in terms of the number of employees on the payroll. That obviously helps from a revenue standpoint. What happens going forward? We simply have to try to estimate what we think is a reasonable, as I said, all-weather scenario. Those are really kind of the two things that are driving it. And I would say this on the back half of the year because I'll get questions on that. The back half of the year we’ll see where we come out of Q2 and then get a better feel for it, understanding we were very strong in the first quarter. There is conservatism in what we've guided to, and we could do better. But as everyone on the call knows, there is uncertainty about a number of things in the macro environment that we want to make sure that investors have completely taken into account and to assure investors that we've taken it completely into account. So all of that mouthful was in the forecast.

Just as a quick follow-up. Efrain, you called out strength in mid-market bookings in the quarter. Is that an industry phenomenon where mid-market generally was stronger than expected in Q2? Or is that a function of market share gains?

Well, I think it's really been that we were progressing slower than anticipated in the second half of last year, but we experienced a strong improvement in the first quarter. I don't believe this is primarily due to the environment; it seems more related to our sales success. We implemented several training initiatives and made various enhancements to our software from a technological perspective. So, it appears to be more about performance. We're very pleased with the growth in the mid-market, and we believe we're well-prepared for the upcoming selling season.

We will take our next question from Ramsey El-Assal with Barclays.

I wanted to ask about sort of what you see as the biggest drivers of this nice margin beat in the quarter. I know you mentioned you made some pandemic-related expense adjustments. I'm just trying to understand the degree to which of those adjustments you made will prove to be the most sort of impactful and lasting?

Yes. Ramsey, I mentioned in my prepared remarks the comparisons to 2020, which I believe are significant. These are public records. If you examine our expenses, they have remained relatively flat compared to 2020. There are two factors at play here; one is likely a one-time event, while the other is part of our ongoing strategy. I've emphasized that we are undergoing a transformation into a technology-enabled services provider. While we can express our thoughts, the proof is in the P&L. When you analyze our expenses, they are essentially at the same level as in the first quarter of 2020. This is surprising since they should be slightly higher. A significant factor here is that we have experienced delayed hiring. The labor market is competitive, making it challenging to fill all the desired positions. We have hired adequately but are not at the hiring levels we expected at this stage. Regarding David's earlier question about why we aren't seeing more flow-through, we anticipate hiring will increase throughout the year, although not at the pace we had expected; it will certainly be higher than in the first quarter. Returning to the first quarter of last year, when we implemented a restructuring charge, it has produced benefits in this quarter. Examining our headcount and efficiency metrics, we are operating more efficiently now than we were in 2020, which is a key factor in the results you are observing. Increased investment in technology and a reduction in unnecessary business areas have driven the efficiency and results we have achieved.

I see. Okay. One follow-up for me. In the slide presentation, I think under Management Solutions, you mentioned some pricing realization. And I'm just curious, have you seen any changes on the positive or negative side to the pricing environment as we emerge from the pandemic? I guess it's a backdoor way of asking about the competitive environment and where there's more opportunity or less opportunity the same amount of opportunities before to modify prices.

I believe we still have strong pricing power. We've seen an increase in revenue per client and have sold them more products. From a competitive perspective, I don't think there have been many changes. However, the support we provided to clients during COVID and the new products we're offering to assist them in obtaining loans and accessing employee retention tax credits have made a significant impact on client retention and prospects. Many prospects are now becoming aware of the benefits of these retention tax credits, which can help them hire new employees or retain existing ones. The support we've shown our current clients during challenging times has proven to be beneficial. While the competitive environment remains strong, we've leveraged the opportunity to demonstrate our capabilities, putting us in a better position than we were in previously.

We'll take our next question from Bryan Bergin with Cowen.

Can you comment on how demand trended within the quarter? So results and commentary are certainly positive here. But taking into account the conservative view, I'm curious if you actually did see any deterioration as you exited August or even in September relative to maybe June and July due to the variants?

Yes, Bryan, we haven't seen any issues from the sales side. We believe we are well positioned for our selling season, which picks up over the next month or so and extends into the end of the year. Everything has been quite stable throughout the quarter. I want to highlight that mid-market performance was strong, and digital sales showed good results. Additionally, our HR outsourcing, both PEO and ASO, performed very well. The trends have remained consistent, without any decline as we moved into summer. We also see potential opportunities for sales this month and in the upcoming months across various areas, including retirement, which has also been performing strongly.

And Bryan, I don't want to speculate on your base question. I would say that if we look at the macro indicators we've observed, June and July were really strong. I want to emphasize that these aren't micro indicators. June and July were strong, but August was softer. We'll see how things go as we come out of September. However, at this point, to Marty's point, it's not affecting the business.

Okay. Okay. Understood. And then on the Management Solutions growth, can you give us a sense of the mix of the drivers of that 17% in that outperformance? How should we think about check volume recovery versus new units and cross-sell versus pricing? Any of these stand out more than others?

Yes, that's a good question. First, I want to emphasize that Management Solutions encompasses more than just payroll; it includes three main components: HCM, retirement services, and HR outsourcing. In terms of revenue, there wasn't anything significant in the PEO that didn't grow by double digits. On the HCM front, we saw upper single-digit gains in pays per control, which was beneficial. This was expected after a significant decline in the first quarter, but we also experienced growth in pricing and our client base, all of which contributed to our results. In HR outsourcing, we had an excellent year, serving more worksite employees, which positively impacted our performance. Regarding retirement services, as Marty mentioned, the sector is gaining traction nationally, and we're capitalizing on that due to new mandates in several states. We believe our pet product is well positioned, and when considering all three areas, it was a combination of factors driving the outcome rather than just HCM. This reinforces our integrated sales approach, which has led to improved revenue per client.

And we'll take our next question from Kevin McVeigh with Credit Suisse.

Efrain, you mentioned that the company has fundamentally transformed, and I truly believe that's true. Could you clarify where you see this transformation leading? It seems like retention rates are hitting record highs. Is there a new range for that? Additionally, regarding client growth, reaching 75,000 clients represents an 11% increase, which is unprecedented for you. This suggests that the business is set for structurally higher growth. I don’t want to get ahead of myself, but could you help us understand the current situation, especially considering the margin leverage as well?

Yes. Kevin, I believe the 75,000 figure reflects growth over several years. We previously reported numbers above 710, having been in the high 600s the year before. However, our client growth has indeed been robust in recent years, largely driven by the move to digital that Marty mentioned. This transition not only enhances efficiency, as reflected in our financials, but is also a primary focus within the company. I want to acknowledge my colleagues in operations for their exceptional work, as well as the IT and product teams whose efforts are essential. Additionally, last year we achieved a revenue retention rate in the high 80s. There is a natural limitation on the revenue retention we can achieve due to the markets we serve, where smaller clients tend to leave more quickly than larger ones, but overall, we've seen a positive trend. Before the pandemic, our retention was around 83% to 84%, which I consider a baseline. Last year, we exceeded that and aim to continue improving, with all my colleagues in operations aligned with this objective.

I believe that when discussing transformation, it's important to reflect on our 50 years in business and the significant changes we've experienced. The software improvements we consistently implement for our clients are providing them with extensive insights through artificial intelligence and data analytics. For example, with Paychex Pre-Check, employees can receive alerts on their mobile devices or smart speakers, notifying them that their pay for the current period is ready. This allows them to acknowledge receipt of that information easily. This enhances efficiency for both employers and administrators, contributing to our retention rates as Efrain mentioned. Despite challenges faced by small businesses, we are elevating our service to new heights. Our response to COVID-19 and our assistance with the employee retention tax credit have made a significant impact. We have transformed into a software-driven company that leverages artificial intelligence and data analytics, providing substantial efficiency to our clients.

And we will take our next question from Jason Kupferberg with Bank of America.

This is Mihir on behalf of Jason. I wanted to ask about what you're observing in the current market. We've discussed that new business creation has been quite strong recently. Has that trend persisted in the last few months? Additionally, can you provide any metrics, such as the percentage of your wins coming from newly formed businesses or your win rates in competition for these new accounts?

New business formations have decreased slightly from last year but remain higher than 2020 and are robust compared to pre-pandemic levels, increasing by 20% to 30%. There was a significant rise in the first quarter and through the first half of our fiscal year, achieving increases of 40% to 50%. Currently, we see an increase of 20% to 30% over the previous pandemic years. We are performing well with new businesses and have seen positive results particularly in the mid-market. Additionally, we are successfully attracting new clients. Our relationships with CPAs and banks continue to be strong, aiding in referrals. We have enhanced our online capabilities, allowing clients to view and demo our products on their mobile devices and facilitating a fully digital onboarding process without needing to speak to anyone. We take pride in our field sales team as well as our digital and telephonic sales teams, but digital sales are becoming increasingly important for new businesses, and we are very proud of that.

And then just if I could ask about the margin increase in the guidance. Is that being driven by the top-line growth and some efficiencies of scale just from the top-line growth flowing through? Or have there also been any changes to your underlying investment or expense plans for the year?

Yes. Let me just answer that. I think there always is some element of both. But I think it's driven more so by improvements on top-line revenue. And I would say that because we have been able to do the things that we have done or the actions we've taken on the expense side. Now when a dollar flows through, you get even more benefit than you would have otherwise. Although, as everyone knows, we have industry-leading margins to begin with.

And we'll take our next question from Andrew Nicholas with William Blair.

Can you touch on the PEO performance versus insurance performance in the quarter? And I know you're maintaining your guide on that revenue line in the aggregate, but is there any change to your expectations at that underlying level in terms of growth through the remainder of the year?

No, I would say both are actually growing quite well. HR outsourcing in total is growing well, and I think we've positioned ourselves very well on the PEO side as well as ASO. I would say the PEO side has picked back up more recently. I think we talked about it last year, maybe the last couple of quarters that insurance wasn't as in demand at that time because of getting through the pandemic. That is starting to come back now more because of a sense of retention of your employees and hiring your employees. It's a very competitive market out there. And so now the insurance plans, your health insurance, etc., your dental, your voluntary insurances, they're becoming very much a competitive offering to attract employees in a tough market and retain those that you have. So the interest in insurance has picked back up. So both our ASO and PEO, frankly, are double-digit growers and have done very well in the first quarter.

Andrew, when you do the math, part of your question is why we aren't increasing the guidance. The short answer is that PEO continues to perform well. The reason we are at 8% to 10% growth rather than double digits is that insurance is growing more slowly, which is in line with our expectations, but we foresee it lagging behind PEO for the year. We had a strong first quarter, which may prove that expectation wrong. Additionally, everyone will face challenges because we just experienced a strong fourth quarter. The comparisons against last year's fourth quarter are tough to fully assess at this point for both the top and bottom lines. We have some perspective on it, but we will need to make adjustments as the year progresses.

No, that's really helpful. And then maybe a longer-term strategic question, you talked a lot about success with digital sales. Is that something that you can apply your learnings and capabilities from to the PEO market? Or is that too involved in the sale? Or is there some middle ground that you're approaching or hoping to target longer term that could make that a more efficient process? Just wondering how that could be part of the strategy and maybe the puts and takes to consider on the PEO front.

No, sure. We're actually already involved in it. What we're doing is automating and digitizing a lot of the underwriting process and the information required for onboarding clients, including in the PEO. We're increasingly focusing on enabling employees to self-onboard, which simplifies the process for both clients and prospects. This involves sending a link to employees, prompting them to input their information and get started. I believe this will also transform the PEO side, particularly through increased automation in underwriting that will expedite the overall process. There will be no limits to digital sales as people seek more ways to automate their experiences, allowing them to set up accounts, view products, and make purchases online. While there will still be some involvement from sales representatives for complex insurance plans, we aim to make that process easier. Our strategic direction is towards empowering clients and their employees to manage their own needs, and we have already taken several steps in that direction.

And we'll take our next question from Kartik Mehta with Northcoast Research.

Marty, I wanted to ask a little bit about sales distribution. I know this might be a little dated, but at one point, it accounted for 1/3. I think direct sales accounted for 1/3 and then kind of others. And you've talked a lot about digital sales improving and being a bigger part. I'm wondering, has the sales distribution or how Paychex acquires clients changed at all as a result of all the changes?

Yes, Kartik, it certainly has. Accounts and banks remain significant for us, particularly relationships with accountants that we've nurtured for many years, along with the support we provide for their clients. However, their contribution has decreased as a percentage, while digital has increased. This shift has been consistent, and I anticipate it will likely accelerate. A larger portion of our lead generation now stems from our marketing investments, which have become a crucial aspect of the sales process in how we obtain leads and how clients perceive us when they come online to make purchases. Many clients, especially those with fewer than 10 employees, now visit our website after seeing our advertisements or finding us through search engine marketing and search engine optimization. They recognize us as experts in this field, demo the product, compare options, and even complete their purchases and setup independently. This trend is certainly growing and contributes to the efficiencies that Efrain has discussed.

Yes. No, we do. And I think that clearly in the first quarter to help offset some of the drag. The short answer is it's interesting the market kind of moves in some ways based on concerns about inflation and stagflation. But in our case, that expectation is largely a positive when you look at it from a float and from a pricing perspective. So those aren't necessarily negative to us, where I would say we're in a heightened state of scrutiny on how to position the portfolio based on what we're seeing in credit markets and on the investment side.

And we'll take our next question from Jeff Silber with BMO Capital Markets.

Earlier, you talked about some of the labor tightness impacting your own ability to hire a bit. I know we talked a little bit about it last quarter about potentially that easing up a little bit in September when folks go back to school, childcare is easier and maybe on the unemployment subsidies kind of peter out. Did you see any impact? Or have you seen any impact from recent rates of things getting a bit easier?

From a macro perspective, I would say we haven't seen the impact yet. What we have observed through data analytics, particularly from our small business index, is that it's not solely linked to unemployment. Despite some states removing extra unemployment benefits, there hasn't been a significant change in the rate of people returning to work. It appears that recovery in the market will take a bit longer; the hiring landscape remains challenging. Cash balances are currently high, with many individuals holding onto their money, either due to a lack of spending or receiving additional stimulus funds, like childcare benefits. People are in a relatively secure position financially and are still exploring their options. Additionally, there are ongoing concerns about health and safety in returning to work, such as mask mandates. It may take a few more months to see clearer trends. Hiring has indeed improved recently, particularly in the leisure, hospitality, and service sectors, but challenges still exist. We anticipate hiring will increase, but it may take longer than simply the cessation of unemployment benefits to see a significant change.

We'll take our next question from Samad Samana with Jefferies.

I wanted to maybe ask a question on your own hiring. I know you guys talked about being a little bit behind. But can you tell us maybe with which part of the organization? Is it broadly? Or is it inside the quota-carrying sales reps side? Or is that the R&D side? Just how should we think about where you're playing catch-up on the hiring?

Yes. I believe it's primarily related to the service aspect and frontline services. There is some impact on sales, but it's spread out, and it's not a significant issue in any particular sales division. We're feeling optimistic about that. The greatest challenge seems to be with frontline service providers. John Gibson, who oversees all services, has collaborated effectively with our HR team to develop innovative strategies. Hiring has really picked up again, and we've adopted various methods to attract new employees, implementing different work schedules and offering flexible options like remote work and additional benefits to enhance their experience. Things are improving, especially over the last month, but as Efrain mentioned, it's a challenging market for hiring frontline service personnel. However, we are experiencing solid client retention, we're managing to get the job done, and we're successfully driving more interactions to our website. Our chat bot handles service inquiries, responding automatically 60% of the time. Customers can always connect with someone live at Paychex around the clock every day of the year. We are actively seeking efficiencies and hiring creatively, and it's beginning to improve again.

Helpful. Efrain, we've discussed the cost controls and their positive impact on our margin structure. However, gross margins have also been improving significantly despite some challenges with our high-margin PEPM revenue. Can you explain the role of the technology stack on Flex in driving these gross margin improvements and how much additional potential there is in the software stack for further gross margin enhancements?

Yes, that's a great question, Samad. Let me address it in two parts. First, if we look at our gross margins and compare them to the industry, we are still among the leaders, especially when considering pure software companies. We're proud of our performance in this area, and we actively manage it. In relation to your earlier question about the strength in Management Solutions, it's noteworthy that this strength spans across the three key areas: retirement, HR, and HCM. Our sales team has excelled at promoting the full value of our offerings through what we refer to as the power of 3,000. The goal is to present clients with our complete value proposition. A brief aside on this: achieving this requires an integrated system that encompasses not just HCM but also various integrated enhancements. When we sell this value proposition and upgrade to a new module, the associated variable costs are very low, which contributes to our overall performance. We have been targeting larger clients lately, but more importantly, we are seeing an increase in the sale of multiple modules, especially in high-value areas like HR. This is indeed driving the margin improvements you are observing.

And we will take our next question from Bryan Keane with Deutsche Bank.

Just wanted to ask on managed solutions from maybe a slightly different angle. If you look at the revenue growth, I think it was up 500 basis points for Street estimate, and it was better than your expectations. So I'm just trying to figure out what exactly was the surprising strength in the quarter for you guys and just trying to figure out why that wouldn't repeat itself maybe in the next few quarters?

I would say this, Bryan. First, the growth in pays per control was solid, showing upper single-digit increases. We don't expect to see that in future quarters, which will create some comparison challenges. Additionally, we had better pricing in this quarter compared to the pandemic-impacted quarter last year. In the first quarter of last year, we delayed price increases to give our customers a breather, and as we commemorated that period, it worked in our favor. Furthermore, our client count increased significantly compared to the beginning of last year, all of which contributed positively to Q1. The combination of these factors was quite important. In the first quarter of last year, our HR segment really accelerated, and we continued to see that strength throughout the year. However, in the first quarter, we experienced the full annualized impact of that HR strength. There is a level of conservatism in our projections. We’ll see where we end up, but we don’t anticipate the same revenue growth in the second quarter. This indicates that Q1 had specific factors that are unlikely to recur in other quarters. Still, there are some underlying factors we’ve mentioned during this call that will continue to play a role throughout the year, and we remain somewhat cautious about the rest of the year.

Got it. No, that's helpful for the going forward. But how about the quarter itself? When you guided originally, I don't think you expected it to be that strong. And some of those factors you just outlined, you would have known about that would have been on a comparative basis. So I'm just trying to figure out the surprise in the quarter, what could possibly surprise that much?

Yes. The short answer as you're pressing me down is that it was better in almost all of those categories. So that's the short of it.

Got it. Got it. And the only other question I have is just looking at some of your metrics compared to some of the global employment metrics and factors you see is your metrics seem to be stronger than kind of what we're seeing on a more macro basis. I'm just trying to figure out if there's any thoughts or reasons why your data might be a little bit showing more strength than what we're seeing on a more macro basis?

Bryan, which ones? Like the employment growth type of things?

Yes. Yes, in particular, employment.

I believe that the growth in small businesses, specifically those with fewer than 50 employees, has been encouraging. There has been a strong recovery in the leisure and hospitality sectors, even though many restaurants and service providers are still struggling to hire enough staff. The demand has certainly been present, and the recovery over the summer has been impressive. Small businesses, which experienced a sharper decline compared to larger ones, are bouncing back more quickly this year after facing significant challenges last year. Overall, I would say they're recovering faster due to that previous hit.

We'll take our next question from Eugene Simuni with Moffett.

The first, I wanted to come back quickly to retention levels. There's been, I think, a pretty broad-based expectation that retention levels might start to come down across the industry really as the economy opens up, as activity picks up. Sounds like in the first quarter, you guys still achieving very high levels of retention. Are you seeing any indication of kind of high churn as activity picks up? And as you're looking out into the rest of the year, are you still expecting some deterioration in retention? Is that maybe part of the conservatism?

Yes, I think it's possible. We have been very pleased with retention, reaching record levels last year. We continue to find that our clients have greatly benefited from the COVID work we've done, particularly in helping them with their loan paperwork over the past 18 months. About 90% of our clients have received loan forgiveness, largely because we made the process easy. We often hear that many were on the brink of going out of business, but we helped them secure loans. Additionally, we've partnered with three fintech companies to offer them alternative loan sources. We supported them through the forgiveness process and now we're informing them about the employee retention tax credit, which allows them to receive cash immediately without delays. This can provide them with an average of $150,000 that doesn’t need to be repaid to the government, which is a significant boost for them. This has positively impacted our retention. It has allowed us to demonstrate the full capabilities of Paychex. Furthermore, as Efrain mentioned, many clients are also recognizing the value of our HR support, not just payroll services. They still need our assistance with vaccine mandates, work-from-home policies, bringing employees back to work, hybrid situations, and coaching employees. The technology we provide has proven invaluable, allowing employees to manage tasks from their mobile phones. This has given us an opportunity to show them all the ways we can help them retain talent, hire new employees, and grow their businesses, while also providing them with cash, which has significantly boosted retention.

Yes, Eugene, I mean, to your point, too, we had a great year in retention. We don't anticipate that we will be at that level. You see the impact of that retention over the course of the year. So that has some impact on where we get to. Where will we end up? We'll have a better sense of that when we get through Q2. We're not anticipating, nor are we planning on the idea that we're going to be at the same level of retention that we were last year. We'd love to do it, but probably not a realistic planning assumption.

And then secondly, I wanted to quickly ask about the ASO, PEO potential upsell opportunity. You mentioned it in the past couple of quarters that with the record strength in ASO growth, there might be some opportunity to convert some of the ASO clients to PEO clients now that folks are more interested or open to switching insurance providers. Are you pursuing that initiative? Is it yielding results? And is there more opportunity there to convert to greater PEO growth?

We've experienced significant success, achieving double-digit growth in both ASO and PEO. We have transitioned clients to an HR outsourcing product first. Additionally, the insurance sector is rebounding. We had a strong quarter in insurance, especially noticeable on the PEO side. A key issue for clients is how to hire and retain talent while also increasing efficiency. The focus on hiring and retention has expanded beyond just salary to include benefits as well, which has become crucial. We are seeing success in upgrading our existing clients and acquiring new clients for both PEO and ASO solutions.

And we'll take our final question from Mark Marcon with Baird.

Just going to one of the conservatism questions, just in some states, such as Florida, where they did see a spike in Delta, did you see any sort of negative impact with regards to the weekly revenue trends when the spike occurred?

I would say the strongest job growth has been in the South. Even though there have been more cases, we are seeing the best job growth from a broader perspective and in our sales in Florida, Georgia, and Texas. This is partly due to strong demand, as many people are migrating there, which is well recognized. Consequently, more businesses are opening, and there are more individuals available to fill jobs. This increased availability is driving demand and raising payroll checks. So while there may have been some impact, overall, states like Florida have been quite positive.

Yes, Mark, it's just been dwarfed by the recovery that probably if we were in a steady state, you'd see more of that. But in the data, as Marty said, the recovery in hospitality and leisure has been I think plus in Florida.

And so even during the weeks when things started heating up for them from a case load perspective, it didn't have a dent?

No, we didn't see it, no.

Okay. Great. Regarding your recent product and technology launches, this has likely been one of your busiest periods. I'm curious about the list, including Paychex Pre-Check, retention insights, pay benchmarking, and the dashboard. Which ones excite you the most? Which ones are experiencing the highest attach rates? And which ones are generating the most incremental revenue?

I believe Paychex Pre-Check will require a phased rollout, but I anticipate it will provide significant efficiency improvements for our clients, which will greatly aid in retention. We are not charging extra for it; it's included as part of the service clients choose to utilize. When clients seek increased efficiency, solutions like these will enhance retention and potentially increase revenue per client. We are enthusiastic about it being integrated with technology, specifically smart speakers. We are the only company connected to all three major voice assistant platforms. This offers clients a new way to communicate with their employees, such as notifying them that their paycheck is ready or reminding employers of tasks to complete. Features like these have shown to improve retention more effectively than other strategies. For instance, our retention insights leverage artificial intelligence significantly. Clients can not only check payroll but also analyze numerous indicators from the system, such as employee performance ratings and compensation comparisons. This awareness can help identify potential turnover risks. Clients who recognize the value often feel they can't operate without these tools, similar to how our five-star mobile app has engaged users who find it easy to navigate and perform various tasks independently. We're truly excited about the rapid software updates and our transformation into a more technologically advanced company, as this is driving better retention outcomes.

Great. I mean, given the recent introduction, could it possibly offset some of the headwinds you noted in terms of the fall when you're thinking about retention?

Yes, it could. It will certainly help maintain our performance. As Efrain mentioned earlier, and as you know well, there is a natural level of turnover among smaller to midsize businesses. So it's not going to remain at that peak, but we are very proud of achieving a record retention level last year, and we anticipate it to decrease somewhat this year. However, as Efrain pointed out, we have a baseline that we believe we should be able to sustain. Ashley, if there's no more, Efrain has a statement he wants to make before we conclude.

Are there no more questions?

There are no further questions at this time.

Okay. Thanks. Final point to the shareholders on the call, I just wanted to mention that we recently filed supplemental proxy materials relating to our proposal on say-on-pay. Glass Lewis has recommended a FOR vote on the proposal, and we would appreciate your support. Should you be interested in engaging with us on the issue, please feel free to reach out prior to the shareholder meeting or after. Happy to chat with you about it. So with that, I will turn it back to Marty.

Great. We will now conclude the call. If you wish to replay the webcast of this conference call, it will be available for about 90 days. Thank you for joining our first quarter press conference and for your interest in Paychex. Enjoy the rest of your week.

Thank you. And this does conclude today's program. Thank you for your participation. You may disconnect at any time.