Earnings Call Transcript
PAYCHEX INC (PAYX)
Earnings Call Transcript - PAYX Q3 2020
Operator, Operator
Good morning. My name is Lisa and I will be your conference operator today. At this time, I would like to welcome everyone to the Paychex Third Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. I would now like to turn the call over to Mr. Martin Mucci, President and Chief Executive Officer. Please go ahead, sir.
Martin Mucci, CEO
Thank you. And thank you for joining us for our discussion of the Paychex third quarter fiscal 2020 earnings release. Joining me today is Efrain Rivera, our Chief Financial Officer. This morning, before the market opened, we released our financial results for the third quarter ended February 29, 2020. You can access our earnings release on our Investor Relations webpage. Our Form 10-Q will be filed with the SEC within the next few days. And this teleconference is being broadcast over the internet and will be archived and available on our website for approximately one month. I will start today’s call with an overview of how we are responding to COVID-19 and then review business highlights for the third quarter. Efrain will review our third quarter financial results and discuss our guidance for fiscal 2020, including our current thinking and the potential impacts of COVID-19 on our business, and then we’ll open it up for your questions. First and foremost, I want to address the evolving situation we are currently facing with COVID-19. Our number one priority is the safety and wellbeing of our employees and serving our clients and their employees. Our business continuity plan was implemented, and our teams are working around the clock to ensure that we take the necessary steps to ensure our employees’ safety while continuing to support our clients through this unprecedented time. Early on, we instituted travel restrictions and began to reduce the number of employees working in our offices. At this time, all employees, unless designated as critical on-site personnel, which is less than 5%, are now working from home, and our service metrics and client response time has been excellent. In fact, our average answer performance yesterday was 7 seconds. I’m extremely proud of this team and the work they’ve done in a very fast period of time. I’m incredibly proud of how the whole leadership team and employees have responded to this situation. Because of their hard work and efforts, we’ve been able to complete all of these transitions without any service disruptions. We continue to help our clients navigate the significant amount of information and changing regulations from state and federal governments, including The Families First Coronavirus Response Act. Our compliance team also remains in contact with federal, state, and local government authorities on a real-time basis to ensure we are aware of and offering support and ideas on any new regulations or support initiatives related to COVID-19 that could impact our clients. So far, we’ve seen minimal changes in our key metrics. However, with the expanding shutdowns of businesses throughout the nation, we do expect that this will be a particularly challenging time for small and midsized businesses. This will impact our results, and Efrain will provide some color when he discusses our current outlook. The federal government has taken a number of steps to stabilize these issues and is considering more relief actions as we speak. I’m sure you’re all aware of the at least handshake agreement last night. We’re working through those detail changes as we see how the vote and the presidential approval goes probably today. Small businesses, in particular, need aid to be able to stay in business and pay their employees. The speed with which relief actions are put in place will impact the severity of the economic impacts resulting from this virus. Last weekend, we were part of a small group that sent a letter to Congress supporting the small business loan program to help businesses continue to pay their employees and offered our assistance as a payroll processor to do that in the most effective and timely way. We continue to monitor leading indicators to gauge the changes in the small business environment. We believe we are well-prepared to navigate our way through these uncertain times. The significant investments we’ve made in our technology, particularly our mobile app, and our expanded product features and service model options allow us to support our clients in any environment. Maintaining a strong balance sheet and cash position is also a priority for us. We will continue to focus on our business objectives and invest in our people and our clients. This is a rapidly evolving situation, but we will keep you informed on the expected impacts as events continue to unfold. Now, I will update you on our business and financial results for the third quarter, which reflect good progress on our key initiatives. Total revenue growth was 7% for the quarter, Management Solutions revenue grew 6%, and PEO and Insurance Solutions revenues grew 10%. Through the third quarter, we have continued to see strong execution in operations with record high net promoter scores and client retention. In addition, we have had strong results in our virtual sales divisions, digital marketing efforts, and mid-market sales through the selling season. As we have discussed on previous calls this fiscal year, we had a slower start than anticipated on the integration of Oasis. We believe we have addressed these issues in sales. We are now fully staffed and have a new leadership team in place. For service, staffing levels are stabilized, and we can now continue servicing our clients without the need to work on integrating clients into the platform. The business has strong fundamentals that will drive growth over the long-term, and we remain very positive about the continued strong demand for HR, insurance support, and PEO services, particularly in this difficult environment. As the largest 401(k) record-keeper in the U.S., Paychex was prepared to respond to the SECURE Act, which was enacted in December of 2019. This legislation provides incentives for employers to offer retirement savings plans and provisions to improve savings for millions of Americans. With our strong expertise in retirement plans and our award-winning Retirement Services Participant Portal, we are well-positioned to assist small and midsized businesses and their employees as they navigate this new legislation and plan for retirement. We launched Pay-on-Demand in December, which improves the employee experience by offering them flexible access to wages they have already earned before payday, helping them manage their personal cash flow. This is a valuable tool for employers to help attract and retain talent. Other companies in the industry offer similar services on a smaller scale, but our solution is unique in that it provides our clients with flexible payment options, including direct deposit, pay card, and digital payment into Amazon or PayPal accounts. We also believe that Pay-on-Demand will see increased usage in this current environment with employers needing a more flexible workforce and more immediate pay. We were excited to launch the first of our wearable apps as well, which we demonstrated in October at HR Tech, and Paychex Time, where the Apple watch was launched in January for Flex customers. This allows clients' employees the flexibility and convenience of punching in and out on their Apple watch. We also launched the Paychex Flex help center, which provides dozens of training resources and how-to tutorials for assistance using Flex technology from within the application itself. The help center allows customers to access help materials that are relevant and easy to consume via their individual preferred learning method, whether that is video tutorials, step-by-step instructions, or chat. The latest product releases included significant enhancements to existing features, which continue to add value by making things simple for our clients and allowing users flexibility and choice. These enhancements include electronic signature capabilities in our document management tool, improved visibility into labor costs and employee data with live reports, and additional integrations with some of the top HR finance time and attendance, and benefit solutions in our Paychex Integrations solution. While Paychex Flex does provide a full suite of HR solutions, the open platform allows customers the flexibility they may need to integrate with other tools, if they so choose or if they already have them and don’t want to switch out of them. Products like learning management services with online training and electronic signature capabilities in document management will support the needs of clients in this time of remote workforce. Our real-time payments offering will be introduced in April, allowing employers to pay employees faster, which can help attract talent and quickly resolve any issues with payroll. Our technology roadmap continues to focus on the area of emerging technologies, such as wearables, real-time payments, product integration options, data analytics, and AI, all of which will play an important role in helping clients in this current environment. We are proud that Paychex’s commitment to technology innovation has been recognized by industry experts. Our Paychex Flex Assistant was selected as a Stevie Award winner for best use of technology in customer service. Flex Assistant answers over 250 questions, covering the breadth and depth of the Paychex payroll and HR suite. What differentiates our technology is that it seamlessly connects to a live specialist in real-time, if the user wants more assistance, and the entire bot transaction is visible to that specialist, so no repetition is needed. Paychex and SurePayroll also received Stevie Awards for our excellent customer service. As a critical business partner for many of our clients, we pride ourselves on doing business with integrity. It is ingrained in our corporate culture, and very evident in the last few weeks as we quickly implemented our business continuity plans for our clients and employees. I’m extremely proud that Paychex has once again been recognized by Ethisphere as one of the 2020 World's Most Ethical Companies, the 12th time we’ve received this recognition. In summary, as we navigate these unprecedented times, we continue to support our clients, our employees, our communities, and our shareholders. We have invested heavily in making our technology solutions and service flexible and mobile, and we are more prepared than ever to handle this current environment. I would like to thank our IT, sales, service, compliance, marketing, and HR teams who have worked diligently to ensure regular communication to our employees and our clients and that all employees have the equipment they need to work remotely and stay connected with each other and our clients. Also, I’d like to thank our employees who have maintained diligence and flexibility during these transitions in the way we all work. I will now turn the call over to Efrain Rivera to review our financial results for the third quarter. Efrain?
Efrain Rivera, CFO
Thanks, Marty. Good morning. I’d like to remind everyone that today’s conference call will contain forward-looking statements that refer to future events and involve risks. Please refer to the customary disclosures in our earnings release. I’ll also refer to non-GAAP measures like EBITDA, adjusted net income, and adjusted diluted earnings per share, so please refer to the press release. Before I start, I hope everyone is safe and in good health. It’s crucial during these times. For those with loved ones affected by the virus, please accept our thoughts and prayers. Being human at this moment is vital. Now, let’s discuss finance. I’ll provide some key highlights for the quarter followed by greater detail in certain areas, and then I’ll review our outlook for fiscal 2020 and share some thoughts on fiscal 2021. Total revenue grew 7% in the third quarter to $1.1 billion, with Oasis contributing about 1% to this growth. Expenses increased 5% to $673 million, driven by higher compensation costs and PEO direct insurance costs related to the Oasis acquisition. Operating income rose 10% to $470 million, and the operating margin was 41.1% compared to 40.1% in the same quarter last year. EBITDA increased by 8% to $520 million, with an EBITDA margin of 45.6%, up from 45% last year. Other expense net for the quarter was $6 million, which includes interest expense from long-term borrowings. Our effective income tax rate was 23.6% compared to 23.7% in the previous year. Both net income and adjusted net income for the third quarter rose 9% to $355 million and $351 million, respectively. Diluted earnings per share and adjusted earnings per share also increased 9% to $0.98 and $0.97 per share, respectively. We received approximately $0.01 in benefit from stock-based compensation payments during the third quarter, which is included for GAAP but excluded in our adjusted diluted EPS. Service revenue decreased 7% in the third quarter to $1.1 billion. Within this, Management Solutions revenue rose 6% to $850 million; PEO and Insurance Solutions increased 10% to $272 million. The strong performance in Management Solutions was mainly driven by growth in our client base and revenue per client, which improved due to higher price realization and increased penetration of our solutions, especially in retirement services and HR outsourcing. PEO and Insurance Solutions revenue growth of 10% was fueled by an expanding client base, while Insurance Solutions revenue benefited from more health and benefit applicants, though it was partially offset by softness in workers’ compensation premiums. Interest on funds held for clients dropped 7% for the quarter, attributed to lower interest rates, partially mitigated by higher average investment balances. The total average investment balances held for clients were influenced by wage inflation alongside client base changes. These results do not account for the March rate cuts by the Federal Reserve. In our investment portfolio, we continue to focus on high-quality credit securities. Long-term portfolios yield an average of about 2.1% with an average duration of 3.1 years. Combined portfolios generated an average return of 1.8% in the third quarter, down from 2% last year. Year-to-date, total revenue increased 12% to $3.1 billion, with service revenue also rising 12%, Management Solutions reflecting 6% growth to $2.3 billion, and PEO and Insurance Solutions showing 36% growth to $763 million, with Oasis contributing approximately 28%. Interest on funds held for clients grew 6% to $62 million. Operating income increased by 10% to $1.2 billion. Net income and diluted earnings per share each grew 9% to $877 million and $2.43 per share, respectively. Adjusted net income and adjusted diluted earnings per share both increased 8% to $863 million and $2.39 per share, respectively. Our financial position is exceptionally strong, with cash, restricted cash, and total corporate investments amounting to $930 million as of February 29, 2020. Funds held for clients were $4.4 billion, up from $3.8 billion as of May 31. The average funds held for clients was $4.5 billion for the third quarter. Total available-for-sale investments, including corporate investments and funds held for clients, showed net unrealized gains of $84 million as of February 29, compared to $20 million as of May 31, 2019. Total stockholders’ equity was $2.8 billion as of February 29, reflecting $667 million in dividends paid and $172 million in shares repurchased during the first nine months. Our return on equity over the past 12 months stands at an impressive 42%. Cash flows from operations totaled $1.1 billion in the first nine months, representing a 3% increase over the same period last year, driven by higher net income despite timing fluctuations in working capital. To summarize our financial position, we are in a solid state with a strong cash position of $900 million and an undrawn revolver. We lead our peer group in cash generation and dividends, and we are confident we will navigate the challenges ahead for our clients, employees, and shareholders. Turning to guidance for the current fiscal year ending May 31, 2020, I want to provide context. Given the new developments occurring daily, our guidance reflects our current assumptions based on the available information about potential effects on the business. This guidance also includes the impact of interest rate cuts of 150 basis points that happened in March. For the full year of fiscal 2020, as stated in the press release, we expect management solutions to grow about 4%, PEO to grow about 24% for the year, interest on funds held for clients to decline by 2% to 3%, and total revenue to grow by 8% to 9%. We anticipate operating income as a percentage of total revenue to be around 36%, and the EBITDA margin for the full year is expected to be about 41%. Other net expenses are expected to be between $22 million and $24 million, and the effective income tax rate is forecasted to be between 23.5% and 24%. We project that net income and diluted earnings per share will increase by approximately 7%, while adjusted net income and adjusted diluted earnings per share will grow by around 6%. For the fourth quarter, guidance indicates a modest decrease in total revenue, with operating margins estimated at approximately 32%. We keep a close eye on various leading internal business indicators to inform these estimates. Our analysis indicates that while we did not see significant impacts through mid-March, by the latter half of March, we began to notice the effects on the business. We believe we have incorporated as much of that insight into our fourth-quarter guidance as possible. This aligns with prior experiences like the shock from 9/11, which was a more short-lived event, and the recession of ’08-’09. We foresee a significant impact in Q1, followed by some recovery in Q2, moderate improvement through Q3, and further recovery in Q4, similar to the patterns observed after 9/11. We continue to review our information daily to solidify our understanding of this situation. As for next year, we plan to offer more complete guidance during the fiscal 2020 fourth-quarter call in June. Nonetheless, based on our current insights, we anticipate that total revenue may remain flat to slightly decline by low single digits in fiscal 2021, accounting for the impacts of recent interest rate cuts. If further cuts occur, particularly if rates turn negative, we will reassess our projections. Our preliminary estimate suggests operating margins could be around 35%, and our tax rate for discrete items will remain in line with fiscal year 2020. We acknowledge that this outlook is preliminary and subject to change. Thank you, and now I’ll turn it back to Marty. We will answer every question you have, so please keep them brief and focused, and avoid repeating previously asked questions to allow everyone a chance to participate.
Martin Mucci, CEO
Great. Thank you. Lisa, if you could now open the call to questions?
Operator, Operator
Your first question comes from the line of Ramsey El-Assal with Barclays.
Ramsey El-Assal, Analyst
Thank you for your question and for providing guidance in a challenging environment. I wonder if you could elaborate on the expense levers and the various strategies you have in place to safeguard the bottom line during adverse conditions. What options do you have that you could adjust to prepare for such scenarios?
Efrain Rivera, CFO
Yes. Like most service businesses, 65% of your costs are people costs, and 35% are variable. We obviously will go right after as much variable costs as we can. And then, we’ll look at where there are other opportunities. I think that’s the order in which we’ll do it.
Martin Mucci, CEO
Yes. I think with the changes when you look back to the financial crisis of ‘08’09, we were very quick to react and yet keep full employment of the people that we had. Given some of the turnover that we have and so forth, I think we have a pretty flexible ability to keep a focus on the margins, as we always have, as Efrain said. We’ve always led by far the industry in margins, and we certainly keep a close eye on that.
Ramsey El-Assal, Analyst
Okay. My second one is on the PEO and Insurance segment in the quarter. Can you parse out what growth would have been there without the Oasis stub? And then, just more broadly, in the insurance part of your business, can you talk about risk management strategies in the context of the environment we’re in? And I’ll hop back in the queue after that.
Efrain Rivera, CFO
Okay. I’m going to ask you to repeat the second question to clarify what you’re asking. But, because I think the way you asked it, I can answer it in a variety of different ways. If you look at the PEO business, we would have grown about mid single digits, I’d say in the PEO business in the third quarter. The second question, I didn’t get.
Ramsey El-Assal, Analyst
In terms of the insurance segment of the business, how do you perceive its performance? Have you noticed any early signs of deterioration based on leading indicators? Additionally, how do you manage risk in that area during an economic downturn? Please feel free to answer as you see fit.
Efrain Rivera, CFO
Yes. Let me just explain why I’m pausing. So, PEO and Insurance, I’ve mentioned this to many of you, is both the brokered insurance business, which is roughly, call it 18% to 20% of revenues in that category, and the PEO business. So, that causes sometimes confusion when people look at it. On the brokered business, we bear no risk. The short answer to your question, which I don’t think is what you’re asking, is that it really doesn’t have much of an impact. The softness in the insurance I keep calling out is really the softness in the workers’ comp insurance portion of the brokered business, not in the PEO. What I think you’re asking is, if I understand the question, is how are we monitoring the at-risk portion of the insurance in the PEO? I think that’s the issue. The short answer is we’ve stress-tested that population, which again is primarily in the state of Florida. We look at medical loss ratios, and they have been running very favorably. Third, which requires a much more understanding of the way we operate the PEO, we don’t anticipate that we will make a profit on the insurance portion of the at-risk, particularly health insurance. What that means is that we are very cautious and very conservative in the amount of reserves that we provide. So, the short answer is that we’re constantly monitoring our medical loss ratios in that population. We adjust reserves as we think appropriate, based on the experience we’re having. At this stage, we feel we’re in pretty good shape.
Martin Mucci, CEO
Yes. I think the only thing I’d add to that is any initial view on the PEO side is actually very active on the HR and insurance side. We’ve done, I think, a very good job on the diligence, the underwriting, and that’s going to certainly continue. We haven’t seen any uptick in claims. Efrain said how well we manage that and are very tight on that to begin with. We’ve actually seen a lot of interest on the HR side obviously with the complexity of the regulations that are coming out, both the PEO and ASO part of our business. Our HR outsourcing, we’re the only one with 600-plus HR specialists around the country that are handling these clients. The interest has grown very quickly. So, initial pieces, there’s going to be a lot of need for HR support, not only at the beginning of this, in case I have to shut down temporarily, et cetera, but how do I handle the support payments, how do I handle small business loans, how do I with payroll taxes, all of those things.
Kevin McVeigh, Analyst
Thank you for your insights on 2021, especially considering the current unpredictable environment. Efrain or Marty, could you share your thoughts on the differences between furloughs and layoffs and how they might affect the business model? Additionally, what unemployment rate are you factoring in for 2021?
Martin Mucci, CEO
Yes. Let me start by saying this is really important. With our new flex technology, we can actually survey clients using our app. In the last four days, we have received a tremendous response asking about the impact on them. We’re seeing that a significant majority of small and medium-sized businesses report that over 50% have had minimal impact so far, while another 40% have implemented furloughs. Our hope, as communicated by our payroll specialists and sales team, is that if businesses can stay operational, whether by furloughing or continuing to pay employees, there will be support available—likely from the small business loan program. That’s why we are pushing to offer our assistance. We have all the necessary information and direct deposit accounts, which allows us to quickly help our clients pay their employees for six weeks, eight weeks, or whatever duration the government decides, using funds from a government loan rather than the client’s resources. I believe this is the fastest way to keep businesses running. Right now, the early indicators show that small businesses are trying to hold on, possibly laying off or furloughing a few individuals, but overall maintaining their business models based on how long this situation lasts. If it doesn’t extend too long, they’ll likely recover well. Just two weeks ago, we had full employment, and small businesses' biggest challenge was finding people to meet the demand. I don’t think demand will change significantly; I believe it will rebound fairly quickly. People will want to go out, return to restaurants, and use services, albeit possibly with some changes to how they interact with others. So, these small businesses are striving to retain their employees, which will greatly influence how many clients we lose and how many checks we process.
Efrain Rivera, CFO
The second question is about our clients on the Management Solutions side. If you look at our revenue, about a third comes from the PEPM model and two thirds from subscriptions. We expect a significant drop in pays per control in the coming months, and unemployment may rise to between 20% and 25%. While I can’t predict the future, our modeling indicates that we anticipate some significant contraction ahead. We will see how long it lasts, but we believe we have a reasonable understanding of the situation. So, I expect a noticeable decline in the next few months.
Bryan Keane, Analyst
Hi, guys. I just want to ask about a bridge going from the 6% organic growth level that we’re at today, down to the slightly negative growth in the fourth quarter, and then for next year. Just thinking about what’s in those assumptions, including bankruptcies and other things that drives it to those levels?
Efrain Rivera, CFO
Yes. We expect to see some client losses and reduced payments per control, which we've modeled based on prior recessions. We need to understand the duration of the current situation before it resolves. The key question is how sharp the rebound will be. We believe things will improve towards the end of the year, but I can’t provide specific projections since the modeling is still in the early stages. We've assessed our client base, considered various impacts, especially among our payroll clients, and compared this to past recessions to come up with our best estimate. We do believe there will be an impact on our client base and on payments per control. I would add, as Marty mentioned earlier, that if the downturn is severe but brief, our assumptions may change. If the downturn is both severe and short-lived, along with government stimulus helping businesses stay afloat, it could positively influence our projections. However, we don’t have enough information yet to assess the situation fully. We'll have a clearer picture in the coming days, though any potential impact is still uncertain at this point.
Martin Mucci, CEO
And then, of course, Efrain you mentioned the interest rate changes is in that as well. That’s a more of a known item.
Bryan Keane, Analyst
Yes. I was going to ask that as my follow-up is how did you account for the stimulus? You’re doing a lot for SMBs to try to prop them up and keep them alive. So, is that modeled in as well or do you just model in as if there would be no stimulus?
Martin Mucci, CEO
I think it was at a high level. Bryan, we were a bit more conservative about who might go out of business and the financial assistance because of that. It was really at a high level. The uncertainty around where the stimulus would go and how long it would take was significant. It's crucial that we communicate that the government has made some commendable progress quickly. If payroll processors are involved, this could move swiftly; however, if it has to go through a loan program, it could take weeks. Those weeks are vital for keeping people employed and ensuring businesses remain operational. I am optimistic that they will expedite the process, and if they continue as they have, it will help keep these businesses running.
David Togut, Analyst
Thank you. I appreciate the preliminary 2021 outlook. Could you dimension for us your revenue exposure to some of the most affected industries, like restaurants, just broadly foodservice, so we can think through 2021, in terms of the framework that you gave?
Martin Mucci, CEO
Yes. I'll begin, and then Efrain can join in. I would estimate that restaurants make up about 5% or 6% of our overall base, which is smaller than some might assume. This should be useful information. These are the sectors that have been significantly impacted, particularly in places like New York and other areas where restaurants were completely shut down. The situation is also influenced by how long these closures last, as Efrain has mentioned. We are looking to gradually reopen in a few weeks, even under a partial occupancy rule, but the question remains about how long these businesses can sustain themselves. Overall, I believe that the client base exposure is around that percentage.
Efrain Rivera, CFO
You know, David, there’s been a fair amount of talk about how this endogenous shock is affecting industries. Marty’s right that if you look at hospitality and foodservices, that’s about 6% of our client base. So, obviously, that’s impacted pretty significantly, both on the payroll side and on the PEO side, but it’s only 6%. If you look at everything else, for example, oil and gas is 1%, and everything else is distributed in a distribution that looks pretty similar to what the broad economy looks like. So, we don’t have significant exposures to one industry or the other on our payroll client base.
Martin Mucci, CEO
One of the significant advantages of our model and financial strength, as Efrain pointed out, is that we do not have a large concentration in any specific industry, ZIP code, or region. This provides us with a greater diversity among our client base and the types of businesses we serve.
Efrain Rivera, CFO
Yes. And I will say that that’s for payroll. It’s a little bit different for PEO.
David Togut, Analyst
Understood. Just a quick final question. You mentioned that the business started to see impacts in the second half of this month compared to the first half. Can you share what you observed in the second half regarding the quantification of the impact on KPIs?
Efrain Rivera, CFO
Yes. We observed that people running payroll did not show significant impacts at first. It appeared that clients were either maintaining their current processing routines or, in some cases, speeding up their processing due to downsizing or closures. However, this initial observation did not provide enough insight, so we further analyzed our data on time and attendance systems. We cross-referenced this with marketing leads and sales activity and noted a considerable decline beginning with the implementation of state closures or lockdowns. This is where we recognized the impact. The positive aspect is that we can assess the effect and observe changes in demand. The concern now is how quickly we recover from this situation. Clearly, New York will take longer to recover, but we need to consider what happens in other states that find themselves in a similar situation.
Martin Mucci, CEO
Yes. One of the interesting things is while we’ve seen leads drop off on the front end, but then there are definitely other pieces that have picked up. So, they’re definitely down, but not like shutdown. They’re down double digits, but not as much as you might have even thought. So, people are still looking for, and maybe because of this looking for payroll support, HR support, insurance, those kinds of things. They’re also finding that frankly, this is the time that they better go with an outsourcer, and that they would want to go with somebody who’s national and has the support and service teams that we have that are desegregated across the entire country and can provide great answer performance and support even with 15,000 people working from home. I think there are some benefits to the strength of who we are and our level of experience at this point in time.
Steven Wald, Analyst
Good morning. Thanks for taking my question. I appreciate you trying to provide as much guidance as we can here. Just maybe following up on some of the comments that you just mentioned about this down double-digit lead, but things aren’t completely frozen. As we think about the developing competitive environment as we go through the trough and come out of this, how are you guys thinking about positioning that? Obviously, you made a lot of investments on the Oasis side to get that fully staffed up from the sales side, but when we think about things like waiving fees right now to offset pressure the clients may be receiving or the fact that you may have some pricing competition from the very crowded market. How are you guys thinking about that over the next 12 months?
Martin Mucci, CEO
It's really about whether we are positioned to support our clients during this challenging time. They are looking for assistance, particularly in terms of pricing in the short term. Our pricing is relatively minor for small to midsized businesses compared to their other concerns. We’ve found that our telesales capabilities are making a significant impact, as we have been effectively selling over the phone, generating leads, and completing the entire sales process remotely, including demos and self-service options for clients. We have enhanced training for our field sales team to engage with clients who prefer phone interactions rather than in-person meetings. We are able to demonstrate our products, finalize sales, and utilize existing features like document management to streamline electronic transactions. Onboarding clients can be completed in just a few hours. Our marketing efforts are centered around how we can assist businesses, showcasing our service model and product offerings. The utilization of our mobile app is increasing, likely because many employees are remote. The investments we've made in this area, along with online training capabilities, are proving beneficial. Features like direct deposit and pay on demand are also valuable for clients needing quick access to cash. We are highlighting the value we offer, and while we are open to discussing specific client needs, the focus isn't primarily on pricing, but rather on being a comprehensive, experienced service provider during these times.
Steven Wald, Analyst
And then, just maybe a quick sort of two-parter. I know Efrain you mentioned a 42-page report you have, sort of running through how to think about this. If we go back to the prior downturn, I believe retention rates dropped towards the mid-to-high 70s. How are we thinking about that relative to the great financial crisis? But also, somebody asked previously about the exposure to industries and how you’re thinking about it versus prior downturns. But, if cross-section it and say a restaurant in the Permian Basin that’s more than just being exposed to oil and gas, how are you guys thinking about this?
Efrain Rivera, CFO
That's a great question, Steven. We'll be providing a more detailed analysis as we progress through the planning process, which we are currently in. We're working on it. The analysis we have already focuses on those specific areas. To address your question, during previous downturns, particularly in 2008 or 2009, we started from a retention level that was lower than it is now. If we had continued on the same trajectory through the third quarter, we would have achieved record retention, aiming for a substantial improvement in that area. I would have been surprised to hear that we would reach such numbers nine years ago, given that we typically operated in the high 70s range. So, we have a solid foundation. However, we need to account for the changes seen in various environments. We've made our best estimate for what to expect. Currently, based on the models and past experiences during recessions, I believe we have a good understanding of how to gauge the range, along with the expected outcomes by industry. Yet, as Marty pointed out, we must consider the assumption that we are quite exposed to the restaurant sector.
Martin Mucci, CEO
Yes. Steven, I guess I’d just say, it is so determined on what Efrain said about the length of how long this goes and then is the stimulus package going to help them through the first couple of months. And then, does it go another two months, three months or so forth. With the financial crisis, it went longer, certainly I think seven quarters or so. If there is something that can hold them on and they can still get business, even if it’s takeout, and they can furlough a few people but give support on their payroll, it could make a huge difference. We’ve done some initial modeling, but we really need to see how the next couple of weeks even play out.
Kartik Mehta, Analyst
Hey Efrain and Marty. Efrain, thank you for at least attempting to provide some guidance for FY21. Could you share the assumptions you're considering regarding pays per control or retention, along with other metrics you typically discuss, to help us understand the context for your FY21 guidance?
Efrain Rivera, CFO
Yes, Kartik, I can't be too specific about that right now. However, I can provide a general framework indicating that we're anticipating declines in pays per control based on the effects observed during the last two contractions. We are using that as a guideline for what the next three to four months might look like. I believe we will face significant impacts unless the stimulus provides a buffer, particularly through the summer into early fall. Additionally, regarding our clients, we are utilizing that data as a reference to develop a framework for next year. I assume many of you are familiar with that data and understand what I mean. Therefore, we have incorporated that into our planning, as having a framework is essential as we approach next year. Energy costs are also something that will be absorbed. At this stage, they’re not high enough to impact them significantly. Certainly, if you look at increases, they have been on the lower end of our spectrum.
Kartik Mehta, Analyst
Efrain, at the beginning, you and Marty discussed the balance sheet. One advantage is that you have an excellent balance sheet. I’d like to know your thoughts on share repurchase. Do you feel confident enough to consider buying back shares when the market allows, or would you prefer to wait and see how things develop over the next couple of quarters before making that decision?
Efrain Rivera, CFO
Certainly. One of the challenges we face in this environment is that, ideally, this would be the moment to consider share repurchases, especially since we believe the business will recover, and we are confident in that outcome. However, I must emphasize the importance of ensuring our liquidity is rock solid, as the dividend is crucial for our shareholders. We need to protect our liquidity in the short term and keep capital markets functioning as they should before making any decisions. Currently, we are focused on ensuring there are no potential issues in this area. Although we have strong cash flow and significant cash reserves, it is vital to weigh all factors before contemplating share repurchases. There may come a time to discuss this with the Board, but that is not the case right now.
Kartik Mehta, Analyst
Marty, I have one last question. Reflecting on previous recessions, did you notice that as we emerged from them, small businesses were more inclined to engage with an outsourced provider for reasons related to the recession or cost-saving measures? Essentially, as we recover from this situation, do you anticipate a potential increase in sales from businesses that previously did not utilize outsourced services but are now inclined to do so?
Martin Mucci, CEO
I don’t remember seeing that much of it at that point. However, there are a couple of factors that are quite different in this situation that I think can be beneficial. One factor is the government stimulus packages and the complex regulatory changes. Many businesses may say that if they want to take advantage of these opportunities, they need outside support to start or revive their businesses. This could lead them to seek help from a provider that can offer the necessary guidance, such as us. Secondly, from a technology standpoint, everything has changed significantly. A decade ago, mobile apps were virtually nonexistent, and remote work was minimal. Now, businesses and their employees have become accustomed to utilizing mobile apps for various services, such as online training, pay-on-demand systems, and accessing 401(k) information online. This shift has created a different environment, and I believe it will permanently alter the workforce. People are now more inclined to embrace remote and self-service options rather than traditional methods like receiving checks in person. All these trends are leading more individuals to explore the technological investments we've made, and as a result, I think there are two encouraging outcomes ahead: more new business startups and existing businesses looking to reignite their operations will increasingly seek providers like us.
Bryan Bergin, Analyst
Hi guys. Thanks for the early guide for us here. Efrain, I appreciate the LIE analogy. Thank you for that one.
Efrain Rivera, CFO
All I ask all of you is to remember when I was wrong that I at least tried. I led with my chin.
Bryan Bergin, Analyst
Here you go. I wanted to ask, just from a business mix standpoint, can you just give us some color on where you are expecting the most and the least pressure? As we think about PEO and Management Solutions, and then the various offerings within Management Solutions that are most and least insulated here?
Efrain Rivera, CFO
Yes. One thing worth mentioning is that we have undergone significant changes since 2008 or 2009. By the end of this year, less than half of our revenue will come from payroll services. If we look at our business, around 80% of our client base is composed of firms with fewer than 20 employees, but our revenue is evenly split between clients with fewer and more than 20 employees. This is a notable shift from what we experienced back in the 2008-2009 period. As we consider future trends, there are some differences to note. We might see a rise in demand for HR services, especially given the complexities of upcoming legislative changes. A closer look at our revenue breakdown shows that approximately 50% is generated from HR-related products. There is likely to be an increase in this demand, particularly due to the intricate nature of the new regulations Congress is set to introduce. There are many positive elements in the forthcoming legislation for businesses, but they require careful interpretation. From an HR perspective, we could see increased demand, which has been highlighted by Marty, particularly affecting smaller clients due to the significant and serious nature of this correction.
Bryan Bergin, Analyst
Okay. And then just a quick sort of two-parter. I know Efrain you mentioned a 42-page report you have, sort of running through how to think about this. If we go back to the prior downturn, I believe retention rates dropped towards the mid-to-high 70s. How are we thinking about that relative to the great financial crisis? But also, somebody asked previously about the exposure to industries and how you’re thinking about it versus prior downturns. But, if cross-section it and say, a restaurant in the Permian Basin that’s more than just being exposed to oil and gas, how are you guys thinking about this?
Efrain Rivera, CFO
That’s a good question, Steven. We will delve deeper into that analysis as we progress through the planning process, which we are currently in. We are focused on that aspect. The analysis we have examines those specific issues. In response to your question, during previous downturns, specifically in 2008 or 2009, we started from a retention level that was lower than where it is now. If we had maintained the trajectory we were on through the third quarter, we would have achieved record retention. We were on track for significant improvement in retention during that time. If you had told me nine years ago that we would reach that level, I would have been surprised, as we typically operated in the high 70s. We are starting from a solid foundation, but it’s essential to consider the stress based on changes observed in various environments. We have made our best estimate regarding that. Currently, we have a solid understanding of how it compares to the models or actual experiences from past recessions, and we can overlay what might occur by industry. Additionally, I agree with Marty that there is an assumption about our exposure to the restaurant sector.
Martin Mucci, CEO
Yes. Steven, I guess I’d just say, it is so determined on what Efrain said about the length of how long this goes and then is the stimulus package going to help them through the first couple of months. And then, does it go another two months, three months or so forth. With the financial crisis, it went longer, certainly I think seven quarters or so. If there is something that can hold them on and they can still get business, even if it’s takeout, and they can furlough a few people but give support on their payroll, it could make a huge difference. We’ve done some initial modeling, but we really need to see kind of how the next couple of weeks even play out.
Kartik Mehta, Analyst
Hey Efrain and Marty, thanks for putting together some FY21 guidance. Can you share the assumptions you're using regarding pays per control or retention, and some of the metrics you typically discuss, to provide insight into the context for your FY21 guidance?
Efrain Rivera, CFO
Yes, Kartik, I can’t be too specific about that right now. However, I can provide a general framework regarding our modeling of decreases in pays per control based on some of the effects we observed during the previous two contractions. We’re using that as a guide for what the next three or four months look like. I believe we will experience significant impacts without considering the support provided by the stimulus, especially during the summer and early fall.
Kartik Mehta, Analyst
Efrain, at the beginning, you and Marty discussed the balance sheet. One advantage is that you have a strong balance sheet. I'm curious about your views on share repurchase. Do you feel confident enough that you would consider buying back shares when the market is right, or do you prefer to wait and see how things evolve over the next few quarters before making such a decision?
Efrain Rivera, CFO
Yes, Kartik, one of the challenges in this environment is that, without other concerns, it may seem like the right time to be positive about share repurchase since we believe the business will recover. We are very confident that this will happen. However, I also want to note that this perspective applies to our portfolio as well. I've experienced similar situations in the past, and it's crucial to ensure that there are no doubts about our liquidity. People rely on the dividend from this company, and we must protect that to avoid any perception of issues. In the short term, until we have a clearer understanding of our position, we need to prioritize liquidity and ensure capital markets are operating properly before making any decisions. There will be a right time to discuss this with the Board, but that time is not now.
Kartik Mehta, Analyst
And then, just one last question, Marty. When you looked at the previous recessions, did you see that as we came out of them, more small businesses wanted to choose an outsource provider, either due to what happened or because they were looking to save money?
Martin Mucci, CEO
I don't recall seeing that much of it at that time, Kartik. However, there are a couple of significant differences in this situation that I believe can be beneficial. One is that the government stimulus packages and regulatory changes are quite complex. More businesses might consider starting or revamping their operations to take advantage of the available opportunities, but they might feel they need external support to navigate this. This could lead more businesses to switch to outsourcing, especially if they previously relied on smaller providers that can't offer the same level of guidance we provide. Secondly, the technological landscape is vastly different now. Compared to a decade ago, we have mobile apps and a greater acceptance of remote work. Employees are now accustomed to engaging with mobile applications for various services, such as online training, pay-on-demand, or accessing their 401(k) balances and loans. This shift towards remote and self-service options will likely lead to a permanent change in the workforce's expectations. People will want to embrace these modern conveniences rather than stick to traditional methods like receiving physical checks. Overall, these developments are poised to significantly boost the demand for the technology investments we've made in our services.
Operator, Operator
Your next question comes from the line of Bryan Bergin with Cowen.
Bryan Bergin, Analyst
Hi, guys. Thanks for the early guide for us here. And Efrain, I appreciate the LIE analogy. Thank you for that one.
Efrain Rivera, CFO
All I ask all of you is to remember when I was wrong that I at least tried. I led with my chin.
Bryan Bergin, Analyst
Here you go. I wanted to ask, just from a business mix standpoint, can you just give us some color on where you are expecting the most and least pressure? As we think about PEO and Management Solutions, and then the various offerings within Management Solutions that are most and least insulated here?
Efrain Rivera, CFO
Yes. One thing I think we should mention is that our business has become much more diversified in customer segments. And we can also mitigate risks through better service delivery and technology investments. I think we’ll manage those pressures effectively.
Operator, Operator
And there are no further questions.
Martin Mucci, CEO
All right. Thank you. At this point, we will close the call. We do wish the best to all of yourselves and your families, and good health to all of you. Thank you for participating in this call. It will be archived for approximately 30 days. Again, we appreciate your participation and interest in Paychex. And stay safe, everyone. Thank you.
Operator, Operator
This concludes today's conference. You may now disconnect.