Earnings Call Transcript
PAYCHEX INC (PAYX)
Earnings Call Transcript - PAYX Q1 2024
Operator, Operator
Good day, everyone, and welcome to today's Paychex First Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, you will have the opportunity to ask questions during the question-and-answer session. Please note, this call is being recorded, and I will be standing by if you should need any assistance. It is now my pleasure to turn the conference over to John Gibson.
John Gibson, President and CEO
Thank you, everyone, for joining us for our discussion of the Paychex first quarter fiscal year '24 earnings release. Joining me today is Efrain Rivera, our Chief Financial Officer; and Bob Schrader, Vice President of Finance and Investor Relations. This morning before the market opened, we released our financial results for the first quarter. You can access our earnings release on our Investor Relations website. Our Form 10-Q will be filed with the SEC within the next day. The teleconference is being broadcast online and will be archived and available on our website for approximately 90 days. I will start the call with an update on the business highlights for the first quarter. I'll then turn it over to Efrain and Bob for a financial update, and then, we'll open it up for your questions. But before getting into the discussion of our earnings results, I want to take a brief moment here to make a few comments to acknowledge Efrain Rivera, who announced his intention to retire as CFO effective October 12, 2023; though he will remain as a Senior Advisor at least through the end of the calendar year. Efrain has been a valuable member of this senior leadership team at Paychex for the past 12 years. He has provided strong financial stewardship, but more importantly, great strategic leadership as well. During his time with Paychex, the company has transformed into a technology-enabled services company, and we significantly expanded our HR Solutions and capabilities. Efrain has been a key strategic advisor and a catalyst for this transformation. Efrain, I think you know how truly I appreciate your intellectual wisdom, your integrity, the guidance you've given me personally over my decade here and to the company. And we are all in great gratitude for what you've done for each one of us personally and for the company. Our customers, our employees, and our shareholders are better off because you were here. So, thank you. Joining us today is Bob Schrader, who will succeed Efrain as CFO. Bob joined Paychex back in 2014 and is taking on progressive leadership roles over the past nine years, including over the last year and a half since I was named President and subsequent CEO of being co-lead of many of our strategic review efforts and strategic initiatives. Bob's promotion is a part of a strategic succession plan to bring in an innovative leader who will continue to guide the company going forward. I want to congratulate Bob and, Bob, I look forward to continuing to work with you as I have in the last 10 years, as we continue to track record of delivering strong financial results and continuing to position Paychex as a leader and innovator, and a company that you can count on for predictable and sustainable results. Now, moving on to the first quarter results, speaking of predictability and sustainability. We have begun the fiscal year '24 with solid growth of 7% in total revenue and 11% in adjusted diluted earnings per share. We've seen operating margin expansion approximately 60 basis points year-over-year, while still investing in our business to drive future growth. Our first quarter reflected solid execution by our sales, service and all of our teams across Paychex. The demand for our HR technology and advisory solutions continued, resulting in strong quarter new sales, revenue growth. We saw positive trends in client, revenue and HR outsourcing worksite employee retention during the quarter, and we continue to focus our resources on acquiring and retaining high-value clients. We are starting to see improvements in some of our key PEO and insurance metrics during the quarter, with good results across sales activity, insurance attachment and retention. We will know more after our open enrollment season is completed, which primarily runs from October through January, but at this time, we believe that the actions we have taken in response to the headwinds we faced in 2023 are beginning to gain traction. Employment levels within our client base have remained stable. Small businesses, which are central to the U.S. economy, continue to show resiliency. Our Small Business Employment Watch has shown that small businesses continue to add workers at sustained, but modest rates, and the trend in wages is showing some cooling in wage growth consistent with overall inflation. Our data indicate a continued stable macro-environment for small and mid-sized businesses. We continue to monitor our leading indicators and are prepared to take appropriate actions to navigate any changes. But again, at this time, we don't see any material change to the macro-environment. Small businesses have faced challenges getting access to capital and managing cash flows in this environment. This has continued to drive demand for our full-service Employee Retention Tax Credit Service. I know there's been some recent news of the IRS pause in ERTC processing in order for them to perform increased audits. This is not expected to have an impact on our ability to provide the service, though it may take longer for our clients to receive their funds. We continue to communicate this opportunity to existing clients and prospects and we continue to file amended returns with the IRS on their behalf. We anticipate that ERTC revenue will be a slight tailwind for the first half of the fiscal year and then turn to a headwind in the back half as the program ends. We are seeing greater adoption of HR software as businesses look to digitize their HR efforts to support the complexities of managing today's workforce in a more efficient manner. We also continue to see strong demand for our HR advisory solutions as businesses deal with the continued challenges of being an employer in today's challenging employment world. Paychex is uniquely positioned to offer a continuum of HR products, technology, and services from do-it-yourself payroll all the way to full-service PEO HR outsourcing. All of these products deliver a strong return on investment for our clients. For the 13th year in a row, we were named the leading retirement record-keeper by number of plans by PLANSPONSOR Magazine. Our leadership position in retirement makes us an excellent resource for small businesses and we continue to educate and execute on this opportunity. There have been several advances in AI and related technology and advancements around the monetization of large datasets. At Paychex, as we've talked on prior calls, this isn't anything new; we have been using artificial intelligence to transform our business for over a decade. We have over 200 AI models that are actively working on our business today, designed to provide valuable insights, fueled by our vast data assets. Our award-winning Retention Insights tool uses AI-based predictive analytics to provide HR leaders with early insights into potential employee retention issues. Our Flex Intelligence Engine is an embedded AI chat capability within our Flex platform that allows the customer to get quick answers to over 900 of the most common questions and access over 1,200 instructional resources. Companies like Paychex with large amounts of data will clearly be the winners with AI, and we will continue to harness the power of AI and leverage our extensive data to drive internal efficiencies and provide actionable insights and solutions to our clients. This quarter, we continued to be recognized for our innovation, service, and the positive impact we are having on our customers, our industry, and the world. For the third time, Paychex has been recognized by TrustRadius with a 2023 Tech Cares Award for the company's Corporate Social Responsibility programs and our community impact. We also received an award from Selling Power for our commitment to fostering a diverse and inclusive workforce, and from Forbes as one of the Best Employers for Women in 2023. On the product and service side, NelsonHall, once again, identified Paychex as the leader in its 2023 Next Generation HCM Technology Market Report. We also earned a silver Brandon Hall Group 2023 HR Excellence Award for breadth and depth of training that we provide our HR advisors to keep them up to speed on the ever-changing complexities of the employer-employee relationship. Paychex was also named in the 2023 Constellation Research on their ShortList for best payroll for North American small and mid-sized businesses. The depth and breadth of our product suite provide American businesses the freedom to succeed with the technology and advice that they desperately need to remain competitive in a very complicated world. I want to thank our over 16,000 global employees who consistently deliver for our clients and our shareholders. It's because of them that we are off to such a good start this fiscal year. I'll now turn it over to Bob Schrader to give you a brief update on our financial results for the first quarter. Bob?
Bob Schrader, CFO
Yeah, thanks, John, and good morning. It's good to be here with you this morning, and I certainly look forward to working with each of you as we move forward. I'd like to remind everyone that today's commentary will contain forward-looking statements; those involve risk. And we will refer to some non-GAAP measures. I'll refer you to our customary disclosures in our press release and our investor presentation that will be posted later today. I'll start providing a summary of our first quarter results and I'm going to turn it over to Efrain, he'll give an update on our financial position and updated guidance for the year. Total revenue for the quarter increased 7% to $1.3 billion. Management Solutions revenue increased 6% to $956 million, primarily driven by higher clients and client employees, product penetration, price realization and HR ancillary services. We continue to see increased attachment and demand for our HR Solutions, retirement, and time and attendance solutions. PEO and Insurance Solutions revenue increased 5% to $298 million, driven primarily by higher revenue per client and higher average worksite employees. As John mentioned, we definitely saw some positive momentum in the PEO in the first quarter as it relates to both sales activity in medical plan participation and attachment; those were obviously headwinds last year, and we are definitely seeing some positive signs as we move through the first quarter here. Interest on funds held for clients increased 83% to $33 million, primarily due to higher average interest rates. Total expenses increased 5% to $750 million. Expense growth was largely attributable to higher compensation costs, PEO direct insurance costs and investments that we've made into the business. Operating income increased 8% to $536 million, with an operating margin of 41.7%, that's a 60 basis point improvement versus the prior year period. And diluted earnings per share increased 10% to $1.16 per share, and adjusted diluted earnings per share increased 11% for the quarter to $1.14 per share. I'll now turn it over to Efrain to take you through our financial position and our updated guidance for the year.
Efrain Rivera, CFO
Thanks, Bob, and good morning to everyone on the call. Before I start, just wanted to say thank you, John, for the generous words. It's been an absolute professional privilege and honor to have been with Paychex during all this time. As you all know, we maintain a strong financial position with high quality cash and earnings. Our balance for cash, restricted cash, and total corporate investments with more than $1.7 billion. Total borrowings were approximately $812 million as of August 21, 2023. Cash flows from operations were $656 million for the first quarter, driven by net income and changes in working capital. There was some influence of timing there. It wasn't quite as strong as the percentages would indicate, but nonetheless, it was a very solid quarter. As you know, our earnings quality, which some of you have pointed out, is among the best candidly in the entirety of the S&P 500. In the first quarter, we acquired a small company that purchases outstanding accounts receivable of their customers under non-recourse arrangements. This acquisition is a good strategic fit with another business that we have called Paychex Advance, and that business purchases accounts receivable for temporary staffing clients. This acquisition will provide an opportunity for our small business clients to manage working capital challenges. As John alluded to earlier, we've seen over the last several years that access to financing is very important for small and medium-sized businesses. We think this plays well into our portfolio of businesses that we have. I'm very excited to have it. The acquisition, at this stage, is not anticipated to have a material impact on our financial results this year. We paid a total of $322 million in dividends during the first quarter. Our 12-month rolling return on equity was a stellar 47%. Now, let me turn to guidance for the fiscal year ending May 31, 2024. I'm going to give you color on not only the full year, the first half and the second half, and we typically do that at this stage. Our current outlook is as follows: You saw that Management Solutions still expected to grow in the range of 5% to 6%. PEO and Insurance Solutions expected to grow in the range of 6% to 9%. Interest on funds held for clients now, as I have mentioned, expected to be in the range of $140 million to $150 million, raised from our previous guide of $135 million to $145 million. Total revenue is expected to grow in the range of 6% to 7%, but now we think this is likely towards the high end of the range. So, operating income margin is expected to be in the range of 41% to 42%. Other income net is expected to be income in the range of $30 million to $35 million. The effective income tax expected to be in the range of $24 million to $25 million. Adjusted diluted earnings per share is expected to grow in the range of 9% to 11%, and this is raised from our previous guide of 9% to 10%. This full year outlook assumes current macroeconomic conditions, which has some uncertainty surrounding future interest rate changes and their impact on the economy. And I would just say, it's been almost six quarters where we keep saying, 'Hey, we don't know what's going to happen in the back half of the year and it could change our outlook.' I think John summarized it very well. At this point, things look pretty stable. So, we are feeling directionally more and more confident in the back half. Projecting the second half of the year, we anticipate total revenue growth of approximately 7% and operating margin in the range of 42% to 43%. I heard some comments when we released guidance that we have a ramp in the back half of the year. I wouldn't describe our current guidance as a significant ramp in the back half of the year. Obviously, there are differences in the back half of the year that we'll navigate through, but the difference between the first half and second half is not dramatic. All of these comments are subject to our current assumptions, which are subject to change. We will update you again on the second quarter call. So, let me just repeat a couple of things to make sure. First half 2024 total revenue growth in the range of 6% to 7%, operating margin in the range of 40% to 41%. And then, in the second half at this point, we anticipate total revenue growth to be approximately 7%, operating margin in the range of 42% to 43%.
John Gibson, President and CEO
Well, thank you, Efrain. Before I open the call for questions, probably two things. One, we have a lot of people here, and the last time Efrain did a great job of providing rules on questions, particularly on compound questions and multiple follow-ups. So, we could just follow the Efrain rule in honor of Efrain's retirement. I know he would greatly appreciate it, and maybe we can create a new tradition here. But no, feel free to asking your questions. But I would like to also add, make everyone aware, there's many ways you can learn more about Paychex, and really the amazing success stories and the impact that we are having on the world. We've recently launched a series of reports that you can find on our Investor page both our annual report, our ESG report, and a new client impact report, and very shortly, you'll be seeing a new Investor Relations 101 Presentation that will be launched on the website prior to our Annual Meeting in the coming weeks. And again, I think these documents provide a lot more color and really a lot more insights into just how significant, how broad our products are, how big an impact we are having on our customers, how big an impact we are having on our employees, how and why Paychex is known as one of the most admired, most ethical, and most innovative companies in the world, and I encourage you to check that out. So, with that advertisement for our Investor website, Shelby, you can now turn it over for questions.
Operator, Operator
And we'll take our first question from Ramsey El-Assal with Barclays. Your line is open.
Ramsey El-Assal, Analyst
Hi. Thank you for taking my question, and congratulations to you, Efrain.
Efrain Rivera, CFO
Thank you.
Ramsey El-Assal, Analyst
We will certainly miss hearing your voice on these calls. I was wondering if you could comment on the relatively high interest from corporate investments in the first quarter, and whether it seems likely that this will carry through for the full year in terms of recurring figures for each quarter. Could you discuss the contribution to other income and how you anticipate it trending for the remainder of the year?
Efrain Rivera, CFO
Sure. There are a few factors that influence that line beyond just what everyone might be focusing on. It's mainly our interest expense, interest income from corporate portfolios, and some gains and losses from our small investment fund. These elements can vary throughout the year and depend on our projected corporate funds balance. We made an acquisition, which means our average corporate balances will likely decrease this year, resulting in lower interest income. Additionally, the gains and losses on that other investment can fluctuate from quarter to quarter due to mark-to-market adjustments. There might be some variability in that number. I should also mention that we ended with a relatively high cash balance due to timing, as it was influenced by the day we closed the quarter. As the year progresses, our cash balances are expected to be lower, which could also affect the overall figure.
Ramsey El-Assal, Analyst
Okay. Fantastic. And a quick follow-up. If you could talk about SECURE Act 2.0? How you see that evolving? And how you see that potentially — presumably benefiting the business over time?
John Gibson, President and CEO
The SECURE Act 2.0 is a significant initiative by the government that supports small and mid-sized businesses in providing retirement plans for their employees. We are actively educating the market about the opportunities this creates. It allows businesses to implement a 401(k) plan and receive tax credits for setup and implementation fees, as well as for employee matching contributions. Our 401(k) business is experiencing strong growth, and we have learned from previous state mandates that educating the market about the costs and benefits of 401(k) plans is essential. We are committed to this educational effort and believe that the SECURE Act 2.0 will help us maintain the double-digit growth we've seen in our retirement business in recent years.
Ramsey El-Assal, Analyst
Fantastic. Thank you very much.
Operator, Operator
And we'll take our next question from Andrew Nicholas with William Blair. Your line is open.
Daniel Maxwell, Analyst
Hey, good morning, guys. This is Daniel Maxwell on for Andrew today. To start off, I was hoping you could dig in a little on any changes to the dynamic between ASO and PEO, and whether over the past couple of months, you've seen any preferences shift on that. You called it out the last couple of quarters, and I was wondering, if anything changed.
John Gibson, President and CEO
We continue to experience strong demand for our HR outsourcing solutions overall. The balance is trending back to pre-2023 levels, with less emphasis on ASO. We are seeing a more traditional balance between ASO and PEO. As mentioned in our previous call, we’ve adjusted our PEO product portfolio, which has contributed to this balance. Furthermore, when we previously had a higher focus on ASO, we viewed it as an opportunity to approach those customers for potential upgrades to our PEO product. We are utilizing AI tools to identify ASO clients who could benefit from a PEO relationship for various reasons, and this initiative has shown positive results in the first quarter. Although it is still early, the number of customers we transitioned from ASO to PEO in the first quarter was almost double compared to the same period last year. We are also acquiring new clients, and our PEO sales have shown strong double-digit growth in the first quarter, providing us with multiple advantages.
Daniel Maxwell, Analyst
Great. Good to hear. And then for my follow-up, any detail you can give on the increase to the direct insurance costs from workers' comp? Any color or reminder of your exposure to any volatility in that area?
Bob Schrader, CFO
Yeah, this is Bob here. I mean, we obviously take risk in the PEO business on workers' comp. Obviously, we are very prudent in managing that risk and picking on which risk we are willing to take. I'd say there is growth in the quarter, primarily driven by growth in worksite employees, and that is going to drive higher workers' compensation costs. We go through every quarter and do true-ups of our reserves and so forth, but nothing specific to call out other than growth in the business that would drive growth in direct costs.
John Gibson, President and CEO
Yeah. There has been no change to our underwriting standards. There's no change to our programs in terms of caps and limits, and there is no real change in the overall program performance.
Daniel Maxwell, Analyst
All right. Thanks a lot, guys, and congrats again to Efrain on your retirement and Bob on your promotion.
Bob Schrader, CFO
Thank you.
Operator, Operator
And we'll take our next question from Bryan Bergin with TD Cowen. Your line is open.
Bryan Bergin, Analyst
Hi. Good morning, guys. Thank you. Efrain and Bob, let me echo my congrats as well. Efrain, it's been nice working with you here. Enjoy your retirement.
Efrain Rivera, CFO
Thank you.
Bryan Bergin, Analyst
I got to ask the question because we've gotten a lot of questions, just as it relates to ERTC. So, it doesn't sound like you have any change in your fiscal '24 revenue expectation there surrounding ERTC after this recent IRS announcement, but can you just dig in there a little bit more since there have been a lot of questions? Is there any evidence of any clients wanting to potentially delay submitting new claims there? Any dynamic there to be mindful of?
John Gibson, President and CEO
Listen, Bryan, appreciate the question. Look, ERTC was in line with our expectations in the first quarter. We continue to submit. No one is wanting to delay. The program is going to end. The IRS announcement is not stopping anyone's efforts — our efforts in approaching clients who are assisting and then filing the tax credits. In fact, the IRS specifically commented to clients and small business owners that they should seek trusted partners to complete their filings. The IRS pause in processing that, and accepting. So they're accepting filings. It's really due to some just bad actors out there that are providing bad advice to small businesses and putting them at risk. I talked about this probably a year ago when this started when these little pop-up companies started to show up. And again, I think the IRS is trying to do a prudent thing to tamp down on fraud and also to make sure these small businesses are not getting bad advice from these pop-up firms. So, we actually are continuing to accept and encouraging our clients and prospects to file, and we provide a service where we are confident that the advice we are giving them is adequate and will continue to try to get their processing done before the filing deadline early next calendar year. The delay impact for the client is really going to be in the processing, which is really going to be when they get the refund.
Bryan Bergin, Analyst
Okay. Very good. That's clear. And then, my follow-up, just on the target here. Can you share as it relates to the M&A the financial profile of this target? Just any revenue attribution to call out now included in the current year outlook? I did hear you mention, I believe, the upper end of your growth range. But just wanted to confirm there were no organic offsets of that.
Efrain Rivera, CFO
Not really, Bryan. I mean, it will contribute a modest amount of revenue, we'll call it out as we go through the year. But it's not masking something or additive in that respect. I think there's a number of different vectors of growth within the company that are working pretty well.
Bryan Bergin, Analyst
All right. Thank you.
Efrain Rivera, CFO
Yeah, you're welcome.
Operator, Operator
And we'll take our next question from Ashish Sabadra with RBC Capital Markets. Your line is open.
Ashish Sabadra, Analyst
Thanks for taking my question. And Bob and Efrain, congrats to both of you. Just on my question, I wanted to better understand the raising of the guidance and confidence in the back half. Is that both on Management Solution as well as PEO? Any color on that front? Thanks.
Efrain Rivera, CFO
Yeah. So, one is, I'd say, process and structural, and then the second is the substance of what we saw in the first half. The process and the substance is simply that, at a point in time you're taking a snapshot and saying, okay, when we issued the guidance back four months ago, we had a certain set of macro conditions. We didn't know if those would hold at that point. The macro conditions, as John said earlier, haven't changed significantly. We fast forward four months and now we have more certainty as to what environment we are looking at, at least in the medium-term. Medium-term being three to six months. The second part is, we look at the trends in the business where we close, where we correct in terms of the trends that we saw. You heard some of the comments that John said on the PEO. Much of that was what we expected from an execution standpoint, but it's one thing to expect it, it's another thing to deliver it, and thus far we've started on a good note. So, those are two parts of it. So, by the time we get to September and we are in the October now, we know with reasonable degree of certainty what Q2 looks like. We project forward into the back half of the year and do we feel reasonably confident based on the combination of all the factors that we are seeing that the back half expectations will be as we expect? As we sit here, the answer is yes. So, as you look at the guidance, it anticipates that PEO will strengthen in the back half of the year.
John Gibson, President and CEO
Yeah, just to add on to that, I think every business has a rhythm, and the third quarter is critical. That's our selling season. What the macro environment will be in the third quarter, fourth quarter is all the things we are trying to guess. I think what I would characterize it at this point in time is when we left the fourth quarter, I talked about the second half of our last fiscal year, we actually saw new sales bookings, both in Management Solutions and the PEO and Insurance accelerating. We continue to see that double-digit momentum in the first quarter, HR outsourcing, ASO and PEO strong mid-market in the quarter, retirement is strong, digital payroll is strong. So, when we look at the demand environment, and then the employment environment with our index, set up to be kind of a repeat and continuation of what we saw in the second half and particularly the fourth quarter. Now, as it relates to the PEO business, we talked about insurance is a portion of that. Insurance attachment is part of the reason we have a little bit of a wider range; what you have to determine there is, how many companies continue to offer benefits to their employees? That's the first choice. The second choice is, how many of those employees sign up for health insurance, and what plans do they sign up for? So, we are only a quarter away through that decision process, which really is already started, about 25% of the way through. What I would say at this 25% away, we are running a little bit on par where we expected. I mean, we are only a quarter way through, so we still have three quarters to go and we are in the middle of our open enrollment, which is critical there. But good early signs. We had good signs in the PEO in the fourth quarter, and we've talked about that on the last call, and that just accelerated in the first quarter. So, now we just got to see if that can continue into the core selling season.
Ashish Sabadra, Analyst
That's a great color. And maybe if I can just ask a quick follow-up question on the commentary on the PEO side on the improved insurance attach rate. Obviously, last quarter you had also talked about a leaner product, and I was wondering if that's driving better adoption, or you are seeing just better demand for the insurance product? Thanks.
John Gibson, President and CEO
I would say that we have made numerous adjustments to our approach to insurance, focusing on the analytics related to targeting customers who can benefit from our value proposition. We have updated our technology, changed our advisory methods, and expanded the product options available to both employers and employees. Additionally, we have enhanced our educational tools, which has led to increased engagement with our HR advisors and clients. After reviewing everything we experienced in the first quarter last year, our team has done an excellent job, and while we are still early in the process, we are already seeing positive outcomes from these efforts. I believe the demand for insurance will be noteworthy. We were very satisfied with our renewal rates, and with the current discussions in the media about health inflation, we usually see more customers looking for alternatives, and we believe we have a strong value proposition to offer.
Ashish Sabadra, Analyst
That's great color. Thank you.
Operator, Operator
And we'll take our next question from Scott Wurtzel with Wolfe Research. Your line is open.
Scott Wurtzel, Analyst
Great. Good morning, guys, and thanks for taking my question. Maybe just going back to the acquisition. I'm just wondering if you could maybe give a little bit more color on the strategic rationale behind it and why now with this deal relative to some of the other targets that you were looking at? Thanks.
Efrain Rivera, CFO
Well, I'll bracket it in three ways. The first thing is that, as John alluded to, the ability for small businesses to access funding is important. So, we had our eyes on building our capability in that area. The second thing is, acquisitions, as you would know, don't always present themselves with exactly the timing when you would expect them to, and when an opportunity arises, you do what you need to do to take advantage of it. We saw an opportunity for a high-quality asset and decided that it was the right time. The third is, it’s an interesting environment for small businesses, where access to funding opportunities is becoming trickier given what has happened with banks and rising interest rates. We think the timing seemed to fit pretty well. Again, I don't spend too much time on it. It's a relatively modest acquisition based on our revenue side, but we think we've had a lot of success with our Paychex Advance acquisition, and it's a very profitable corner of the market. We think we can do the same thing with the company that we bought.
John Gibson, President and CEO
Yeah. And I would just add, neither one of these things are new to us. When COVID hit, if you remember the PPP program, we put a program together, and that started a partnership with several fintechs. We did both technology, integrations, et cetera, and that led to more of a partnership approach. We have several partners that if we have clients that meet our risk profile and are wanting to fund payroll or something like that, we've got partners that we can introduce them to. We got kind of introduced to this concept. And the macroenvironment with rising interest rates, many of our strong customers have struggled to get access to capital at affordable rates. So, we thought there was an attractive opportunity for us to potentially help them grow their business. We've already been introducing them to partners. Why not introduce them to ourselves and get a piece of that action? So that was kind of the strategic rationale, and it’s a small acquisition.
Scott Wurtzel, Analyst
Got it. That's super helpful. Thank you. And then, just as a follow-up. I mean, just one quickly on the float portfolio. When we think about the recent Fed commentary and dot plot showing maybe a sustained higher rate trajectory than maybe we were expecting a few months ago. I know you've talked about in the past wanting to position the portfolio more on longer duration securities. I was just wondering if this recent Fed commentary sort of gears you even more towards longer-duration securities in the portfolio rather than shorter duration? Thanks.
Efrain Rivera, CFO
Yeah. We are reviewing monthly to figure out based on and looking at the same dot plots you are to see what happens. I would just go back to something I've said since the point that the Fed started raising rates. The problem isn't taking advantage of the rates going up; the problem is what happens when it comes down. We are positioning the portfolio, and I'm sure Bob will do the same, to be able to manage it in an orderly way on the way down. So, we are looking at - this is a time when you want to go longer, even if perhaps there are opportunities on the short end of the curve, because at some point it will come up, and we've got to figure out how best to manage that, and that's what we are working on.
Scott Wurtzel, Analyst
Great. Thank you, and congrats, Efrain.
Efrain Rivera, CFO
Thank you.
Operator, Operator
And we'll take our next question from Tien-Tsin Huang with JPMorgan. Your line is open.
Tien-Tsin Huang, Analyst
Hey, good morning. Thanks. I just wanted to follow up on the acquisition, the $200 million acquisition here, and the strategic fit with Paychex Advance. I remember when that deal was announced there was a lot about payroll funding and factoring and what not. Is this now more about early wage access and some of the more modern funding opportunities for employees? Just want to make sure I understand what you're adding specifically here.
Efrain Rivera, CFO
The short answer is no. That's a separate initiative. We will discuss it more when it becomes significant. Tien-Tsin, this initiative is primarily focused on receivables. However, we see a broader opportunity because all of our clients, to some extent, deal with receivables, which can serve as a source of financing.
Tien-Tsin Huang, Analyst
Okay, very clear. So, this is an AR opportunity?
Efrain Rivera, CFO
Yeah.
Tien-Tsin Huang, Analyst
Understood, okay. No follow-up for me. Just want to wish you, Efrain, all the best, of course, for the next chapter. And I've said it before, you've been really helpful for us for a long time. So, thanks for that. I'm definitely going to miss talking to you.
Efrain Rivera, CFO
Thanks, Tien-Tsin.
Operator, Operator
And we'll take our next question from Peter Christiansen with Citigroup. Your line is open.
Peter Christiansen, Analyst
Good morning. Welcome, and congrats to Bob, and certainly congrats and thank you to Efrain. John, I wanted to dig a little bit into your thoughts on SMB lending in general. Obviously, this news of big money center bank is getting into the payroll business a bit more and SMB lending is often thought of as a nice adjacency here. Should we consider the possibility that Paychex may further delve into SMB lending, whether it would be merchant cash advances or other types of working capital solutions? You see that in Paychex's future?
John Gibson, President and CEO
No, well look, I think what we are trying to do is make sure that we are focused on what do we need to do to help our clients succeed. As I said, whether that's through partnership or if there's opportunities for us to participate in that process integrating that with our technology. Those are really the things that we are interested in. We hear our clients, and we engage those clients through our advisors on a constant basis, say, this is an issue for them. We go and search for answers, and partnerships are part of that. Most of these clients are just not getting access to the funds at affordable rates. We are going to try to figure out how we can build partnerships to do that.
Peter Christiansen, Analyst
Well, thank you. That's super helpful. And then just as a follow-up, just wondering if you could call out any trends balance of trade-wise, are there areas where you see Paychex has an opportunity to improve the competitive dynamics or vice versa some areas where you're a bit more on defense versus offense? Just any sense on balance of trade versus some of your competitors and maybe some of the regionals as well?
John Gibson, President and CEO
Our sales momentum from the first quarter has continued into the second quarter. On the macro side, I’m not observing any significant changes in balancing trade within the competitive landscape. I mentioned the fourth quarter earlier, and upon reviewing, I would say conditions are slightly more favorable for us in certain key competitive areas that we track. We had a solid first quarter in the mid-market, with several positive indicators, though it's not a groundbreaking shift. The market remains stable with a competitive environment. It's a competitive marketplace overall, and I believe we are capturing more than our fair share.
Peter Christiansen, Analyst
Yeah, for sure. Thanks again, and congrats, Efrain. Good luck.
Efrain Rivera, CFO
Thank you.
Operator, Operator
And we'll take our next question from Bryan Keane with Deutsche Bank. Your line is open.
Bryan Keane, Analyst
Hi, good morning. I wanted to ask about the free cash flow increase year-over-year in the first quarter; it was substantial. I think it was up over 23%. How much of that was one-time in working capital? And how much should that carry through the fiscal year? Or should we see a decreasing kind of growth rate in free cash flow to equal out the same growth of the 9% to 11% earnings growth by the time we get to the end of the fiscal year?
Bob Schrader, CFO
Yeah, Bryan, this is Bob. I mean I think that's a fair way to think about it. We typically don't have big swings in our working capital, and as Efrain mentioned, we had a little timing influence there at the end of the quarter. The quarter ended on a big collection day, so we had a big influx of cash that would go out the next day. The way to really think about our operating cash flows and then, obviously, free cash flow gets impacted by M&A. There was a little bit of an impact there in Q1 to free cash flows. But typically, our operating cash flows growth is going to trend in line with our net income growth. And so, you'll see that moderate as we move through the year and that's what you should expect from a growth standpoint.
Bryan Keane, Analyst
Got it. And then just a follow-up. I was hoping to get an update on what you guys are seeing for SMB bankruptcy rates. I know they have been a little bit elevated in the recent past here. And just curious if that's still at elevated levels or has it become more normalized?
John Gibson, President and CEO
When we refer to elevated levels, we mean that they are higher than what we experienced during the COVID period, which lasted about two to two and a half years. Bankruptcies are currently slightly below pre-pandemic levels and are moving toward a more normalized rate. This trend is particularly evident in start-up businesses. During the significant startup boom, we noticed an increase in bankruptcies among very small businesses, as mentioned in our press release. Revenue retention is at nearly record levels, and our HR outsourcing businesses are also performing at record levels. On the bankruptcy front, an interesting statistic from the first quarter is the increase in new business starts. After experiencing a high level, we have returned to more normal levels, but we actually observed a rise in new business starts in the first quarter, which was intriguing.
Bryan Keane, Analyst
Got it. Great. And Efrain, it's been a real pleasure working with you. You'll be missed.
Efrain Rivera, CFO
Thank you, Bryan. Appreciate it.
Operator, Operator
And we'll take our next question from Samad Samana with Jefferies. Your line is open.
Samad Samana, Analyst
Great. Thank you. Efrain, I'll echo, missing working with you and enjoy a well-deserved retirement, sir. Appreciate all the help over the years.
Efrain Rivera, CFO
Appreciate it.
Samad Samana, Analyst
Maybe just a quick one for me. A lot of the questions have been asked. But just how are you guys seeing the top of the funnel in terms of inbound leads, the digital channel? Any change in maybe interest levels, registrations for webinars, just anything that we can look at as a leading indicator of bookings? And how has that trended in the first quarter?
John Gibson, President and CEO
If our sales are increasing at double-digit rates in the first quarter, it's clear that digital is becoming a larger part of that business, which indicates its growth as well. We continue to observe a strong demand environment across all sectors, both digitally and otherwise. That's about it.
Samad Samana, Analyst
Great. And then maybe on your own hiring plans with the quarter doing better than expected and maybe some trends you're seeing, any change to your own sales hiring plans or should we expect maybe the original game plan to stay?
John Gibson, President and CEO
No, really no change in plans. We are certainly, in the second quarter, always staffing up and making sure we are fully staffed to cover any thought or planned attrition going into the selling season, both on the service side and the sales side. I think it's fair to say when you add now going on close to three quarters of strong demand, you want to make sure that we are properly staffed to take full advantage of all the opportunity in our selling season and we are fully staffed on the operations on the service side to make sure that we can cater to these clients during year-end.
Samad Samana, Analyst
Great. Appreciate you taking my questions. Thank you.
Efrain Rivera, CFO
Thank you.
Operator, Operator
And we'll take our next question from Eugene Simuni with Moffettnathanson. Your line is open.
Eugene Simuni, Analyst
Thank you. Good morning, guys, and congratulations, Efrain and Bob.
Efrain Rivera, CFO
Thank you, Eugene.
Eugene Simuni, Analyst
Efrain, we will miss working with you, and Bob look forward to working with you. Just have two quick follow-ups. One tying together your comments on sales and current, can you comment on how it adds together to client growth trends this year so far? Last year, it was a bit below your historical target range, and I think you commented that last quarter that this year you're looking for a reacceleration in client growth kind of above 2% a year. So, can you comment on how it's going so far?
Efrain Rivera, CFO
Hey, Eugene, I'll start, then John can add his thoughts. If I were to give you a number, it might create a misleading perception. It's quite challenging to reach any conclusions at this stage in the first quarter. While there are some positive trends that suggest potential projections for the year, our client base is quite unpredictable. This is primarily due to the significant fluctuations in client acquisition and loss during the selling season, making predictions difficult. We anticipate performing slightly better than last year, but it’s still early in the year.
Eugene Simuni, Analyst
Got it. Okay. And then, another follow-up is on the PEO and the question there is, in your PEO customer base, in terms of kind of checks per control, are you seeing any trends that are different from your overall base, whether better or worse employment growth?
John Gibson, President and CEO
Yeah, I would say it's probably consistent. We definitely see employees in our PEO clients adding employees. I wouldn't say it's a huge tailwind, but it's positive and probably in line with what we are seeing in other areas of the business.
Eugene Simuni, Analyst
Got it. Okay. Thank you very much, guys.
Efrain Rivera, CFO
Thank you.
Operator, Operator
And we'll take our next question from Mark Marcon with Baird. Your line is open.
Mark Marcon, Analyst
Hey, good morning. Hey, Efrain, we go back a long way as it's been an absolute pleasure working with you.
Efrain Rivera, CFO
Same here.
Mark Marcon, Analyst
I want to thank you for the relationship. And Bob, looking forward to working with you, but Efrain, it's been an absolute pleasure.
Efrain Rivera, CFO
Thank you.
Mark Marcon, Analyst
There have been many questions about the short term. John, here’s a broader question. A quarter ago, everyone was inquiring about AI. Clearly, Paychex has been utilizing AI for quite some time. I'm curious if you could share your thoughts on how the recent advancements in large language models have influenced your ongoing journey with AI and what the long-term implications might be regarding margins or business scope.
John Gibson, President and CEO
Wow, that's a big question. It is a great one, because I really think this is probably has the potential to be one of the biggest differentiators that's going to help company like Paychex, separate ourselves from the rest. Because as you said, the large language models, it starts with large, and the only way that this works is you've got to have large sets of data and large sets of data coming through to continually train those models. I will also say relative to, it's expensive to do, and it's getting more expensive both in terms of finding the people and buying the technology. But let me just give you some idea. We have multiple teams across the organization looking at every aspect of our business, front-office, back-office, G&A, and evaluating how we could better leverage all of the capabilities of the data that we have. Think of it today; we are recording 6.5 million calls with our clients. This year, we are transcribing those calls. We are using analytics to determine whether or not we have a service opportunity, or if we have a sales opportunity or an upsell opportunity in the conversations that we are having with our advisors. We are already doing almost 1 million natural language processing and analysis on our sales conversations with prospects looking for what are the right phrases, words, markets, segments where we are winning. And then adjusting that overnight and changing our sales play the next morning. Using some of that in our PEO, we've nearly doubled our close rates in the first quarter. I mean, I just could go on and on about where we are piloting and testing and using our data to do this. I think there are tremendous opportunities. When you begin to productize this and start thinking about the value that we can provide, the Retention Insights, which we launched, I keep bringing this up. We launched this a year-and-a-half ago; we won an award for AI, and I think at the time, no one even wrote anything much about it.
Mark Marcon, Analyst
And then for my follow-up, just a quick question. Just in terms of the margin uplift from the first half to the second half, aside from normal seasonality and processing, is there anything to call out above and beyond that? Is it just pace of investments in the first half being a little bit front-end loaded?
Efrain Rivera, CFO
Yeah, I think that's it. Mark, it's a couple of things. One is, we have attended to front-load a little bit more of spending, in part to make sure that we are prepared for the selling season. Usually, in Q3, we have that influx of annual processing that generally makes Q3 margins higher, and in Q4, I don't anticipate it would be quite as heavy as it has been in prior years when you combine those two, you get a little bit more spending in the first half and a little less in the back half, but more revenue in the back half; that explains the margin uplift I mentioned, but there’s nothing unusual about it. It's just the way that revenue and expenses flow through.
Mark Marcon, Analyst
Terrific. Thanks again, Efrain. I'll miss working with you.
Efrain Rivera, CFO
Yeah, thank you.
Operator, Operator
And we'll take our last question from James Faucette with Morgan Stanley. Your line is open.
James Faucette, Analyst
Thank you very much. And I want to share my congratulations to Bob and Efrain. Just wanted to quick follow-up question here on PEO, and you had mentioned some of your customers, and I think you've talked about this and had pulled back on providing ancillary services like insurance and 401(k), et cetera. But now you're calling out some growth in those same ancillary services as the driver of PEO growth in the quarter. What are the things that you're watching for to gauge like the durability of that improvement and kind of responses by your customers and employers?
Efrain Rivera, CFO
So, James, you mean, what are we looking at...
James Faucette, Analyst
Yeah, like what are the things in a more macroeconomy or even in your customer behavior to try to gauge and project the durability of that improvement?
Efrain Rivera, CFO
Well, let me start, and then John can weigh in. If I were to give you a number, it would give you some sort of false sense of reality. It's almost impossible to draw a conclusion on that where you are in the first quarter. Some trends are positive, but the client base is tricky. The reason is you just lose so many and gain so many in the selling season that it's difficult to predict. We expect to perform a bit better than last year, but it's still early innings.
John Gibson, President and CEO
Yeah, I would say it's probably consistent. We definitely see employees in our PEO clients adding employees. I wouldn't say it's a huge tailwind, but it's positive and probably in line with what we are seeing in other areas of the business.
Efrain Rivera, CFO
Thank you.
John Gibson, President and CEO
Shelby, I think that wraps it up.
Operator, Operator
That concludes today's teleconference. Thank you for your participation. You may now disconnect, and have a wonderful day.