Earnings Call Transcript
PAYCHEX INC (PAYX)
Earnings Call Transcript - PAYX Q2 2025
Operator, Operator
Good morning, and welcome to the Second Quarter Fiscal 2025 Paychex Earnings Conference Call. Participating on the call today are John Gibson and Bob Schrader. After the speakers’ opening remarks there will be a question-and-answer period. As a reminder, this conference is being recorded, and your participation implies consent to our recording of this call. If you do not agree with these terms, please disconnect at this time. I would now like to turn the call over to Bob Schrader, Chief Financial Officer. Please go ahead.
Bob Schrader, CFO
Thank you for joining us for our review of the Paychex second quarter 2025 financial results. Joining me today is John Gibson, our Chief Executive Officer. This morning before the market opened, we released our financial results for the quarter ended November 30, 2024. You can access our earnings release and Investor Presentation on the SEC's website, as well as on our Investor Relations website. Our Form 10-Q will be filed with the SEC within the next couple of days. This teleconference is being broadcast over the Internet and will be archived and available on our website for approximately 90 days. Today's call will contain forward-looking statements that refer to future events and involve some risks. We encourage you to review our filings with the SEC for additional information on factors that could cause actual results to differ from our current expectations. We will also reference some non-GAAP financial measures; a description of these items along with the reconciliation of the non-GAAP measures can be found in our earnings release. I will now turn the call over to John.
John Gibson, CEO
Thanks, Bob. I will start today's call with an update on the business highlights for the second quarter and then I'll turn it back to Bob for a financial update and then, of course, we'll open it up for your questions. We delivered solid results in the second quarter and the first half of the fiscal year. Excluding the impact of the expiration of the ERTC program, revenue growth was 7% in the second quarter, as we continue to deliver a comprehensive suite of HCM solutions that help businesses solve real problems. Diluted earnings per share growth was 6%, as we continually find ways to operate the company more efficiently, while also enhancing the value proposition that we offer our customers. The demand for our HR technology and advisory solutions remains healthy, as we head into the key selling season. A challenging labor market and rising health care and benefits costs are forcing many small businesses to reevaluate their HR strategies and technology needs, and they can rely on Paychex to help them succeed. Our sales activities and pipelines are strong, most notably in our PEO and middle market HCM businesses where we have invested, as you know, to take advantage of the growth opportunities we see in these attractive markets and where we believe our breadth of solutions provides us with a competitive advantage. We’re fully staffed across our sales and service teams for this critical time of year. We are also investing in advertising to drive improved awareness and adoption of our expanded product offerings. Our PEO business continues to perform exceptionally well, driven by our robust value proposition as evidenced by solid worksite employee growth, due to strong sales performance, record levels of retention and higher overall insurance enrollment. While the underlying business is strong and our attachment and participation levels in our health plans across the country increased mid-single digits, enrollment in our Florida at-risk medical plan was flat year-over-year. We also saw more employees opting for lower-cost health plans in light of rising health care costs. These factors create a headwind to our pass-through revenue, but had no impact on our earnings or the strength of our PEO value proposition. Our revenue retention improved during the past year and remains above pre-pandemic levels as we continue to remain disciplined on acquiring and retaining high-value clients. Client retention has improved since last year, and retention in our HR outsourcing solutions remains near record levels. Client losses are down over the past year, with improvements across all our employee size segments. Our continued strong retention in a highly competitive marketplace speaks to the hard work and execution of our service teams and the strength of our value proposition. The pace of U.S. job growth has moderated over the past year, and overall customer employment levels have remained consistent with our expectations. Small and mid-size businesses remain resilient and are generally optimistic, as we head into a new year with hiring intentions in November rebounding to the highest level since last November. We continue to make investment in our product suite to help our customers solve their biggest problems. In October, we announced the Paychex Recruiting Copilot, a digitally AI-powered solution designed to help clients proactively find talent in a challenging labor market. Although it's still early, we are seeing momentum building for the product, as we head into the busiest time of year for hiring. According to a recent NFIB survey, 55% of small businesses reported hiring or trying to hire in November, and 48% reported few or no qualified applicants for the positions that they're trying to fill. This is something we're actively trying to address. We recently expanded our HR analytics offering to provide our customers with deeper and more meaningful insights. With the addition of the Premium Plus offering that we announced last month, businesses of all sizes now have access to real, current market data for compensation benchmarks to enable them to more effectively recruit, manage talent and develop growth strategies. Premium Plus also has a Generative AI assistant and a chat interface. We're pleased to report strong early adoption of our HR analytics solution, which we are planning to launch broadly to our PEO clients this month. Through AI insights, we are using generative AI to provide our customers with access to robust data and meaningful insights through simple, easy-to-use interactions. Since launching the product in September, we've seen a significant increase in customer engagement. Over 80% of the early adopters have actively engaged with the platform, and we've seen AI-focused usage increase significantly in the past three months. As a reminder, Paychex has used AI technology for many years and we believe GenAI offers a new set of opportunities for value creation, especially when paired with a large and high-quality data set. Paychex captures 14 billion data elements last year and we pay one in 12 private sector workers in the U.S., giving us one of the largest workforce data sets in the industry. Our vast and growing data set provides us with the ability to deliver actionable insights to customers and strengthens our competitive mode. Our clients can now leverage Paychex Flex Perks to compete for scarce talent more effectively. Perks is an award-winning digital marketplace that offers our clients’ employees access to affordable benefits and discounted products and services from third-party providers. Perks is available at no cost to employers and payments are processed automatically through payroll deductions. Since we launched the product in September, over 100,000 client employees have purchased at least one product offered in the marketplace. The value proposition of our new product innovation is resonating with our customers and also with industry experts. The Paychex Flex Perks was awarded the Top HR Product of the Year Award by HR Executive and also recently received a Brandon Hall Excellence in HR Technology Silver Award. Paychex was also recently named a leader in payroll services by NelsonHall for the eighth consecutive year. We were evaluated and placed in the Leader Quadrant for our ability to deliver immediate client benefit and meet future client requirements. To sum it up, we remain focused on our North Star and that simply is helping small and midsized businesses succeed. By offering the most comprehensive suite of HCM solutions, best-in-class advisory support and actionable insights gleaned from our large proprietary data based upon our long history of helping businesses. I will now turn it over to Bob to give us a brief update on our financial results for the second quarter.
Bob Schrader, CFO
Yes. Thanks, John, and good morning. I'll start with a summary of our second quarter financial results and then provide an update on our outlook for fiscal 2025. Total revenue for the quarter increased 5% to $1.3 billion. This includes the headwind from the expiration of the ERTC program of approximately 200 basis points, which is consistent with the expectation we shared with you last quarter. Excluding this headwind, as John mentioned, total revenue grew 7% in the quarter. Management Solutions revenue increased 3% to $963 million. This was primarily driven by growth in the number of clients served across our suite of HCM solutions, as well as client employees for HR solutions and higher product penetration, partially offset by lower ERTC revenues. PEO and Insurance Solutions revenue increased 7% to $318 million, driven primarily by higher average worksite employees and an increase in PEO insurance revenues. Interest on funds held for clients increased 15% to $36 million, primarily due to higher average interest rates and invested balances. Total expenses increased 4% to $779 million. This is due to higher PEO direct-generated costs related to growth in our average worksite employees and PEO insurance revenues, as well as continued investments in product innovation, data, AI, and our go-to-market initiatives. Operating income grew 6% to $538 million with an operating margin of 40.9%, which was up year-over-year approximately 60 basis points. And as a reminder, operating income is also impacted by the expiration of the ERTC program. Excluding that impact, operating margins would have expanded 180 basis points in the quarter compared to the prior year period. Diluted earnings per share and adjusted diluted earnings per share both increased 6% to $1.14 in the second quarter. Now let me quickly touch on the results for the first six months of the year. Total revenue grew 4% to $2.6 billion, which includes approximately 300 basis points of headwinds from ERTC as well as having one fewer processing days in the first quarter. Excluding these headwinds, total revenue grew 7% in the first half of the fiscal year. Management Solutions revenue increased 2% to $1.9 billion. PEO and Insurance Solutions increased 7% to $637 million and interest on funds held for clients increased 15% to $74 million. Total expense growth for the first six months of the year was 3% to $1.6 billion, and operating margins expanded approximately 20 basis points to 41.2%. And again, this is despite the ERTC headwind that we had in the first half of the year. Diluted earnings per share increased 4% to $2.32 and adjusted diluted earnings per share increased 3% to $2.30 a share. Our financial position remains strong with cash, restricted cash and total corporate investments of $1.3 billion and total borrowings of approximately $817 million as of November 30, 2024. Cash flow from operations was $841 million for the first half of the year, driven by net income and reflects changes in working capital, influenced by the timing of our quarter end. Through the first six months of the year, we returned a total of $810 million to our shareholders through cash dividends and share repurchases, and our 12-month rolling return on equity remains robust at 46%. I'll now turn to our guidance for the fiscal year. This outlook assumes the continuation of the current macro environment. And I assume most of you have seen in the press release, we are not making any changes to the guidance. I will, however, provide color on the guidance ranges for two of the line items. Total revenue is still expected to grow in the range of 4% to 5.5%, and as a reminder, this includes approximately 200 basis points of headwind from the expiration of ERTC. Management Solutions is still expected to grow in the range of 3% to 4%. PEO and Insurance Solutions is expected to grow in the range of 7% to 9%, due to some of the factors that John discussed earlier as it relates to our MPP enrollment in the state of Florida; we would now expect growth to be at the lower end of that range. Interest on funds held for clients is expected to be in the range of $145 million to $155 million, and other income net is expected to be income in the range of $30 million to $35 million. Operating income margin is expected to be in the range of 42% to 43%. However, we would now expect that to be at the higher end of the range. And our effective tax rate is expected to be in the range of 24% to 25%, and adjusted diluted earnings per share is still expected to grow in the range of 5% to 7%. Turning to the third quarter, we would anticipate total revenue growth to be in the range of 4.5% to 5%. This includes approximately 150 basis points of headwinds from the expiration of the ERTC program. This will be the last quarter of headwind as it relates to ERTC. So I'm looking very much forward to anniversarying that as we get to the end of Q3. We would also expect our operating margin to be between 46% and 47%. I think as most of you know, Q3 is our largest operating margin quarter. That's due to the fact that we benefit from our annual form filings. And of course, all of this is based on our current assumptions, which are subject to change and we'll update you again on the third quarter call. I'd also refer you to our Investor Relations website for more information in our investor slides. And with that, I will turn the call back over to John.
John Gibson, CEO
Thank you, Bob. We will now open the call to questions.
Operator, Operator
And we'll take our first question from Mark Marcon with Baird. Your line is open.
Mark Marcon, Analyst
Hi, good morning and happy holidays, John and Bob.
Bob Schrader, CFO
Thanks Mark. Happy holidays.
Mark Marcon, Analyst
Thank you. Wondering what you're seeing with regards to any sort of change in terms of business sentiment post-election. We did see the NFIB confidence index really jump up fairly materially. And I'm wondering if that's actually translating to events in the field just in terms of the pipeline build. Any commentary there would be really helpful.
John Gibson, CEO
Yes, Mark, this is John. Happy holidays. We continue to see moderate growth in small businesses, and looking at our index, it reflects the story of the year—essentially, the year that avoided the anticipated recession. I would say there is ongoing downward pressure on wages in small businesses, even though we don't observe any signs of a recession. You mentioned the uncertainty surrounding the election, which is now behind us. There certainly seems to be an improvement in optimism indexes, but we haven't yet seen that translate into positive momentum. However, job openings have increased, and our clients still have a strong desire to add employees. One of the main challenges, especially in the small market, remains finding qualified candidates. This is why we are implementing various solutions. Currently, while there is increased optimism, it has not yet resulted in any substantial change in the moderate growth we've experienced throughout the year.
Mark Marcon, Analyst
Thank you for that. And then my follow-up question relates to the PEO business. It actually looks like relative to all the public data that we see, it looks like you're actually growing the PEO business faster than some of the competitors that are out there. And what I'm wondering is, what are you attributing that to? To what degree are some of the new AI field solutions that you are offering helping? What are you doing on the insurance side that's really addressing some of the needs that you outlined?
John Gibson, CEO
Yes, Mark, I can tell you that our PEO is gaining market share. The demand we observe is evident, as our contracted revenue in the PEO rose significantly. Specifically, our new contracted revenue for the quarter was up considerably, and client additions also increased notably. This marks the second consecutive year of record retention in that segment. Our proposals experienced a substantial rise as well, indicating a lot of activity in the PEO market. It's important to note that health inflation is a concern, leading many to explore their options annually, as people will consistently seek the best choices available. You've raised a valid question about how we distinguish ourselves. We offer a comprehensive range of products and services that allow clients and prospects to remain with us even if their needs evolve, helping them to establish a strong reputation. We possess a robust ASO business and an excellent HCM business, which provides significant flexibility. Our Insurance Agency is also integrated within the PEO, enhancing our ability to meet clients' needs, particularly regarding pricing. While our PEO health plans offer numerous options, we recognize that we can't manage every possible option due to risk management constraints. However, if clients seek plans with higher deductibles that we don't provide, we can explore the open market for those solutions. Importantly, from both the client and employee perspectives, the experience during open enrollment, billing, and other aspects remains consistent whether they are PEO clients through our agency or enrolled in one of our master plans. We can efficiently manage transitions during the enrollment period. This broad suite of offerings truly sets us apart, allowing clients to consider Paychex a lasting partner as their business needs evolve.
Mark Marcon, Analyst
That’s great. Thank you so much. And again happy holidays.
Bob Schrader, CFO
Happy holidays.
Operator, Operator
Thank you. We'll take our next question from Bryan Bergin with TD Cowen. Your line is open.
Bryan Bergin, Analyst
Hi guys. Good morning. And happy holidays from me as well. I wanted to start on management solutions growth here. So I guess, like in total, I know you maintained all the growth ranges, and we appreciate the color on the PEO. Do you have an offset in the Management Solutions business that will offset that and help you maybe land favorably within the total range? Just curious where you feel most comfortable in the Management Solutions range.
John Gibson, CEO
Yes. I mean I think, Bryan, we gave you the guide. No change to the Management Solutions guide. I think we're comfortable with the range there. And yes, PEO is strong, but ASO has been strong as well. So we've been able to grow both of those businesses; I think when we look at new bookings, worksite employee growth for both of those businesses is upper single digits. I think we flagged that in the investor presentation. Retention is strong in both businesses. So we don't really see a trade-off. We've seen that in the past, maybe a trade-off between ASO and PEO. We did not see that this quarter; both businesses had strong growth. And then within Management Solutions, again, we continue to see strong product penetration. We have several businesses in that category; they grew double digits in the quarter. Retirement Solutions, our Funding Solutions business. So we feel good about the performance of both of those businesses, both for the quarter and then with the updated guidance ranges that we provided.
Bryan Bergin, Analyst
Okay. That's clear. And then just on ERTC. I know you were reserving revenue for this year given some proposed legislation. Was there any reserve release in the quarter here? And if not, how are you thinking about that going forward as that proposed retroactive legislation on the ERTC seems less likely?
John Gibson, CEO
Yes, Bryan, what you're referring to is the reserve we made last year in Q3 for the ERTC amount we sold in February when the proposed legislation put it at risk due to the program potentially ending retroactively at the end of January. We took a conservative approach and set that reserve aside, although it wasn’t a significant amount. We planned to release it this year and had carried it for a couple of quarters, but we no longer have that reserve on the books. This was considered in our guidance for Q2 and for the year, and we felt there was no justification to keep it any longer given there has been no movement on the legislation. Ultimately, it was a small, immaterial amount in the overall context.
Bryan Bergin, Analyst
Got it. Okay, happy holidays.
Bob Schrader, CFO
Yeah, same to you. Thank you.
Operator, Operator
Thank you. We'll take our next question from Ramsey El-Assal with Barclays. Your line is open.
Ramsey El-Assal, Analyst
Hi, thank you very much for taking my question. I think last quarter, you were contemplating something like 125 basis points worth of Fed cuts into guidance. You maintain that range despite the solid beat this quarter. I'm just curious about how we should think about that given what the Fed sort of announced yesterday, do you see this range being a little more conservative, perhaps?
John Gibson, CEO
Yes, we didn't have the opportunity to update our forecast based on yesterday's news, but our earlier forecast, as well as the current one, anticipated 125 basis points of cuts this year. Two cuts have already occurred: the 50 basis points in September and the cut in November, along with yesterday's cut. This means we have one more potential cut in the latter half of this year, depending on the update provided yesterday, which may or may not happen. There could be some slight upside, but it is not expected to have a significant impact given the timing of the year. That's the basis of our forecast.
Ramsey El-Assal, Analyst
Got it. Okay. And then you called out higher product penetration of the HCM products and management solutions, which is obviously an ongoing trend. Can you kind of give us an update on your growth algorithm? How much does HCM in totality contribute versus the core business? How has that sort of evolved over time? Just trying to put my finger on the pulse of the way that core key drivers of your growth have changed over time?
John Gibson, CEO
Yes. To be honest, there hasn't been a significant change. We discuss this in terms of total business. Historically, we've driven substantial growth through increased penetration, a larger share of wallet, and effectively monetizing our existing client base. This has likely accounted for at least half of our growth. We usually note it to be in the 3% to 4% range. When we analyze the penetration rates within our existing client base, we find they are still relatively low for some key solutions, especially in the PEO. Therefore, we see a lot of potential for growth through product penetration as we move forward.
Bob Schrader, CFO
I think the thing that the trend that continues and this quarter has continued for nearly a decade. Pure payroll has become less than 50% of what really is driving our business. It's really an HR story and a technology story. And when you get under it, we're very pleased with the product attachment that we're seeing in the products that really excited about the new market that we've opened up for ourselves, which is to monetize our clients' employees through our Paychex Flex Perks product we've been investing a lot of the ERTC money into this technology plan. It's basically a rewiring of our technology to be able to really position the clients' employees as customers of Paychex. We kind of did that before. Now we can do that. We built this marketplace. And when you think about starting the first initial launch or wave launch in September, and since that launch, we did a small trial. I think we opened it up to about 100,000 potential client employees. And now we started to open it up to the broader base that's on our Flex platform and in a relatively short period of time, six weeks, we have 100,000 customers. It's a small dollar amount, but it is a pretty impressive start to something we think has a lot of legs.
Ramsey El-Assal, Analyst
That is impressive. Thanks so much.
Operator, Operator
Thank you. We'll take our next question from Andrew Nicholas with William Blair. Your line is open.
Andrew Nicholas, Analyst
Hi, thank you and good morning. I wanted to ask about the upper single-digit growth in outsourced or HR outsourcing worksite employees. Is there any way for us to think about how much of that comes from upsell from clients with an existing payroll relationship versus clients that are new to Paychex entirely?
John Gibson, CEO
Yes. And maybe I will add on to the point that Mark made relative to the use of AI and how we are using AI. It certainly in the second quarter, we had a lot of increase inside the base. It’s a time when we have insurance renewal, so we're actually able to look across our client base and do analytics and AI about what they are paying for health insurance, both from our agency and others and then really target that with some sales plays to say, hey, we may have a good PEO value proposition with this client. So I think it ebbs and flows. We have a very solid both inside and outside the base capability in the PEO specifically. Almost all of our ASO business is inside the base upsell. But in the PEO, we had a good balance of performance, I would say, both outside the base as well as inside the base, tilted a little bit more inside the base, I would say, in the last quarter. But again, I would imagine that will rebalance itself out as we go through the second half of the year. Again, it's during that enrollment period that we really gin up the AI models to be able to look across our client base and figure out whether or not what's the best value proposition to target in off of them.
Andrew Nicholas, Analyst
Makes sense. Thank you. And then for my follow-up, just on the enrollment dynamic in Florida. Could you speak a little bit more if you have any insight in terms of what's driving that? And also if there is any way to kind of refresh us on the PEO business's exposure to Florida? Obviously, quite a bit of that came from Oasis over a half decade ago now. But just trying to get an understanding of how much of the business that represents at this point? Thank you.
John Gibson, CEO
Yes. I'll start, and Bob can add if needed. What drives our performance is us. The PEO results, including the flat at-risk MPP insurance revenue growth in Florida, should be seen positively by investors and clients. The pass-through revenue does not impact earnings. In the PEO business, we have actually increased insurance penetration, growing the percentage of clients and employees with insurance. We approached this cautiously by underwriting more conservatively due to rising costs and health cost volatility. We have options beyond the MPP plan in Florida; we have the agency as well. Overall, our insurance within the PEO saw mid-single-digit growth. It was flat in this particular program, partly due to intentional decisions. Our model allows us to offer alternatives to clients seeking plans that don't fit our 40 MPP offering. If we encounter a competitor with aggressive pricing, we won't take on that risk. Inflation in health costs is a real issue in the PEO space, especially when at risk, and we plan to manage it well while growing responsibly. I'm very pleased with the management team for striking the right balance between growth and risk. We achieved solid growth while better managing risks and increased insurance penetration across our base. These are all positive outcomes for me. The way revenue is recognized will be explained further by Bob regarding the accounting.
Bob Schrader, CFO
I would like to add that our business model is somewhat unique compared to others. We decided that insurance operates on a scale basis, and we have that scale in Florida. A few years ago, we strategically decided to take on risk with our medical plans only in Florida. This means that variations in our operations inside and outside of Florida could affect revenue. Overall, we are very satisfied with the ongoing strength of our PEO business. Earlier, someone mentioned competition, and I can confirm that our sales performance this quarter was robust, with strong retention and solid growth in worksite employees. However, MPP enrollment did not meet our expectations in Florida this year. When we look at the PEO clients using our agency medical plans in Florida, we saw upper single-digit growth. We are committed to making sound business decisions rather than chasing revenue numbers that aren't beneficial for the company. From a net service revenue or earnings perspective, as John pointed out, this situation would not have a significant impact. We feel confident about the sustained strength of our PEO business.
John Gibson, CEO
Yes, I would like to add that we observed this trend not only in the PEO but also in the insurance sector, where employees are opting to downgrade their plans. The percentage of downgrades has doubled and is now in the double digits, while it typically hovers in the single digits. Generally, once an employee selects a plan, they tend to stick with it and are reluctant to make changes. Usually, we see a small number of individuals choosing to downgrade their plans, but this time it was widespread. This health inflation is indeed significant. I want to emphasize the MPP revenue number. We have substantial control over that figure, and while we can achieve it temporarily, we can only sustain it for a short time before facing risks. We've witnessed similar situations in the industry before. As I mentioned, that's not our approach. We maintain discipline, explore our options, and will consistently pursue a measured approach to revenue growth in our business.
Andrew Nicholas, Analyst
Thanks so much.
Operator, Operator
Thank you. We'll take our next question from Michael Infante with Morgan Stanley. Your line is open.
Michael Infante, Analyst
Hi everyone. Thanks for taking our question. I just wanted to start on the partnership channel more broadly. If I think about one of your competitors striking an SMB partnership to embed some of their payroll capabilities alongside of some of their B2B payments capabilities. I'm just curious how you think about the partnership channel and whether or not that's a source of incremental investment for you. Thanks.
John Gibson, CEO
Yes. Look, we have a lot of partners. We have a lot of long-standing partners, including those in the payment space, some of which you're probably referring to. So we partner with them, and we partner with many others. And certainly, we have a capability to partner in a, what I would say, you call it embedded, I call it, wholesale or white label type of way as well within our business. And we're certainly open to that. And I would say in the CPA micro area, that's a healthy business and has been growing. So more to come on that in terms of how we approach broader partnerships. I think what we've tried to look for are ways in which we can bring something to the partner, and they can bring something to us. And like I said, we continue to expand our partnerships and continue to look at ways to expand that going forward.
Michael Infante, Analyst
That's helpful. Maybe just on the retention front, you obviously spoke to the fact that you're sort of tracking above historical ranges. Is that both on a revenue and logo basis? And how would you sort of compare those two buckets relative to historical levels? Thanks.
John Gibson, CEO
Listen, retention was solid. Revenue retention was solid, continuing near record levels, I think really demonstrating the value proposition, the hard work of the team, but also value proposition. There's a lot of alternatives out there and client losses have improved over the last year. So even on a logo basis, we saw improvement year-over-year. So very pleasing, it was across all the segments as well which is also a positive. Typically, we have one segment or one business that is kind of not doing as well as the others, and this is one of those quarters where in one of the really first half of the years where we've seen pretty consistent improvements. So hats off to the team there.
Michael Infante, Analyst
Thanks John.
Operator, Operator
Thank you. We'll take our next question from Bryan Keane with Deutsche Bank. Your line is open.
Bryan Keane, Analyst
Hi, guys. Happy holidays. Any pickup yet or any signs of growth that you'll see for kind of new business starts or the development of new business starts?
John Gibson, CEO
Yes, Bryan, business starts are down year-over-year. However, they remain above pre-pandemic levels. During COVID, there was an unusual spike as many people ventured out on their own. Now, the trend is what I would call moderate, but we are still above those previous levels. I still perceive a greater level of entrepreneurship in the economy, and this trend hasn't reversed; it has continued to moderate this year.
Bryan Keane, Analyst
And is that something that cyclically comes back if the economy starts to improve? I'm just trying to think about timing on when that might balance.
John Gibson, CEO
The idea behind your question seems to be that the economy is struggling, but we believe it's actually in a solid state, particularly for small businesses. If you examine the large small business index, we are noticing moderate growth and there is a sense of optimism among our clients who are eager to expand their businesses. However, they face challenges, notably with accessing capital. Additionally, if someone wants to open a new restaurant or location, even if financing is available and the cost of capital is manageable, the question remains whether they can find qualified workers to meet customer needs. These are the primary obstacles we observe in the current economy. Our focus is on small businesses, not on Wall Street trends or cryptocurrencies; we are engaged with everyday services like haircuts. Thus, the constraints on our economy stem mainly from these two issues.
Bryan Keane, Analyst
Got it. And just as a follow-up, you called out kind of the mid-market HCM business with strong sales activity. Anything in particular causing that? Is that a competitive dynamic? Or is that a new product that seems to be resonating better?
John Gibson, CEO
Well, I think it is a combination of things. I think that certainly, we continue to invest in the product, the new Paychex Flex Engage product, which is an AI-based engagement tool that allows our businesses to manage both performance and rewards and engagement with their employees and compensation more effectively. That's been a big winner in the mid-market. So I think on par, our technology has always been on par. We continue to have a very strong technology capability in the mid-market. I do think that the HR outsourcing value proposition is resonating in the marketplace. I think that our value proposition to be able to say, you can come to Paychex, and as your business is changing your needs change, you can stay in one place. You don't have to move. You can go back and forth. I think that's resonating. And I think there's been some disruption. I think there's been some disruption in the mid-market that has provided an opportunity for us to position ourselves at the builder table, quite frankly. And so I think, again, that market has changed a little bit. I think there is a little bit more rationality. They're actually talking about profitability as well as growth, and we've been talking about that for some time. So I think there's more rationality in that market, and I think customers are coming around to Paychex.
Bryan Keane, Analyst
Got it. Got it. Okay. Congrats on the results.
Bob Schrader, CFO
Thanks Bryan.
Operator, Operator
Thank you. We'll take our next question from Kevin McVeigh with UBS. Your line is open.
Kevin McVeigh, Analyst
Great. Thanks so much. You had mentioned, I think, that you were capturing some share in a PEO, which is good news to see. Where do you think that's coming from? I wanted to kind of start there because I thought that was an interesting data point.
John Gibson, CEO
Yes, Kevin, we're focused on introducing people to the PEO concept, which remains a significant part of our business. We generally don’t engage in direct competition with other PEOs. While we do compete in the market when clients are choosing a PEO, we typically don't take substantial business directly from specific PEOs. There are complexities associated with that approach that we prefer to avoid. Our primary strategy involves showcasing our HCM clients the value of our PEO services or competing for clients who are considering PEO benefits. In those situations, we do compete with other PEOs, and I believe our competitive edge lies in our strong value proposition, technology, and advisory services. Our HRGs are highly regarded for the guidance they provide. Additionally, we leverage AI and data analytics effectively in the PEO space, and we offer a comprehensive range of services. Clients start with us as a PEO, but if their needs change, we provide non-PEO HR outsourcing options, and if further changes occur, we have HCM-only solutions available. I've noted that clients prefer not to manage multiple vendors and seem to favor a consolidation approach. As competitors level up their capabilities across the HCM suite, clients are increasingly inclined to partner with a reliable, trustworthy provider to foster long-term relationships instead of juggling various vendors and dealing with frequent switches.
Kevin McVeigh, Analyst
That makes sense. I apologize for being in and out. I believe you provided some insights on the Q3 revenue. Could you remind us what that figure is and also share the pace for Q4? Additionally, what would it take to reach the higher end of the guidance range compared to the lower end, particularly from a revenue standpoint? I'm trying to better understand this for the latter half of the year.
Bob Schrader, CFO
Yes. In our Q3 update, we indicated that we expect growth to be between 4.5% and 5%, which factors in about 150 basis points of headwind from the Employee Retention Tax Credit. This will be the final quarter impacted by the ERTC. With the ERTC headwind lifting, we expect to see an acceleration in revenue growth in the latter half of the year. Regarding the Professional Employer Organization, growth in the second half is likely to be somewhat slower than what we experienced in the first half, primarily due to at-risk enrollment affecting pass-through revenues in Florida. However, this does not influence our overall revenue earnings. When comparing the first half to the second half, I believe that excluding the ERTC, the growth rates will remain quite consistent. In fact, excluding the ERTC for this quarter, we noted a 7% increase. Reflecting on the second half of last year, we saw an increase in organic growth. The first half of last year experienced a 5% growth, and since then, we are looking at four consecutive quarters of strong growth, reaching about 7% when excluding the ERTC. Interest rates have positively contributed to growth, particularly in the back half of last year and into the first half of this year, showing a 15% rise. However, we anticipate that this will become a challenge as we progress through the remainder of the year. Overall, we expect the business performance in the latter half, excluding the ERTC and interest rates, to be comparable to the first half.
John Gibson, CEO
I just realized we're going to have to shorten the calls in the future. We don't have ERTC to talk about.
Operator, Operator
Thank you. And we'll take our next question from Tien-Tsin Huang with JPMorgan. Your line is open.
Tien-Tsin Huang, Analyst
Thank you very much. Good morning, everyone. I wanted to quickly ask about the Florida situation that you mentioned, which is always insightful. Given the risks associated with this and the focus on safety, does that change your outlook on small to medium-sized businesses, employee health, and overall demand, especially as you gather more data? I'm specifically referring to the possible downgrading of planned comments. Thank you.
John Gibson, CEO
I don't see it that way. I see this more as a means of controlling costs, both for individuals managing their personal expenses and employers managing their workforce costs. We've actually observed an increase in the percentage of clients and employees in our PEO who are enrolling in insurance. So, we disagree with the idea that more of them are not offering insurance. Last year, I provided a Cataract plan, and it was purchased. Now, I might use some outdated terms, but people are opting for a less comprehensive CV plan. What we're witnessing is that more individuals are exploring options to manage their costs. Health inflation is a challenge, and we've effectively managed it for our clients over the past decade, maintaining mid- to high single-digit increases during that time, which has outperformed the market concerning medical inflation. Our commitment to clients is to help them navigate these situations, providing them with predictable inflation. However, a 9% increase is significant for someone already feeling the pinch from rising food and gas prices. They are looking for ways to cut back and are reassessing their coverage. They appreciate their former plan but are noticing that a different plan is less expensive than what they paid last year. This trend shows they are not abandoning their insurance; they're simply making different choices regarding deductibles and plans.
Bob Schrader, CFO
And the only thing I would add to that is we're somewhat indifferent to that choice. I mean, obviously, it would be great if they pick the higher plan from a revenue standpoint. But at the end of the day, we want them to attach out because what we found in our model, is when we get that health attachment that really drives retention, stickiness and lifetime value in the difference in those plans, there may be a little bit of an impact to the top-line, there's no impact to the bottom line. And so we want to give them choice and help them find a plan that meets their needs but provide them that plan because that really drives retention in lifetime value for us.
Tien-Tsin Huang, Analyst
Got it. No, it's good. Now the attach being strong is great, and I'm just trying to learn around the planned selection there? It sounds like it's mostly health care inflation and SMBs attacking that. So this is not intended to be related, but just thinking about that and broader HCM pricing and discounting for you in terms of what you are seeing or maybe thinking any new considerations there? So not a PEO or health-specific question, but just broader question around pricing and discounting as you're trying to retain and pursue new growth.
John Gibson, CEO
Yes, I would say across all market and business segments, we haven't noticed anything unusual. It's a competitive market. We continue to achieve a price-value premium as there are some lower-cost options available, but I think people recognize value when they see it. We're not encountering anything out of the ordinary. We anticipated some price competitiveness, which we have observed, but nothing drastic across any of the segments. I want to emphasize that we will remain disciplined in our growth strategy. It's vital to understand that when pursuing clients, especially in health insurance risk, we will maintain discipline. We're not willing to pursue revenue at any cost. For example, if the cost to gain visibility on Google exceeds the lifetime value of a client, I would rather let someone else cover that expense. We intend to stay disciplined and won't engage in reckless actions that could threaten our long-standing reputation for predictability and consistency, which we believe clients will appreciate over time. Ultimately, a business needs to be profitable. If the costs to acquire a client or the risks taken exceed what we can manage on our balance sheet, that's not a viable approach. We will continue to be disciplined. As I mentioned in our last call, I sense greater rationality is emerging in our markets, where both the down market and mid-market players are starting to recognize the importance of profitability, which will lead to more rational pricing.
Tien-Tsin Huang, Analyst
Yeah, the discipline is clear. Thank you for your thoughts.
Operator, Operator
We'll take our next question from Ashish Sabadra with RBC Capital Markets. Your line is open.
Ashish Sabadra, Analyst
Hi, thanks for taking my question. There was a reference to an increase in PEO direct insurance cost. I was just wondering if you could comment on how that's trending on a per worksite employee basis just given the health care inflation? And then as we think about going forward, are there any changes to the plan in order to manage these insurance costs. Thank you.
Bob Schrader, CFO
Yes, our direct costs have increased. I don’t have the exact numbers right now, but these costs include not only health care but also workers' compensation. This rise is primarily due to the growth in worksite employees, which has been in the upper single digits. We do not have any significant changes planned for the design of our plans. Our performance is strong in both medical and workers' comp, influenced by two key factors: the growth in worksite employees and our performance in attachment, applicable to both medical and workers' compensation.
John Gibson, CEO
We have discussed this before. We are always seeking innovative approaches and regularly assessing our offerings. We aim to address a wide range of customer needs with our health products, and we will continue to do so. However, health inflation is a significant public policy concern and a pressing issue. We are still witnessing the lingering effects of COVID and the health inflation that arose during that time, which is now affecting the health pricing system.
Ashish Sabadra, Analyst
Very, very helpful color. And just for my follow-up, a quick clarification. So in 2Q of last year that was impacted by slower seasonal hiring, I was wondering if you have seen any trends on the seasonal hiring trend this year? Thanks.
Bob Schrader, CFO
No. I mean hiring has been in-line with our expectations. And I think we've talked about this earlier in the year, what was assumed in our guide, which was pretty much not a lot of hiring, assumed in the client base. That's pretty much how the year has been played out. So both Q1 and Q2, I would say, employment levels within our existing client base is pretty much lined up with what our expectations were.
Ashish Sabadra, Analyst
Very helpful. Thank you, thanks.
Operator, Operator
Thank you. We'll take our next question from Kartik Mehta with Northcoast Research. Your line is open.
Kartik Mehta, Analyst
Hi, good morning John and Bob. Just on – John maybe just on the pricing commentary. Obviously, inflation probably a little bit higher than everybody expected. And I know last year, maybe the year before, you've got some better pricing than in the past. I'm wondering how that's playing out this year. You have some ancillary products and stuff, is there an opportunity to get some of that pricing back? Or do you anticipate pricing will be maybe on the lower end than it was years ago?
John Gibson, CEO
Our price value proposition remains strong with our existing clients. Once clients begin working with Paychex, they recognize the value we provide. We have maintained our historical growth strategy in this area. This includes our product penetration and our ability to introduce new products and services that enhance value, which consequently increases pricing for those clients. These aspects have been very effective. I have observed that prospects and clients have become more price sensitive compared to before COVID, which is understandable as they transitioned to digital HR systems to manage remote workforces and faced various compliance challenges. Currently, when I analyze our proposal volumes and call volumes, I can see a lot of activity, indicating that we are in a market where some participants are comparison shopping, checking prices, and ensuring they are getting the best deals. However, this behavior is not different from what I experienced prior to COVID and throughout my 20-plus years in the industry. My main point is that we continue to be a value provider and maintain a premium pricing position in the market across all segments. Clients are recognizing this value, as evidenced by our revenue retention, client retention, and continued growth in every segment.
Kartik Mehta, Analyst
And then just, Bob, on the float, I know you talked about maybe at the beginning of the year, you anticipated more rate cuts that are going to happen. But I'm wondering, any change in maybe how you're managing the float or how you'll manage the float because of this changing environment?
Bob Schrader, CFO
Not anything specific, Kartik. I mean, we did some repositioning a while ago in anticipation that rates were going to come down. So I don't think there's a whole lot for us to do there. I think right now, probably over the most recent past, when we've been reinvesting in the long portfolio, it's probably been more on the shorter end of the curve, just kind of given where the rate curve was a little bit inverted there. As things roll off, we'll continue to look at the shape of the curve. And you've got to spread it out, so you don't want to get too much in any one year because then you have reinvestment risk. But we'll look at the shape of the curve and look to place our investments to optimize the portfolio. We have a strong team in our treasury department that's looking at this every day. But I would say no significant changes to our approach philosophy, just looking to optimize based on where the curve is at any given point in time.
Kartik Mehta, Analyst
Perfect. Thank you both. I really appreciate it.
Operator, Operator
Thank you. We'll take our next question from Scott Wurtzel with Wolfe Research. Your line is open.
Scott Wurtzel, Analyst
Hi, thanks for taking my questions. Just want to ask on the margin side. I mean, the outperformance has been pretty constructive in our view also pointing towards the higher end of the guide for this year. And I know there's been some investments around the sort of advertising front. So I'm wondering if you can just remind us of where you're kind of finding some of those efficiencies to drive some of the better margin performance that we've seen.
John Gibson, CEO
Yes, Scott. I want to start by emphasizing that it's integral to our company culture to continually ask ourselves how we can improve from yesterday. Throughout all areas of the business, we are consistently focused on this. Currently, we are benefiting significantly from digital adoption and our enhanced use of AI in our data sets, which is enabling us to drive productivity much more effectively. This has been a major advantage. We observe our clients and their employees increasingly using digital tools to complete their tasks, leading us to deliver better customer experiences. Additionally, our employees are finding innovative ways to optimize work processes, digitize them, and utilize our insights and data to enhance decision-making. This includes boosting close rates and proactively addressing client concerns before they reach out to us with better offers. While I won’t go into specifics for competitive reasons, we are effectively preempting such situations. This proactive approach lowers client retention costs, as we don’t need to redirect them to a rescue team, which also saves on commissions for retaining the same clients. Overall, this proactive stance is contributing positively across the market.
Scott Wurtzel, Analyst
Got it. That's helpful. And then just as a follow-up, just on the go-to-market side. I'm wondering if you're kind of seeing in your environment with your clients, are you seeing clients sort of maybe adopt more on the initial sale instead of maybe selling sort of the initial product and then going in more for sort of the cross-sell upsell dynamic.
John Gibson, CEO
I would say I'm not seeing a major difference in that. I would say that we've done a better job from a sales execution kind of what we call integrated selling and making sure that we're offering a full value proposition of Paychex upfront in the initial dialogue versus waiting for them to become a payroll client and then 30 days later upgrade them to ASO or upgrading them the PEO. So that if you look back on our old model, I would say that was a little more how we would operate. And so you saw a lot more upsell if is get them in. I would say today, that still happens. It's probably still the majority of what we do. But I do think we're doing a better job upfront that if we think we can add a higher-value product package. I would say in the other market HCM area, that's the area where I do see clients wanting to go with more of the full suite. And a lot of times, that's really their dropping point solutions, point solutions that they have kind of cobbled together and therefore, they're looking for a talent management. They have talent management suite that they're using that was an ancillary and then what that integrated in. So I'm seeing that a little bit more in, I'd say, more the upper end of the mid-market and lower in the enterprise.
Scott Wurtzel, Analyst
Got. Thanks guys. Happy holidays.
Operator, Operator
Thank you. We'll take our next question from Jason Kupferberg with Bank of America. Your line is open.
Jason Kupferberg, Analyst
Thanks guys. Good morning. I was just wondering as you entered the key selling season, is there anything different you're preparing for in the environment versus last year's selling season, whether that's regulatory backdrop for a competitive environment or other factors?
John Gibson, CEO
We are not preparing for anything significantly different from a competitive standpoint. You can expect us to launch some advertising and really focus on our award-winning product suite introduced this year. We've enhanced our HR analytics through our Premium Plus product, now featuring GenAI insights, which includes 20 million employee records. This will help determine appropriate compensation benchmarks and provide advanced workforce analytics. Users will be able to ask simple questions to the chatbot and receive analytical reports comparing them to these benchmarks. We will continue to develop this area. Additionally, our Paychex recruiting copilot, another AI-assisted talent acquisition solution, is available to both Paychex and Paychex Flex clients as a stand-alone product. We will discuss this further, along with our Perks product, which provides small businesses the ability to offer benefits to their employees. Many small businesses face a significant disadvantage by not providing benefits, as employees can choose larger companies that do. This product allows employers to offer a value proposition to new hires with access to various benefits at no cost to them. It has been encouraging to see client adoption and employees engaging in the open enrollment process. We plan to emphasize our unique value proposition and how we stand apart from competitors. While I expect the market to remain rational across different segments, we will maintain our discipline as cautious growth continues. At this point, we're going to close the call. If you're interested in a replay, the webcast of the conference call will be archived for approximately 90 days. Look, I would like to wish each and every one of you and your families a safe and happy holiday season. We look forward to talking to you in the new year, and so I wish all of you a happy New Year as well. So thank you for your interest in Paychex, and have a great day.
Operator, Operator
That concludes today's teleconference. Thank you for your participation. You may now disconnect.