Earnings Call Transcript - PAYX Q4 2020

Operator, Operator

Good morning. My name is Lisa and I will be your conference operator today. At this time, I would like to welcome everyone to the Paychex Fourth Quarter and Year-End Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. Thank you. I would now like to turn the call over to Mr. Martin Mucci, President and Chief Executive Officer. Please go ahead, sir.

Martin Mucci, CEO

Thank you for joining us to discuss Paychex's fourth quarter and fiscal year 2020 earnings release. Today, I am joined by Efrain Rivera, our Chief Financial Officer. This morning, we released our financial results for the fourth quarter and fiscal year that ended on May 31, 2020. You can find the earnings release on our Investor Relations webpage, and our Form 10-K will be submitted to the SEC by the end of July. This teleconference is being streamed online and will be available on our website for about a month. I will begin with an update on key metrics and our response to COVID-19 and then discuss business highlights for the fourth quarter. Efrain will cover our financial results for both the fourth quarter and the full year, as well as our projections for fiscal year 2021, after which we will open the floor for your questions or comments. In May, we updated you regarding our business's response to COVID-19, highlighting some positive trends in our key metrics despite the ongoing situation. Over the past month, we've seen consistent improvements across all key metrics that we track weekly. There has been a steady rise in paid employees and in the number of worksite employees for our HR outsourcing clients, along with an increase in sales leads and productivity. A notable highlight is client retention, which has been stronger than ever as clients appreciate the value Paychex brings during these challenging times. I commend our dedicated Paychex teams in IT, development, product, marketing, and service who have worked hard to ensure a smooth transition to remote operations while continuing to support our clients and their CPAs in these critical times. When the Paycheck Protection Program was initiated, we quickly released an online payroll report to help clients easily file applications for loans. This report has been processed over half a million times for our clients and their CPAs. Additionally, we partnered with three fintech companies—Biz2Credit, Fundera, and Lendio—to give clients direct access to alternative lenders for PPP loans. Our clients have processed loans exceeding $100 million through these partnerships. On June 5th, the Paycheck Protection Program Flexibility Act was enacted, easing original loan requirements while still allowing for loan forgiveness. Shortly after, we launched the PPP Loan Forgiveness Estimator, which simplifies the complex forgiveness process and integrates Paychex client data for ease of use. Our service teams have maintained excellent responsiveness despite increased call volumes, achieving an all-time high in client retention. During this uncertain period, we have experienced strong performance in several areas of our business. Sure Payroll has grown as more clients seek user-friendly, do-it-yourself solutions. Our Flex virtual sales efforts have also seen positive results. Demand for outsourced HR services, both PEO and ASO, has risen due to the complexities of the current climate. Our suite of customizable solutions empowers businesses of all sizes to effectively navigate today's challenges. The COVID-19 pandemic has tested our business resilience, but it also validated the investments we've made in recent years. The pandemic accelerated various workplace trends, and we are well-positioned to assist clients in adapting. Our five-star mobile app offers clients and their employees access to solutions from any device, enabling them to manage a remote workforce and ensuring productivity. Keeping employees engaged has been crucial during this time, and our tools, like HR conversations and HR Connect, facilitate communication and connectivity. We've also seen an uptick in Paychex Learning, our online platform for employee training and professional development, which helps companies retain talent even without in-office work. Our payroll solutions include flexible payment options, allowing clients to pay employees on demand for wages earned prior to payday. We are continually enhancing our data analytics and reporting functionalities to provide clients with the clear information they need to make future business decisions. Our advanced analytics suite now incorporates insights on labor costs, workplace health trends, and HR details, while new digital solutions improve organizational collaboration, streamline processes, and add efficiencies. We have become a vital business partner during this period, helping clients navigate legislation and manage remote operations, exemplified by our record high webinar participation. While our solutions have been essential for clients adapting to a remote environment, they are also instrumental as businesses begin to reopen. By employing digital solutions, clients can reduce infection risks with more contactless procedures. Regarding our own team, we remain committed to employee safety, with over 95% of our workforce still working remotely, and this transition has been successful. Consequently, we are accelerating strategies to utilize a more distributed workforce and are implementing plans to downsize our physical footprint, among other cost-saving initiatives. As we start fiscal 2021, there is cause for optimism. Our employees stay engaged and have consistently surpassed expectations, ensuring excellent service to clients. Record retention, high client satisfaction scores, and positive testimonials underscore the value we deliver. We continue to return capital to shareholders, and key performance indicators suggest steady growth. Despite the uncertainty surrounding state reopening plans, we remain confident in the relevance of our offerings and are committed to providing innovative solutions as we work through these challenges. I'll now hand the call over to Efrain Rivera to discuss our financial results for the fourth quarter and the fiscal year.

Efrain Rivera, CFO

Thank you, Martin. Good morning, everyone. I'd like to remind you that today's conference includes forward-looking statements related to future events which carry risks. Please refer to the earnings release for more details on these statements and associated factors. Additionally, I will reference some non-GAAP measures like EBITDA, adjusted net income, and adjusted diluted earnings per share. For a discussion on these measures and a reconciliation of our fourth quarter and full year fiscal 2020 results to related GAAP measures, please check the press release and investor presentation. Let’s start with some key points for the quarter. Our fourth-quarter results were influenced by COVID-19. I’ll summarize our results and then go into our full-year fiscal 2020 performance. In the fourth quarter, total revenue decreased 7% to $915 million, mainly due to volume declines affecting our HCM solutions. Total service revenue also fell 7% in the fourth quarter to $890 million. Within this, Management Solutions revenue dropped 6% to $662 million, and PEO and Insurance Solutions revenue fell 11% to $228 million. Interest on funds held for clients rose 14% to $25 million in the fourth quarter. Higher realized gains offset lower average investment balances and interest rates, part of the portfolio repositioning we mentioned in a previous call. Average balances for client-held funds declined 8% in the fourth quarter due to a decrease in checks per client resulting from COVID. Expenses fell 8% to $615 million, primarily due to reduced discretionary spending from company-wide expense controls. Operating income decreased 5% to $300 million, with an operating margin of 32.7%. EBITDA also dropped 5% to $351 million, reflecting an EBITDA margin of 38.4%. Other net expenses for the fourth quarter included interest from long-term borrowings, partially offset by corporate investment income, which was affected by lower interest rates. Our effective income tax rate was 24.3% for the fourth quarter compared to 25.8% for the same time last year. Net income fell 4% to $221 million, with adjusted net income decreasing 3% to $221 million for the fourth quarter. Diluted earnings per share decreased 5% to $0.61, and adjusted diluted earnings per share also dropped 3% to $0.61. Now, let’s look at the year-to-date results. The first nine months showed solid performance. Our full-year growth was impacted by COVID in Q4, but the year reflected solid progress. Total revenue increased 7% to $4 billion. Service revenue was also up 7% to $4 billion, with Management Solutions growth of 3% to $3 billion and PEO and Insurance Solutions growth of 22% to $991 million. Management Solutions benefitted from higher revenue per client, while PEO and Insurance Solutions benefited from a full year of Oasis results, despite challenges in Insurance Services from lower workers' comp premiums. Interest on funds held for clients rose 8% to $87 million, driven by higher realized gains, partially offset by lower average investment balances and interest rates. Operating income rose 7% to $1.5 billion, with an operating margin of 36.1%, similar to the prior year. Net income and diluted earnings per share both increased 6% to $1.1 billion and $3.04 per share, respectively. Adjusted net income increased 5% to $1.1 billion, and adjusted diluted earnings per share rose 6% to $3 per share. Regarding investments and income, our goal is to protect principal and optimize liquidity. We continue to invest in high-quality securities, with our long-term portfolio yielding an average of 2.1%. The current average duration is 2.9 years, but we’re slightly shorter on the curve. Our combined portfolios yielded average returns of 1.5% and 1.8% for the fourth quarter and fiscal year, respectively, down from 2.1% and 1.9% for the same periods last year due to the Fed cutting interest rates multiple times this year. Now, regarding our financial position, it's particularly strong, with cash, restricted cash, and total corporate investments exceeding $1 billion as of May 31, 2020. This achievement emphasizes the company's resilience during these challenging economic times for both us and our clients. Funds held for clients as of May 31 were $3.4 billion, down from $3.8 billion on the same date in 2019. These funds fluctuate daily, averaging $3.8 billion for the fourth quarter and $3.9 billion for the fiscal year. Our total available-for-sale investments, including corporate investments and funds held for clients, showed net unrealized gains of $100 million as of May 31, 2020, compared to $20 million on May 31, 2019. The increase in net gain resulted from declining interest rates. Total stockholders' equity was $2.8 billion at the end of May 31, 2020, reflecting $889 million in dividends paid and $172 million in shares repurchased during fiscal 2020. Our return on equity for the past 12 years remained robust at 41%. Cash flows from operations were strong, totaling $1.4 billion for the fiscal year, representing a 13% increase from the previous period, driven by higher net income, amortization of intangible assets, and changes in net working capital. We finished the quarter with a very strong operating position in cash and cash flow. Now, turning to 2021, the outlook I’m about to share reflects our current thoughts on the timing and speed of economic recovery. The situation remains volatile, and I’ll discuss this concerning the first and second halves of the year. We expect significant impacts in the first half, followed by sequential improvement, with recovery largely happening in the second half of the year, particularly in the fourth quarter. This outlook includes several expense control measures we have implemented, which I’ll discuss shortly, including a one-time charge we will recognize in the first half of the year. Our outlook is as follows: Management Solutions revenue is expected to decline between 1% and 4%, while PEO and Insurance Services revenue is anticipated to decline between 2% and 7%. Interest on funds held for clients is expected to fall between $55 million and $65 million. Total revenue is predicted to decline between 2% and 5%. Adjusted operating income as a percentage of total revenue is forecasted to be between 34% and 35%, excluding the one-time costs I will discuss soon. Adjusted EBITDA margin for the full year 2021 is anticipated to range between 39% and 40%. Other net expenses are expected to be between $30 million and $35 million, and the effective income tax rate for fiscal 2021 is estimated to be 24.5% to 25%. I also want to note that we do not account for any expected benefit from stock compensation expense in these projections; we adjust that out, which may vary based on the benefits we receive throughout the year. Adjusted diluted earnings per share is forecasted to decline between 6% and 10%. As Martin mentioned previously, given our experiences over the past several months, we are expediting various cost-saving initiatives. These measures include headcount optimization along with reduced discretionary spending. Additionally, we are fast-tracking our long-term plan to downsize our geographic footprint, which constitutes the majority of the charge I’ll describe next. We anticipate recognizing one-time costs around $40 million, mostly in the first quarter. Our guidance for adjusted operating margin, adjusted EBITDA margin, and adjusted diluted EPS (which, as I remind you, are non-GAAP measures) excludes these one-time costs, expected primarily in the first quarter and geared towards geographic optimization, a plan we've opted to accelerate due to current conditions. Now that I've provided full-year guidance, let me give you some insights into the gating. We will share the presentation on our website, which will provide additional details. I expect revenues to be most impacted in the first quarter of fiscal 2021, with improvements each quarter thereafter. When viewing fiscal 2021, we consider the first half versus the second half of the year. In the first half, we expect Management Solutions revenue to decline in the mid to upper single digits, and PEO and Insurance Solutions revenue will likely drop in the high single digits to low double digits. Adjusted operating margins, excluding the mentioned one-time costs, are anticipated to be around 32%. Specifically for Q1, we expect the largest impacts in that quarter, with total revenue anticipated to decline in the high single to low double-digit range, and operating margin expected to be around 30%. Therefore, please factor that into your models. For the second half of the year, we anticipate more significant improvement, with much of the recovery occurring in the fourth quarter. During that quarter, we expect conditions to resemble a normal pre-COVID quarter, with Management Solutions and PEO and Insurance Solutions revenues projected to grow in the low single digits. When I say low single digits, I mean on the lower end. The combined expectations for Q3 and Q4 will generate low single-digit revenue growth. Adjusted operating margins are anticipated to be around 37%, reflecting both typically higher margins in Q3 and the improvement we expect in revenue. In the second half of the year, adjusted earnings per share are projected to be flat to down slightly in the low single digits. Please refer back to the investor slides to consider all the gating points. With that, I will turn it back over to Martin.

Martin Mucci, CEO

Thank you, Efrain. And Lisa, we'll now open up for questions please.

Operator, Operator

Your first question comes from the line of Ramsey El-Assal with Barclays.

Damian Wille, Analyst

This is Damian on for Ramsey. Good to see some of the improvement in trends here sequentially. I guess, the big question here for me is on 2021, just how you characterize the conservatism in your guidance. In other words, are you assuming there’s some sort of improvement in the key metrics throughout the year? Or to what extent is it sort of a bottoming out of trends and then you growing over them? Just some color there I think would be really helpful.

Efrain Rivera, CFO

That's a good question. In the first quarter, we clearly saw the most impact. Reflecting on the past several years, we've experienced sequential improvement week by week. It's challenging to predict the pace of that acceleration, but it's clear that Q1 marks the lowest point, and we anticipate improvements moving forward throughout the year. Compared to our expectations three to four weeks ago at the start of the year, we're performing better. There are strong indications of a recovery underway. The duration and speed of this recovery will unfold as the quarter progresses. Overall, I believe you'll see significant recovery in the latter half of the year.

Damian Wille, Analyst

And maybe if I were to just zoom out here then, maybe there is a question for Marty. But can you maybe just give some updated thoughts about the long-term composition of the company's business lines here? Obviously, the pandemic has changed a lot for a lot of people. But are you looking more seriously to move into adjacent areas or businesses? In five years, does the Paychex model look similar to how it is today or do you think it changes a little bit?

Martin Mucci, CEO

I believe we are definitely transitioning further into being an HR company. While many still see us primarily as a small business payroll provider, our revenue growth indicates that we are increasingly becoming an HR services company for small and mid-sized businesses. This shift will likely continue. Historically, HR involved administrative functions, but it's now expanding to focus more on recruiting and staffing. In the near term, the emphasis might also shift towards facilitating the return of employees to physical workspaces and managing remote work. The investments we've made in our SaaS products and mobility have been beneficial. It's clear that our role as an HR company is becoming more comprehensive, encompassing everything from staffing and recruiting to streamlined administration, retirement, and various insurances, including workers’ compensation. Additionally, analytics are taking on a greater importance in HR, enabling businesses to make informed decisions—something our services can assist even if they lack extensive resources. Moreover, our learning management system is perfectly timed to support the training and development of employees remotely, a critical need for our clients today. In five years, I envision Paychex being recognized as a comprehensive HR company that offers a wide range of support services, constantly evolving in how we define HR while leveraging our technology for current and future needs.

David Togut, Analyst

Thank you. Good morning. Could you expand upon the performance of the key performance indicators in the fourth quarter? I think, Marty, you talked on the Business Update Call about a number of businesses being on hiatus, suspending their processing. I think as of May 19th checks per payroll were down double-digits. What are you seeing in particular on this KPI? And then my follow-up really relates to new bookings trends in the fourth quarter and how the salesforce is operating still mostly remote, some in-person meetings, so forth?

Martin Mucci, CEO

Sure, David, I'll begin with the key metrics. The businesses we identified as suspended had not closed down entirely, but they had stopped processing. The number of these businesses is now less than half of what it was at its peak and continues to decline weekly. We’re observing a resurgence of businesses, although they are not always returning with the same level of staffing as before. For instance, a business that once had 20 or 30 employees might now have between 15 and 20. This is to be expected as many are operating at reduced capacity, like restaurants. On a positive note, more than half of the suspended businesses have come back, which is a strong sign and has happened relatively quickly. We're also witnessing improvements in checks and the number of employees at work sites within our PEO and ASO services. The changes in our client base have occurred rapidly, and businesses are rehiring employees faster than we anticipated. I hope this trend continues, as we are seeing consistent improvement. Regarding sales, we are predominantly still operating remotely but are beginning to visit clients who prefer in-person meetings, provided our representatives are comfortable and all safety protocols are followed. While some clients express a desire to meet face-to-face, most of our sales are still conducted remotely via online discussions and phone calls, with significant success. I was actually surprised by the volume of final sales we achieved in the fourth quarter, considering our remote workforce. We have also permanently transitioned a notable percentage of our small business sales representatives to inside sales due to the success of our remote sales efforts. While we have been conducting virtual telephonic sales for years, we are increasing this segment due to its positive outcomes and productivity, with our established tools continuing to perform well. Thus, we are seeing an increase in sales productivity, checks per client, and a significant reduction in suspended clients. Efrain, do you have anything to add?

Efrain Rivera, CFO

I think in addition to all of those metrics, David, we track a number of other metrics, including everything from hours punched, time recorded to funds flow through the systems and they're all showing a pretty significant recovery from the depths of where we were 4 or 5 weeks ago.

Steven Wald, Analyst

Great. Thanks for taking my question, Marty, and Efrain. Hope you guys are staying safe and well. Thanks. Maybe just following up on David's set of questions on the KPIs, moving forward towards what you're seeing now, and I believe Marty your comment about client retention being up highest it's ever been. First, can we get that specific number? I think the last we had seen a number there was 82% or just hovering above 82%. And separately, as we think about the revenue dynamics, given client retention is typically a bigger piece for sensitivity on the revenue front, but the revenue guide seems to have changed, stayed roughly the same, the down 2 to 5 sounds like the low to mid-single-digit decline you gave in mid-May. Would it be fair to say that the bookings activity, although, holding up relatively better than what you expected has gotten pretty worse, if the retention has gotten maybe better, or were you already assuming that retention would have gone up?

Martin Mucci, CEO

No. I think we assume that the retention is around 83%, which is an all-time high for us. We’re being conservative here. When you consider the suspended clients, which are now less than half of their peak, the situation is changing rapidly. We're working to understand how many clients are suspended and how many might permanently close their businesses. Our retention is the best it’s been, but we'd prefer to wait another month to see how many of those clients return or if there are any losses. Sales have remained steady, and we haven’t noticed any decline in that area. Although sales have not yet reached pre-COVID levels, there is definite improvement. Overall, sales are improving, and retention is at an all-time high. We're just waiting to confirm over the next 30 to 60 days that those clients we believe we’ve retained are indeed retained and not just suspended clients who may go out of business. Our losses to competitors have improved significantly as well. We have also found that clients are not moving during this time, which reduces the chance of them switching to competitors for discounts, especially when they need our assistance with loans and forgiveness calculators, which have received positive feedback from clients. We’ve managed to keep more clients and have done better at avoiding losses due to pricing or competition. The conservative approach is just to see how things unfold in the next 30 to 60 days.

Steven Wald, Analyst

Thank you for your comments. I’d like to follow up on the underlying assumptions you have. Efrain, I appreciate the detailed insights on fiscal year 2021, especially comparing the first half to the second half. Could you discuss your views on the unemployment rate? While you may not have a specific figure, could you provide a range for mid-year or the end of the fiscal year? Additionally, what are your thoughts on the exit rate? I’m also curious about how you see the differences in employment across various regions and states influencing this. We’re noticing significant variations in experiences among states, whether it’s a resurgence of cases or a continued situation, along with some states moving towards reopening while others are tightening restrictions. How are you approaching these underlying assumptions overall?

Efrain Rivera, CFO

Yes, let me address that, Steven. When you experience a shock like this, the effects are certainly felt, as we saw in April and May, and we anticipated those effects would continue into June, July, and August, which is our first quarter. I expect other companies will report similar impacts within that timeframe as well. Our expectation is that as we move through the first quarter, improvements will start to become visible; however, we do not anticipate returning to pre-COVID levels in the second quarter. In fact, we believe that improvements won’t materialize until the latter part of the third quarter. By the fourth quarter, we expect the environment to resemble conditions from the third quarter of this year, rather than the first three quarters. This expectation stems from our understanding of how our clients are recovering, the trends in checks, and anticipated growth in bookings. We've conducted extensive simulations and modeling to ensure our forecasts are reasonable. Therefore, we project only modest and gradual improvements over the first three quarters of the year. In the fourth quarter, we will have an easier comparison, which should lead to significantly better results than in the first quarter. We are closely monitoring the situation and can identify which sectors are affected, as well as disparities by state. The struggles in New York and California regarding reopening are certainly a factor in our outlook, but we have accounted for that. We also expect some recovery in certain states based on the specific industries present there, such as hospitality in Florida, which we believe will take longer to recover. We anticipate seeing these trends headline into next year, and we remain cautious about the pace of recovery in the first three quarters.

Jason Kupferberg, Analyst

Hi, Efrain. I wanted to follow up on the discussion about the states you've mentioned that have experienced these partial reclosures, such as Florida, Texas, and Arizona. Are you noticing an increase in clients who have had to go dormant again due to these reclosures?

Martin Mucci, CEO

Jason, I'll address the first part of your question. We have noticed some changes, but not much so far, given that these developments have occurred relatively recently, this month. Interestingly, some Southern states are still performing quite well according to our small business index, especially in construction. However, leisure and hospitality industries are negatively impacted by the re-closure of certain establishments like bars and restaurants. On the positive side, construction is still thriving, and we have numerous clients in that sector. Home sales and new home sales continue to rise, particularly in the South, including Florida, where commercial construction remains robust. Therefore, we don't anticipate significant negative impacts from this situation. Although leisure and hospitality may fluctuate, our weekly indicators show no significant declines in the states experiencing higher rates of reoccurrence or closures.

Jason Kupferberg, Analyst

I wanted to ask for more details regarding the comment about client retention reaching an all-time high of 83%. Is this figure for the entire fourth quarter, or does it refer to the full fiscal year 2020? Additionally, could you clarify the various factors influencing retention? I understand that takeaways have decreased due to minimal switching activity. I'd like to know how the churn you're observing is divided between businesses shutting down, other reasons, and third-party takeaways. What does that look like currently, and what are you projecting for the retention figure in 2021?

Martin Mucci, CEO

Yes, the challenging aspect currently involves the suspended accounts, which have impacted our retention positively. There have been fewer takeaways, and while some clients have left due to pricing, those going out of business have only slightly increased. Overall, our retention rates appear to have remained consistent or possibly improved slightly. We anticipate that enhancements will stem from competitive takeaways or pricing strategies. Currently, we are experiencing high satisfaction levels, with impressive net promoter scores and positive client testimonials. Our clients have greatly benefitted from tools like the payroll report for PPP loan applications and the comprehensive Loan Forgiveness Estimator, which have received much praise. These resources have undoubtedly added value during tough times, as clients felt supported when they needed us most. However, we are taking a cautious approach regarding the suspended accounts and would like to observe how retention levels hold over the next month or two. Although we've seen more than half of the peak accounts suspended, we are assessing whether these clients can maintain their status or if some may still be in business but at risk in the long term. I had expected that a number of these suspended accounts would have declared they'd closed by now. We are also considering potential impacts from reclosures, especially for bars and restaurants that have faced shutdowns multiple times. However, at present, we remain optimistic based on the data we are observing.

Jason Kupferberg, Analyst

Okay. And just to clarify, the 83% number was for Q4 or that was full year.

Efrain Rivera, CFO

I'm sorry. Full year, full year, I am sorry. Full year.

Bryan Keane, Analyst

Thank you. I wonder what led to the decision regarding the $40 million charge. It seems that a significant part of it is related to occupancy. It's generally tied to specific geographies. Is the success you experienced while operating remotely what influenced this decision? I'd appreciate any additional insights on that, as well as the potential long-term margin impact from these actions.

Martin Mucci, CEO

Sure. I'll start with it. We had a plan in place, as you know, with several offices across the country. As we consolidated and reduced the size of our offices, we transitioned to regional service centers where we could implement better technology. We already had a number of employees working from home, and when we closed some remote offices, we allowed experienced employees to work from home since we had all the necessary tools in place. Notably, 95% of our employees were working from home, and we saw an increase in client satisfaction and a stronger retention rate. This prompted us to consider whether we could reduce costs more quickly. We decided to speed up the closure of several physical locations, permitting remote work even in local areas, which would allow us to significantly save on lease and rental expenses. This is why we chose to accelerate the process. We have already communicated this to our employees and are progressing with these steps, which accounted for the majority of the $40 million charge. Additionally, as Efrain mentioned, there was a small reduction in force, less than 2% of our employees, which is always challenging. However, along with the closure of certain offices and other reorganizations, we took these actions as part of our strategy.

Efrain Rivera, CFO

In response to your second question, Kevin, if you consider the $40 million and apply the tax effect to it, you can determine the impact on EPS. We expect that this amount will be reflected in the cost structure moving forward.

Kevin McVeigh, Analyst

That's helpful. And then just one quick follow up. It sounds, it assume funded no incremental federal stimulus, again just that was a little concern that, if some of the states don't get incremental funding, there could be some layoffs, things like that. Is that embedded in the guidance as well? Or would that be something that would be another thing that continues to setback?

Efrain Rivera, CFO

Yes. I don't think we're at that level right now, Kevin. I mean, literally, I would say, if you were in our management meetings every week, we're looking at different scenarios in terms of both what ideas that are coming out of Congress, extension of PPP and what the impact of all of that is. But we're not at a granular level where we're saying, hey, if that happens, it's going result in a bump of X-percent, where it’s still early to do that.

Andrew Nicholas, Analyst

I was just hoping you could compare the resiliency of the PEO business, the payroll business in terms of the health of your end client. Is there any major difference in the way the two client bases have reacted to the current environment, and how is that impacting your outlook for each business?

Martin Mucci, CEO

I will begin by addressing the situation and then ask Efrain if he wants to contribute. We've observed a decline due to furloughs and other factors. In the small business sector, some businesses shut down or ceased operations, resulting in no employees. On the PEO side, which typically has a larger clientele, they did reduce their workforce, but both sectors have rebounded quite well. The worksite employees, referring to changes in existing employees, have recovered better than we anticipated on the PEO side. There is strong demand for both PEO and ASO services. More clients are opting for HR outsourcing, as it has become increasingly difficult to manage the complexities for companies with 25 to 40 employees, which is our average PEO client size. This shift is largely driven by the need to navigate regulations, manage furloughs, and reintegrate employees. While the small business segment has also shown signs of recovery, it has been more variable, with some businesses oscillating between open and closed, whereas PEOs have remained operational but with a reduced workforce. Overall, both sectors are showing signs of improvement that exceed our expectations, and we hope this trend continues.

Efrain Rivera, CFO

Yes. Andrew, I would add that our PEO business operates differently from our SMB business in terms of geographic reach. Our PEO is more concentrated in Florida, as we've mentioned before. Consequently, when we consider this factor alone, we have greater exposure to hospitality and some industries that have been severely impacted. The data showed a very quick reaction in terms of staff reductions. However, to Marty's point, we are beginning to see a resurgence. I believe we have somewhat over-indexed in certain hospitality areas, leading to a harder hit than some other companies. Nonetheless, we are now observing a fairly swift recovery in worksite employees. How a PEO responds in this environment will largely depend on its geographic concentration. If you are concentrated in states that have faced shutdowns, you will see one outcome. Conversely, if your worksite employees are primarily in states that have remained relatively open, your situation will differ. Just to reiterate what Marty mentioned, we did not witness clients ceasing their processing entirely; rather, we observed significant reductions in processing, followed by a return to adding employees.

Martin Mucci, CEO

Yes, I think we're still very interested. Clearly, we see the PEO business as a growing part of our operations. We believe there are M&A opportunities available. Although the current environment presents some challenges due to remote working and due diligence, we're in contact with certain prospects and monitoring them closely. The remote nature of the diligence process complicates things, especially when trying to assess where companies may have reduced their workforce or client base. There are questions about current valuations as well. Many potential sellers seem hesitant to sell at this point unless buyers are prepared to offer inflated valuations, anticipating a future rebound. It's a somewhat precarious time to pursue acquisitions, but we remain engaged with the market and keen on finding the right opportunity.

Bryan Keane, Analyst

Just following up on the discussion, thinking about the suspended clients, what percentage of those fall in that bucket still or remain dormant? Is it 10% of the base, 20% of base, I just don't have a good sense of that?

Martin Mucci, CEO

Much smaller, Bryan, much smaller. I don't think we've shared the specific number, but it’s dropped in half. Even at its peak, it wasn't close to 10%. So, yes, that's a good question actually. We want to ensure that people don't perceive it as too large. It's not that large. We haven't disclosed the number, but it's not even 10%. Honestly, when you consider everything, we might be at around 1% to 2%. So we probably over-discussed that considering the available numbers.

Bryan Keane, Analyst

So it's only 1% to 2% that look like they could close down or fail I guess at this point?

Martin Mucci, CEO

Yes, those are still suspended due to COVID. We typically have some suspensions that are seasonal, but if we focus specifically on what is related to COVID in terms of timing, it is definitely under 2%, likely in the 1% to 2% range.

Bryan Keane, Analyst

And does that include businesses that you've already kind of realized that have failed or turned off?

Martin Mucci, CEO

No.

Bryan Keane, Analyst

Are there another percentage of group already that are closed, that are basically turned off?

Martin Mucci, CEO

We have already accounted for those as lost clients, so they are not included in our retention figures. Currently, about 1% to 2% of our clients are suspended due to COVID, and we are still observing the situation to see how it develops. Anything that we have identified as lost is no longer part of our client base.

Bryan Keane, Analyst

Yes. How does that loss percentage compare to a typical recession? I'm trying to understand the significance of that percentage.

Martin Mucci, CEO

At this point, the last recession was significantly deeper, but we haven't experienced anything comparable to that now. The previous recession lasted about 18 months, during which losses accumulated over time. This time, we went deeper, but I believe we managed it effectively through our relationships with payroll specialists. We discussed suspensions with them, which prevented a scenario where they might have chosen to go lost. Instead of losing clients and facing competition again, we maintained those relationships, making it easier for both our clients and ourselves. Overall, the situation has been considerably better than during the last recession a decade ago, where the losses were more substantial and spread out over a longer duration.

Efrain Rivera, CFO

I have just one last question for Efrain regarding the fourth quarter guidance. You mentioned it appears to indicate more normal growth. I'm curious if this will serve as a starting point as we transition into fiscal year '22. Considering the weaker numbers alongside the easier comparison and whether business will start to recover with new sales, how should we approach that trajectory as we move into the fourth quarter and subsequently into fiscal year '22? Well, I guess it looks like a more normalized quarter, Bryan that’s what the best I can say right now. And I would say this about the second half. Obviously, compared to a normal year, we have less visibility in the second half compared to where we would be otherwise. But I would say, by time, we get around to Q4, there's a number of things that we think will be occurring that are going to create a situation, where that quarter looks a lot more normalized than certainly the first three quarters. So at this point, I'll just hold talking more specifically about Q4 until we start getting our sea legs under us in this year. But I think that we've got reasonably good basis for thinking that that's the way the quarter will look.

Bryan Keane, Analyst

And then as we get into fiscal '22, just there's no reason why it shouldn't be more normalized as well to jump off of that point?

Efrain Rivera, CFO

We’ve been discussing non-processing clients and the decrease in worksite employees and checks per payroll. All of these factors are expected to normalize as we move forward. I want to stress, as Marty has mentioned in this call, that we have the right model for the current situation. The tech services model is ideally suited for unpredictable environments. While my opinion is relevant, what truly matters is the positive feedback we’re receiving from clients. We have never received as much encouragement for the role we have played recently. We believe not only that we will recover, but we also have the opportunity to gain market share for the remainder of the year, thanks to our robust model that suits the uncertain environment and the clients we serve. Therefore, we are optimistic that by the end of the year, we will not only have recovered compared to our current position but also that the strength of our model will become evident. We could very well find ourselves in a stronger position than we were before the COVID era.

Bryan Bergin, Analyst

Wanted to ask on the outlook, how would you characterize the projected sequential improvement in Management Solutions, as far as it being driven predominantly from the improving check volumes versus some of the increased penetration of retirement and some of the other services you referenced? And Efrain, the high teens check volume decline that you called out on the update call, did you say you did better than that here in 4Q, curious how you see that playing out in '21?

Efrain Rivera, CFO

We did, I would say a little bit better. Bryan in 4Q and we're seeing improvement as we go through Q1. Still early, but that's where we expect. So, to the point, the question that you're asking, yes, we expect that we'll get through Q1. We'll understand what clients didn't make it, and then the clients that remain have an opportunity to grow and to build, and build up their work force and the combination of a better sales environment, a better sales combined with recovery from our clients, then drives a better revenue as we go through the year.

Bryan Bergin, Analyst

And then on pay offerings. So can you just comment on what you're seeing in the adoption of the real-time pay solution versus the pay on demand offering? And then just as we think about an acceleration of digital payment methods from traditional paper checks, is there a margin story to be had for you as potentially through rep service or other means?

Martin Mucci, CEO

I believe we are starting to see some expense reductions, which is contributing to our margins. As more clients have utilized our services, we have become more productive by offering a range of self-service options. In the past, employees had to go through their HR representative or business owner to make changes like direct deposits or address updates, but now they can do it themselves. This shift has benefited both the clients and us. Regarding the pay-on-demand service, it's still in the early stages; we introduced it around December, but its adoption was somewhat slowed by COVID. However, interest is growing. The process requires client enrollment, which has presented some challenges recently, but I anticipate a quicker uptake soon. There has been considerable interest from restaurants looking to bring back employees on flexible schedules, allowing them to access their pay immediately instead of waiting weeks. This presents significant opportunities ahead. In terms of profitability, pay-on-demand does have some margin potential, especially since it features self-service elements that reduce our workload. It's also a valuable retention tool, as clients appreciate our product, and it helps them keep their employees engaged. As for real-time payments, we are still among the few companies in our industry to offer this service. Since launching it a few months back, we've experienced a positive response, and clients appreciate the ability to access funds almost instantly. This service has received favorable feedback, especially when clients face last-minute changes or corrections, allowing them to resolve issues within minutes instead of waiting for traditional payment methods.

Jeff Silber, Analyst

On your Business Update Call, you talked a little bit about what was going-on on the workers’ comp side. I think you'd seen lower rates, but it was offset to some extent by lower healthcare expense, because of fewer electric procedures. Can we just get an update on how that's been trending?

Efrain Rivera, CFO

I think comparable just, not a lot of changes. We've seen a continuation of those trends into the beginning of the year.

Jeff Silber, Analyst

Okay. And it doesn't matter in terms of geographically in certain states that are opening up faster. It's still pretty steady?

Efrain Rivera, CFO

Not so far. We have significant healthcare exposure in the PEO sector, and our performance in Florida has been positive. So far, everything appears to be good. We'll provide an update if anything changes. Yes. So, I think if you take the $40 million and the tax effect, then you'll get the benefit, that we expect going forward.

Lisa Ellis, Analyst

First one is just a cadence clarification. If I understood the cadence right, it looks like 1Q revenues are expected to be a downtick from 4Q, so high single to low double-digits, despite a lot of these operating metrics. But can you just clarify why that is? Is that because of new sale dipping, because of the pandemic or what causes that?

Efrain Rivera, CFO

Because, Lisa, remember, Q4 has one month of pre-COVID results in it, and April and May were the COVID months. So Q1 has, you're right, a little bit better results, but unfortunately it also has one less pre-COVID month in Q4 there.

Lisa Ellis, Analyst

I have a follow-up question regarding the competitive landscape. Efrain, you mentioned Paychex gaining market share during this period. Are you noticing any significant changes among your competitors? For instance, do you see legacy regional service providers and some SaaS players without a service component struggling as a result of the pandemic? Are you experiencing a higher win rate against them? I’d like a bit more detail on this, please.

Martin Mucci, CEO

Yes, Lisa, we are definitely noticing fewer people leaving for competitors, which is a positive sign for our competitive landscape. In terms of our win rate in sales, we're experiencing an increase, particularly with products like SurePayroll at the lower end of the market. We are still evaluating whether this uptick is primarily due to competitive wins, but it appears that we are gaining more traction in the micro business segment. Additionally, many clients who previously managed their payroll in-house are now looking to online processors. SurePayroll has benefited significantly from our initiatives on the federal side, especially with the payroll report that assisted them in securing loans and loan forgiveness, along with various webinars we conducted. This has strengthened their position in the market. Overall, I don’t think we've witnessed any significant disruptions in the competitive environment at this point, although some competitors have experienced furloughs and layoffs. I believe our strong tools developed during COVID have helped us win over clients and prospects looking to outsource for the first time. Sure. I'll start with the key metrics. The businesses we referred to as suspended have not gone out of business, but they have paused processing. This number has reduced significantly, continuing to decline each week. We're seeing businesses return, although many are not back to full employment levels. For instance, if a company previously had 20 or 30 employees, they might currently have 15 or 20. This is understandable given the circumstances, especially for establishments like restaurants that are operating at 50% capacity. More than half of the suspended businesses have resumed operations, which is encouraging, and this recovery is happening relatively quickly. We have also noticed improvements in both checks and work site employees in our PEO and ASO services. The changes in our client base have occurred swiftly, with businesses bringing back employees faster than we anticipated. We hope this trend of continuous improvement will persist. On the sales front, we are still primarily working remotely, although we are beginning to visit clients who are comfortable with in-person meetings, adhering to all necessary safety protocols. Some clients prefer face-to-face interactions, but most of our sales continue to stem from remote online discussions and phone calls, which is proving effective. I am pleasantly surprised by the number of final sales we achieved in the fourth quarter, given our remote workforce. Additionally, we have permanently transitioned a significant portion of our small business sales representatives to inside sales due to its success. Although we have been engaging in virtual sales for many years, we are increasing this approach because of its productivity and the success we've seen, supported by the tools we have in place. Consequently, our sales productivity is rising, the number of checks per client is increasing, and the number of clients who have suspended processing is decreasing dramatically. Efrain, do you have anything to add?

Efrain Rivera, CFO

Steven Wald, Analyst

Martin Mucci, CEO

No. I think we assume that retention is around 83%, which is an all-time high for us. We're being cautious. When you consider that we still have suspended clients, even though their numbers are now less than half of what they were at their peak, things are still changing quickly. We're working to understand how many clients remain suspended and how many might permanently go out of business. Our retention is the best it's ever been, but we prefer to wait another month to see if those suspended clients return or if any are lost. Regarding bookings and sales, they have remained steady, and we haven't seen any decline in sales. Although sales haven't yet returned to pre-COVID levels, they are definitely improving. I would say sales have been improving, and our retention is at an all-time high. However, we're cautious and want to ensure in the next 30 to 60 days that the clients we've retained are not just suspended and at risk of going out of business. Our losses to competitors have improved significantly. People aren't switching to competitors, possibly due to needing our support, especially with loans and other forgiveness calculators, as we've received many positive client testimonials. We're retaining more clients and have improved our ability to keep clients from leaving due to pricing or competition. I think our cautious approach is just to observe what happens in the next 30 to 60 days.