Bob Schrader: Yes. I mean I wouldn’t say significantly, Samad. I don’t want to get into providing specifics on the 2 categories yet as we’re still going through our annual budget process. But we certainly would expect the PEO and Insurance category growth next year to be similar to what we’ve seen this year and Management Solutions is where the big headwind is with ERTC. But I would say similar trend lines to where we’re exiting the year.
Samad Samana: Great. Thank you so much. Have a great day.
John Gibson: Samad, I appreciate that you recognizing the three questions. I remind everyone of the effort rule. Although he’s gone.
Operator: We have our next question from Jason Kupferberg with Bank of America.
Unidentified Analyst: This is Caroline on for Jason. So in terms of capital deployment heading into 4Q and also 2025, can you give an update on the relative attractiveness of buybacks versus M&A? And then also, could you give an update on like the general health of your M&A pipeline?
John Gibson : Bob, you want start with the M&A?
Bob Schrader : Yes. Look, I would say that we continue to be open to acquisitions that meet the strategic objectives that we’ve laid out and that make financially sense. I would say that I feel like in several areas and industries that we have interest that the multiples that I’ve seen are getting into line that are more reasonable and trying to be active. And the key thing is just the timing of that, when is the right time of that. So we’re certainly open for business, active engaging in both tuck-ins where we can add capability. We’re doing a lot of things and looking at what we can do from an AI and digital HR perspective, constantly looking for adjacencies that are driving really the needs of our customers in terms of what they need to succeed and what we’ve talked about, the access to capital, being able to retain it and hire employees and really getting access to affordable benefits that allow them to attract clients.
So all of those things are open. We’ve got an active engaged team that is talking to a lot of different prospects. But more to come. We certainly have the capital capability and the ability to do acquisitions, and we’re prepared to pull the trigger if we can come across something that makes financial sense.
John Gibson: And Caroline, I mean the only thing I would add to that, just overall as it relates to capital allocation, really no change in our approach there. We’re going to continue to invest in the business. Dividends are — we’re going to continue to grow the dividend, and that will continue to be our primary use of cash. You mentioned share repurchases, really no change in our philosophy there. We do that to offset dilution from executive comp. You saw recently, a month or so ago, we did do a new share reauthorization so we can continue to do that. The old authorization had expired. And then to John’s point, we certainly are interested in M&A opportunistically, and we’ll continue to use M&A to drive growth in the business. So our strategy and philosophy around capital allocation is very consistent with what you are all used to in the past.
Operator: And we have our next question from James Faucette with Morgan Stanley.
James Faucette: I wanted to go back on just a quick couple macro points that you’re making. If I rewind back in December, you talked a little bit about some concerns you had about potential for increases in out-of-business rates, et cetera. I’m just wondering, like how that’s evolved and what your current outlook is there? And it seems like you feel better about it, but I just want to make sure I’m interpreting your comments correctly.
John Gibson: Yes, Jim, I would say that out-of-business rates are not out of the norm that you would expect given the accelerated new business starts that we saw 2 to 3 years ago. Small business starts are down a little bit from those peaks and highs, but still above pre-pandemic levels. But again, it goes back to what I said before. We’re not seeing signs of what would typically be seen in a recessionary period where there was accelerated out of businesses. Right now, what I would say out-of-business is elevated and particularly in the low end. But when you look at that in context of how many new businesses were started over the last 3 years, that’s not atypical because within 2 years 50% are gone; within 5 years, 75% of them are gone. So that’s — it’s not being driven by, what I would say, economic hardship or broad-based. Businesses that you would not expect to go out of business don’t seem to be going out of business, if that makes sense.
James Faucette: Yes, it does make sense. I appreciate that. And then we’ve talked about kind of labor scarcity pretty consistently for the last few years. And I think your incremental comments in terms of the quality of labor and specifically employers being more discerning now, it’s interesting. Any specific areas or whether it be industries or geographic regions that that’s important too. And I’m asking the question because I’m trying to think about what the path to resolution there is or if this is just something we’re perpetually going to be grappling with?
John Gibson: Well, look, what we keep trying to focus ourselves on is what more can we do to help our clients retain and attract quality employees. It’s in their interest. It’s certainly in our interest, given the way we get paid. I think, as you know, we launched 2 years ago the AI-based retention insights product that gives them insights to where they may have retention risk. We’ve got this — the partnership with Indeed that’s fully integrated, and we’re actually elevating their job postings up in the listings for them as part of that partnership. We just did the Visier product, which is on the way to being launched. We’ll give them compensation information to be done. We’re going to be doing some things in the next fiscal year around creating benefit bundles for our non-insurance HCM clients that allow their employees to feel like being part of that employee relationship gives them access to catastrophic care.
We’re trying to do a lot of things to solve this problem for our clients. And obviously, there’s more we need to do because the simple fact is we have a generational change happening in the labor force. Participation rates remain below pre-pandemic levels and it’s going to be very difficult given the rate of retirements that we’re seeing in Baby Boomers to really see that change. And what you see in the prime age workers were actually at record highs. The problem is not enough prime age people to fill all the opportunities. And then when you look at the productivity gap that you have generationally — and that’s just in terms of experience, I don’t want to disparage any generation in any way. But just the fact you’re replacing someone with years of experience with someone that’s new or experienced, I really think this is going to be an ongoing public policy issue that’s going to have to be addressed.
There’s a lot of retraining with AI and digital jobs. I think more needs to be done. I mean, we got the R&D tax credit thing that’s sitting out there. Not to get on political bandwagon here, but we need to do more to allow businesses to invest in productivity and drive productivity enhancements and that’s not going to replace workers. That’s going to enable them to get the work done with less workers that are going to exist in the marketplace. So I think this is a systemic problem. I think it’s a great opportunity for us because it really goes to the products and services that we offer for a small and medium-sized business owner. So that’s kind of my personal view on it, and it continues to show up in the data that we look at.
Operator: And we have our next question from Ramsey El-Assal with Barclays.
Ramsey El-Assal: How much did M&A contribute in the quarter? And if you could help us think through whether there’s an inorganic contribution when it comes to your preliminary F ’25 guidance, what that might be as well?
Bob Schrader: Yes. Ramsey, I mean, M&A, we didn’t do any new M&A. The only M&A that we’ve done this year was the small Alterna acquisition that we did at the end of Q1. Obviously, it contributes something. It’s a small number, it doesn’t even round to 1%. So it’s really not a big contributor at all. In the guide, we typically don’t — although we’re always active in looking for opportunities, we’re not going to put anything into a forecast until the deal is closed. So that does not assume any — the preliminary guide does not assume any level of M&A next year.
Ramsey El-Assal: Got it, got it. One quick follow-up for me. SECURE Act 2.0, what are you seeing there? Does that have the potential to emerge as kind of a tailwind that might help offset some of the year ERTC headwind? Or is it too early to tell? Maybe give us an update on what you’re seeing on SECURE Act 2.0?
John Gibson: Yes. I think, Ramsey, replacing ERTC is a very difficult thing to do, both in terms of the revenue nature of it and the profitability of it. And I would say that helping — and basically, we’re doing filing, as you know. We were doing tax filings, which is something that’s core to our business and there was a lot of hype around ERTC. So there was a lot of education going on by others that was helping that. What I see in secured the SECURE Act is I think it’s a great thing. I mean, our retirement business had a solid quarter and it’s had solid year-to-date, and that continues to be a strong growth driver. I think you’ve still got to talk to business owners and educate them on it. It’s still a sales process. We’ve had states that have made it mandatory.
Those kind of come and go in the area. The other thing on the SECURE Act 2.0, which we’ve been pushing on is there is a little bit of a loophole that kind of disadvantages businesses with under 10 employees. I won’t get into the nuances of it. And there’s pretty bipartisan support in both the House and Senate to try to close that loophole and we keep pushing for that because I do think that would particularly help in our micro segment, really accelerate some adoption there. But right now, that will pull is still there.
Operator: And we have our next question from Ashish Sabadra with RBC Capital Markets.
David Paige: This is David Paige on for Ashish. I just had a question on your AI initiatives. Maybe can you provide some of the customer feedback, what — I guess, what parts of your tools or your AI models that they’re liking and maybe some of the benefits you’re seeing internally in terms of greater sales teams, productivity, et cetera?
John Gibson: Yes. So David, what I would tell you at this point in time, a lot of our AI initiatives and investments have really been focused internally, both in terms of how we drive efficiency, how we drive better sales productivity, how we do better marketing and targeting, how we do better customer service and identify clients that are risk, how we do better pricing and discounting so that we’re not getting too much away, but we’re giving enough to get the right type of lifetime value that we want. Really on the client side, the retention insights has been a very popular product with our larger customers in terms of getting insights to what they’re doing, and we’re just in the stages of really rolling out our Visier product, which will give them basically 750 million data compensation data points that will allow our customers in real time to understand how competitive they are if they’re making a job offer what they could potentially do.
And that’s just in the early stages. What I believe is because of our vast data set, we’re going to be able to provide a degree of insights and information when coupled with our HR advisers that I truly think is going to set us apart from any of the smaller regional players or a local CPA because we’re just going to be able to give them the vast data set insights that we have. And so as I’ve mentioned, we just hired a new SVP whose full-time job is to do nothing, but pull all of the capabilities we have across the company and develop a robust strategy of how we can drive the most out of AI to drive more value for our customers and drive more operational efficiency into the company.
Operator: And we have our next question from Bryan Keane with Deutsche Bank.
Bryan Keane: I just had a couple of clarifications. The miss on revenue in third quarter versus your guided expectations, it sounded like 1/3 of that was the ERTC decision to stop recognizing the revenues. Then I’m just trying to fill in the gap and the other 2/3 of kind of versus your expectations on the miss, if I heard that correctly.
Bob Schrader: That’s right, Bryan. So it’s roughly — there’s 3 big drivers — 3 drivers that we’ve talked about. They’re all small, but there’s 3 drivers that we’ve talked about. Certainly, the continued moderation of employment — we definitely saw lower checks per client, lower change in base relative to what our assumptions were. That started in Q2. We updated our forecast in Q2 for some of the trends that we are seeing. But I would say employment came in a little bit softer than even our revised assumptions in the forecast. And then John mentioned a little bit on the rate. We saw smaller client sizes maybe a little bit higher discounting than what we assumed. I mean, we’re still getting really good price realization overall and strong growth in revenue per client.
But I would say it was a little bit softer relative to what our forecast assumptions were. And then the bigger piece there was the ERTC that I mentioned. So when you look at those 3 things, they’re roughly 1/3 of piece is how I would characterize it.
Bryan Keane: No, that’s helpful. And then when I jump from the third quarter revenue growth of 4% to the guided 5%, what accounts for the extra — the strength of 100 basis points when I go into the fourth quarter?
Bob Schrader: Yes. So I’d say there’s a few things to call out there, Bryan. One, I mentioned the ERTC headwind being similar to Q3. It’s a little bit less than it was in Q3, so that has a little bit of an impact. You have less of a headwind from ERTC in Q4. We’re still getting a strong client base, price realization, product penetration that carries into Q4. And then I would say on the PEO side, we came out of selling season in a stronger position from a worksite employee standpoint in medical enrollment and so we’re going to get the full quarter benefit of that in Q4 relative to where we were in Q3. So we got positive momentum, I would say, heading into Q4 in both businesses. And then we are getting a little bit of a lift in interest on funds in Q4.
You’ve seen a little bit stronger growth there versus Q3. Some of that is the compare we did some repositioning of the portfolio. I think we had some — or some realized losses that we took in Q4 to better position the portfolio going forward. And so you get a little bit of a tailwind in growth from that as well. And I’d say when you put those together, that’s what accounts for a little bit stronger growth in Q4 relative to Q3.
Operator: And we have our last question from Scott Wurtzel with Wolfe Research.
Scott Wurtzel: Just one for me. I wanted to go back to the margin side. I mean the outperformance, I think was notable despite the ERTC revenue going away. And I just wanted to clarify. I know you talked about some of the efficiencies off of the investments over the last few years. But were there any specific actions on the expense side that you took during the quarter as the ERTC revenue sort of wound down?
Bob Schrader: Yes. I wouldn’t say anything specific to call out, Scott. I mean, obviously, we’re always trying to look at expenses and making sure that we’re not letting new costs into the business and really focusing. We saw the headwind come in. So I wouldn’t say there’s anything specific to call out other than good expense management. And some of that margin expansion that you saw in the quarter is being driven by interest rates. But even when you exclude that, we saw good margin expansion during the quarter.
John Gibson: Yes. I don’t want to shortchange the tremendous job that each and every employee does in the company in terms of managing expenses. And we have it built into our DNA when we say, hey, we’re seeing signs it’s time to go. People know what to do and they do it. Because again, as Bob pointed out, some of that PEO and Insurance revenue is direct revenue pass-through. So when you look at our margins, you think some of that revenue into ERTC. I just want to come in how good a job we’ve done and I think have done historically as part of our just DNA as being the best operators. And so it’s every little bit, every little thing matters. And so there’s no one big thing. I would say that the insights that we’re gaining and the opportunity for digitalization, the investment we’ve made in enabling our clients and their employees to engage our systems and the rate in which they’re adopting that opportunity is tremendous.
And we’ve invested over the last several years into building out both our AI robotics capabilities and our global footprint. And I think all of those investments we’ve made over the last 3 years during the pandemic era, when we had ERTC are going to serve us well as we move forward. So I just look at it and say, as we exit this era of the pandemic from a Paychex perspective, I think we’re entering the new era of just fundamentally a better positioned company. I think we’re a more positioned, trusted adviser to small businesses. We’re delivering more value to our customers. They’re rewarding that with retention and with better pricing in a market where there’s a lot of cheaper alternatives out there. We’re more digitally enabled in all aspects of our business than we’ve ever been.
And I think we’re more agile and focused and also more profitable, quite honestly. So hats off to the team for all the things we’ve done to get ourselves in this position that when the tide turned, we had leverage we could pull to make sure that we’re delivering for our shareholders.
Operator: And that does conclude our Q&A session for today.
John Gibson: Okay. Well, listen, everyone, at this point, we’ll close the call. If you’re interested in a replay of the webcast of the conference call, it will be archived for approximately 90 days. And I want to thank you for your interest in Paychex and hope all of you have a great day. Thank you.
Operator: This does conclude today’s program. Thank you for your participation. You may now disconnect.
