All right. I think we've gotten the people that want to leave out, and we'll get the people that are coming in, still coming in, as I get started here. So thanks, everybody, for joining us here at the Nasdaq Conference, and I appreciate their partnership with us here at Morgan Stanley to put on this event. It's always a great time, and certainly enjoy having the companies that come over to visit, including the senior management here from Paychex. I'm James Faucette, senior fintech analyst at Morgan Stanley, and I'm very pleased today to have John Gibson, CEO of Paychex, as well as Bob Schrader, CFO of Paychex. Obviously, time is short, and these go quick. So I guess without any further ado, John, Bob, pretty interesting start to the week. We know that you've got earnings coming up, but you had some AI-related announcements.
That certainly is a topic in every conversation that we're having today. Why don't you kind of talk to us about some of your recent announcements, and we can start to talk a little more broadly about how you think that'll impact, how you think AI will impact the labor market. But I'd love to hear the work you're doing now.
Yeah, no, actually, it's been a work in progress for probably a decade. I don't know whatever you call AI or its predecessors, but that's something we've been working on. As you can imagine, we pay one in 11 private sector workers in the United States, the largest 401(k) provider in the United States, 30th largest insurance agency in the United States, and we're arguably the largest HR outsourcer to small, medium-sized businesses. So we talked about 5 million small businesses every year just in our sales process when you think about the number of clients we have. So we've got huge amounts of data. So we've been leveraging that for over a decade. We have an AI innovation center, and we've now gotten enough things far enough along. We made a series of announcements in terms of AI products.
So we've made a commitment to take all three of our core platforms. We have three platforms all built for purpose: in the small market, SurePayroll. In the mid-market, we have the Paychex Flex product. And then with the recent acquisition of Paycor, we now have Paycor for enterprise. And we're going to be introducing new platforms. All three of those will be updated. They'll be AI-driven as we go into next calendar year. So that's one product-side announcement we've made. We also announced that we've been given a patent, a provisional patent by the U.S. government, and we had been working for some time on the ability to take our data sets unstructured and structured and in compliance and in all the interactions we have with our clients. So we record every one of our conversations. We digitize those, all of our emails.
Now, the ability to take all that information and, by asking it a question, we can give a curated answer based upon the role you play in an organization to give you guidance, so we thought it was interesting. We thought it was unique. We thought we'd try to go for a patent, and indeed we got the pending patent, so we're excited about that. That's already been introduced in our back office, so all of our HR professionals that are consulting with our clients each and every day are using that tool, and we're making that tool better. We've just embedded it into the SurePayroll product. That will be available for the micro market, and we'll continue to expand that up. Excited about that, and then we put into production agentic AI.
So we now have agentic AI actually digesting emails and running payrolls with accuracy that we get historically from someone doing it themselves. We also have a voice agentic AI tool. So you can talk to our bot, tell it what to do, and it's going to run your payroll. So I'm excited about that innovation.
Yeah, yeah, a lot of interesting tools for sure there. So I want to come back to that and have some questions about impact on labor markets. But maybe as we're talking about labor markets, let's start with the big picture. What are you seeing across the U.S. employment landscape, particularly among the small, midsize businesses that you serve primarily? And how are you thinking about managing the potential for an acceleration in small business bankruptcies in the base? I mean, I think if we go back to COVID, it's been this period where we've seen fewer out-of-businesses and bankruptcies than we have historically. There seems to be some normalization, but I don't know if we're fully there. So how do you think about the market generally?
Well, so James, I feel like for the last 18 to 24 months, the only thing I've done wherever I'm at is talk about the pending recession and collapse of employment in the U.S., and I keep saying I don't see it. It's not coming. Continue to see we don't see it. When we look at all of our data across the board, I would say the small businesses continue to be very resilient. We continue to see moderation. When you go back, the index that we actually produce, the small business index for firms under 50 in the U.S., that actually went up in November. It's moderated over last year, less than 1%, and so what we see is just continued moderation. I look at all the other data that we have. We don't see that.
In fact, in the small end of the market, the real labor discussion is a supply problem. Still a supply problem. In the small end of the market, both because of restrictive immigration. That's one thing. Another problem you have is we continue to see accelerated retirements in the U.S. Y ou've got that movement, and then quite frankly, I think that for small businesses, it's a skill problem. Remember, about 70% of our clients are blue and gray-collar, so when you begin to think about the trades and you begin to think about those types of jobs, those are in short supply in the U.S. Actually for us, it's interesting. I actually believe that we have underemployment in our client base. We actually have more openings than what you would generally index in the general economy, and a lot of it has to do with supply problem.
So I want to ask, back tying AI and labor, there's been some speculation. We even have this debate internally at Morgan Stanley about is AI hurting job growth? Is it impacting some elements of employment, at least even in introductory or entry-level white collar, et cetera? You talked about that you guys have a high level of exposure to blue and gray collar. But what is your view on AI's impact on the labor market? And is the pace of employment growth due to AI, not a risk to bookings? Or how should we think about that?
Well, look, I think everybody in the room should cheer up. All this doom and gloom and the big debate, and you got to debate something, right? There's got to be something that is catastrophic that is looming for all of us. But I just don't see it. I've not seen it, quite frankly. I don't buy into AI is going to wipe out employment. And a technological, maybe I've lived long enough to see it. Technological revolutions do not wipe out unemployment. Financial bubbles do, pandemics do, but you don't see mass unemployment. The fact of the matter is people adapt, right? Government policymakers are going to adapt. Does anyone think any government in the developed world is going to allow their unemployment rate to go to 10%-15% and not do anything? It's not realistic.
So our general view is, and my general view is just based upon my past history of watching technology get introduced, is jobs are going to change. I was just talking to our team here in Europe in Copenhagen yesterday. I said, "Everyone should expect your job is going to be much different over the next two years as we introduce all the AI tools that we're expecting our employees to use." But I look at it and say they're going to adapt. They're going to be doing something different. We're really trying to move ourselves more into an advisory capacity for our clients. That's what we're trying to do. Let's get out of the transactional work.
Let's be able to use our data sets within AI to really get them more insights in the hands of our employees and allow them to go and talk to our employees about how to do that, so I look at it and look. I say today, are there less bank tellers than there were 40 years ago? Absolutely, but there are, I think it's like nine times more people employed in financial services than there was 40 years ago, and that's why I think AI is going to impact.
Hey, James, I would just add on to that. When you look at our model, employment growth is not a big part of our model. We're not dependent on getting employment growth within our client base to drive revenue growth, so when you look at our checks per client, that's kind of our same store measure of what's going on with employment within our client base. Outside of some of the disruption you saw during COVID and the recovery, it's typically flattish, and so it's not a real. There's not a tailwind of growth. There are real headwinds of growth, and so we're not dependent on employment growth to drive revenue growth.
And then the other thing I would add to that, when you look at kind of our billing model, we have some defense relative to pure people models because all of our billing models have a base fee component and then a per employee or per check. And when you get to the low end of our client base, that base fee is a larger percentage of the overall fee. It could be as high as 70% of the overall fee. So we have some defense or some mitigation on downside. And I think if you go back to COVID, you'll see that in the numbers when unemployment was very high that year after COVID, our service revenue was still flat to up 1%. So we have some defense on the downside just based on our billing models.
So I think that that's a good place for us to look at kind of on a kind of look forward. And both Paychex has always been like a very consistent business. I mean, you guys do a very good job historically and up to today continuing to drive that business the way you have. But one thing that certainly raised eyebrows was your announced acquisition of Paycor. And can you walk us through a little bit the strategic rationale? It was a little bit of a product and market pivot for you, at least looking at it from the outside. What was the strategic rationale for you? How is integration progressing? And what are you talking about in terms of potential revenue synergies?
Yeah, so that's a big question, so I put it in context. I don't think it's as far-fetched. I mean, number one is Paycor was a natural extension of the journey that we've been under at Paychex for probably 15 years, and it's a natural extension to our business. We were in that business. We had a nice-sized enterprise business, and we felt like it was an opportunity for us to extend our total addressable market by another $10 billion and get us over $100 billion in addressable market, so it was a natural extension for us, so I think you have to put the, everybody looks at the Paycor thing.
You got to put it in broader context as to the journey we've been on for really the last 15 years as a company to really build the most comprehensive capabilities in HCM, both in terms of technology and advisory services for businesses of all size. So let's stop there. 15 years ago, Paychex had no technology that our clients used. We made an acquisition, SurePayroll, and they'll go into the market. That gave us a technology capability in the micro market. Okay, we were predominantly an advisory firm. We were in insurance and benefits. We were a retirement 401(k) business, but we were a services business. This transformation to integrate technology in what we're doing. So we started there. We started investing in building Paychex Flex. Along that journey, we also wanted to build up our advisory and our HR outsourcing capabilities.
So we made a series of acquisitions there, including the Oasis acquisition, which at the time $1 billion was the largest acquisition the company had done. So move forward. We're building out capability, and we're constantly looking, do we build or buy? Speed to market, capability, what do we have to do? Our vision was always to have the most comprehensive set of products and services, both technology and advisory for businesses of all size. So we were constantly looking at that. And the opportunity to acquire Paycor came up. And it was a natural extension to what we were trying to do in the enterprise space. And we wouldn't have met that. And the thing I would say to investors, I want you to think about, is think about all the money we invested over the last 15 years.
You look across the board, and our margins are higher today than they were 15 years ago. We've invested in the business. We've grown the business. We've made strategic acquisitions, and we've improved the margin profile of the business. Now let's talk about even on the debt side. I mean, our leverage is still less than 2. I think Bob is going to write a check in March, and it'll be down below 1.5. We have tremendous cash flows and capabilities to support the debt that we have. I go back on the Paycor side. It's going exceptionally well. We're best operators in the industry. Cost synergies, we've already exceeded the ones we've set. Revenue synergies, Bob can give you some more numbers, but we're on pace to do what we want to do.
And what's amazing is we now have an opportunity to go into the Paycor base of 50,000 customers. And they've never been offered our managed services before, our advisory services. And that's resonating there. They also, when we part of that acquisition, we picked up an embedded capability. We have been working, we have SurePayroll. We do embedded for banks and for other technology companies and for other CPA firms in the U.S. We're now putting those assets together and creating an entire embedded strategy that's going to come out of the Paycor acquisition as well. So it's another extension. That's not even included in my TTM numbers I gave you 10 days. So we're just beginning to put those investments together. So look, Paycor is one step in the journey of us building, buying, and assembling the most comprehensive HCM set of products and services.
It's not just tech. It's also our advisory and HR capabilities, which I think are going to be really what differentiate us in the market.
And let me maybe add just a couple of comments on the synergies. As John mentioned, what we communicated this year, we're well on track to meet our cost synergies. I think we said $90 million. A lot of those actions are already behind us, and we're not stopping there. We're seeing other opportunities from a cost synergy standpoint. One area that stands out to me is procurement. A lot of overlap with vendors. And as those contracts are coming up for renewal, we're seeing some success there with the combined leverage. So I feel really good about the cost synergies. But the reality is that's not why we did the deal. Although I would say the cost synergies alone really justify the purchase price that we paid for it. We did it for the revenue synergy opportunity.
I think most people understand we've had a lot of success in monetizing our client base. As John mentioned on day one, we just inherited 50,000 clients in the top of our payroll funnel that on average are larger than our client base and are more apt to have the needs that our solutions, our ancillary solutions, particularly ASO, PEO, and retirement solve for. What we said this year is we expected about 30-50 basis points worth of growth for revenue synergies. But that grows over time. I think we're trying to be thoughtful and intentional how we go after the opportunity. We didn't want to just unleash our 3,000 sales reps on day one on their client base. We didn't think that that would turn into a good client experience. And we're doing what we've done with our client base.
We're leveraging our data and our AI models to really identify those clients that are great fits for these solutions. And then we're going to go after that opportunity. So we feel great about the opportunity. Again, we're trying to be intentional as we go after it. And those revenue synergies will build over time.
So John, I want to come back and just have you elaborate a little bit on how you're thinking about the incremental steps now that you've got Paycor, you're integrating that. But what are the incremental steps that you look at in terms of adding incremental functionality to the HCM solution, etc.? What are your priorities for the next few years?
Yeah, I think in terms of, I think we pretty much got every bell and whistle there is in HCM covered at this point in time. I think what we're really trying to do now is really integrate our data and AI and the insights into the products, and part of the product roadmap that we just announced on Monday is we kind of want to blow up the HCM experience with AI, so you're not going to menus and you're not going point and click. You're basically just telling our systems what you want done, and we need to close a factory or we need to close this site in Texas. Okay, we'll do that for you. We'll take care of all that for you.
All the way up to and including now you're going to engage in our technology with one of our HR advisors to help you work through the human capital change management issues that AI can't do. So it's just really putting the expert and embedding the expert into the technology. And we really think the AI is going to be able to do that. So that's kind of where we're at.
So let's transition a little bit to PEO. This has been really an area of strength for Paychex, especially when we compare your work site employee growth versus some of the competitors. What's driving the dynamic for you and PEO generally?
Yeah, I'll take that one. One, I think we're significantly better than the other. Okay, that's the easy answer. One, I think that PEO business, John and I are both bullish on the PEO opportunity. And I think one of the reasons is we're trying to help small businesses and medium-sized businesses solve problems. And that business model checks a lot of boxes there. And so we're bullish on the opportunity. And I'd say in general, there's a lack of awareness overall on that PEO business model. It's very popular in New York, California, Texas, and Florida. But there's just a long runway for growth. There's only roughly 200,000 of the 6.5 million businesses in the U.S. that are in that model. So we're bullish on the opportunity.
I'd say there's probably three things that stand out to me on why we're seeing a little bit better growth than maybe our competitors. One, we've been investing in that area. So it's probably one of the areas that we continue to invest in sales and marketing resources. So that's certainly helping to drive the growth. Over the last several years, we strengthened the value proposition, and we've seen record levels of retention. And we continue to see that. And so that's driving work site employee growth. And I would say the third thing that probably stands out for us, certainly relative to the public PEOs, is we have a captive audience. We have 800,000 clients. Obviously, ADP has that as well. But we have 800,000 clients, and we can leverage our data and AI models to really go in and cherry pick that client base.
And that gives us an advantage as well. So that's what's really driving the better performance.
So I want to ask you just as a follow-up there, just to help at least me understand the business a little bit better. One of the trends that we've observed within PEO businesses generally is that when employment or macro may be softened, employees tend to opt for lower-cost health plans and/or employers stop offering some of the ancillary services like insurance and 401(k). Is that a structural phenomenon? And is that accurate? I guess maybe is the first question. And is that structural? Or what can you do to mitigate the impact as we see different parts of the economic cycle?
Well, I don't think that the ability for employees or employers to afford benefits, particularly health benefits in the U.S., has anything to do with employment. It has everything to do with health inflation. And we have a significant health inflation. I actually think you're still seeing the sonic boom of the COVID era ripple through the U.S. health center. It's the center of attention in Washington right now. For sure. So certainly, there's no question that for employers and for employees, the affordability issue is what causes them to maybe downgrade their plans, capabilities. And so one of the things that we do, because we have an insurance agency, and then we have the ability through our PEO to pull insurance pools together, we're actually able to give them something better than what they could get in the open market.
Now, whether or not they can afford that is a question. So what we've continued to try to do is have the broadest set of capabilities and options for small, medium-sized businesses to be able to offer their clients, their employees, benefits. Because that's a competitive advantage against larger firms. If you're a small business, you've got to be able to offer competitive benefits to be able to attract and retain employees against larger firms. So we've done a lot of things across there, up to including something we launched last year, very innovative, which was also part of our monetize the employee effort, which is our Paychex Perks program. So give you an idea, so we launched this in July of last year. We have, Bob's going to kick me if I hit the wrong number. We have over 225,000 active individual customers on the Perks product.
We launched a product there two weeks ago. We got 8,000 customers, and what this basically does, we go to an employer and we say, you can no longer afford employee benefits, but we're going to let you tell your employees that you're going to offer them benefits. Because in the Perks platform, we've created a marketplace where we went with the insurance carriers, fintech companies, things that are a relevant part of any big company package, and we've pulled those together and gotten great deals by volume, so now you can log on individually as an employee. You can buy the insurance, and we deduct it from your paychecks, so no longer do you have to write three months in advance or a year in advance, so that becomes a cash flow issue.
We take it right out of your paychecks every week, just like your employer was providing it, but it's direct pay from the employee and because we have such scale, I mean, we pay one in 11 private sector workers, we have a lot of insurance companies that want to talk to us because it's a digital distribution. You go in as an employee, you're onboarding a new employee. It takes you through open enrollment digitally, just like you would in a large company, and it says, do you want dental? You want this? This is how much it's going to come out of your check every week, and it's all automatic, and then we take care of all of the receivable and payments for the carrier as well, so it's a win-win for them because they reduce their cost of administration.
So we've got a curated set of products, and we've identified about 100 different products we want to do there. And then as Bob says, what we're doing is we're really using AI to really determine what you're seeing in terms of age and other factors. So what we're trying to do in the benefits area is a problem. It is a big problem for small businesses. Because if they can't offer competitive benefits, they can't go and attract the type of labor that they want.
Right. And it goes back then to the point that you were making earlier is there's still some underemployment there to lack of skills, etc., for your customer base. We've got just a few minutes left. Did want to touch on a couple of financial questions. And obviously, keeping in mind that you guys are due to report earnings next week.
I'll let Bob answer this.
Yeah, yeah. But how should investors be thinking about the drivers of medium-term revenue growth, either by segment or consolidated across new logos, upsell, cross-sell? Just elaborate that a little bit.
Yeah, I think in general, we operate in a large market opportunity, well-positioned, growing by our estimates, mid-single digits. So I'd say in general, we're growing at or above market. Just given the comments on the PEO and the opportunity there, it would be our expectation that PEO would continue to probably grow at a faster rate than our management solutions business. And then when you kind of look at the components, James, we call it our growth formula. It really hasn't changed. We're typically trying to get some growth from client-based growth. That's usually in that 1%-3% range. And it's easier to grow your client base when you have 30,000 clients. When you have 800,000 clients, it's a little bit harder. But that's certainly an area that we're focused on driving client-based growth.
But when you look at our model, it really is a revenue per client model. And that comes from two areas. One, obviously, we have to deliver on our value proposition, continue to find ways to create new value for our customers. When we do that, that gives us pricing power. And that's typically in that 2%-4% range. We get very little pushback from our customers on that. And then the other area that drives revenue per client is larger share of wallet and our ancillary attachment. We've driven a lot of growth there. Historically, I think when John and I take a step back and we look at our client base, our Paychex client base, and we look at the penetration rate of a lot of those key solutions, ASO, PEO, retirement, they're still relatively underpenetrated within our own client base.
So we feel like there's a lot of opportunity to continue to grow revenue there. And then, as we mentioned, we now have the 50,000 Paycor clients that's going to provide us an opportunity to drive up share of wallet over time. And so those are kind of the components. The other area, if you look historically, we typically have gotten about 1%-2% of growth from M&A. Obviously, this year it's much higher with the Paycor acquisition. But we would look to continue to deploy capital towards M&A opportunities to drive revenue growth in the future as well. After we get through kind of this big integration, we'll continue to look for opportunities there.
So last question here to wrap us up. Just elaborate in a little more detail there on capital allocation. Took on about $5 billion in debt. Some of that comes due within the next 12 months. How are you prioritizing capital allocation between the debt paydown? Dividends are currently like 97% payout ratio and that kind of thing. So just.
Here we have 4% return.
Right.
Yeah, I would say let's talk about the debt first. John mentioned it. We have some of the debt that we took on about seven years ago from the Oasis acquisition. That was roughly $400 million. That comes due in March. Our plan would be to pay that off, and I think that with the synergies that we're going to realize from the Paycor acquisition, that's going to drive our leverage. We're targeting our gross leverage to be below 1.5 x, and then just in general, I think we've been very clear with the acquisition that really not a significant change in our capital allocation policy. Certainly, number one, we're going to continue to invest in the business. We've talked about the areas. I think the priorities there are data, AI, technology, and our go-to-market are probably the two areas that we would focus on.
And then as it relates to returning excess capital to shareholders, we're going to favor the dividend. You mentioned a higher number. That's because of the amortization. But from a non-GAAP standpoint, we typically target 70%-80% payout ratio. We've committed to growing our dividend in line with our earnings. And when you kind of take a step back and you look at the free cash flow generation of our business, I mean, we're 30% + free cash flow margins. And so we have the free cash flows not only to pay the dividend, but to service the debt. And that's before we even include the free cash flows that we got from the Paycor acquisition. So I'll just touch on share buybacks. We do do share buybacks. Our philosophy there is really just to maintain our share count offset dilution.
You could have some timing differences there based on opportunities. But in general, that's how we think about share buybacks. And then again, I mentioned M&A as being an area that we'll continue to deploy capital as we move forward.
Great. Well, that's all the time we have. John, Bob, thanks for joining us today.
Thank you.
Thanks for having us.