Paychex, Inc.

Ladies and gentlemen, thank you for standing by, and welcome to the Paychex Fourth Quarter and Fiscal Year 2019 Earnings Conference Call. At this time, all participants have been placed in a listen-only mode, and the floor will be open for your questions following the presentation. If you would like to ask a question at that time, please press star 1 on your touchtone phone. If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key. We ask that while posing your question that you please pick up your handset to allow optimal sound quality. Lastly, if you should require operator assistance, please press star zero. It is now my pleasure to turn the floor over to Martin Musi, President and Chief Executive Officer, to begin.

Great. Thank you. And thank you for joining us for our discussion of the Paychex fourth quarter fiscal 2019 earnings release. Joining me today is Efren Rivera, our Chief Financial Officer. This morning before the market opened, we released our financial results for the fourth quarter and fiscal year ended May 31, 2019. You can access our earnings release on the Investor Relations webpage. Our Form 10-K will be filed with the SEC before the end of July, and this teleconference is being broadcast over the internet and will be archived and available on our website for approximately one month. On today's call, I will review business highlights for the fourth quarter. Efren will review our financial results for both the fourth quarter and full year and discuss our guidance for the upcoming fiscal 2020, and then we'll open it up for your questions. We closed fiscal 2019 with growth across our major product lines and solid progress toward our objectives. Our total revenue growth was 16% for the fourth quarter, which includes, of course, the incremental results from Oasis Outsourcing Group. Management Solutions revenue grew 4%, while PEO and Insurance Services revenues grew 67%, or 10%, excluding the impact of OASIS. As we look back on fiscal 19, we had a solid service and retention performance, a number of innovative enhancements to our product offerings and mobile app, and we completed the largest acquisition in our history. The acquisition of OASIS added scale to our PEO business. and we ended the fiscal year serving 1.5 million worksite employees across all of our HR outsourcing services. In addition, we are beginning to realize the strategic benefits of the acquisition through the expansion of relationships with insurance partners and opportunities to upsell within the existing OASIS base. Our newly combined PEO leadership team continues to expand our leadership position in the HR outsourcing industry. Fiscal 2019 reflected excellent execution in client service and operations, as seen in our client retention and our client satisfaction scores. Our client retention has continued to increase from the prior year, and we ended the fiscal year with payroll client retention on par with our historic best. We have made significant investments in our sales force this year, particularly in our inside sales and mid-market sales forces and in demand generation. These incremental investments are having an impact as we have experienced increased sales momentum with these efforts. In addition, we have continued to produce solid new sales growth from our Sure Payroll, HR Solutions, Retirement, and PEO sales teams. The momentum in new sales coupled with improved client retention has resulted in overall growth in our payroll client base. As of May 31, 2019, we serve approximately 670,000 payroll clients. In addition, excluding worksite employees acquired as part of the OASIS acquisition, the number of worksite employees served by our HR outsourcing services reflected double-digit growth. America's businesses are operating in challenging times. The unemployment rate is at its lowest in nearly 50 years while employers try to ramp up their hiring. As a result, there is a lack of talent to fill open jobs, and the regulatory environment is complicated and continuously changing. State jurisdictions are continuing to advance employment-related laws and regulations that impact the hiring and employment of workers. Also, the way people work is changing, requiring employers to understand employees' workplace expectations, challenges, and requirements. In this evolving landscape, businesses are looking for simple solutions that help them build their business, stay compliant, improve productivity, and recruit, hire, and retain talent. Paychex is uniquely positioned to meet these needs through our breadth of service offerings, but more importantly, through the combination of our innovative technology and personalized service model. This sets us apart and allows us to be true partners and advocates for our clients. We renewed our commitment to reducing the complexity for our customers related to payroll benefits and HR administration when we launched our new branding earlier this year. Our tagline, The Power of Simplicity, reinforces this commitment. We continually invest in our solutions to make payroll and HR administration simpler for our clients and their employees and provide solutions the way they are working today. Seventy percent of the usage of our five-star mobile app is done by our clients' employees. We are making it easier for the employees and more productive for our clients through an increased number of self-service options. The enhancements we have made throughout this past year include the HR Center with performance and learning management and enhanced HR data analytics, benefits management enhancements with a refreshed enrollment experience for health and benefits and retirement, and increased options through the use of chatbots and artificial intelligence. All of these enhancements are designed to provide simple solutions for our clients and their employees. This focus is on steadily investing in the innovation of our Paychex Flex platform Human capital management technology played a significant part in our recognition by Nelson Hall as a leader in payroll outsourcing for the North American small business market. This was our third year in a row receiving this designation. Shifting to other solutions, we currently face a retirement crisis in the U.S. A recent report from the U.S. Federal Reserve found that a quarter of Americans have no retirement savings. We recently launched enhancements to our 401K product design to help address this crisis by simplifying retirement plan enrollment and management. These enhancements included a new participant dashboard and added functionality in the advisor portal. The new participant dashboard makes the process of enrolling in a 401K simpler than ever and also provides a unique combination of tools and resources to empower participants in preparing for the retirement. Our mobile app allows a new participant to enroll in as few as four clicks, which has already resulted in increased participation rates. We also continue to return value to our shareholders. In May, we announced an increase in our quarterly dividend of $0.06 or 11% to $0.62 per share. During fiscal 19, we returned almost $900 million to our shareholders through a combination of dividends and share repurchases. In summary, our fourth quarter caps another successful year for paychecks. Our state-of-the-art technology, full suite of HCM product offerings, and world-class personalized service is a powerful combination that positions us for sustainable growth within our market ecosystem. Our organic business, combined with our new acquisitions, have positioned us well for fiscal 2020 and beyond. The sustained efforts of our employees and their commitment to our clients continue to drive the company forward. I will now turn the call over to Efren Rivera to review our financial results for the fourth quarter and fiscal year.

Efren? Thanks, Marty, and good morning. I'd like to remind everyone that today's conference call will contain forward-looking statements that refer to future events and, as such, involve some risks. Please refer to our earnings release for the customary disclosures. In addition, I will periodically refer to some non-GAAP measures such as adjusted operating income, adjusted net income, and adjusted diluted earnings per share. These measurements exclude certain discrete tax items and one-time charges. Please refer to our press release and investor presentation for a discussion of these measures and a reconciliation for the fourth quarter and full-year fiscal 2019 to their related gap measures. I'll start by providing some of the key highlights for the quarter and then follow up with some greater detail in certain areas. I'll touch briefly on full-year results and wrap with a review of the fiscal 2020 outlook. Total revenue and service revenue both grew 16% for the fourth quarter to $980 million compared to $958 million respectively. Excluding OASIS, service revenue and total revenue both grew by 5%. Expenses increased 22% for the fourth quarter to $666 million, but if you exclude the OASIS acquisition, expense growth was 6%. The increase in total expenses excluding OIS is primarily driven by increased headcount due to incremental investments in the sales force, technology resources, and operations to support the growth in business. In addition, an increase in PEO insurance costs contributed approximately 1% to the growth in total expenses in the fourth quarter. Operating income increased 4% to $314 million. Operating margin was 32.1% for the fourth quarter compared to 35.7% for the same period last year. Margins were impacted by business mix due to the growth in the PEO business, accelerated investments in sales, technology, and operations, as well as some one-time acquisition integration and amortization costs associated with the OASIS acquisitions. Our effective income tax was 25.8% for the fourth quarter compared to 28.5% for the same period last year. Net income increased 6% to 230 million, and adjusted net income increased 10% to 228 million for the fourth quarter. Diluted earnings per share increased 7% to 64 cents for the fourth quarter, and adjusted diluted earnings per share increased 9% to 63 cents. I'll now provide some additional color in selected areas. Management Solutions Revenues. As you know, this includes our payroll service revenue together with other HCM products included in many of our product bundles. It increased 4% to $695 million for the fourth quarter. The increase was primarily driven by growth in our client base across many of our services, along with growth in payroll revenue per check, which increased or improved as a result of increases in net of discounts. Within management solutions revenue, retirement services revenue also benefited from an increase in the number of plans served, as well as an increase in revenue earned on the asset value participants 401K funds. PEO and insurances revenue. It increased 67%, as Marty mentioned, to $263 million for the fourth quarter. Excluding the acquisition of OASIS, PEO and insurance services revenue increased approximately 10% for the quarter. The increase was driven by growth in clients and client worksite employees across our combined PBS and HROI PEO businesses. Demand for our existing PEO services along with growth within our client base resulted in double-digit growth in the number of client worksite employees served. Insurance service revenue benefited from an increase in the number of health and benefit clients and applicants. partially offset by the impact of softness in the workers' comp market as we discussed last quarter. Interest on funds held for clients increased 25% from the fourth quarter to $22 million, primarily as a result of higher average interest rates earned. Average balances for interest on funds held for clients remained flat for the fourth quarter as the impact of lower client withholdings resulting from the tax reform legislation and changes in client base mix, were partially offset by the impact of wage inflation. Interest expense net. I'll note that we had a net non-operating interest expense compared to net investment income in the prior year. This is a result of interest expense of the $800 million of debt financing that we utilized to fund a portion of the OASIS purchase price. The $800 million is made up of private placement debt securities with terms of 7 or 10 years with coupon rates of 4.07 to 4.25% respectively. Let me touch on year-to-date results quickly. Management solutions revenue, again, up 4% to $2.9 billion. PEO and insurance services revenue increased 48% to $822 million, 19% excluding OASIS. Interest on funds held for clients up 27% to $81 million driven by interest rate increases and partially offset by impact of decline in average invested balances. Total revenues increased 12% to $3.8 billion, 7% growth excluding OASIS. Operating margins were 36.3% tempered by investments in the business, the acquisition of OASIS and growth in the existing PEO direct insurance costs. Net income increased 4% and adjusted net income increased 11%. Diluted EPS increased 4% and adjusted diluted EPS also increased 11%. Turning to our investment portfolio, as you know, our goal is to protect principal and optimize liquidity. We continue to invest in high-credit quality securities. Our long-term portfolio has an average yield of 2.1% and average duration of 2.9 years. Our combined portfolios have earned an average rate of return of 2.1% and 1.9% for the fourth quarter and fiscal year respectively. These are up from 1.7% and 1.5% for the respective periods last year. Let's talk about our financial position. It remains strong with cash, restricted cash, and total corporate investments of almost $800 million as of May 31, 2019. Funds held for clients were, as of May 31, 2019, were $3.8 billion compared to $4.7 billion as of May 31, 2018. As you know, funds held for clients vary widely on a day-to-day basis and average $4.1 billion for the fourth quarter and $4 billion for the fiscal year. Our total available for sale investments, including corporate investments and funds held for clients, reflected net unrealized gains of $20 million as of May 31, 2019 compared with net unrealized losses of $38 million as of May 31, 2018. The move to a net gain position was due to declines in longer-term yields. Total stockholders' equity was $2.6 billion as of the end of the year, reflecting $827 million in dividends paid and $57 million worth of shares repurchased during 2019. Our return on equity for the past 12 months was a very robust 42%. Cash flows from operations were $1.3 billion for the fiscal year, an increase of 1% from the same period last year. The increase was driven by higher net income and non-cash adjustments, partially offset by fluctuations in working capital. Working capital fluctuations related to timing around collections and related tax payments for a combined PEO business, along with higher accounts receivables related to growth in our payroll funding business for temporary staffing clients. Now let's turn to the guidance. I remind you that our outlook is based upon our current view of economic conditions continuing with no significant changes. Management solutions revenue anticipated to grow 4%. PEO and insurance revenue is anticipated to grow in the range of 30% to 35%, reflecting a full year of OASIS. Interest on funds held for clients is anticipated to grow in a range of 4% to 8%. At this stage, we do not contemplate either any increases, obviously less likely, and no rate declines. We will watch and see what happens. Total revenue is anticipated to grow in the range of 10% to 11%. Operating income as a percent of total revenue is anticipated to be approximately 36% comparable with this year, reflecting the expected impact of higher PEO direct insurance costs. EBITDA margin for the fiscal year 2020 is expected to be approximately 41%, again, comparable to where we end this year. Net interest expense is anticipated to be in the range of $15 million to $18 million, reflecting a full year of interest on outstanding long-term debt, which I discussed previously. The effective income tax rate for fiscal 2020 is expected to be in the range of 24% to 24.5%. Net income and diluted earnings per share are both anticipated to grow approximately 8%, and adjusted net income and adjusted diluted earnings per share are both expected to increase in the range of 8% to 9%. And remember that we don't plan on necessarily the tax benefit when we get a stock comp exercise, which is why we adjust it out. I will provide further color on the gating. Management Solutions revenue quarterly gating is anticipated to be consistent with the full year guidance, with the exception of the first quarter, which is anticipated to be in the range of three to four percent, largely due to a mix of days in the quarter. However, please note that growth rates for the PEO and insurance revenues are anticipated to be significantly higher in the first half of the fiscal year. until we reach the anniversary of the OASIS acquisition. So we anticipate growth in the range of 60 to 65% in the first half of fiscal 2020, and then growth of 11 to 14% in the second half. So let me just repeat that. We anticipate growth in the range of 60 to 65% in the first half of fiscal 2020, for PEO and insurance services and then growth moderates to 11 to 14% in the second half of the anniversary of the OASIS acquisition. Our net income gating is also impacted by the timing of the OASIS acquisition together with related amortization expense and integration costs. This causes lower net income growth in the first half of the fiscal year. In addition, incremental investments in sales, technology and operations are ramped over the year during fiscal 2019, we expect net income growth to be below the full year guidance range provided at approximately 3% for the first half of the fiscal year. And then we expect it to increase to a range of 11 to 13% in the second half of the year. So let me repeat that. We expect net income growth to be below the full year guidance range for the first half of the year, and we expect it to be approximately 3% for the first half of the fiscal year, and then we expect it to increase to a range of 11 to 13% for the second half of the year, due to the factors described above. Then one final point specific to Q1. For the first quarter of fiscal 2020, netting income growth is anticipated to be in the range of 1% to 2%, with the most significant driver being that of investment spending funded by tax reform that was just starting to ramp up during the first quarter of fiscal 2019 and incremental expenses from OASIS. So with that, and with that color on the guidance, I will, one, refer you to our investor slides for more detail that have been posted on the web, and I will now turn the call back to Marty. Thank you, Efren.