Paychex, Inc.

Good morning and welcome to Paycheck's first quarter fiscal year 2020 earnings conference call. After the speaker's opening remarks, there will be a question and answer period. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. I would now like to turn the call over to Martin Mucey, President and Chief Executive Officer of Paychex. Please go ahead.

Thank you. And good morning, and thank you for joining us for our discussion of the Paycheck's first quarter fiscal 2020 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 first quarter, ended August 31, 2019. You can access our earnings release on our Investor Relations webpage, and our Form 10-Q will be filed with the SEC within the next few days. This teleconference is being broadcast over the Internet and will be archived and available on our website for about approximately one month. On today's call, I'll review business highlights for the first quarter, Efren will review our first quarter financial results, and discuss our guidance for fiscal 2020. And then we'll open it up for your questions. We are pleased with a solid start to the fiscal year 2020. Our financial results reflect good progress in operations and sales. Total revenue growth was 15% for the first quarter, including the incremental results from Oasis Outsourcing Group, which we acquired back in December of 18. Management Solutions revenue grew 5%, while PEO and Insurance Services revenues grew 56%. And not only are we off to a solid financial start, but our client retention and satisfaction continue to be at record high levels, and sales continues to perform well as we start this fiscal year. We are excited to introduce several new technology enhancements and solutions at HR Tech, which is happening this week in Las Vegas. And as a longstanding leader in this human capital management space, we have insight into the needs of our clients and their employees and see trends in our markets. These new solutions address key developments in payments, wearable devices, integrations, and data and analytics. Our new wearable solutions allow Paychex FlexTime users to track time worked with their smartwatch. Employees can clock in and out with a simple tap of the watch. It also makes time and attendance tracking easier for the increasingly remote workforces with enhanced geofencing capabilities, which remind employees to punch out as they leave their work locations. This is the first of many potential use cases utilizing wearable solutions that we'll be making available to Flex users. We're also excited to be introducing pay on demand and real-time payments. By the end of calendar year 2019, Paychex clients can allow employees to access a portion of their earned pay before the scheduled check date. With many Americans living paycheck to paycheck, this advancement in technology allows financial flexibility when needed. Following this enhancement, Then in early 2020, we'll be offering the option to have earned funds deposited in an employee's bank account in real time. Real-time payments is an extension of our market-leading innovative technology. We will be one of the first providers to offer real-time payments for employee direct deposits, continuing our position as a tech leader in this space. While Paychex offers the full breadth of services across the HCM spectrum integrated into our Flex platform, we understand that clients may prefer to keep some solutions they use in place. Our Paychex product integrations is a private marketplace that takes the company's integration partner strategy a step further, continuing to simplify the process for customers looking to connect Paychex Flex with some of the most popular HR, accounting, point of sale, and productivity applications on the market today. Clients can determine how and when an integration deploys with the ability for it to happen real-time, regularly scheduled, or based on an action within their Flex platform. Our robust and continually evolving set of APIs allows clients the flexibility to choose how they receive their services through one integrated provider or by using various HR solutions. Data and analytics are areas of increasing focus. Paychex is a rich and reliable depository of data gathered from interactions with clients. We are pleased to introduce the Paychex Flex Intelligence Engine. One aspect of this feature is the Paychex Flex Assistant, which we've discussed before. This is our customer service chatbot introduced last year, which continues to evolve and be enhanced. A user's inept interactions are with Flex Assistant allows them to elect a preference for their learning via written how-to documents, tutorial-style video, vignettes, short videos, or a guided interactive tour. Coming in December, the chatbot will offer these options during every customer interaction, providing the ultimate in learning flexibility. At any time, a live Paychex agent is just a click away to provide personalized service experience based on the context collected through the bot. Seven by 24 by 365, Paychex is the only company to offer that personalized service option in our space, seven by 24 by 365 days a year. Through machine learning, our chatbot continually expands its knowledge base and provides a more robust data set to leverage and formulate answers to frequently asked questions. During the past quarter, we approached a quarter of a million sessions interacting with a Flex Assistant. The bot is able to address approximately 200 commonly asked questions, and that number is growing. In addition to these exciting introductions during HR Tech, during the quarter, we also provided a set of enhancements to our solutions designed to help common Solve common HR and payroll challenges, including Paycheck Solo, a bundled offering designed to meet the specific needs of sole proprietors, which includes a payroll incorporation services and a solo retirement plan. A new customizable new grid entry view for payroll. Electronic App Form I-9 and E-Verify processes that is integrated with our paperless onboarding. HR conversations, this is a tool in our performance management module that enables collaboration between employees, managers, and HR staff. And document management, a centralized and secure digital file repository for company forms, policies, references, employee documents, and certifications. We are singularly focused on continued innovation to meet not only our customers but also their employees' evolving needs, simplify HR complexities, and offer solutions to help them thrive and grow. Also, we're offering cyber attacks are a growing threat to businesses of all sizes. We are now making cybersecurity liability protection available to our clients through our Paychex Insurance Agency and Axis Insurance Company, a leading cybersecurity insurance carrier. This solution helps business owners mitigate and the potential impact of financial impact of data breaches, hackers, and ransomware and online banking fraud. It is particularly critical for businesses with fewer than 1,000 employees, since 60% fail within six months of a cyber attack due to a lack of resources to offset the breach. Shifting to our PEO business, the acquisition of Oasis was the largest acquisition in our history and doubled the number of worksite employees we serve in our PEO. We are making steady progress on our integration plans, and we are now focused on completing the integration of our sales and service teams. Through all of these efforts, we remain focused on what is most important, serving our clients and their employees and growing our PEO. We launched new branding for our HR outsourcing solutions, including our Paychex PEO and ASO solutions. This new product brand, Paychex One, conveys the power of a comprehensive, flexible, total HR solution that can scale and meet the needs of any business at every stage of their development. We're also very proud that for the ninth consecutive year now, Paychex has earned the distinction of being the retirement industry's leader, number one, in the total number of defined contribution plans. This ranking was announced as part of the annual 401K record-keeping survey published by Planned Sponsor Magazine. We provide solutions to remove the complexity of saving for retirement, and this is an integral part of the package for our clients to use as part of the recruitment for new talent as well as retaining talent. Recent enhancements to our mobile app make enrollment in the retirement plan possible with only four clicks. This has already led to an increase in participant enrollment, which will lead as well to improved client retention. We also ranked number three on Seller's Selling Power 50 Best Companies to Sell For list in 2019. This is the seventh consecutive year we've appeared on the list, and our ranking reflects our commitment to providing our sales teams every opportunity to succeed. We continue to return exceptional value to our shareholders. And in May, we announced an increase in our quarterly dividend of $0.06 or 11% to $0.62 per share. Our dividend yield remains approximately 3%, a leader in this market. And during the first quarter, we repurchased 2 million shares of common stock. In summary, we continue to focus on the growth of our business, providing great value and convenience to our clients. Our state-of-the-art technology allows our service to to our clients and their employees the way they want, when they want, where they want. We're focused on providing technology enabled service to improve business efficiency and meet our clients' needs. Our full suite of HCM product offerings and world-class service is a powerful combination that positions us for sustainable growth. The continued efforts of our employees and their commitment to our clients is making a difference. I'll now turn the call over to Efren Rivera, and Efren's going to review our financial results for the first quarter. Efren?

Hey, 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 risk. Please refer to the customary disclosures. In addition, I'll periodically refer to non-GAAP measures such as EBITDA, adjusted net income, and adjusted diluted earnings per share. Please refer to our press release and investor presentation for discussion of these measures and a reconciliation for the first quarter 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 wrap with a review of our fiscal 2020 outlook. As you saw, total revenue and total service revenue both grew 15% for the first quarter. Our growth, excluding OASIS, was between 5% and 6%. Expenses increased 18% for the first quarter to $643 million, increases in compensation-related costs, PO direct insurance costs, and amortization of intangible assets contributed to total expense growth for the first quarter, primarily driven by the acquisition of OASIS. Operating income increased 9% to $349 million. Operating margin was 35.2% for the first quarter. EBITDA increased 13%. and EBITDA margin was approximately 41% for the first quarter. Margins were moderated by business mix due to growth in the PEO business and accelerated investments in sales technology and operations. Other expense net for the first quarter of $5 million includes interest expense of $8 million related to our long-term borrowings. As a reminder, we used $800 million of private placement bonds to fund a portion of the OASIS purchase price. The effective income tax rate was 23.3% for the first quarter compared to 24.5% for the same period last year. Net income increased 8% to $264 million, and adjusted net income increased 6% to $258 million for the first quarter. Diluted EPS increased 9% to $0.73 for the first quarter, and adjusted diluted EPS increased 6% to $0.71. We received approximately $0.02 of benefit from stock-based compensation payments during the first quarter, which we exclude in our adjusted diluted EPS. I'll now provide some additional color in selected areas. Management Solutions revenue increased 5% to $724 million for the first quarter. The increase was primarily driven by increases in our client bases across many of our services and growth in revenue per client, which improved as a result of price increases and that of discounts. Retirement services revenue also benefited from an increase in asset fee revenue earned on the asset value participant funds, and we had a strong quarter in management solutions, if you recall the guide I gave you for Q1. PEO and insurance services revenue increased 56% to $247 million for the first quarter in addition to the acquisition of OASIS. The increase was driven by growth in clients and client worksite employees across our combined existing PEO business. Insurance services revenue was moderated by softness in the workers' comp premiums. This was partially offset by an increase in the number of health and benefit clients and applicants. Interest on funds held for clients increased 20% for the first quarter to $21 million, primarily as a result of higher average interest rates earned. Average balances for interest on funds held for clients increased 1% for the first quarter compared to the same period last year. Investments and income. We continue to invest primarily in high – not primarily, but in high credit quality securities. Our long-term portfolio has an average yield of 2.1% currently, and an average duration of 3.1 years. Our combined portfolios have earned an average rate of return of 2% for the first quarter, up from 1.8% from last year. I'll now walk through the highlights of our financial position. It remains strong with cash, restricted cash, and total corporate investments of approximately $700 million as of August 31, 2019. Funds held for clients were $3.8 billion, consistent with the balance as of the end of last fiscal year, May 31. I'll remind you that funds held for clients vary widely on a day-to-day basis and averaged $3.7 billion for the first quarter. Total available for sale investments including corporate investments and funds held for clients reflected net unrealized gains of $53 million as of August 31 compared with $20 million as of May 31, 2019. Stockholders' equity was $2.5 billion as of August 31, reflecting $222 million in dividends paid and $172 million worth of shares were purchased during the quarter. Our return on equity for the past 12 months was a robust 42%. Cash flows from operations were $295 million for the first quarter, an increase of 8% from the same period last year. The increase was driven by higher net income and non-cash adjustments. Offset by changes in operating assets and liabilities, the increase in non-cash adjustments was primarily due to higher amortization expense, largely driven by intangible assets acquired through the acquisition of OASIS. Now let me talk about guidance for the balance of the year. I remind you that our outlook is based upon current view of economic conditions and trends and business trends, continuing with no significant changes, though we have reflected the impact of the two interest rate cuts that have already occurred this fiscal year. So we are not, at this point, including additional guidance on further rate cuts. We're uncertain about what will happen in the balance of the year. I'll provide our current outlook and then add color in a couple areas. We provided updates to the guidance, as you saw. On the strength of a strong quarter in Q1, we now think management solutions revenue is anticipated to grow 5% above the range of previous guidance of approximately 4%. We thought that first quarter would be sequentially a little weaker. We actually got out of the gate a little bit stronger. PO and insurances revenue is now anticipated to grow approximately 30% at the lower end of the previously provided range of 30% to 35% more. to come on that, but we started a little slower than we had originally contemplated. Other expense net, which was previously referred to as net interest expense, is anticipated to be in the range of $18 million to $20 million, a modest change from previously reported guidance of $15 to $18 million here due to interest rate changes. And if you remember what that is, it's a combination of interest income and interest expense. So the decrease in interest rate changes affects what we will earn on the corporate portfolio. Net income and diluted earnings per share are both now anticipated to grow 9% above the range of our prior guidance of approximately 8%. Adjusted net income and adjusted diluted earnings per share are both expected to increase approximately 9% above the range of our previous guidance of growth in the range of 8% to 9%. Other guidance remains unchanged. Interest on funds held for clients anticipated to grow in the range of 4% to 8%. That's what we said at the beginning of the year, and that's what we're sticking with. We assume that there was a good probability that there'd be a second rate cut. It happened, and that was contemplated in the guidance. Total revenue anticipated to grow in the same range of 10 to 11 percent. Operating income as a percent of total revenue anticipated to be approximately 36 percent, although inching ever so slightly up. EBITDA margin for the full year of fiscal 2020 is expected to be approximately 41 percent. And the effective income tax rate for fiscal 2020 is expected to be in the range of 24 to 24.5 percent, although we anticipate that now will be toward the high end. As I indicated, PEO and insurance revenues are now anticipated to grow approximately 30%. We anticipate that growth for the second quarter will be in the range of 56% to 60%, and growth in the second half of the fiscal year will be within the range previously provided of 11% to 14%, but at the lower end of that range. PEO and insurance revenues growth was partially impacted by a change in classification of an immaterial OASIS revenue stream out of PEO and insurance services into management solutions after we last provided guidance. So make sure when you look at the presentation we posted that you got the right beginning number. It's not a big difference, but make sure you're working off that number as you look at updating your models. Management solutions. In addition, we've experienced lower workers' compensation insurance rates that moderated our insurance services growth. It was a little softer than we had anticipated in Q1. We anticipate the trend eases as we go through the year, but started a little bit slowly there. And we are also anticipating modestly lower at-risk insurance attachment in our PEO business based on current trends. And remember for us, If it's not at-risk insurance, we don't recognize it as revenue. So our business can do very well without having significant at-risk insurance attachment. We, looking at the trends, think it'll be a little bit lower than we had originally projected. Now, in contrast, management solutions guidance was increased to approximately 5% growth from our previous guidance of approximately 4% growth due to favorable trends we've seen during the first quarter. In addition, management solutions has increased partially due to the change of classification of the immaterial OASIS revenue stream. It had a negligible effect in the first quarter and will have a negligible effect for the remainder of the year. For the second quarter, we expect growth at approximately 5%, and then between 4% and 5% in the back half of the fiscal year. operating margins, which for the full year are anticipated to be approximately 36 percent, very quarterly, as you probably captured in your models. For Q2, we expect margins to be in the range of 33 to 34 percent, and for the second half of the year, we expect to see them at approximately 38 percent. So, in the second half, we're anticipating at this point Approximately 38% margins. I got asked a lot after the guidance, did we expect to see higher margins in the back half of the year? And the answer is yes. Now, I refer you to our investor slides on our website for more information. And with all of that, I will turn it back to Marty.