Paychex, Inc.

Ladies and gentlemen, thank you for standing by and welcome to the Paychex second quarter FY20 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker today, Martin Musi. Please go ahead.

Thank you, and thank you for joining us for our discussion of the Paycheck second 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 second quarter ended November 30th, 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 one month. On today's call, I will review the business highlights for the second quarter. Efren will review our second quarter financial results and discuss our guidance for fiscal 2020, and then we'll open it up for your questions. Financial results for the second quarter of fiscal 2020 reflect good progress on our key initiatives. Total revenue growth was 15% for the quarter. Management solutions revenue grew 6%, and PEO and insurance services revenues grew 57%, including the results from the OASIS acquisition. We have been investing significantly in the area of sales, marketing, service, and technology. These investments are paying dividends as we've seen continued momentum in new sales, efficiencies, and operations, and the introduction of new and enhanced products. Paychex is being known much more as a provider of innovative HR technology solutions than ever before. Our investments in demand generation and sales are contributing to solid growth in new sales revenue, and in particular, we are pleased with the strong performance of the mid-market space, aided by greater attachment of our broad suite of HCM SaaS-based software solutions, such as our time and attendance and HR administration products. We are now in the main selling season. We believe we are well-positioned for continued momentum. We're also continuing to experience improved efficiencies in our operations through the use of self-service functionalities in our robotic process automation efforts. By automating more routine processes, we are reducing operating costs and providing more time for more high-value client service interactions with our team. The evidence of high-quality service by our teams is demonstrated by our client retention and satisfaction scores, which remain consistent with record high levels. We have seen continued increases in net promoter scores, most notably in the mid-market space. Let me touch briefly on what we are seeing in the small business environment. The Paychex IHS Market Small Business Employment Watch showed hourly earnings growth at its highest level since 2011, while job growth has been holding steady. Wage increases are beginning to reflect the tight labor market for small businesses. The constant battle for talent highlights the importance of having a partner like Paychex who can provide solutions to simplify HR recruiting and onboarding and a competitive benefits package to attract and retain top talent. We are currently operating in an unpredictable regulatory environment, Compliance with a rapidly evolving regulatory landscape is one of the many reasons employers choose Paychex for their HR needs. We're proud of our leadership role within the industry, partnering with regulatory agencies, keeping our clients informed, and quickly updating our systems to be in compliance and support changes as they become effective. Just this month, the IRS released the final version of the new Form W-4 to be used by all new employees and for all adjustments effective January 1, 2020. By remaining actively engaged with the IRS and providing feedback throughout their process, we were able to have the new forms and related calculations integrated into our systems within minutes of the issuance by the IRS. The workplace continues to evolve both in technology and the way people work, and we are very proud that Paychex has been included on the Fortune magazine's future 50 list of companies that are best positioned for long-term growth. In addition to solid financial results, Paychex was recognized for its commitment to innovative technology offerings designed to meet the needs of the evolving workplace. We continue to focus on enhancing our product offerings and the use of technology to remain a leader in this industry. Last quarter at HR Tech, we discussed some of the newest products being introduced. This month, we launched one of those products, Pay on Demand, which enables workers to access wages they have already earned before payday. This pay option is a great tool for recruitment and retention of talent as it allows employees to be paid when they want, allowing flexibility, more flexibility than the traditional weekly, biweekly, or monthly pay schedule. Other companies in the industry offer similar services on a smaller scale, but our solution is unique. in that it provides our clients with flexible payment options, including direct deposit, pay card, and digital payment into Amazon or PayPal accounts, however the client employee wants it. The other exciting products we demonstrated at HR Tech are progressing on track and will be launching in the coming months. We continue to focus our investments in emerging technologies such as wearables, real-time payments, product integrations, data analytics, and artificial intelligence. We are proud that Paychex's commitment to tech innovation has been recognized by industry experts. We were very proud to earn the Awesome New Technologies for HR Award at the HR Technology Conference and Expo in October. This recognizes the enhancements and increased flexibility of our Paychex Flex service product. We were also named to the HR Examiner 2020 Watch List for Artificial Intelligence in HR. This recognized our innovation using AI tools and machine learning to strengthen existing operations. Our Flex Assistant chat bot currently answers over 200 commonly asked questions, spanning the Flex suite of products, and seamlessly integrates with real-time live chat capability with a paycheck service agent 7 by 24 by 365 days a year. In addition, we have intelligent tools within Flex architecture that deliver a more personalized user experience through learning individual user preferences over time. That can be listing out how to do something or even watching now short videos to learn how to use the Flex product. Paychex Flex also won a Gold Award for Excellence in Technology from Brandon Hall Group in the category of Best Advance in HR or Workforce Management Technology for Small and Midsized Businesses. This is the fourth straight year that Paychex Flex has been honored with a Technology Excellence Award, which validates our tech vision, investment in that vision, and the value tech brings to our clients. We are proud of the experience our Flex platform and our employees enhance through automation we have built into the application based on individual patterns and preferences. We also continue to see increased utilization of our industry-leading five-star rated mobile app. During the quarter, we experienced an increase of over 50% in the number of mobile sessions and a 35% increase in the number of mobile-only users. This increased mobile usage by clients and their employees has led to efficiencies internally and higher net promoter scores. We are serving clients and their employees the way they want to be served. 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. As with any significant acquisition, the integration efforts can cause some initial disruption in sales cadence and some operating inefficiencies as we realize the expected synergies. As we discussed last quarter, we realized some of this in the first part of this fiscal year as we went through that process. That has led to slower than anticipated revenue growth for the year. However, we believe we are in a good position now as we progress with full sales rep ad count and our operation teams continue to focus on what's most important, that is serving our clients and providing them the right combinations of solutions to help them succeed. We are excited about the continued strong demand for PEO services in the markets that we serve. In summary, we continue to focus on growing our business by making things simple for our clients. Our innovative technology allows us to service our clients in a way that they want, when they want, and where they want. We're focused on continuing to introduce innovations to our technology-enabled service to improve business efficiency and drive even more value for our clients. Our full suite of HR solutions has been the recipe for growth and positions us for continued growth going forward. The efforts of our employees and their commitment to our clients are definitely making a difference. I will now turn the call over to Efren Rivera, our Chief Financial Officer, to review our financial results for the second quarter. Efren?

Thanks, Marty, and thanks to everyone on the call. I'd like to remind you that today's conference call will contain forward-looking statements, refer to the customary disclosures. In addition, I'll periodically refer to non-GAAP measures such as EBITDA, etc., Again, refer to our investor presentation press release for reconciliation of second quarter to related gap measures. I'll begin by providing some of the key highlights for the quarter, and then I'll follow up with some greater detail on certain areas and wrap with a review of the fiscal 2020 outlook. As you saw, total revenue growth was 15% for the second quarter. OASIS contributed approximately a little bit less than 9% to this growth. Expenses increased 18%. For the second quarter, $649 million, similar to last quarter, increases in compensation-related costs, PO direct insurance costs, and amortization of intangible assets contributed to total expense growth. Total expense growth was primarily driven by the acquisition of OASIS. Operating income increased 11% to $342 million. Operating margin was 34.5% for the second quarter, and EBITDA increased 16%, and EBITDA margin was 4%. was approximately 40% for the quarter. The EBITDA margin increased slightly compared to a year ago. Operating margin declined due to the amortization of intangibles associated with the OASIS acquisition, as you all know. Other expense net for the second quarter of $5 million includes interest expense of approximately $8 million related to long-term borrowings. As a reminder, we borrowed $800 million of bonds to fund a portion of the OASIS purchase price. The effective tax rate was 23.2% for the second quarter compared to 23.8% for the same period last year. Net income increased 10% to $259 million. Adjusted net income increased 8% to $254 million. Diluted earnings per share were up 11% to $0.72 for the second quarter, and adjusted diluted earnings per share increased 8% to $0.70. We received a little over one cent of benefit from stock-based comp payments during the second quarter, which is included for GAAP, but we excluded for our adjusted diluted EPS. Let me provide some additional color in certain areas. Total service revenue was up, as I said, to $971 million, 15% within service revenue. Management solutions revenue increased 6% to $727 million, and PEO and insurance services increased 57% to $244. Management solutions revenue growth of 6%, which actually exceeded our expectations, included a contribution from OASIS of slightly less than 1%. The remaining growth was primarily driven by increases in our client bases across many of our services, along with growth in revenue per client. Revenue per client improved as a result of higher price realization and increased penetration of our suite of solutions, particularly time and attendance, retirement services, and HR outsourcing. And that's been a focus of our efforts over the last several years. And if you chart our growth in revenue per client, you've seen a pretty steady increase. Retirement services revenue also benefited from an increase in asset fee revenue earned on the asset value participant funds. PO and insurance services revenue growth of 57% was largely due to the acquisition of OASIS, which contributed 47% to this growth. In addition, the increase reflects growth in clients and client worksite employees across our existing PO business. Insurance services revenue benefited from an increase in the number of health and benefit applicants, partially offset by the impact of softness and workers' compensation premiums, as we've been discussing all year. Interest on funds held for clients increased 9% for the second quarter to $20 million, primarily as a result of higher realized gain, average investment balances, and interest rates. Funds held for clients' average investment balances were impacted by wage inflation and increases within our base, offset by changes in client base mix and timing of collections and remittances. Turning to our investment portfolio, we continue to invest in high-credit quality securities. Our long-term portfolio has an average yield now of 2.1%, average duration of 3.1 years. Our combined portfolios earned an average rate of a return of 2% for the second quarter, up from 1.9% last year. Quickly, looking at year-to-date results, total revenues up 15% to $2 billion, service revenue up 15%. to $1.9 billion with management solutions reflecting growth of 6% to $1.5 billion, PO and insurances reflecting growth of 57% to $491 million. Interest on funds has grown 14% to $40 million, operating income up 10% to $691 million, and net income and diluted earnings per share each increased 9% to $523 million. and $1.45 per share, respectively. Adjusted net income increased 7% to $511 million, and adjusted diluted earnings per share increased 8%, $1.42 per share. Let me walk through the highlights of our financial position. It remains strong with cash, restricted cash, total corporate investments of $708 million. As of the end of the quarter, funds held for clients For $3.7 billion compared to $3.8 billion as of the end of last year, May 31, 2019, funds held for clients, as you know, vary widely on a day-to-day basis and average $3.7 billion for the second quarter. Total available for sale investments, including corporate investments and funds held for clients, reflected net unrealized gains of $39 million as of the end of the quarter compared with $20 million as of the end of last year, May 31, 2019. Total stockholders' equity was $2.6 billion as of November 30, 2019, reflecting $444 million in dividends paid and $172 million of shares repurchased during the first six months. Return on equity for the past 12 months has been a stellar 42%. Cash flows from operations were $565 million for the first six months. a robust increase of 14% from the same period last year. So, strong performance on cash flow. The increase was primarily driven by higher net income and non-cash adjustments. Increase in non-cash adjustments was primarily due to higher amortization expense, largely driven by intangible assets acquired through the acquisition of OASIS. Let me talk about 2020 guidance. I remind you that our outlook is based on our current view of economic conditions continuing with no significant changes. Though we have reflected the impact of the three interest rate cuts that have already occurred this fiscal year, I'll provide our current outlook in some color on a couple of areas. We provided updates to the guidance, as you saw. Management Solutions revenue has been trending positively, and now we anticipate it to grow in the range of 5% to 5.5%. This has raised from the previous guidance of approximately 5% growth. And we're doing well in almost all of the buckets that comprise that revenue stream. PO and insurance services are now anticipated to grow in the range of 25% to 30%. As Marty previously mentioned, we got off to a slow start with the OASIS, slower than we anticipated. We still maintain a strong long-term outlook and continue to execute on our plans to integrate our PBO business. Interest on funds held for clients is now anticipated to grow approximately 4%, modified from a range of 4% to 8% when we started the year, and this simply reflects the most recent federal fund rate cuts. And diluted earnings per share growth has been increased to a range of 9% to 10% growth, raised from our guidance of approximately 9%. Other guidance remains unchanged as followed. Total revenue 10 to 11%. Operating income as a percent of total revenue approximately 36. Even margin for the full year expected to be approximately 41. Effective income tax rate expected to be in the range of 24 to 24 and a half. Net income adjusted net income and adjusted diluted earnings per share are all expected to grow at approximately 9% for fiscal 2020. Now, let me provide a little color on the back half of the year. As I indicated, PEO and insurance revenues are now anticipated to grow in the range of 25% to 30%. While the second quarter results were within the range provided 56% to 60%, we have taken a more conservative approach for the back half of the year, given our current trends. In particular, we've continued to experience lower compensation, lower workers' compensation insurance rate that have moderated our insurance services growth, We anticipate that this trend will likely ease as we enter the next fiscal year. We're also seeing modestly lower at-risk insurance attachment in the PEO. In addition, this change reflects impacts from the slower start from the OASIS acquisition. We now anticipate that growth for the third quarter of PEO and insurance will be approximately 10%. Management solutions guidance was increased to a range of 5% to 5.5% growth from our previous guidance of approximately 5% due to favorable trends that we've seen in the first half of fiscal 2020. This incorporates the higher than anticipated growth achieved in the second quarter and assumes the third quarter will come in the full year range. I refer you to slide 16 in our investor presentation, which shows the impact of the reclass in the fourth quarter of fiscal 2019 of an immaterial amount of OASIS revenue. Please note that the as-adjusted numbers on this slide represent the base on which we apply the growth rates we are guiding to in management solutions and PDO and insurance revenues. And the reason I call that out is when I look at your models today, Two-thirds of you do it that way, and one-third have split between third and fourth quarter. Please look at that number so that you can adjust your models correctly. Operating margins, which for the full year are anticipated to be approximately 36%, do vary quarterly. Our margins for the second quarter exceeded the guidance we provided in the last call. which was a range of 33% to 34%. That beat was impacted by delays in hiring related to the tight labor market. We still anticipate margins of approximately 38% for the back half of the year. We expect to continue to invest significantly in sales and marketing in the back half of the year, while still achieving our target of a full-year operating margin of approximately 36%. And with all that, I'll turn the call back over to Marty.