Paychex, Inc.

Good morning. My name is Lisa, and I will be your conference operator today. At this time, I would like to welcome everyone to the Paychex Third Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. 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. I would now like to turn the call over to Mr. Martin Mucey, President and Chief Executive Officer. Please go ahead, sir.

Thank you. And thank you for joining us for our discussion of the Paychex Third 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 third quarter, ended February 29, 2020. You can access our earnings release on our Investor Relations webpage. Our Form 10-Q will be filed with the SEC within the next few days, and this teleconference is being broadcast over the Internet and will be archived and available on our website for approximately one month. I will start today's call with an overview of how we are responding to COVID-19 and then review business highlights for the third quarter. In effort, we'll review our third quarter financial results and discuss our guidance for fiscal 2020, including our current thinking on the potential impacts of COVID-19 on on our business, and then we'll open it up for your questions. First and foremost, I want to address the evolving situation we are currently facing with COVID-19. Our number one priority is the safety and well-being of our employees and serving our clients and their employees. Our business continuity plan was implemented and our teams are working around the clock to ensure that we take the necessary steps to ensure our employees' safety while continuing to support our clients through this unprecedented time. Early on, we instituted travel restrictions and began to reduce the number of employees working in our offices. At this time, all employees, unless designated as critical on-site person, that's less than 5%, are now working from home, and our service metrics and client response time has been excellent. In fact, our average answer performance yesterday was seven seconds. Extremely proud of this team and the work they've done in a very fast period of time. I'm incredibly proud of how the whole leadership team and employees have responded to this situation. Because of their hard work and efforts, we've been able to complete all of these transitions without any service disruptions. We continue to help our clients navigate the significant amount of information and changing regulations from state and federal governments, including the Families First Coronavirus Response Act. Our compliance team also remains in contact with federal, state, and local government authorities. on a real-time basis to ensure we are aware of and offering support and ideas on any new regulations or support initiatives related to COVID-19 that could impact our clients. So far, we've seen minimal changes in our key metrics. However, with the expanding shutdowns of businesses throughout the nation, we do expect that this will be a particularly challenging time for small and mid-sized businesses. This will have impact on our results, and Efren will provide some color when he discusses our current outlook. The federal government has taken a number of steps to stabilize these issues and is considering more relief actions as we speak. I'm sure you're all aware of the at least handshake agreement last night, and we're working through those detailed changes as we see how the vote and the presidential approval goes probably today. Small businesses in particular are in need of aid to be able to stay in business and pay their employees. The speed in which relief actions are put in place will impact the severity of the economic impacts resulting from this virus. Last weekend, we were part of a small group that sent a letter to Congress supporting the small business loan program to help businesses continue to pay their employees and offered our assistance as a payroll processor to do that in the most effective and timely way. We continue to monitor leading indicators to gauge the changes in the small business environment. We believe we are well prepared to navigate our way through these uncertain times. The significant investments we've made in our technology, and in particular our mobile app, Our expanded product and features and our service model options allow us to support our clients in any environment. And as you are well aware, we maintain a strong balance sheet and cash position. We will continue to focus on our business objectives and invest in our people and our clients. This is a rapidly evolving situation, but we will keep you informed on the expected impacts as events continue to unfold. Now I will update you on our business and financial results for the third quarter, which reflect good progress on our key initiatives. Total revenue growth was 7% for the quarter, management solutions revenue grew 6%, and PEO and insurance solutions revenues grew 10%. Through the third quarter, we have continued to see strong execution and operations with record high net promoter scores and client retention. In addition, we have had strong results in our virtual sales divisions, digital marketing efforts, and mid-market sales through the selling season. As we have discussed on previous calls this fiscal year, we had a slower start than anticipated on the integration of OASIS. We believe we have addressed these issues in sales. We are now fully staffed and have a new leadership team in place. For service, staffing levels are stabilized, and the focus now continues to be on servicing our clients with less need to work on integration of the clients into the platform. The business has strong fundamentals that will drive growth over the long term, and we remain very positive about the continued strong demand for HR and insurance support and PEO services, particularly in this difficult environment. As the largest 401k record keeper in the U.S., Paychex was prepared to respond to the SECURE Act, which was enacted in December of 2019. This legislation provides incentives for employers to offer retirement savings plans and provisions to improve savings for millions of Americans. With our strong expertise in retirement plans and our award-winning retirement services participant portal, we are well-positioned to assist small and mid-sized businesses and their employees as they navigate this new legislation and plan for retirement. We launched Pay on Demand in December, which improves the employee experience by offering them flexible access to wages they have already earned before payday, helping them manage their personal cash flow. This is a valuable tool for employers to help attract and retain talent. 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. We also believe that pay on demand will see increased usage in this current environment with employers needing a more flexible workforce that will need much more flexible pay options and probably more immediate pay. We were excited to launch the first of our wearable apps as well, which we demonstrated in October at HR Tech. Paychex Time for the Apple Watch was launched in January for Flex customers. This allows clients, employees the flexibility and convenience of punching in and out on your Apple Watch. We also launched Paychex Flex Help Center, which provides dozens of training resources and how-to tutorials for assistance using Flex technology from within the application itself. Help Center allows customers to access help materials that are relevant and easy to consume via their individual preferred learning method, whether that is video tutorials, step-by-step instructions, or chat. The latest product releases included significant enhancements to existing features, which continue to add value by making things simple for our clients and allowing users flexibility and choice. These enhancements include electronic signature capabilities in our document management tool, improved visibility into labor costs and employee data with live reports, and additional integrations with some of the top HR finance time and attendance and benefits solutions in our Paychex integrations solution. While Flex, Paychex Flex, does provide a full suite of HR solutions, the open platform allows customers the flexibility they may need to integrate with other tools if they so choose or if they already have them and don't want to switch out of them. Products like learning management services with online training, electronic signature capabilities of document management will support the needs of clients in this time of remote workforces. Our real-time payments offering will be introduced in April. We believe we are one of the first to offer this capability to customers, and this will allow employers to pay employees faster, which can help attract talent, can also help quickly resolve any issues with payroll. Our technology roadmap continues to focus on the area of emerging technologies such as wearables, real-time payments, product integration options, data analytics, and AI, all of which will play an important role in helping clients in this current environment. We are proud that Paychex's commitment to technology innovation has been recognized by industry experts. Our Paychex Flex Assistant was selected as a Stevie Award winner for Best Use of Technology in Customer Service. Flex Assistant answers over 250 questions covering the breadth and depth of the Paychex payroll in HR Suite. What differentiates our technology is that it seamlessly connects to a live specialist in real time if the user wants more assistance, and the entire bot transaction is visible to that specialist, so no repetition is needed. Both Paychex and SurePayroll also receive Stevie Awards for our excellent customer service. As a critical business partner for many of our clients, we pride ourselves on doing business with integrity. It is ingrained in our corporate culture and very evident in the last few weeks as we quickly implemented our business continuity plans for our clients and employees. I'm extremely proud that Paychex has once again been recognized by Ethisphere as one of the 2020 world's most ethical companies, the 12th time we've received this recognition. And in summary, as we navigate these unprecedented times, We continue to support our clients, our employees, our communities, and our shareholders. We have invested heavily in making our technology solutions and service flexible and mobile, and we are more prepared than ever to handle this current environment. I would like to thank our IT, sales, service, compliance, marketing, and HR teams who have worked diligently to ensure regular communication to our employees and our clients is and that all employees have the equipment they need to work remotely and stay connected with each other and our clients. Also, thank you to our employees who have maintained diligence and flexibility during these transitions in the way we all work. I will now turn the call over to Efren Rivera to review our financial results for the third quarter. Efren?

Thanks, Marty. Good morning. I'd like to remind everyone that today's conference call will contain forward-looking statements that refer to future events and such involved risks please refer to the customary disclosures in our earnings release. In addition, I'll periodically refer to non-GAAP measures such as EVA Digest and net income adjusted diluted earnings per share. Again, refer to the press release. Before I start, I hope that as we speak, you all are safe and in good health. That's the most important thing at times like this. If you have loved ones who are affected by the virus and its impacts, please accept our thoughts and prayers for you and for your family. Being human at this time is the most important thing we can do. So now let's talk finance. 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 fiscal 2020 outlook and some high-level commentary on fiscal 2021. Yes, some high-level commentary on fiscal 2021. Stay tuned. Based on preliminary looks into next fiscal year. Total revenue, as you saw, grew 7% for the third quarter to $1.1 billion. OASIS contributed about 1% to this growth. Expenses increased 5% to the third quarter to $673 million. Increases in compensation costs and PEO direct insurance costs contributed to total expense growth, partially driven by the acquisition of OASIS. Up income increased 10% to $470 million. Up margin was 41.1% for the third quarter compared to 40.1% for the third quarter fiscal year 19. EBITDA increased 8% to $520 million. EBITDA margin was 45.6 compared to 45% for the same period last year. Very strong results. Other expense net for the quarter of $6 million includes interest expense related to long-term borrowings. Our effective income tax was 23.6% for the third quarter compared to 23.7% for the same period last year. Net income and adjusted net income for the third quarter both increased 9% to $355 and $351 million, respectively. Diluted earnings per share and adjusted earnings per share each increased 9% to $0.98 per share. and $0.97 per share, respectively. We received approximately $0.01 of benefit from stock-based comp payments during the third quarter, which is included for GAAP but excluded and are just diluted EPS. Let me provide some additional color in selected areas. Service revenue increased 7% for the third quarter to $1.1 billion. Within service revenue, management solutions revenue increased 6% to $850 million. P.O. and insurance solutions increased 10% to $72 million. So you saw through the third quarter continued strong performance on management solutions. This is primarily driven by increases in our client base across many of our services, along with growth in revenue per client. Revenue per client improved as a result of higher price realization, increased penetrance of arts. suite of solutions, particularly retirement services, time and attendance, and HR outsourcing. PEO and insurance solutions revenue growth of 10% was driven by the growth in clients across our PEO businesses. Insurance solutions revenue benefited from an increase in the number of health and benefit applicants, partially offset, as we've been saying all year, by the impact of softness in workers' compensation premiums. Interest on funds held for clients decreased 7% for the third quarter, primarily as a result of lower interest rates earned partially offset by higher average interest investment balances, I should say, and realized gains. Funds held for clients' average investment balances were impacted by wage inflation and increases within our client base offset by changes in client base mix and timing of collections and remittances. These results obviously do not include the impact of the 2 March rate cuts by the Federal Reserve. Turning to our investment portfolio, we continue to invest in high-quality credit securities. Long-term portfolios have an average yield of 2.1% and average duration of 3.1 years. Combined portfolios have earned an average rate of return of 1.8% for the third quarter, down from 2% last year. Now year-to-date. Total revenue increased 12% to $3.1 billion. Service revenue increased 12% with management solutions reflecting growth of 6% to $2.3 billion and PEO and insurance solutions reflecting growth of 36% to $763 million. OASIS contributed approximately 28% to the growth. Interest on funds held for clients grew 6% to $62 million. Operating income increased 10% to $1.2 billion. Net income and diluted earnings per share each increased 9% to $877 million and $2.43 per share respectively. Adjusted net income and adjusted diluted earnings per share both increased 8% to $863 million and $2.39 per share respectively. Let me talk about our financial position, which I think is really, really important in a time like this. It remains obviously very, very strong with cash, restricted cash, and total corporate investments of $930 million as of February 29, 2020. Funds held for clients as of February 29, 2020 was $4.4 billion compared to $3.8 billion as of May 31. Funds held for clients, as you know, vary widely on a day-to-day basis and average $4.5 billion for the third quarter. Total available for sale investments, including corporate investments and funds held for clients, reflected net unrealized gains of 84 million as of February 29, 2020, compared with 20 million as of May 31, 2019, and as interest rates oscillate, that number changes very, very significantly. Total stockholders' equity was 2.8 billion as of February 29, reflecting 667 million in dividends paid and $172 million of shares We purchased during the first nine months. Our return on equity in the past 12 months was a very robust 42%. Cash flows from operations were $1.1 billion for the first nine months, an increase of 3%. Over the same period of last year, the increase was driven by higher net income offset by timing fluctuations in working capital. Let me just summarize our financial position because it's very, as I said, important. We are very solid. with our cash position is strong. We have $900 million in cash. We have an undrawn revolver. We have the highest cash generation of our peer group. We have the highest dividend. And we have confidence that we will weather the storm for both our clients, our employees, and our shareholders. Now I turn to guidance for the current fiscal year ended May 31, 2022. First, I want to provide context. As you know, there are new events unfolding daily and we're constantly incorporating this information. Our guidance reflects our assumptions as of today based on the information that we have regarding potential effects on the business. This guidance also reflects the impact of 150 basis points of interest rate cuts that have occurred in March. Our guidance for the full year fiscal 2020, as you saw in the press release now, is that we anticipate management solutions to grow approximately 4%. PEO now about 24% for the full year. Interest on funds sold for clients is anticipated now to decline in the range of 2% to 3%, and total revenue is now anticipated to grow in the range of 8% to 9%. Op income as a percentage of total revenue is anticipated to be approximately 36%. EBITDA margin for the full year 2020 is expected to be approximately 41. Other expense net is expected to be in the range of 22 to 24 million. And the effective income tax rating is expected to be in the range of 23.5 to 24%. Net income diluted earnings per share growth are now anticipated to increase approximately 7. And adjusted net income and adjusted diluted earnings per share are expected to grow approximately 6%. For the fourth quarter, as you can do it when you plug in your models, you can see that the guidance implies we're anticipating the total revenue will decrease modestly, and operating margins will be approximately 32%. We monitor a variety of leading internal business indicators to drive this estimate. Let me just provide some thought on that, and then I'm going to talk about next year. So we look at leading indicators, and as I'm sitting here, I have a 42-page a document from our data analytics group that tells me a lot of stuff about what's going on in the business. Not everything, can't forecast all of the future, but we see what's happening in real time. We, through the middle of March, were not seeing significant impacts. Marty mentioned earlier that we were monitoring key metrics, didn't really see significant drops. And then towards the last, the second half of March, we started to see the impacts on the business roll through. We've incorporated as much of that into the guidance in fourth quarter as we can. We think we have a reasonably good handle on what's going on. But you also temper that with experience of both what happened in 9-11, because that was an endogenous shock that was more short-lived, And then you also balance that against the 08-09 recession. So all of those ideas are part of the information we're triangulating to get not only to fourth quarter, but to the next year, which I'll talk about in a second. It is, for many of you, as you know, it's as though we are on the LIE expressway on our way to the beaches. You know there is, the traffic is flowing smoothly, but you know there's a stop ahead. What you don't know is, those of us who've been caught there, whether it's a two-hour stop, a three-hour stop, or something longer. And so we know a stop is coming. We expect that impacts will be felt in April and May for the remainder of this year. We've estimated them as best we can, but circumstances can change, especially as more states decide to go on on full lockdown. So with that, that analogy, and with the caveats that I just am about to mention, let me talk about next year. We typically give at least a preview of where we expect next year to be. And we won't bail out and say it's too early to say anything, we know some things and we'll give we'll tell you what we know. We will give guidance during our fiscal 2020 in the fourth quarter call in June. So our intent is to provide you with guidance that's more complete then. But let me tell you about our thought process based on everything that we're monitoring. And again, we're early on in the process and subject to change. By the way, shout out to Accenture. They went first. They said what they could, and obviously circumstances have changed. I am certain that when others report later, circumstances will have changed. They'll be in possession of better information, but this is what we have at this point, and we'll share it with you. So based on the leading indicators that we have, and then based on modeling on the impacts of the business in other business contractions, on a very preliminary basis, our thought process is that total revenue is going to be flattish to down low single digits for fiscal 2021. This scenario, remember, includes the impact of the most recent cuts to interest rates, and so that will impact total revenue growth next year. We're anticipating at this point that impact will be somewhere in the range of about $20 million off of where we end this year. That part, we have some some understanding of, but obviously if the Fed decides to go negative, we'll have a conversation about that. Looking very preliminarily, we would anticipate that operating margins will be somewhere in the range of about 35%. We would obviously manage the business to that, and our tax rate before discrete items will remain consistent with fiscal year 20. I just can't emphasize enough that this is preliminary subject to change. At this point, the scenario that we see unfolding is significant impact in Q1, followed by some improvement in Q2, moderate improvement through Q3, and then more of a recovery in Q4. That is consistent with the shock that we saw when we went through 9-11. We continue to update our information every day, literally, and wanted to give you at least an understanding of how our thought process is going at this point. So with that, I will turn it back to Marty. One thing I would say is we want, I get a lot of questions at the end. Why don't you guys just stop taking questions at a certain point? We will not do that. We'll answer every single question you got. The only issue I would ask is that you keep them brief and focused. If someone's asked the question before, unless you need clarification on it, please don't repeat the question so everyone can have a chance to talk before our voices give out. So with that, I'll turn it back to Marty.