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 fourth quarter and year end results 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. Thank you. I would now like to turn the call over to Mr. Martin Moosey, President and Chief Executive Officer. Please go ahead, sir.

Thank you, and thank you for joining us for our discussion of the Paychex fourth quarter and fiscal year 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 fourth quarter and fiscal year ended May 31, 2020. You can access our earnings release on our investor relations webpage, and our Form 10-K will be filed with the SEC before the end of July. 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 update on some of the key metrics in our response to COVID-19 and then 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 year 2021. And then we'll open it up for your questions or comments. In May, we provided you with an update on our business as we were responding to the impacts of COVID-19. At that time, we talked about the positive trends we were seeing in our key metrics, but it was still early. Over the past month, we have continued to experience steady improvements across all of our key metrics we are tracking on a weekly basis. We are seeing a steady increase in paid employees and in the number of worksite employees for our HR outsourcing clients. We have also continued to see an increase in sales leads and sales productivity. One particular bright spot is client retention. Now more than ever, our clients are experiencing their value proposition of Paychex as we help them navigate through this very challenging time. I credit the dedication of our Paychex IT development, product, marketing, and service teams who have worked tirelessly to ensure a seamless transition to remote working for us while providing the products and service to support our clients and their CPAs during a time of great concern for their businesses, in fact, many times their business survival. When the Paycheck Protection Program was introduced, we were the first in our industry to release an online payroll report to help simplify the filing of the application for the loan. As a client of Paychex, we pre-populated the payroll information that you had ahead of time. We have processed this report over a half a million times for our clients and their CPAs to assist them. We also partnered with three FinTech companies, Biz2Credit, Fundera, and Lendio to provide our clients with direct access to alternative lenders for the PPP loans if they did not want to go through their own banking partner. Over $100 million worth of loans have been processed through these partners by our clients. On June 5th, The Paycheck Protection Program Flexibility Act was signed into law, relaxing the original requirements for businesses using use of the PPP loans while continuing to qualify for loan forgiveness. Shortly after we launched the PPP Loan Forgiveness Estimator, this tool, which I feel is the most comprehensive in our market, simplifies the complicated process for our clients and, again, pre-populates the Paychex client data and provides a very simple way to add non-payroll data to satisfy the new forgiveness requirements. Our service teams have provided excellent responsiveness to our clients, 7 by 24, even with much higher call volumes and call complexity, all while maintaining and even improving our client satisfaction and retention performance. In fact, client retention reached a new all-time high. Throughout this uncertain time, we have seen strong performance in multiple areas of the business. Sure, payroll has continued to grow as more prospects are looking for intuitive, do-it-yourself solutions. We have seen similar results in our flex virtual sales efforts. We are also experiencing increased demand for our outsourced HR services, both PEO and ASO, due to the complex demands of the current environment. Our leading suite of customizable solutions allows us to help any business, large or small, simple or complex, do-it-yourself or fully outsourced with today's challenges. The COVID-19 pandemic has been a challenge to our business. However, this challenge confirmed that the investments we have made in the recent past were the right investments. COVID-19 accelerated many workplace trends, and we have had the right solutions in place to help our clients adapt to their new, unexpected environments. Our five-star rated mobile app provides clients and their employees with access to solutions from anywhere on any type of device. This, along with our broad set of human capital management solutions and our comprehensive self-service capabilities, have allowed our clients to effectively manage a remote workforce and maintain productivity. Maintaining employee engagement has been critical for our clients during this time, especially as communications are rarely face-to-face. Whether a client needs to capture and track employee issues and requests or simply check in with their people, Paychex makes it simple to stay connected and maintain a productive and engaged workforce. This can occur through our HR Conversations tool or HR Connect, a tool that we recently released that allows employees to submit their questions, requests, and incidents directly to HR through an easy-to-use workflow. We have also seen an increase in the use of Paychex Learning, an online learning platform which allows clients to retain employees by providing them with various training and professional development options, even while not in an office environment. Our comprehensive suite of payroll solutions offers flexible payment options to help address employees' needs or time-sensitive situations. We provide clients the ability to pay employees on demand for wages earned prior to payday, and make real-time payments in minutes for time-sensitive or emergency situations. We continually enhance our data analytics and live report functionality. Faced with a rapidly changing business environment and market uncertainty, providing clients with access to clear, accurate information is critical for them to make decisions about the future for their businesses. Recent updates to our analytics suite provide additional insights on labor costs and workers' compensation information, workplace illness and injury trends, and other HR details, such as employee record updates and performance feedback. Additional new enhancements are geared toward improved organizational collaboration and streamlining processes through digital solutions, such as allowing for electronic workflow and e-signatures on direct deposit in W-4 forms, simplifying the process of adding new workers. We offer many new self-service capabilities, for our clients' employees that has streamlined the process for both the employees and the client. We have been a valuable business partner to our clients through this time, providing them with information to navigate legislation, helping them access federal loans, and managing a remote workforce. Our extensive number of webinars have exceeded all records of participation, with over 100,000 clients and CPAs registering for multiple sessions. While our solutions were invaluable to clients in adapting to the new environment of a remote workforce, they are also key to helping businesses as they begin to reopen and get back to business. By using digital solutions, it helps clients integrate more contractless processes to reduce infection risk at their business. In regards to our Paychex family, we have an ongoing commitment to our employees to ensure their safety. At this time, we still have over 95% of our workforce continuing to work remotely, and it has been going well. Given this success, we are accelerating some of our strategies to leverage a more distributed workforce. We are implementing plans to reduce our physical location footprint among other expense savings initiatives. These plans have recently been announced to our employees and we are moving forward with these initiatives. As we begin fiscal 2021, we see several reasons for optimism. Our employees remain engaged and have continued to go above and beyond reacting in real time to continue to provide excellent service to our clients. Our record retention and high client satisfaction, net promoter scores, and client testimonials highlight the value we provide our clients and their advisors as we help them navigate this challenging time. We continue to return capital to our shareholders, and our leading indicators continue to show signs of steady progress. While much uncertainty remains as businesses or states pause or delay reopening as a result of COVID-19, We are confident that the value of our offerings is more relevant to our clients than it has ever been, and we will continue to provide innovative products and services through online offerings or our well-trained and experienced service providers as we get through this together. I will now turn the call over to Efren Rivera to review our financial results for the fourth quarter and the fiscal year. Efren?

Thank you, Marty, and good morning to everyone. I'll remind you. that today's conference contains the customary forward-looking statements that refer to future events as such involve risk. Please refer to the earnings release for more disclosure on these statements and related factors. In addition, I'll periodically refer to some non-GAAP measures such as EBITDA, adjusted net income, adjusted diluted earnings per share, et cetera. Please refer to the press release and investor presentation for a discussion of these measures and a reconciliation of the fourth quarter and full year fiscal 2020 to their related gap measures. Let me start by providing some of the key points for the quarter. Our fourth quarter results reflected the impact of conditions resulting from COVID-19. I'll provide a summary of our results and then discuss our full year fiscal 2020 results. For the fourth quarter, let's start there. Total revenue, as you saw, decreased 7% to $915 million, largely due to volume declines impacting revenue across our HCM solutions. Total service revenue decreased 7% for the fourth quarter to $890 million. Within service revenue, management solutions revenue declined 6% to $662 million, and PEO and insurance solutions revenue declined 11% to $228 million. Interest on funds held for clients increased 14% for the fourth quarter to $25 million. Higher realized gains more than offset lower average investment balances and lower average interest rates earned, and this was part of the portfolio repositioning we discussed on an earlier call. Average balances for interest on funds held for clients declined 8% during the fourth quarter, primarily due to the impact of lower checks per client resulting from from COVID. Expenses decreased 8% to $615 million. The decline was largely impacted by reductions in discretionary spending as a result of company-wide expense controls. Op income decreased 5% to $300 million and reflected an operating margin of 32.7%. EBITDA decreased 5% to $351 million with an EBITDA margin of 38.4%. Other expense net for the fourth quarter includes interest on our long-term borrowings, partially offset by corporate investment income, which was impacted, as you all know, by lower interest rates. Our effective income tax rate was 24.3% for the fourth quarter, compared to 25.8% for the same period last year. Net income decreased 4% to $221 million and adjusted Net income decreased 3% to $221 million for the fourth quarter. Diluted earnings per share decreased 5% to $0.61 for the fourth quarter. And adjusted diluted earnings per share decreased 3%, again, at $0.61. Let's talk about year-to-date results. Through the first nine months, results were solid. Our full-year growth, though, was tempered as a result of COVID in Q4. but the year still reflected solid progress. Total revenue increased 7% to $4 billion. Service revenue increased 7%, again, to $4 billion, with management solutions growth of 3% to $3 billion, and PEO and insurance solutions growth of 22% to $991 million. Management solutions benefited from higher revenue per client. PEO and insurance solutions benefited from higher revenue per client. I'm sorry, from the full year of OASIS results, while insurance services remained challenged by lower workers' comp premiums. Interest on funds held for clients increased 8% to $87 million, driven by higher realized gains, partially offset by lower average investment balances and lower average interest rates. Up income increased 7% to $1.5 billion. Operating margin was at 36.1% comparable to the prior year. Net income and diluted earnings per share each increased 6% to $1.1 billion and $3.04 per share respectively. Adjusted net income increased 5% to $1.1 billion and adjusted diluted earnings per share increased 6% again to $3 per share. Let's talk about investments and income. Our goal, as you know, 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%. Average duration is currently 2.9 years. So we're a little bit shorter on the curve. Our combined portfolios have earned an average rate of return of 1.5% and 1.8% for the fourth quarter and fiscal year, respectively. These are down from 2.1% and 1.9% for the respective periods last year, as you realize the Fed has cut interest rates a number of times this year. Let's talk about our financial position, which we're particularly proud of. It remains strong with cash, restricted cash, and total corporate investments of over $1 billion as of May 31, 2020. And it really highlights the strength of the company. that we achieved that result during a very challenging time in economic time for both us and our clients. Funds held for clients as of May 31 were $3.4 billion, compared to $3.8 billion as of May 31, 2019. Funds held for clients vary widely on a day-to-day basis, an average $3.8 billion for the fourth quarter and $3.9 billion for the fiscal year. Our total available for sale investments including corporate investments and funds held for clients reflected net unrealized gains of $100 million as of the end of May 31, 2020. This compares with $20 million as of May 31, 2019. The increase in net gain position obviously resulted from declines in interest rates. Total stockholders' equity was $2.8 billion as of the end of May 31, 2020. reflecting $889 million in dividends paid and $172 million of shares repurchased during fiscal 2020. Our return on equity for the past 12 years remained strong at 41%. Cash flows from operations were also strong. We reached $1.4 billion for the fiscal year. That's an increase of 13% from the same period last year. The increase was driven by higher net income. amortization of intangible assets and fluctuations in networking capital. So we ended the quarter in a very, very strong operating position, cash and cash flow. Let's talk about 2021. The outlook that I'm about to present reflects our current thinking regarding the speed and timing of the economic recovery. I don't need to remind you of how volatile the situation is. And we'll talk about this in terms of really the first half and the second half of the year. We expect the impacts on the first half of the year will be significant, and then there will be improving sequential – we will start improving sequentially. And recovery is going to occur in the second half of the year, primarily in the fourth quarter. This outlook also includes various expense control measures we have implemented, which I'll discuss shortly, including a one-time charge that we're going to take in the first half of the year. I'll come to that and discuss that more fully in a second. Our outlook is as follows. Management Solutions revenue is anticipated to decline in the range of 1% to 4%. PEO and insurance services revenue is anticipated currently to decline in a range of 2% to 7%. Interest on funds held for clients is anticipated to be between $55 and $65 million. Total revenue is anticipated to decline in the range of 2% to 5%. Adjusted operating income as a percentage of total revenue is anticipated to be between 34 and 35%, which excludes, as I mentioned earlier, the impact of one-time costs, which I will discuss in a moment. Adjusted EBITDA margin for the full year 2021 is expected to be between 39 and 40%. Other expense net is anticipated to be in the range of 30 to 35 million. And the effective income tax rate for fiscal 2021 is expected to be in the range of 24.5% to 25%. I'll just remind you, too, that we don't include in any of these projections what we expect benefit from stock comp expense. We adjust that out. So that could change depending on what benefit we get during the year. Adjusted diluted earnings per share is expected to decline in the range of 6% to 10%. Now, as Marty mentioned earlier, given what we've experienced over the last several months, we are accelerating a range of cost savings initiatives. These include headcount optimization in addition to reduced discretionary spend. In addition, we're planning an acceleration of our long-term plan to reduce our geographic footprint, and this is the majority of the charge that I'm about to describe. We anticipate recognizing one-time costs in the neighborhood of $40 million, most of which will be incurred during the first quarter. Our guidance for adjusted operating margins, adjusted EBITDA margin, and adjusted diluted EPS which I'll remind you again are non-GAAP measures, excludes these one-time costs. Again, $40 million, we expect it to be primarily in the first quarter, and it is primarily directed at geographic optimization, a plan that we've had in place and that we've decided to accelerate given current conditions. Now, I've given you full year. Let me give you some color on the gating. One of the things that I would say is we will post on the website our presentation. You can take a look at it. It'll provide some detail on this also. So hopefully that will be clear once you've read it. But now let me just describe what we're anticipating. We currently expect revenue to be the most impacted during the first quarter of fiscal 21. with each quarter improving sequentially. We view fiscal 2021 in terms of first half and second half of the year. So let me talk about the first half. We anticipate that in the first half management solutions revenue will be down mid to upper single digits and PEO and insurance solutions revenue will be down in the high single digits to low double digits. Adjusted operating margins, excluding the one-time cost that I just mentioned, are anticipated to be approximately 32%. Now, specifically Q1, I would say this. The greatest impact is going to be felt in that quarter, and total revenue is anticipated to be down high single to low double digits range in Q1. And operating margin is anticipated to be approximately 30%. So be sure to bake that into the model. In the back half of the year, we anticipate greater improvement with much of the recovery occurring in the fourth quarter. So we see it accelerating into the fourth quarter. And in the fourth quarter, it'll look much more like a normal quarter pre-COVID. Management solutions and PEO and insurance solutions revenues are expected to grow in the low single digits. And when I say low single digits, I mean low. So the combination of Q3 and Q4, because Q3 is a big revenue quarter and we still don't anticipate full recovery in Q3, with more of it occurring in Q4, combines to create low single digit revenue growth. Adjusted operating margins are anticipated to be approximately 37%, reflecting both higher seasonal margins in the third quarter and the improvement that we expect to see in revenue. So I'm talking now about the second half of the year, where we typically see higher margins. Adjusted earnings per share, again, in the second half are expected to be flat to down low single digits. So let me refer you back to the investor slides so you can think through all that gating. And with that, I will turn it back over to Marty. Thank you, Efren.