Paychex, Inc.

Ladies and gentlemen, thank you for standing by and welcome to the Paychex Q2 FY21 earnings conference call. At this time, all lines have been placed in a listen-only mode. After the speaker's remarks, there will be a question and answer session. To ask a question during this time, simply press star, then the number 1 on your telephone keypad. To withdraw your question, press the pound key. Thank you. I will now turn the call over to Martin Mucey. Please go ahead, sir.

Thank you. And thank you for joining us for our discussion of the paycheck second quarter of fiscal 2021 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, 2020. You can access our earnings release on our investor relations website 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 approximately 90 days. I will start today's call with an update on our business highlights for the second quarter. Efren will review our second quarter financial results and provide an update on our outlook for fiscal 2021, and then we'll open it up for your questions. While the first half of fiscal 2021 was affected by the economic impacts of COVID-19, we have been pleased with the results of our business and the sequential improvement over the first quarter in both revenues and earnings. Improvements in revenue occurred across the board, all lines of business. Most of our key business metrics have continued to show steady improvement, though at a more moderate pace as we entered the quarter. We have not yet experienced any deterioration related to recent surges in COVID-19 cases across the country, but we continue to monitor trends closely, especially as new restrictions are being implemented in many states. Throughout the COVID-19 crisis, our business model has proven resilient. Our client base has grown despite economic headwinds, and we continue to see good sales momentum with growth year over year in new units sold. Our digital sales remain an area of strength, and we continue to invest in digital marketing, lead generation, and sales technologies to drive growth. We also see strong demand for HR solutions and HR outsourcing, which we deliver through both our ASO and PEO models. Since the onset of the pandemic, we have seen a greater interest in the ASO model as businesses are looking for more immediate HR support. We are on track for another year of record retention as losses have declined significantly compared to the prior year. Client satisfaction scores continue to improve as we focus on providing excellent service to our customers, supporting them in this most challenging time and helping them simplify complex regulations. We have not let up on our efforts to help our clients navigate this environment, and we continue to educate clients and prospects on state and local specific regulations, which are frequently changing, including the new stimulus initiatives passed by Congress. Our retention team is proactive in reaching out to clients who may be showing signs of difficulty to consult with them regarding available options. And our clients are facing the most complex calendar year-end many have ever seen, and we are here to help them through it. We have expanded our thought leadership not only in the area of COVID-related regulations, but more recently offering information on the 2020 election results and the potential impacts to our clients' businesses. We continue to see demand for virtual events and webinars to help educate clients and prospects in this changing environment. Our financial strength allows us to continue to make investments in technology. Our fall product for launch builds on our track record of innovation and delivers on our promise to make complex business issues simple. We introduce several new offerings and enhancements that help businesses increase productivity, reduce risk, maintain compliance, and adapt to mobile and AI-driven trends. More business leaders are turning to tech solutions to increase productivity in this environment. and respond to the interest of their employees. Our Apple Watch and Google Assistant device integration now allows employees to access their HR and payroll information easily without even logging onto their phone or PC. We also added new features in our performance management system to allow for greater feedback and engagement with remote employees, critical to employee retention and development in this work-from-home environment. We continue to enhance our analytics suite and dashboards. We deliver a user experience that enables clients to define the data that is most relevant and actionable to them, which saves time, improves productivity, and supports better business decisions. We also see positive trends with double-digit increases in mobile and self-service usage as our strategy of device independence continues to gain traction with customers. We recently announced the integration of Paychex Flex with the market leading Clover point of sale platform from Fiserv. Available on the Clover app market, this gives business owners the ability to streamline payroll and time and attendance management. This is another example of our commitment to connect Paychex Flex users with some of the world's leading business tools. We are proud of these innovations and more were recognized by industry experts this quarter, most recently the Paychex Flex platform, was recognized by Human Resource Executive Magazine with an HR Tech Award for the top HR product of the year. The combination of a single device-independent application with HR services and benchmarking capabilities sets us apart from others in this category. We continue to design solutions that add value to our clients. Our new PEO Protection Plus Package helps business owners reduce risk by offering coverage related to cyber attacks and employee lawsuits. Exposure to these risks has been rapidly increasing in the COVID-19 environment, and we are the only provider offering both cyber liability and EPLI coverage as part of our PEO solution. And by leveraging the group plan model of our PEO, the coverage is significantly more affordable to businesses. The COVID-19 environment has also impacted the financial security of millions of Americans further exacerbating the issue of a lack of retirement savings in the U.S. This month, we announced that we are among the first in the retirement industry to sponsor and maintain a pooled employer plan to help businesses nationwide provide a cost-effective retirement plan option for their eligible employees. This offering is an outcome of the SECURE Act, And along with a reduced cost compared to a single employer plan, it will reduce fiduciary liability for employers and simplified plan management. As we move through this period of uncertainty, we are confident that our resilient business model, strong liquidity position, and dedicated employees who are focused on service and innovation for our clients and their employees will have paychecks emerge from this pandemic in an even stronger position in the market with our clients having experienced the full value and support that we deliver. I will now turn the call over to Efren Rivera to review our financial results for the second quarter. Efren?

Thank you, Marty. Before I begin, let me just wish everyone on the phone call a safe and a joyous holiday season. I hope you get some time off to enjoy this Covidian season. we're making of it what all of us can make of it to make it a good time. So let's start. I want 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 some non-GAAP measures. Please refer to the press release and investor presentation for more information on these measures. Let me start by providing some of the key points for the quarter, follow up with some greater detail in certain areas, and then wrap with a review of the fiscal 2021 outlook. As Marty mentioned, while second quarter results continue to reflect the impact of economic conditions resulting from the COVID-19 crisis, they improved sequentially from first quarter. For the second quarter, Total service revenue of $969 million was even with the prior year. And this was moderated by a lower volume of client employees paid across our HCM solutions. Results improved from a decline of 6% in the first quarter, as you recall. Within service revenue, management solutions revenue started to increase. It was up 1% to $733 million, and PEO and insurance solutions revenue decreased 3% to $236 million. During our October earnings call, I noted that second quarter revenue was anticipated to be down mid to high single digits for management solutions and high single digits to low double digits for PEO and insurance solutions. Our results exceeded those expectations, obviously. Total revenue declined 1% to $984 million. That basically is the impact of further declines in interest on funds held for clients. Interest on funds held for clients were down 25% for the quarter to $15 million due to lower average interest rates. Average investment balances and realized gains Average balances for interest on funds held for clients declined 4% during the quarter, primarily due to lower client fund collections and changes in the client-based mix. That was offset by timing of collections or remittances and some wage inflation. Expenses decreased 3% to $629 million. The decline in expenses was driven by lower headcount, discretionary spending, and facilities costs as a result of our cost savings initiatives, operating income, of 4% to $354 million and reflected an operating margin of 36%, I'm sorry, a 150 basis point improvement from the prior year quarter. As a reminder, other expense NAF for the second quarter includes interest on our long-term borrowings, partially offset by corporate investment income, which was impacted by lower interest rates. Our effective income tax was 22.1% for the second quarter compared to 23.2% for the same period last year. Both periods reflect net discrete tax benefits related to stock-based comp payments that occur with the exercise of stock option awards. As you know, we call those out simply because it's difficult to predict when they will occur. Net income increased 5% to $272 million and adjusted net income increased 4% to $265 million for the quarter. Adjusted net income excludes one-time costs and the tax benefit from stock-based comp payments. Diluted earnings per share and adjusted diluted earnings per share both increased 4% during the quarter to $0.75 and $0.73 per share respectively. Year-to-date, I'll touch on these very quickly. They're in the press release. Service revenue declined 3% to $1.9 billion with management solutions revenue declining 2%. PEO and insurance solutions declining mid-single digits. Interest on funds for clients declined 27% as we bore the brunt of lower interest rates. Total revenue was down 3% to $1.9 billion. Operating income decreased 8% to $638 million. Adjusted operating income decreased 3% to $670 million, reflecting a margin of 35%. Adjusted operating margin, as you know, excludes one-time costs of $32 million related to acceleration of cost savings initiatives, including the long-term strategy to reduce our geographic footprint. and headcount optimization, the majority of which was recognized in the first quarter. The amount recognized in the second quarter was minimal, about $1 million or so from that amount that we had talked about when we initially released guidance. Diluted earnings per share decreased 8% to $1.34, $1.34 I should say, and adjusted diluted earnings per share decreased 4% to $1.36. Investments and income. As you know, our primary goal is to protect principal and optimize liquidity. We continue to invest in high-credit quality securities. Long-term portfolio has an average yield of 1.9%, average duration of 3.4 years. Our combined portfolios earned an average rate of return of 1.3% for the quarter, down from 2% last year. Let's talk about financial position. It remains strong with cash, restricted cash, and total corporate investments of $963 million and total borrowings of $804 million as of November 30, 2020. Funds held for clients were $3.4 billion in line with the balance as of May 31, 2020. Funds held for clients vary widely on a day-to-day basis and averaged $3.6 billion for the second quarter. Our total available for sale investments, including corporate investments and funds held for clients reflected net unrealized gains of $109 million compared with $100 million as of May 31, 2020. The increase in net gain position resulted from the declines in interest rates. Total stockholders' equity was $2.9 billion as of November 30, 2020, reflecting $447 million in dividends paid and $29 million of shares were purchased during the first six months. Return on equity for the past 12 months remained very strong at 38%. Cash flows from operations were $431 million for the first six months, a decrease from the same period last year. The decrease was driven by lower net income and fluctuations in working capital, including an increase in accounts receivable, which drives most of that. and that is parallel to our recovery in our revenue. Now I'll turn to our guidance for the current fiscal year ending May 31, 2021. It reflects our current thinking regarding the speed and timing of the economic recovery, while results for the first half of the fiscal year exceeded expectations. Uncertainty about the trajectory of the recovery over the remainder of the year remains year remains, particularly with the recent surge in COVID-19 cases. Improvements in key indicators have moderated, and our guidance reflects a steady but gradual improvement through the rest of the fiscal year, although not at the pace of the first six months. We have provided the following updates to our guidance after seeing the second quarter results. Management Solutions revenue year over year is expected to be in the range of a decline of 1% to growth of 1%. We previously got it to a decline in the range of 1% to 3%, with a bias toward the high end of that range. PEO and insurance solutions is expected to decline in the range of 2% to 5%. That is unchanged from prior guidance. Interest on funds held for clients is expected to be between $55 and $65 million. That's also unchanged from prior guidance. Total revenue expected to be in the range of a decline of 3%, too flat, or even with last year. We previously got into a decline in the range of 2% to 4%. Adjusted operating income as a percentage of total revenue is now anticipated to be approximately 36%, up from previous guidance of approximately 35%. An adjusted EBITDA margin for the full year fiscal 2021 is expected to be approximately 41%, up from approximately 40%. Other expense net is anticipated to be in the range of 25 to 30 million, previously was a range of 30 to 35 million. Our effective income tax rate is expected to be approximately 24% while we previously got it to a range of between 24 and 25% and adjusted diluted earnings per share is expected to decline in the range of 1 to 4%. We previously got it to a decline in the range of 6 to 8%. Turning to the second half of the fiscal year, we currently anticipate total revenue will be in the range of flat to up low single digits. Adjusted operating margin is expected to be in the range of 37 to 38%. Now, let me talk about the third quarter. Management solutions revenue is expected to decline in the low single digits, and PEO and insurance solution revenue would decline in mid to high single digits, impacted by lower rates for workers' compensation and state unemployment insurance. Adjusted operating margins excluding one-time costs are anticipated to be approximately 41 percent in the third quarter. Of course, all of this is subject to our current assumptions, which are subject to change. We'll update you again on the third quarter call. I will refer you back to our investor shares on our website for more information. And now, with all of that, I'll turn it back to Marty.