Paychex, Inc.

Good day and thank you for standing by. Welcome to the Paychex third quarter fiscal year 2021 conference call. At this time, all participants are in a listen-only mode. After the speaker's 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 Paychex third quarter fiscal 21 earnings release. Joining me today is Efren Rivera, our chief financial officer. And this morning before the market opened, we released our financial results for the third quarter ended February 28, 2021. 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, will be archived and available on our website for about 90 days. I will start today's call with an update on the business highlights for the third quarter, and then Efren will review our third quarter financial results and provide an update on our outlook for fiscal 21. We will then open it up for your questions. It is hard to believe that it's been over a year since the beginning of the mass shutdowns in response to COVID-19. This past year has been different from any other that we've experienced before. You know, new challenges have forced us to find innovative ways to connect with our clients, prospects, and our own employees. I'm very proud of how the Paychex team embraced these challenges and took a leadership role throughout this pandemic, as evidenced by the newly released Sapient Insights Group annual HR survey just coming out this week that ranked Paychex Flex, our SaaS-based cloud application, number one. among all solution providers as rated by their voice of the customer report in both user experience and client satisfaction scores. Our results for the third quarter reflect strong retention in client-based growth across all of our lines of business, most notably in our ASO HR outsourcing business. We completed the selling season with strength in our virtual, digital, and HR outsourcing sales, driven by new business starts and the increasing need for HR support. Our traditional sales channels have been impacted by headwinds arising from restrictions on face-to-face meetings and delayed decision-making by the prospects. However, we've seen growth in key sales metrics, including sales presentations and close rates, which have continued in March, as well as increases in win rates versus our competitors. We are well-positioned to take advantage of the opportunities as we transition back to a normal market condition. As Efren will discuss in more detail, with less than a quarter remaining in our fiscal year, we are proud of the fact that our total service revenue for the year will be roughly flat to last fiscal year after the major impact of businesses during the pandemic. Our initiatives to reduce expenses while accelerating our investment in the innovation of our products and service delivery has not only maintained our industry-leading profit margins, but has positioned us well for growth as the pandemic situation improves. We have delivered solid client growth and demonstrated our unique value to our clients and partners through some of the most difficult times. Throughout every stage of the pandemic, we have demonstrated our commitment to helping clients with our multifaceted approach response, which includes a comprehensive COVID online help center, state-specific resources, educational webinars, product innovations, in-app paycheck protection program tools, specialized employee training, and more. Our efforts were recognized not only by our clients in the form of strong client satisfaction scores and retention, but we were also recently honored as a 2021 Silver Winner of the Stevie Award for the most valuable COVID-19 response. We continue to listen to and work with small and mid-sized businesses to provide the information, resources, and support they need. A recent paycheck survey to these businesses revealed that three of the biggest obstacles facing small and mid-sized business owners our financial instability, planning the return to office, and employer vaccination policies. While financial instability is the biggest concern, the government stimulus plans have been very effective in helping small and mid-sized businesses stay afloat. Paychex has continued to build on its portfolio of PPP solutions in real time as new government relations are passed. To date, We have assisted our clients in quickly applying for and obtaining over $60 billion in PPP loans. We have also helped them claim approximately $1.5 billion in paid leave and employee retention tax credits. Paychex Flex is the first HR software solution to introduce integrated tools to help businesses maximize tax credits while not impacting PPP loan forgiveness. Our experienced HR professionals help our clients by delivering effective recommendations based on our clients' unique circumstances and business needs. These unique challenges include assisting in navigating the complex stimulus legislation, developing return-to-office plans, creating vaccination policies, and the data analytics and tools to support employee recruitment and retention in this difficult time. The complexity of these issues has resulted in higher demand for HR outsourcing as more clients recognize the advantage of putting our expertise to work for them. In recent months, this increased demand has contributed to strong growth in our ASO business as businesses are looking for more immediate HR support, but some reluctance to make changes to their employee benefits by selecting the PEO model. We do expect that as businesses begin to evaluate their options and implement benefit decisions, there will be a more normalized mix of ASO and PEO product selection. We announced on the last call that we were introducing our new Pooled Employer Plan, or PEP. This new product is a cost-effective retirement plan designed to expand retirement plan access with reduced administration for employers. We have been very pleased with the reception of this new offering in the market, and after just a few short months, have approximately 2,000 new clients on PEP. We believe that recent mandates in California requiring retirement benefits for employees will lead to even more interest in our pet product and other retirement solutions. Paychex remains the top record keeper for retirement plans, originating the most new plans annually. We also announced our integration with Fiserv's Clover point-of-sale systems. We offer integrated payroll and time and attendance for small business retailers via a new app in the Clover app market. Integration is now complete and existing Paychex customers can download the app to allow for time and attendance to be handled within the Clover system with seamless integration with Paychex Flex. This integration increases cross-selling opportunities for both companies and significantly enhances the client experience for shared customers. In addition, we launched several enhancements to our data analytics in Paychex Flex, including a diversity and equal pay live report that builds upon our recently released EEO-1 compliance solution to give administrators the ability to analyze their pay and diversity data, allowing businesses to uncover opportunities to create a more diverse and equitable workforce. Our innovative solutions continue to receive industry recognition. We were recognized by the Business Intelligence Group, earning a 2021 BIG-BIG Innovation Award for being a leader in real-time payments. And last May, we were the first HR solutions provider to offer real-time payments, giving businesses more freedom and flexibility. I'm very proud of the two awards that Paychex has been honored with recently. For the 13th time, Ethisphere named us one of the world's – 2021 world's most ethical companies, and we are also on the fortunes list of world's most admired companies. These awards acknowledge our commitment to ethical business practices, values-based culture, innovation – social responsibility and leadership, as well as our support for the business community and its employees throughout the COVID-19 pandemic. I give credit to the innovation, integrity, and hard work of our employees who have continued to show up for our clients, even while navigating the challenges of the pandemic in their own lives. As we enter our second year with COVID, we remain diligent in helping businesses continue to navigate the pandemic and remain hopeful that the worst is behind us, We are confident that our resilient business model, strong financial position, and dedicated employees will help paychecks to finish fiscal year 21 even stronger than we started it. I will now turn the call over to Efren to review our financial results for the third quarter. Efren?

Thanks, Marty. Hello, everyone on the call. Good morning. I'd like to remind you that today's conference call will contain forward-looking statements. You know where to look for those disclosures, and please refer to them. In addition, I'll periodically refer to non-GAAP measures such as adjusted operating income, adjusted EBITDA, et cetera. Please refer to our press release, again, in our investor presentation for more information on these measures. I will start by providing some of the key points for the quarter, and then I'll follow up with some greater detail in certain areas, and then I'll wrap with a review of our fiscal 2021 outlook. some initial thoughts on fiscal 2022. Our third quarter results reflect the impact of economic conditions resulting from COVID for the third quarter service revenue of 1.1 billion decreased 2% compared to the prior year, largely due to a lower volume of client employees paid across our HCM solutions. As a reminder, our third quarter includes certain annual revenue streams that declined due to lower employment Total revenue declined 3% to $1.1 billion, impacted by a decline in interest on funds held for clients. Within service revenue management solutions, revenue was even at $847 million, and PEO and insurance solutions revenue declined 8% to $250 million. Interest on funds held for clients decreased 29% for the quarter to $15 million due to lower average interest rates and realized gains. Average balances for interest on funds held for clients were consistent with the prior year. Expenses were down 4% to $643 million. The decline in expenses was driven by lower discretionary spending, reduced facilities costs, and lower amortization of intangible assets. Operating income was flat at $469 million and reflected an operating margin of 42.2%. a 100 basis point improvement from the prior year quarter. Our effective income tax was 24.2% for the third quarter compared to 23.6% for the same period last year. Both periods reflect net discrete tax benefits related to stock-based compensation payments that occur with the exercise of stock option awards. Adjusted net income decreased 1% to $349 million for the quarter. Adjusted diluted earnings per share also decreased 1% during the quarter to $0.96 per share. Year-to-date, service revenue declined 3% to $3 billion, with management solutions revenue declining 1% and PEO and insurance declining 6%. Interest on funds held for clients declined 27% to $45 million. Total revenue declined 3% to $3 billion. Operating income decreased 5% to $1.1 billion, and adjusted operating income decreased 2% to $1.1 billion, reflecting a margin of 37.6%, an improvement of 50 basis points compared to the prior year period. Adjusted operating margin 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 optimizations. the majority of which was recognized during the first quarter. Adjusted diluted earnings per share decreased 3% to $2.32. Turning to our investment portfolio, our primary goal is to protect principal and optimize liquidity. As we've mentioned frequently, we continue to invest in high credit quality securities. Our long-term portfolio has an average yield currently of 1.9% and an average duration of 3.4 years. Our combined portfolios, having an average rate of return of 1.1% for the quarter down from 1.8% last year. Those were the good days. I will now walk through the highlights of our financial position. It remains strong. Cash, restricted cash, and total corporate investments are $1.1 billion, and total borrowings were $804 million as of February 28, 2021. Funds held for clients as of the same date, February 28, 2021, were 4.2 billion, an increase from 3.4 billion as of May 31, 2020. Funds held for clients, as you know, vary widely on a day-to-day basis and average 4.5 billion for the third quarter. Our total available for sale investments, including corporate investments and funds held for clients, reflected net unrealized gains of 82 million as of February 28, 2021. That compares to 100 million as of May 31, 2020. The decrease in net gain position resulted from increases in longer-term yields during the nine-month period. Total stockholders' equity was $3 billion as of February 28, reflecting $671 million in dividends paid and $78 million of shares repurchased during the first nine months. Our return on equity for the past 12 months was 37%. Cash flows from operations were 871 million for the first nine months. That was 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 purchased accounts receivables due to continued recovery from COVID-19. Pandemic and growth in the business, the COVID-19 pandemic and growth in the business, sorry, offset by an increase in worksite employees, payroll-related liabilities. Now, I'm going to turn to guidance for the current fiscal year ending May 31, 2021. The outlook reflects our current thinking regarding the speed and timing of the economic recovery. It does not assume any acceleration due to government stimulus, but rather assumes current course and speed of the recovery. Results for the first nine months of the fiscal year exceeded expectations. However, uncertainty about the pace of the recovery over the remainder of the year remains We have provided the following updates to our guidance after seeing the third quarter results. Management Solutions revenue growth year over year is expected to be in the range of flat to growth of 2%. We previously guided to a range of decline to 1% to growth of 1%. PEO and Insurance Solutions is expected to decline in the range of 2% to 5%. This is unchanged from prior guidance. We're now providing guidance on total service revenues. This is total service revenue, not total revenue, which is now expected to be in the range of a decline of 1% to growth of 1%. Interest on funds held for clients is expected to be between $55 to $65 million, and this is unchanged from prior guidance. Total revenue is expected to be in the range of a decline of 2% to flat. we previously got into a range of a decline of 3% to flat. Adjusted operating income as a percent of total revenue is now anticipated to be in the range of 36 to 37%, up from previous guidance of approximately 36%. Adjusted EBITDA margin for the full year fiscal 2021 is expected to be in the range of 41 to 42%, up from approximately 41%. Other expense net, is anticipated to be in the range of 25 to 30 million unchanged from previous guidance. Our effective income tax rate is expected to be in the range of 23 to 24%, while we previously got it to approximately 24%. And adjusted diluted earnings per share is expected to be in the range of a decline of 2% to flat, we previously guided to a decline in the range of 1% to 4%. Obviously, we need to go through the fourth quarter to see where the year ends, but we're really pleased with our ability to manage through the P&L impacts of the pandemic, especially loss of variable revenue, which, as you all know, carries a high margin. We offset much of that, including a decline in interest on funds held for clients, and if there's any doubt about our ability to manage the P&L. I think that this year we showed some of the skeptics on that. Now, turning to the fourth quarter of the fiscal year, we currently anticipated total service revenue growth will be in the range of seven to nine percent. Remember, I said total service revenue growth. To get total, you need to understand the next one, which is interest on funds held for clients expected to be approximately $15 million. consistent with previous quarters. That is, interest on funds is consistent with previous quarters. Obviously, in the fourth quarter, we expect to see a sharp rebound from what we've experienced in the first three quarters and a return to growth. Adjusted operating margin is expected to be in the range of 33 to 34%. Now, we're also currently in the process of preparing our annual plan for fiscal year 2022. So now we'll lead. Others haven't talked about it. We'll talk about it. And wanted to give you some indications of what our thinking is. We'll provide more complete guidance for fiscal 2022 during our fiscal 2021 fourth quarter call in June. but I want to provide some very preliminary color on our initial thoughts around fiscal 2022 in this call. With those caveats, we believe that total service revenue growth will be in the range of six to seven percent. Interest on funds held for clients is expected to be in the range of 55 to 65 million, and does not assume any significant change in interest rates. Obviously, we've got a lot of work to do with thinking about the right way to position the portfolio, but this is where we're at right now. We also anticipate that adjusted operating margin will be approximately 37%, and that the effective tax rate will be in the range of 24% to 25%. Let me just say one thing on that. As you know, we typically will exclude our benefits from stock comp exercise at this point. We're not baking any in. We probably will get some benefit, but too early to call. Now, as if that wasn't enough of a caveat, all of this is subject to our current assumptions, which are subject to change. And we will update you again on the fourth quarter call after we have gone through the fourth quarter. I'll refer you to our investor slides on our website for additional information. And with that, I'll turn the call back to Marty.