Paychex, Inc.

To all sites on hold, we appreciate your patience. Please continue to stand by. Thank you. Please stand by, your program is about to begin. If you need assistance during your conference today, please press star zero. Good day, everyone, and welcome to today's Paychex Third Quarter Fiscal 2022 Earnings. At this time, all participants are in a listen-only mode. Later, you'll have the opportunity to ask questions during the question and answer session. You may register to ask a question at any time by pressing the star and one on your touchstone phone. You may withdraw yourself from the queue by pressing the pound key. Please note this call may be recorded. I will be standing by if you need any assistance. It is now my pleasure to turn the conference over to Mr. Martin Musi, Chairman and Chief Executive Officer of Paychex.

Thank you, Katie, and thank you for joining us for our discussion of the Paychex third quarter fiscal year 2022 earnings release. Joining me today, of course, is Efren Rivera, our Chief Financial Officer. And this morning, before the market opened, our financial results for the third quarter ended February 28, 2022. You can access our earnings release on our Investor Relations website. 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 90 days. I will start today's call with an update on our business highlights for the third quarter, and Efren will review our financial results for the quarter and provide an update on fiscal 2022, and then we'll open it up for your questions or comments. Our strong results for the first half of the year continued in the third quarter as both management solutions and PEO and insurance solutions revenues increased by double-digit percentages year over year and adjusted diluted earnings per share increased 20%. We continue to see positive trends in our key indicators and strong momentum across all our lines of business driven by a combination of solid internal execution in a market-leading suite of innovative solutions uniquely designed to address today's HR challenges. This momentum carried through calendar year-end and selling season, resulting in record sales performance and near record level retention. Our value proposition continues to resonate in the market, particularly in this challenging environment. And our sales results were broad-based with double-digit growth and new annualized revenue across all lines of business, HR outsourcing, retirement, payroll, and insurance. We continue to improve our traction in the mid-market space, which has benefited from the investments we've made in our technology and product suites. Our client retention continues to surpass our expectations and remains near our record levels of the prior year, well ahead of the pre-pandemic levels. Our revenue retention remains at record levels for the year as we continue to bring in even more focus on our higher value clients. Demand for our comprehensive set of solutions, including our integrated Paychex Flex human capital management technology and our comprehensive ASO and PEOHR offerings remains high. Businesses of all sizes are facing continued pressure from supply chain and labor shortages, the rising costs of doing business, and ongoing challenges with COVID-19. As staffing challenges persist, businesses are looking for integrated technology to deliver increased productivity, operating efficiencies, and access to experienced HR professionals to help them navigate a complex regulatory environment and complicated distributed workforce dynamics. We continue to invest in our product set to differentiate us in the market and deliver solutions designed to meet the growing challenges of running a business. Our most recent product launch introduced a series of enhancements designed to support both an on-site and distributed workforce, including an enhanced iris scanning time clock, which delivers a hands-free punch experience with industry-best security, including both the iris and facial scanning. A new secure document management solution which allows clients to safely and confidentially store documents like employee vaccination status within the Flex platform. And a compensation summary which allows clients to provide employees a full view of their compensation to promote retention. And enhancements to our financial wellness offering to help client employees more effectively budget, manage debt, and save for retirement. Each of these enhancements builds on our award-winning Paychex Flex technology. Several industry awards provide the latest validation of the benefits of our innovative technology. We were recently recognized with two awards for our Paycheck Pre-Check solution, the 2022 BIG Innovation Award presented by the Business Intelligence Group, and a 2022 Stevie Award for Innovation in Customer Service. Paycheck's Pre-Check combines payroll, HR, time and attendance, and employee self-service to into a complete system of check and balances ensuring that work hours are never missed, pay rates are properly applied, paid time off is not overlooked, and that pay is always calculated correctly. We have seen a strong response in terms of both client adoption and client results with paychecks pre-checked. Our focus on helping clients maximize available government stimulus was recognized by accounting today as we were awarded with a top new product award for our employee retention tax credit service. We recently surpassed $7 billion in total credits processed for our clients. I'm very proud of the agility demonstrated by our IT and service teams to proactively assist our clients with these government subsidies to help them sustain and enhance our clients' financial position. Our mobile and self-service technology solutions deliver efficiency for our clients and their employees, and we have seen significant increases in flex sessions, both through the desktop and mobile devices, with an increasing proportion of the sessions, of course, done by the mobile app. Contributing to this growth is traction we are gaining with wearable devices. The use of the Apple Watch has increased mobile usage for our time and attendance solution. Obviously, this provides another safer method for employees to punch in and out and avoid exposure to COVID and other illnesses. I am particularly proud of two awards that Paychex has recently been honored with for our commitment to business integrity through our best-in-class ethics, compliance, and government practices. For the 14th time, Ethisphere named us one of the world's most ethical companies. We are also on Fortune's list of the world's most admired companies. These awards acknowledge our ethical business practices, our values-based culture, innovation, social responsibility, and leadership. We believe doing business the right way leads to greater success. Atmosphere agrees. noting that their 2022 Ethics Index, a collection of publicly traded companies recognized as recipients of this year's world's most ethical companies designation, outperformed a comparable index of large cap companies by almost 25% over the past five years. I give credit to the innovation, integrity, and hard work of our employees who live our paychecks values each and every day. In summary, we are very proud of our performance during the third quarter and year to date and I thank our employees for their tireless dedication during our busiest time of the year. Our set of innovative technology and service solutions provides industry-leading value to our clients and leaves us well-positioned for a strong finish for fiscal 2022 and continued growth into fiscal 2023. I'll now turn the call over to Efren to review our financial results for the third quarter.

Efren? Thanks, Marty. Good morning. Thanks for being on the call. I'd like to remind everyone that today's conference call will contain forward-looking statements. Refer to the customary disclosures. Let me start by providing some of the key points for the quarter. I'll follow up with greater detail in certain areas. I'll finish with a review of fiscal 22 outlook and some very, very, very preliminary thoughts on fiscal 2023. Our third quarter results reflect strong internal execution, as Marty mentioned, and continued improvement and key indicators, service revenue and total revenue, increased 15% to $1.3 billion. Within service revenue, management solutions revenue increased 13% to $960 million, driven by higher client bases across our HCM suite, check volumes, revenues per client, payroll funding, and outsource service for temporary staffing clients and ancillary HR services resulting from ERTC, which Marty just mentioned. Although the revenue associated with ERTC is substantially non-recurring, ERT has afforded Paychex the opportunity to continue to deepen its relationship with clients, increase revenue with clients, and showcase its industry-leading suite of solutions for small and medium-sized businesses. A significant opportunity remains both inside and outside our base. And one thing I'd like to point out here is there are a number of HCM platforms in the market, you all know that, but they're only a select few partners. In order for you to be able to access the opportunities that arise from having an HCM suite with bundled ancillary services. You have to be a partner, not simply a platform provider. There's only a few of those in the market. Our results demonstrate the power of being one, and we are one of the leading ones. So our results are not surprising to us. Our clients want to know the difference between a MEP, a SEP, and a PEP. They want to know what the implication of the ERTC is for their businesses. and they want to know what the implications of legislation like the SECURE Act, how it's going to impact their business. We know that. We're experts, and we're the partner that our clients look to for solutions to those issues. Our results demonstrate that this quarter. Now, client-based growth in the quarter resulted from both strong sales performance and high levels of client retention. In particular, HR solutions business continues to benefit from strong demand as businesses look for more HR support. PEO and insurance solutions revenue increased 21% to $302 million. Our PEO business benefited from higher average worksite employees, state unemployment insurance revenue, and health insurance attachment. Interest on funds held for clients decreased 5% for the quarter to $14 million as the impact of lower average interest rates. was partially offset by an increase of 13% in average investment balances. And obviously, this is one of the things that's going to change as we go through both the remainder of the year and into the next year. We haven't seen the impact of rising rates yet. We will. Total expenses increased 11% to $713 million. The growth in expenses resulted from higher PEO direct insurance costs, headcount to support our growing client base, and continued investment in our product technology, sales, and marketing. Op income increased 20% to $563 million with an operating margin of 44.1%, an expansion of almost 200 basis points. Our effective income tax rate was 22.3% compared to 24.2% for the same period last year. Both periods reflect net discrete tax benefits related to stock-based compensation benefits, or payments, I'm sorry. In addition, the current quarter includes tax benefits related to prior year research and development expenses incurred in the production of customer-facing software. So we had an adjustment there, and that's part of our lower tax rate. Net income and diluted earnings per share both increased 23% for the quarter to $431 million and $1.19 per share respectively. Adjusted net income and adjusted diluted earnings per share increased 20% for the quarter to $419 million and $1.15 per share respectively. I'll quickly highlight our results for the nine-month period ending February 28th. Both revenue and earnings have grown by double digits for each of the past three quarters. Total service revenue and total revenue growth of 15% each to $3.4 billion and $3.5 billion respectively. Expenses, excluding one-time costs incurred during the prior year, increased 7%, so we've gotten very good leverage. Operating income and adjusted operating income were 1.4 billion, increases of 31 and 27%, respectively. Diluted earnings per share increased 31% to $3.02 per share. Adjusted diluted earnings per share increased 27% to 295 a share. Let me walk through the highlights of our financial position. As you all can see, it's very strong. Cash, restricted cash and total corporate investments now total over $1.4 billion. And our total borrowings of approximately $806 million is where it stood at February 28, 2022. Cash flow from operations was robust in the quarter. It was at $1.2 billion, an increase of 34% from the same period last year. Free cash flow generated for the nine months was $1 billion, up 36% over last year. The increases were driven by higher net income and fluctuations in working capital. We paid out quarterly dividends at $0.606 a share for a total of $715 million during the first nine months. Our 12-month rolling return on equity was 44%. Those are strong numbers. Now I will turn to our guidance for the current fiscal year ending May 31, 2022. The outlook reflects the current macro environment, which saw improvement in the quarter despite some disruption from Omicron. We've taken into account the fact that third quarter results exceeded expectations, but have tempered our outlook. given the changing macroeconomic environment, and we provided the following updated fiscal 22 guidance. As you saw in management solutions, revenue is now expected to grow in the range of 12 to 13%. We previously guided the growth in the range of 10 to 11%. PEO and insurance solutions is expected to grow in the range of 13 to 14%. We previously guided the growth in the range of 10 to 12%. Interest on funds held for client is expected to be relatively flat year over year. We won't see the impact yet significantly of Fed raises. Total revenue is expected to grow in the range of 12% to 13%. We previously guided to growth in the range of 10% to 11%. Adjusted operating income margin is expected to be approximately 40% up from previous guidance of 39% to 40%. Adjusted EBITDA margin is expected to be in the range of 44 to 45 percent, up from previous guidance of approximately 44 percent. Other expense net is expected to be approximately 15 million. Our previous guidance was in the range of 15 to 18. Effective income tax rate is expected to be approximately 24 percent. We previously got it in the range of 24 to 25 percent. Adjusted diluted earnings per share is expected to grow in the range of 22.5% to 23% and previously guided growth in the range of 18% to 20%. This guidance reflects our intention to continue to invest in our businesses to help drive future growth and I would just comment that in the fourth quarter we intend to take some additional actions with respect to investment in the business. That will temper the margin a little bit as we head into 23. Now comments on 23. We're currently in the process of preparing our annual plan. We'll provide guidance, final guidance for fiscal 2023 during our fiscal 2022 fourth quarter in June. but I want to provide a preliminary thought process around fiscal 23 as we enter the planning cycle. On a preliminary basis, we believe that total revenue growth will be in the upper single digits. At this stage, I'd call that somewhere around 7%. I would caution that there's a lot of work to be done to digest completely where the Fed's going to end up and how we position the portfolio so there's still So some moving pieces there. The other thing we would say right now with respect to operating margins, we expect an improvement of about 50 basis points. You know that typically that's what we're aiming for. We've had very, very significant operating margin improvement, but we're still committed to leveraging the business. That's where we're at right now. I want to call out one thing that's important. Other expense net is going to be in the range of $25 to $30 million next year due to the absence of equity gains that we got this year. So we have a portfolio that we invest in equity gains during the year. Those will not be in next year. At least we can't plan on them or anticipate they will be there. And then the effective tax rate will be in the range of 24 to 25%. Of course, all of this is very preliminary. It's subject to revision, and it's based on assumptions that could change given the uncertain macro environment, especially as we gain additional insight into what the Fed actually will do. We'll update you again on the fourth quarter call. So with all of that, I'll turn it back over to Marty.