Paychex, Inc.

Good morning and welcome to the fourth quarter 2024 Paychecks Earnings Conference Call. With us today are John Gibson and Bob Schroeder. After the speaker's opening remarks, there will be a question and answer period. 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, please press star and two on your telephone keypad. As a reminder, this conference call is being recorded and your participation implies consent to our recording of this call. If you do not agree with these terms, please disconnect at this time. Today's commentary will contain forward-looking statements that refer to future events and therefore involve some risks. In addition, the company will periodically refer to non-GAAP measures, such as adjusted operating income and adjusted diluted earnings per share. Please refer to their press release for further information. I would now like to turn the call over to John Gibson, Paychex President and CEO. Please go ahead.

Thank you for joining us for our review of the Paychex fourth quarter and fiscal year 2024 fiscal results. Joining me today is Bob Schroeder, our Chief Financial Officer. This morning before the market opened, we released our financial results for the fourth quarter and fiscal year ending May 31st, 2024. You can access our earnings release and investor presentation on our Investors Relations website. 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 90 days. I'll start the call today with an update on the business highlights for the fourth quarter and fiscal year. Bob will review our financial results for fiscal year 24 and outlook for fiscal year 2025. We'll then open it up for your questions. As we close out the fiscal year, I am pleased to report that Paychex delivered solid financial results, reflecting our ability to navigate changing market conditions by providing both innovative HR technology and advisory solutions that continue to deliver value for our clients and their employees. And as the best operators in the business, we are continually finding ways to run our business more efficiently. For fiscal 2024, we achieved 5% growth in total revenue and 11% growth in adjusted diluted earnings per share. These results are a testament to the hard work and dedication of our more than 16,000 employees and the investments we have made in our technology and advisory solutions. Revenue retention remains near record levels, and HR outsourcing worksite employee retention continued to improve and hit new record levels. We believe our sustained high revenue retention demonstrates that our value proposition is resonating in a competitive marketplace. Our client retention for fiscal year 2024 was in line with last year and pre-pandemic levels with out of business losses back to pre-pandemic levels but stable. We continue to see demand for our HR technology and advisory solutions. Our activity and pipelines remain strong and, in fact, increased year over year in the fourth quarter. But close rates were softer than historical norms and our expectations. Sales results in some market segments faced headwinds in the quarter. In S&B, we made some adjustments to our go-to-market strategy and in our digital technology stack in the micro segment, which impacted our lead and sales volumes. We believe these are one-time issues which we have addressed. In the mid-market, we have seen some of the same pressures our competitors have mentioned with delays in decision-making and increased focus on cost. Our HR outsourcing, both ASO and PO, and our retirement business continue to perform well, and we believe the value proposition for those solutions remains strong. The breadth of our solutions, both technology and complete outsourcing advisory solutions, along with the market segments we serve, provides us with the ability to pivot our sales and marketing investments as market conditions change to maximize the opportunity. Small and mid-sized businesses continue to face a challenging operating environment due to complex regulations, a historically tight labor market, and persistent inflationary pressures. Our Small Business Employment Watch has shown stabilization in job growth and continued downward pressure in hourly wages in the recent months. In fact, our May index posted the biggest one-month increase in job growth this year. We also saw improvements in hiring within our client base with both better checks per client and worksite employee growth in the quarter after a few quarters of declines. As we mentioned last quarter, Our data and conversations with clients reveal they are having a tough time finding qualified candidates. As an innovative leader in our industry, we took this as an opportunity to find a way to help these businesses by launching a new program starting in our PO called the Employer of Choice Playbook. This program combines our digital HR technology and analytics with our dedicated HR professionals to work directly with our clients to find, attract, hire, and retain qualified employees. It starts with our digital recruiting and hiring technology which provides both seamless integrations with the top job boards. This solution streamlines and automates the hiring process for the employer and provides a better candidate experience. Our PO clients are able to attract top talent by offering a Fortune 500 suite of employee wellness benefits as well. To help them retain employees, our HR professionals proactively work with our clients to leverage our HR data analytics and our retention insights to identify at-risk employees, determine the top drivers of turnover, and implement strategies to engage and develop their people. We are excited to offer a comprehensive solution to help our clients solve one of their biggest problems. hiring and retaining talented employees. We are planning more innovations in this area for all our market segments in the coming fiscal year. Our PO business has continued to gain momentum with excellent performance in fiscal year 2024. We finished the year with strong results in sales, retention, and insurance enrollment. We have continued to see a shift back towards the PO offering, both inside and outside our client base. This mixed shift has a long-term positive impact on lifetime value in our model, particularly as clients attach insurance benefits. Our retirement services business was another strong contributor in the fourth quarter with double-digit revenue growth. As the industry leader in 401k plan record-keeping in the U.S. with approximately $52 billion in assets under management and over 120,000 clients, We are dedicated to helping small and mid-sized business owners offer an affordable retirement solution for their employees. According to our own data, less than half of US employers currently offer a retirement plan. We are committed to providing affordable solutions to these companies that will help them offer their employees the opportunity for a secure retirement. Legislation like the SECURE Act and SECURE Act 2.0 The introduction of pooled employer plans and state mandates are helping to address the growing retirement crisis in the U.S., but there is still more to be done. We are committed to educating business owners and industry professionals on available programs, potential tax benefits, and the cost-effective plans available to them and their employees by paycheck. As you know, AI has been a hot topic in our industry and is something we have focused on for many years. Our AI initiatives and investments have been centered around enhancing our customer service model and identifying clients that are at risk, optimizing our pricing and discounting strategies, and driving higher sales productivity through improved marketing and targeting efforts. Additionally, we are focused on harnessing the power of our vast data to drive more value for our customers and continue to drive greater operational efficiencies across the company. We continue to gain recognition for the strength of our technology. For the fifth consecutive year, Paychex Flex, the company's cloud-based SaaS solution, earned an HR Tech Award for Best Small Business Focus Solution in the Core HR and Workforce category from Lighthouse Research and Advisory. For the 10th time, Paychex was named among the best employers in excellence in health and well-being, which affirms our longstanding commitment to our own employees. Paychex was also recently recognized by Forbes as one of America's best employers for diversity. These recognitions and the many product and service awards that we have received in the last year and over the decades are a testament to the strength of our business model, our culture, and our commitment to invest in our business to deliver long-term value for our customers and our investors. In this post-pandemic era, Paychex is uniquely positioned to help small and mid-sized businesses navigate the challenges they face in a ever-evolving world. And we believe our value proposition to these businesses remains compelling based upon the breadth and quality of the solutions we can provide. We remain committed to our purpose to help businesses succeed while making a positive impact on our clients, employees, communities, and shareholders. I'll now turn it over to Bob to give us a brief update on our financial results for the fourth quarter and fiscal year.

Bob? Thanks, John, and good morning, everyone. I'll start with a summary of our fourth quarter and full year financial results, and then I'll review our fiscal 25 outlook. Total revenue increased 5% to $1.3 billion in the fourth quarter, which reflects a lower contribution from our ERTC service, and this impacted revenue growth by approximately 300 basis points in the quarter. Management Solutions revenue increased 3% to $930 million. This was driven primarily by growth in the number of clients served across our HCM solutions and increased product penetration, partially offset by lower ERTC revenue. PEO and insurance solutions revenue increased 9% to $327 million. This was primarily driven by higher average worksite employees and an increase in our PEO insurance revenues. Our PEO saw continued momentum in worksite employee growth and medical plan participant volumes during the fourth quarter. Interest on funds held for clients increased 54% to $38 million. This was primarily due to higher average interest rates and invested balances. and lower realized losses on investment sales related to some repositioning of the portfolio that happened in the prior year period. During the fourth quarter, we did recognize a one-time charge of $39 million related to cost optimization initiatives. These initiatives include a reduction of our underutilized real estate, a reprioritization of our technology investments towards AI and headcount optimization. These measures, along with strong expense management during the year, will allow us to reallocate resources to invest in our strategic priorities, as well as continue to deliver operating margin expansion for fiscal 25, despite the expiration of the ERTC program. Including these charges, total expenses increased 5% to $813 million. Excluding these charges, total expenses were relatively flat for the fourth quarter as compared to the prior year period. Operating income increased 6% to $482 million, with an operating margin of 37.2%. Adjusted operating income, which excludes the one-time costs recognized in the fourth quarter, grew 15% to $521 million, with an adjusted operating margin of 40.2%. And this represents 330 basis points of margin expansion over the prior year period. Diluted earnings per share increased 8% to $1.05 per share, and adjusted diluted earnings per share increased 15% to $1.12 in the fourth quarter. Now I will quickly summarize our full year results. Total revenue grew 5% to $5.3 billion and reflects a lower contribution from our ERTC service, and that impacted growth about 100 basis points on a full year basis. Management solutions revenue increased 4% to $3.9 billion. PO and insurance solutions increased 8% to $1.3 billion. Interest on funds held for clients increased 47% to $146 million. Total expenses grew 4% to $3.1 billion. Excluding the one-time costs I discussed earlier, expense growth was approximately 3% for the year. Operating income increased 7% to $2.2 billion, and adjusted operating income increased 9% to $2.2 billion, with a margin of 41.9%, and that's an expansion of 130 basis points over the prior year period. Diluted earnings per share increased 9% to $4.67 per share, and adjusted diluted earnings per share increased 11%, to $4.72 per share. Our financial position remained strong at the end of the year with cash, restricted cash and total corporate investments of $1.6 billion and total borrowings of approximately $817 million. Our cash flow from operations for the year was $1.9 billion and that's up 11% from the prior year. That was driven primarily by higher net income and fluctuations in working capital. We returned $1.5 billion to shareholders during the year. That included $1.3 billion of dividends and $169 million of share buybacks, and our 12-month rolling return equity remains robust at 47%. I will now turn to our guidance for the fiscal year 2025. This outlook assumes the current macro environment, which has some level of uncertainty. Our current outlook is as follows. Total revenue is expected to grow in the range of 4% to 5.5%. If you take the midpoint of this range, that is consistent with the preliminary thinking we provided last quarter. And as a reminder, this includes approximately 200 basis points of headwind from the expiration of ERTC. Adjusted diluted earnings per share is expected to grow in the range of 5% to 7%. I'll now give you the breakdown of some of the components. Management solutions is expected to grow in the range of 3% to 4%. P.O. and insurance solutions is expected to grow in the range of 7% to 9%. Interest on funds held for clients is expected to be in the range of $150 to $160 million. Other income net is expected to be income in the range of $35 to $40 million. Those last two metrics both are impacted by short-term interest rates. We can talk more in the Q&A, but it is our expectation that the Fed begins to lower short-term interest rates as we get into the back half of the year. Operating income margin is expected to be in the range of 42% to 43%. This is also consistent with our preliminary expectations around margin expansion, and our effective tax rate is expected to be in the range of 24% to 25%. Turning to the quarter, we anticipate total revenue growth of approximately 2%. The first quarter growth rate is impacted by two headwinds. The first is the ERTC headwind that you are all familiar with. The second one is one less processing day in the quarter versus the prior year, and it's one of our largest revenue days. Combined, these two items represent a headwind of more than 400 basis points to revenue growth. We would also expect an operating margin in the range of 40% to 41% in the quarter. Of course, all of this is based on our current assumptions, which are subject to change. We'll update you again on the first quarter call. I will refer you to our investor slides on our website for additional information. And with that, I'll now turn the call back over to John. Thank you, Bob. We will now open the call to questions.