沛齊 (PAYX) 2018 Q4 法說會逐字稿

Welcome, and thank you for standing by.

(Operator Instructions) This call is being recorded.

If you have any objections, you may disconnect at this point.

Now I'll turn the meeting over to your host to Mr. Efrain Rivera, Senior Vice President, Chief Financial Officer and Treasurer.

You may begin.

Good morning, everyone.

Thanks for joining the call again.

Joining me today is our Controller, Jennifer Vossler.

This call is being streamed live over the Internet.

A replay of the webcast will be available for approximately 30 days.

My goal on the call is to help you understand how our financial results will be impacted by the implementation of new accounting guidance regarding revenue recognition.

In addition, I'll include a discussion of tax reform, other non-GAAP adjustments and the income impact they'll have as well.

Just a quick reminder of our typical legal disclaimer.

During this call, there will be forward-looking statements that refer to future events and as such involve risk.

Please refer to the earnings release, which includes a discussion of our forward-looking statements, and I hope that you have the presentation in front of you, that really was basically Slide 3.

Now on to Slide 4, we're also presenting non-GAAP financial measures of adjusted net income and adjusted diluted earnings per share.

Within this presentation, these non-GAAP measures are reconciled to our restated GAAP measures and net income and diluted earnings per share.

These non-GAAP measures more appropriately reflect our ongoing business operation and exclude the following: discrete tax benefits realized on employee stock-based comp payments.

I get asked why we exclude that, and the reason is, while in 1 year, we know what the actual was, it's difficult to predict what they will be in the next year, because that will relate to timing of exercises, so we pull it out so you have a little bit more comparability.

Other people don't do that, but we think it's important to do that to get comparability.

The onetime revaluation of deferred tax liability balances at the lower corporate tax rate as a result of tax reform and the charge following the termination of certain licensing agreements that occurred in the third quarter of fiscal 2018, both unusual items that we call out so you can get a sense of what, on an ongoing basis, our results look like.

So you should have the presentation for the call in front of you and we're going to walk through the impacts of 606 for fiscal 2018 and 2017 and also reconcile to non-GAAP adjusted numbers.

So again, Slide 4, that's the agenda.

Highlight to the implementation of ASC 606, financial impacts resulting from the adoption of the new accounting standard, restatement of historical results for full year fiscal 2017 to fiscal 2018 as well -- as quarterly income statements for fiscal 2018, which you'll need to understand the guidance that we have, and finally, a recap of the fiscal 2019 guidance which was provided on the basis of the adoption of 606.

So I'll now flip to Slide 5. This slide provides a few highlights of the adoption of ASC 606.

The new accounting standard supersedes previous general and industry-specific guidance on how and when to recognize revenue.

The new guidance is applicable to Paychex for fiscal 2019.

We will be adopting this new guidance on a full retrospective basis, which means we will be restating prior periods presented in our fiscal 2019 financial statements to be consistent with this new guidance.

This will include fiscal 2018 in our quarterly 10-Qs and full year fiscal 2018 and fiscal 2017 in our fiscal 2019 10-K.

So you'll see the full effect in the 2019 10-K.

You'll start to see the fact in the Qs of 2019.

Full retrospective adoption allows for better comparability year-over-year.

Accumulative effect of change in accounting principle will be recognized in retained earnings as of the beginning of fiscal 2017.

So if you're looking at the balance sheet, the balance sheet, particularly the equity account will change because there is a cumulative effect of having gone back and done the work that we did.

We examined all of our revenue streams, following the 5-step model that's laid out in the new standard, if you've read it.

The majority of the revenue streams won't have any change in how we recognize that revenue.

However, there are a couple of areas that are impacted though the changes are not material when you look at it year-over-year.

There will be some changes in the timing of the recognition of the revenue related to certain annual processes or annual revenue streams that we perform for our clients.

Currently, we recognize this revenue throughout the fiscal year, but we'll change in the timing of the recognition of the revenue to our third fiscal quarter upon completion of these annual processes.

This change will move revenue into Q3 out of the other fiscal quarters.

So what ends up happening and you'll see it shortly in the schedule, this is key take away number 1, you move a little bit more than $20 million in revenue from Qs 1, 2 and 4 into Q3.

That has obviously impacts on revenue, which we'll see in a second and it also has impacts on net income in the quarter.

The impact again on the full year is immaterial.

We did change recognition related to certain setup fee revenue based on the application of the new guidance.

So when we set up a client there's -- there are fees that we charge and there are costs associated with that, we looked at the guidance and it resulted in some small changes.

These amounts are not significant though to our results of operations.

The most significant impact to Paychex will be recognition of cost to obtain and cost to fulfill contracts, that's what the standard talks about.

Costs that are directly incremental based on obtaining a contract, things like sales commission, bonuses, et cetera, and costs that are related to implementing a client to be able to fulfill our performance obligation of the contract are to be recognized over the average life of a client according to the new standard.

Currently, our sales commissions and bonuses are recognized when earned by sales reps.

Also, salary cost for implementation specialists that are directly related to the new client setup are recognized -- also recognized when incurred.

This change results in significantly more cost being deferred and then amortized over the estimated client life, and under our client practice.

And by the way, estimated client life is just a little bit under 5 years given the size of our clients.

These are changes to timing of revenue and related recognition of cost and our only accounting change.

They don't impact our processes, service to clients or cash flows.

So movement within periods but overall, not a significant impact.

The standard will also require more disclosures surrounding revenue streams in our related-contract assets and liabilities.

These disclosures you will start to see them in our first quarter fiscal 2019 10-Q.

So let's look at more detail.

So now let's turn to Slide 6. This is where you start to see what the impact is, and I called it out, this shows the impact of our service revenues or Slide 6 does for the full year fiscal 2017 and quarterly periods of fiscal 2018, you can see on the schedule that the full year impact of $3 million for fiscal 2018 is simply not significant to our total revenues.

However, within payroll processing revenue there is a shift in the quarterly gating that moves revenue into the third quarter and you can see it as you go down into the schedule, in the middle of that schedule, you can see what the shift is.

So basically in Q1, $24 million, in Q2 about $24 million, in Q4 $25 million, that's going to shift now into Q3.

You see this reduction in the first, second and fourth fiscal quarters and then this causes an increase of approximately $70 million in the third quarter of fiscal 2018, again, annual revenue streams that shift back into Q3.

So that should be clear, it's spelled out there, you can see what's happening.

That's the big change to revenue and essentially the -- for all intent and purpose, the only thing that's changing in revenue.

Now other things will change as a result of that, but that's the big change.

When you look at guidance that I provided, we're looking at this revised or restated fiscal 2018.

So, for example, in the call that I just had, I called out Q1 as being lower, largely due to the composition of days within that quarter, I called it out as approximately 1%.

What you're comparing against is to this new restated number, not to the as-reported numbers that you may have in your model.

So that's that.

Let's go to Slide 7 and Slide 8. 7 and 8 reflect the impact on net earnings and diluted earnings per share.

The schedules reconcile results to previously reported U.S. GAAP to new GAAP based on results that reflect implementation of 606.

So what we're doing here is we are taking you from where we were on as-reported in those quarters and we thought this would be easiest way to do it.

And then now taking you to where restated GAAP is, and you can see what the adjustments are.

In the first and second quarter, it's primarily just that shift in revenue and in fourth quarter, you see something similar.

There's some stock-based comp that we typically pull out, that shouldn't be a surprise if you looked at our financial statements and then you see a big number in Q3 that's for deferred tax liabilities.

Let me just tell you what this number is.

If you look at the Q3 results for -- or as-reported Q3 results.

What ended up happening was that we had 1 element of deferred tax liability revaluation when we reported Q3.

So that was about $0.06 to $0.07 when we reported.

We called that out separately, if you go back to Q3, you'll see it.

Now because of the adoption of ASC 606, it generates changes in deferred tax liabilities that we have to recognize and we recognize those now on a restated basis in Q3 of 2018.

In order for you to be able to get to the adjusted number, you need to adjust out that number.

For GAAP purposes, it needs to be recognized, but for adjusted GAAP, it does not and all of that change is coming from the fact that you are changing in prior periods the amortization of the cost that we just talked about.

So that is -- that's why you're generating a more significant deferred tax liability number -- revaluation number.

So we had unusual adjustments in 2008, discrete tax benefits, you see those on the schedule.

Given the significance on reported results, we've reconciled these revised GAAP results to restated adjusted net income and adjusted diluted earnings per share.

Now the thing I want to call out on the schedule is, you can see that the growth rates are essentially comparable when you make the adjustments and you also can see that if you look at what the adjusted number for 2008 is versus what we just are reporting on the pre-ASC 606 result, which we just discussed, the difference is $0.01.

But there are shifts between the quarters, which you need to pick up as you're looking at it.

The onetime benefit recognized in the third quarter related, as I said, to the tax effects of ASC 606 and it was approximately $63 million.

The deferral cost to obtain and cost of the subcontracts creates a large contract asset and results in significant deferred tax liabilities related to that asset balance.

Again, let me just repeat it.

If you remember the third quarter fiscal 2008, we had significant discrete tax benefit recognized for the revaluation of the deferred tax liabilities, that was $21 million.

That's separate from this amount.

In the fourth quarter, we had another small adjustment of approximately $5 million.

When we restate fiscal 2018, we'll have an additional onetime revaluation in the third quarter of these new contract -- related to the new contract asset balance.

This adds an additional $63 million discrete benefit to the total of $26 million previously recognized for a total of approximately $89,000,000.23 per share for the full year fiscal 2018.

This is adjusted out to get to our new non-GAAP measure of adjusted net income.

So it's all detailed there in the schedules, and if you look at it closely, the 2 things I want to call out just to make sure you understand.

One is, you're having some impact because you're shifting revenues from quarters 1,2 and 4 into quarter 3, so that's impact one.

That has lowered that results and lowered net income in Qs 1, 2 and 4, shifted into Q3.

Now that's the first part.

The second is, and this is a deferred tax impact because of the adoption of ASC 606 that you see in Q3, to get to the adjusted number you need to adjust that out to get to the correct adjusted number on which we provided guidance.

So hopefully, you look at the schedule, it should be relatively clear.

The other thing that we're doing there just so we're clear is, we're also taking out those discrete tax benefits that we were recognizing in the year, and also, as I said, even before we adopted ASC 606, we had a deferred tax impact in Q3 that we had previously recognized.

So now we're adjusting and including the impacts of ASC 606 on top of that.

So let's look at Slide 9 because it pulls it together.

It shows the information in a slightly different format, by showing the as-reported and the reinstated income statements for fiscal 2018 and 2017, it's an important schedule to look at.

You can see that overall the growth rates for revenue are not materially affected, once we apply 606 retrospectively.

Also, once we adjust net income and diluted earnings per share for certain discrete tax benefits the growth rates and adjusted net income compared to what was previously reported and again are not materially different.

I've just said that about 3 different ways, but just so it's clear, you can look at Slide 9 to get you grounded and anchored in terms of where the numbers are.

Slide 10 shows you the quarterly periods for fiscal 2018 as restated and excluding certain non-GAAP adjustments.

These amounts are not audit, but do reflect what we anticipate our restated quarters will be when we issue the fiscal 2009 -- 2019 10-Qs.

This should help you adjust the models accordingly.

So we've given a lot of detail there, side-by-side comparisons, hopefully, that's helpful and now let me just go to the final slide, which is Slide 11.

And it basically restates -- reiterates the guidance for the full year fiscal 2019 that I just discussed on the earnings call.

The guidance was prepared assuming implementation of ASC 606 in fiscal 2019 and the related reinstatement of fiscal 2018 results.

So GAAP is going to change because of the implementation, but when you look at the adjusted numbers, as I said, they don't change that dramatically that significantly from what we just reported, there are shifts in the quarters that you need to be aware of.

You'll see a significant difference, as I said, on GAAP basis net income and adjusted non-GAAP, but adjusted non-GAAP net income guidance, that's largely due to the impact of the reevaluation of deferred tax liability balance for lower corporate income taxes.

So what I want to say there is that the other thing that's happening here that requires you to look at those schedules is that, our tax rate is changing from what the effective tax rate we had during the year and it's dropping.

So you've got those impacts going on.

As I mentioned earlier, we'll also be disclosing a revised method of disaggregating service revenues.

We've talked about that briefly, it will result in more disclosure of revenue streams rather than less.

The breakout of payroll in HRS revenue doesn't completely reflect or adequately reflect our business, and the transition to cloud-based HCM provider and greater use of product bundles blurred the lines increasingly from payroll in HRS.

Payroll is more -- payroll, we'll provide detail on payroll and we feel a more proper presentation will show payroll and HCM service revenue together and then display PEO insurance services revenue as another category.

We'll provide all of this information on our website and you'll still continue to see payroll and HRS, so you can adjust models accordingly.

The new disaggregation is more consistent with how we manage and measure the business and it's also something that we required to look at for ASC 606.

Over the next few weeks, we'll finalize the disaggregation, we'll post the schedule on the website that gives you the -- historical service revenues now broken down into these other categories, including HR, HRS and payroll.

This will occur before Q1 when we plan to start talking more completely about these changes in disclosures.

We'll continue to support and provide information you need to adjust the models, you have any question going forward, just give me a ring.

With that, I hope that whirlwind presentation was helpful.

Again, refer to the schedules.

I think the thing to remember is that there is 2 major things going on here.

One is that revenue shifts from quarters 1, 2 and 4, not a significant amount into Q3.

That becomes the new gating of revenues after ASC 606, and then as a result of the implementation of ASC 606, there is a deferred tax impact that occurs in Q3.

The effect of this will be for GAAP to show higher net income in Q3, but we adjust that out, because it's a onetime discrete item caused by the adoption of the standard on an adjusted basis, when you take those numbers out, you're essentially pretty close to where you were before all of this occurred.

So with that, I will close and then see if there are some questions that any of you have.

And by the way, I have time for about 10 or 15 minutes worth of Q&A, if there are questions.

Operator, please, open the line for questions.

(Operator Instructions) We have a question coming from Mark Marcon from R.W. Baird.

I was wondering would it be possible to get a schedule for fiscal '17, similar to what we have on Slide 10.

Broken by quarters, you mean?

Yes, that way we can see the year-over-year growth and the change in the margins.

Okay.

Yes, Mark, we'll -- we will -- we'll take a look at it and post it.

I can't say it will be done immediately, but we'll do it as quickly as we can.

(Operator Instructions)

Speak now.

Okay, operator, if there are no other questions in the queue, we can end the call.

And what I would invite you to do is if you want to follow up with me, happy to take your calls.

Are there any other question, operator?

At this time, there are no questions in queue.

Okay.

Well, then, I think we'll close the call.

Again, any questions you have, just give me a ring and thanks for your interest in the discussion.

So we'll be in touch.

Thank you.

Thank you, and that concludes today's conference.

Thank you all for participating.

You may now disconnect.