(EDGAR Online via COMTEX) -- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Management's Discussion and Analysis of Financial Condition and Results of Operations reviews the operating results of Paychex, Inc. and its wholly owned subsidiaries ("Paychex," the "Company," "we," "our," or "us") for each of the three fiscal years ended May 31, 2020 ("fiscal 2020" or the "fiscal year"), May 31, 2019 ("fiscal 2019"), and May 31, 2018 ("fiscal 2018"), and our financial condition as of May 31, 2020. This review should be read in conjunction with the accompanying consolidated financial statements and the related Notes to Consolidated Financial Statements contained in Item 8 of this Annual Report on Form 10-K ("Form 10-K") and the "Risk Factors" discussed in Item 1A of this Form 10-K. Forward-looking statements in this review are qualified by the cautionary statement under the heading "Cautionary Note Regarding Forward-Looking Statements Pursuant to the United States Private Securities Litigation Reform Act of 1995" contained at the beginning of Part I of this Form 10-K.
We are a leading provider of integrated human capital management ("HCM") solutions for human resources ("HR"), payroll, benefits, and insurance services for small- to medium-sized businesses. Within our HCM solutions, we offer a comprehensive portfolio of services and products that allow our clients to meet their diverse HR and payroll needs.
We support our small-business clients, reducing the complexity and risk of running their own payroll, while ensuring greater accuracy with up-to-date tax rates and regulatory information. Clients may choose to have our service team handle everything for them, or process payroll themselves utilizing our proprietary, robust, software-as-a-service ("SaaS") Paychex Flex(R) platform and our SurePayroll(R) SaaS-based products. Our mid-market clients generally have more complex payroll and employee benefit needs. However, in the current environment of increasing regulations, we believe the needs for HR outsourcing solutions have been moving down-market. Any of our clients using Paychex Flex can opt for the integrated suite of HCM solutions, which allows clients to choose the services and software that will meet the needs of their business.
Our portfolio of HCM and employee benefit-related services is disaggregated into two categories, Management Solutions and Professional Employer Organization ("PEO") and Insurance Solutions, as discussed in Part 1, Item 1 of this Form 10-K.
Our mission is to be the leading provider of HR, payroll, benefits, and insurance solutions by being an essential partner to small and medium-sized businesses across the U.S. and parts of Europe. We believe that success in this mission will lead to strong, long-term financial performance. Our strategy focuses on providing industry-leading, integrated technology; increasing client satisfaction; expanding our leadership in HR; growing our client base; and engaging in strategic acquisitions.
We continue to focus on driving growth in the number of clients, revenue per client, total revenue and profits, while providing industry-leading service and technology solutions to our clients and their employees. We maintain industry-leading margins by managing our personnel costs and expenses while continuing to invest in our business, particularly in leading-edge technology. We believe these investments are critical to our success. Looking to the future, we believe that investing in our products, people, and service capabilities will position us to capitalize on opportunities for long-term growth.
Effective December 20, 2018, the Company acquired Oasis Outsourcing Group Holdings, L.P. ("Oasis"). Upon closing, Oasis became a wholly owned subsidiary of the Company. Oasis is an industry leader in providing HR outsourcing services. The purchase price was $992.2 million, net of $262.3 million in cash acquired, including $132.1 million of restricted cash. The acquisition was financed through a combination of cash on hand and the issuance of long-term private placement debt totaling $800.0 million.
Fiscal 2020 Financial Highlights
Financial highlights for fiscal 2020, compared to fiscal 2019, are as follows:
�Total revenue increased 7% to $4.0 billion. Oasis contributed approximately 4% to the growth in total revenue.
�Operating income increased 7% to $1.5 billion.
�Net income increased 6% to $1.1 billion. Adjusted net income(1) increased 5% to $1.1 billion.
�Diluted earnings per share and adjusted diluted earnings per share(1) both increased 6% to $3.04 per share and $3.00 per share, respectively.
�Dividends of $889.4 million were paid to stockholders, representing approximately 81% of net income.
(1)Adjusted net income and adjusted diluted earnings per share are not U.S. generally accepted accounting principles ("GAAP") measures. Refer to the "Non-GAAP Financial Measures" section of this Item 7 for a discussion of these non-GAAP measures and a reconciliation to the most comparable U.S. GAAP measures of net income and diluted earnings per share.
Table of Contents
For further analysis of our results of operations for fiscal years 2020, 2019, and 2018, and our financial position as of May 31, 2020, refer to the tables and analysis in the "Results of Operations" and "Liquidity and Capital Resources" sections of this Item 7.
In March 2020, the World Health Organization declared the outbreak of COVID-19 as a pandemic. The COVID-19 pandemic affected our business, our customers' businesses, and the markets we serve during the three months ended May 31, 2020 (the "fourth quarter"). See the "COVID-19 Response" section of this Item 7 for further discussion on the impact of COVID-19 on our results of operations along with our response to the pandemic.
Our payroll and PEO client base, including all acquisitions, was greater than 680,000 and approximately 670,000 clients as of May 31, 2020 and May 31, 2019, respectively, and greater than 650,000 clients as of May 31, 2018. Client retention was at record levels of over 83% of the beginning client base for fiscal 2020. Client retention was over 82% for fiscal 2019 and approximately 81% of the beginning client base for fiscal 2018.
While our HR product offerings provide services to employers and employees beyond payroll, they effectively leverage payroll processing data. These services are included as part of the integrated HCM solution within Paychex Flex or provided through the Prism HR PEO platform. The following table illustrates the growth in selected HR product offerings:
$ in billions As of May 31, 2020 Change(1) 2019 Change(1) 2018 Paychex HR Solutions and PEO client worksite employees(2) 1,428,000 (4) % 1,491,000 29 % 1,157,000 Paychex HR Solutions and PEO clients 55,000 7 % 52,000 26 % 41,000 Health and benefits services applicants 182,000 (4) % 189,000 7 % 177,000 Retirement services plans 91,000 4 % 87,000 6 % 82,000 Asset value of retirement services participants' funds $ 32.3 4 % $ 31.0 1 % $ 30.6
(1)Percentage changes are calculated based on unrounded numbers.
(2)Oasis is included in the total number of worksite employees and clients for both fiscal 2020 and fiscal 2019.
Concentrated effort remains on the continued enhancements of Paychex Flex, our robust, cloud-based HCM software solutions platform, which allows direct client access to HR, payroll, and benefits information in a streamlined and integrated approach to workplace management. In fiscal 2020, we continued to focus on enhancing the value to clients, including new offerings and enhancements to Paychex Flex as follows:
�Paychex Integrations enabling users to connect Paychex Flex with some of the world's leading HR, accounting, point-of-sale, and productivity applications on the market;
�Smartwatch Solution, which enables users to track time worked via their smartwatch;
�Pay-on-Demand, which provides participating customer employees the option to request access to a portion of earned pay before the scheduled pay date;
�Real-Time Payments, which provides employers an efficient way to instantly pay their employees for time worked;
�Help Center, which provides users access to training resources and how-to tutorials in written, video, and tour-like deliverables;
�Enhancements to Flex Assistant, that provides a user with an in-app learning journey that aligns with their preferences as a verbal, visual, or physical learner and offers written how-to documents, tutorial-style video vignettes, or a guided interactive tour from in-app step-by-step messaging;
�Document Management was enhanced to add electronic signature capabilities and the ability for customers to run on-demand reports that show the entire process, from initial log-in through signature event;
�HR Conversations, a new tool that enables managers, employees, and HR staff to collaborate and capture day-to-day interactions; and
�Other enhancements including, grid entry view capabilities and the ability for employees and administrative users to create a custom dashboard.
Table of Contents
We continue to strengthen our position in the industry by serving as a source of education and information to clients, businesses of all sizes, and other interested parties. We provide free webinars, white papers, and other information on our website to aid existing and prospective clients with the impact of regulatory changes. The Paychex Insurance Agency, Inc. website, www.paychex.com/group-health-insurance , helps small-business owners navigate the area of insurance coverage. Both this website and www.paychex.com/worx have sections dedicated to the topic of health care reform.
In March 2020, the World Health Organization declared the outbreak of COVID-19 as a pandemic. The COVID-19 pandemic began affecting our operations and employees, our customers' businesses, and the markets we serve in the three months ended May 31, 2020 (the "fourth quarter"). The health and safety of our employees remains our top priority. We were expedient with the implementation of our business continuity plan, which included moving 95% of our workforce to work remotely and restricting unnecessary travel. Results of operations for the fourth quarter were adversely impacted by the COVID-19 pandemic as businesses suspended operations. Management Solutions revenue was impacted by a decline in check volumes, partially offset by increased penetration of retirement services and time and attendance services. The decline in check volumes was due to a reduction in the number of clients processing payrolls as well as the number of employees paid due to state and regional shutdowns. PEO and Insurance Solutions revenue was impacted by a decline in the number of worksite employees serviced by our existing clients. Insurance Solutions revenue was impacted by a decrease in the number of health and benefit applicants and a decline in workers' compensation premiums. Since the end of April, we have seen sequential improvement in our key business metrics across our lines of business.
As our clients continue to manage through the COVID-19 pandemic, our priority remains helping them keep their businesses open and return to more normal operations. Our blend of technology and service provides valuable tools and resources to assist our clients and their employees during this critical time. The technology investments we made to our Paychex Flex payroll and human resources suite of products positioned us to service our clients and support them in managing a remote workforce.
We created a COVID-19 Help Center on our website to assist our clients and provide them with the support and resources they need, including:
?Webinars and white papers with information on the Coronavirus Aid, Relief, and Economic Security Act, including the historic PPP, and Families First Coronavirus Response Act;
?Guidance on the Small Business Administration ("SBA") loan and debt relief process,
?Interactive PPP loan estimation tool for businesses who are considering or have received funding through the SBA program; and
?State-by-state resources to help our clients understand specific directives that may impact their business.
The COVID-19 Help Center also provides resources to our key business partners, including accountants, financial institutions, financial advisors, and national associations. The COVID-19 Help Center has been translated into Spanish to serve our Spanish-speaking clients.
Our strong balance sheet and operational flexibility allowed us to successfully manage through the initial impact of COVID-19 while protecting our cash flow and liquidity. We will continue to evaluate the nature and extent of future changes to market and economic conditions related to COVID-19 and will assess the potential impact to our business and financial position. We expect to take a cautious approach to modifying our office and travel restrictions and will wait until we have a clearer vision on how the pandemic unfolds and utilizing guidance provided by the federal, state, and local governments.
For further information on the risks posed to our business from the COVID-19 pandemic, refer to Item 1A of this Form 10-K.
Table of Contents
Results of Operations
Summary of Results of Operations for Fiscal Years: In millions, except per share amounts 2020 Change(1) 2019 Change(1) 2018 Revenue: Management Solutions $ 2,963.0 3 % $ 2,877.7 4 % $ 2,758.4 PEO and Insurance Solutions 990.6 22 % 814.2 46 % 555.8 Total service revenue 3,953.6 7 % 3,691.9 11 % 3,314.2 Interest on funds held for clients 86.9 8 % 80.6 27 % 63.5 Total revenue 4,040.5 7 % 3,772.5 12 % 3,377.7 Total expenses 2,580.0 7 % 2,401.2 15 % 2,086.2 Operating income 1,460.5 7 % 1,371.3 6 % 1,291.5 Other (expense)/income, net (23.4) n/m (3.3) n/m 8.6 Income before income taxes 1,437.1 5 % 1,368.0 5 % 1,300.1 Income taxes 339.0 2 % 333.6 9 % 306.0 Effective income tax rate 23.6 % 24.4 % 23.5 % Net income $ 1,098.1 6 % $ 1,034.4 4 % $ 994.1 Diluted earnings per share $ 3.04 6 % $ 2.86 4 % $ 2.75
(1)Percentage changes are calculated based on unrounded numbers.
n/m - not meaningful
We invest in highly liquid, investment-grade fixed income securities and do not utilize derivative instruments to manage interest rate risk. As of May 31, 2020, we had no exposure to high-risk or non-liquid investments. Details regarding our combined funds held for clients and corporate cash equivalents and investment portfolios are as follows:
Year ended May 31, $ in millions 2020 2019 2018 Average investment balances: Funds held for clients $ 3,931.3 $ 3,969.7 $ 4,040.8 Corporate cash equivalents and investments 870.7 848.4 915.1 Total $ 4,802.0 $ 4,818.1 $ 4,955.9 Average interest rates earned (exclusive of net realized gains): Funds held for clients 1.9 % 2.0 % 1.6 % Corporate cash equivalents and investments 1.4 % 1.6 % 1.3 % Combined funds held for clients and corporate cash equivalents and investments 1.8 % 1.9 % 1.5 % Total net realized gains $ 11.3 $ - $ 0.1 $ in millions As of May 31, 2020 2019 2018 Net unrealized gains/(losses) on available-for-sale securities(1) $ 100.0 $ 19.7 $ (38.3) Federal Funds rate(2) 0.25 % 2.50 % 1.75 % Total fair value of available-for-sale securities $ 2,757.2 $ 3,620.8 $ 3,104.8 Weighted-average duration of available-for-sale securities in years(3) 2.9 2.9 3.1 Weighted-average yield-to-maturity of available-for-sale securities(3) 2.1 % 2.1 % 1.9 %
(1)The net unrealized gain on our investment portfolios was approximately $112.4 million as of July 15, 2020.
(2)The Federal Funds rate was in the range of 0.0% to 0.25% as of May 31, 2020, in the range of 2.25% to 2.50% as of May 31, 2019, and in the range of 1.50% to 1.75% as of May 31, 2018.
(3)These items exclude the impact of variable rate demand notes ("VRDNs"), as they are tied to short-term interest rates.
Table of Contents
Management Solutions revenue: Management Solutions revenue was $3.0 billion for fiscal 2020 and $2.9 billion for fiscal 2019, reflecting growth of 3% and 4%, respectively, compared to the prior fiscal year periods. Both fiscal 2020 and fiscal 2019 benefited from increases in our client base and growth in revenue per client, which improved as a result of higher price realization and increased penetration of our suite of solutions, particularly HR outsourcing, retirement services, and time and attendance. Retirement services revenue growth for both fiscal 2020 and fiscal 2019 benefited from an increase in the number of retirement services plans, along with an increase in revenue earned on the asset value of participants' 401(k) funds.
PEO and Insurance Solutions revenue: PEO and Insurance Solutions revenue was $990.6 million for fiscal 2020 and $814.2 million for fiscal 2019, reflecting growth of 22% and 46%, respectively, compared to the prior fiscal year periods. In addition to the acquisition of Oasis, PEO and Insurance Solutions revenue growth in fiscal 2020 and fiscal 2019 was driven by growth in clients across our PEO business. In addition, for fiscal 2019, PEO and Insurance Solutions revenue growth was driven by growth in client worksite employees across our PEO business.
Insurance Solutions revenue for both fiscal 2020 and fiscal 2019 benefited from an increase in the number of health and benefit clients, offset by declining rates in the workers' compensation market. In addition, for fiscal 2019, Insurance Solutions revenue was impacted by an increase in the number of health and benefit applicants.
Interest on funds held for clients: Interest on funds held for clients increased 8% for fiscal 2020 and 27% for fiscal 2019 to $86.9 million and $80.6 million, respectively. For fiscal 2020 the increase was due to higher realized gains, offset by lower average investment balances and average interest rates. The realized gains primarily resulted from the strategic repositioning of our client fund portfolio to enhance liquidity in response to the uncertainty caused by COVID-19. For fiscal 2019, the increase was primarily due to higher average interest rates earned.
Average investment balances for funds held for clients decreased approximately 1% and 2% for fiscal 2020 and fiscal 2019, respectively. For fiscal 2020, funds held for clients average investment balances were impacted by lower client fund collections due to COVID-19 and changes in client base mix, offset by wage inflation and timing of collections and remittances. For fiscal 2019, the decrease in average investment balances for funds held for clients was primarily driven by the impact of lower client withholdings as a result of the Tax Cuts and Jobs Act of 2017 (the "Tax Act"), and changes in client base mix, partially offset by the impact of wage inflation.
Refer to the "Market Risk Factors" section contained in Item 7A of this Form 10-K for more information on changing interest rates.
Total expenses: Total expenses increased 7% and 15% for fiscal 2020 and fiscal 2019, respectively, compared to the prior fiscal year periods. The following table summarizes total combined cost of service revenue and selling, general and administrative expenses for fiscal years:
In millions 2020 Change(1) 2019 Change(1) 2018 Compensation-related expenses $ 1,480.8 6 % $ 1,396.8 13 % $ 1,235.2 Depreciation and amortization 209.7 16 % 181.5 32 % 138.0 PEO insurance costs 334.7 17 % 286.7 40 % 205.2 Other expenses 554.8 3 % 536.2 6 % 507.8 Total expenses $ 2,580.0 7 % $ 2,401.2 15 % $ 2,086.2
(1)Percentage changes are calculated based on unrounded numbers.
Compensation-related expenses increased 6% for fiscal 2020 and 13% for fiscal 2019. For fiscal 2020, the increases in compensation-related expenses were driven by the acquisition of Oasis, increased headcount, and higher wages, offset by a decrease in performance-based pay. For fiscal 2019, the increases in compensation-related expenses were driven by the acquisition of Oasis, increased headcount, higher wages, and an increase in performance-based pay. As of May 31, 2020, we had approximately 15,800 employees compared with 15,600 employees as of May 31, 2019.
Depreciation expense is primarily related to buildings, furniture and fixtures, data processing equipment, and both purchased and internally developed software. Amortization of intangible assets is primarily related to client list acquisitions. The growth in depreciation and amortization for both fiscal 2020 and fiscal 2019, were primarily driven by the amortization of acquired Oasis intangible assets.
Table of Contents
PEO insurance costs include workers' compensation, minimum premium medical insurance plan arrangements, and self-insured dental and vision plans where we retain risk. The acquisition of Oasis, along with the growth in our PEO business, contributed to the increase in PEO insurance costs for both fiscal 2020 and fiscal 2019. In addition, the acquisition of HR Outsourcing Holdings, Inc. ("HROi") contributed to the increase in PEO insurance costs for fiscal 2019.
Other expenses include items such as non-capital equipment, delivery, forms and supplies, communications, travel and entertainment, professional services, and other costs incurred to support our business. Other expense growth for fiscal 2020 was impacted by the acquisition of Oasis and by continued investment in product development and supporting technology, tempered by the impact of COVID-19 in the fourth quarter which drove decreases in other selling, general and administrative expenses, including travel and entertainment. The increase in other expenses for fiscal 2019 was impacted by the acquisitions of Oasis and HROi and continued investment in product development and supporting technology. Other expenses for fiscal 2018 included a one-time expense of $32.6 million related to the termination of certain license agreements.
Operating income: Operating income increased 7% to $1.5 billion for fiscal 2020 and 6% to $1.4 billion for fiscal 2019. Operating margin (operating income, as a percentage of total revenue), was 36.1%, 36.3%, and 38.2% for fiscal years 2020, 2019, and 2018, respectively. Adjusted operating income(1) increased 7% to $1.5 billion for fiscal 2020 and 4% to $1.4 billion for fiscal 2019. Earnings before interest, taxes, depreciation, and amortization ("EBITDA")(1) increased 8% to $1.7 billion for fiscal 2020 and 9% to $1.6 billion for fiscal 2019. EBITDA margin(1) was 41.4%, 41.2%, and 42.3% for fiscal years 2020, 2019, and 2018, respectively.
(1)Adjusted operating income, EBITDA and EBITDA margin are not U.S. GAAP measures. Refer to the "Non-GAAP Financial Measures" section within the "Results of Operations" section of this Item 7 for a discussion of these non-GAAP measures and a reconciliation to the most comparable U.S. GAAP measures of operating income and net income.
Other (expense)/income, net: Other (expense)/income, net, primarily represents interest expense incurred on our debt instruments, netted against earnings from our corporate cash and cash equivalents and investments in available-for-sale securities. We recognized $23.4 million and $3.3 million of other expense, net in fiscal 2020 and fiscal 2019, respectively, which was driven by interest expense related to our long-term borrowings. Other expense, net included $33.3 million and $13.7 million of interest expense related to our long-term borrowings in fiscal 2020 and fiscal 2019, respectively.
Income taxes: Our effective income tax rate was 23.6% for fiscal 2020, 24.4% for fiscal 2019, and 23.5% for fiscal 2018. The effective income tax rates in all periods were impacted by recognition of net discrete tax benefits related to employee stock-based compensation payments. In fiscal 2019, the effective income tax rate included discrete tax expense for changes in tax reserves and the revaluation of deferred tax balances for legislative updates. In fiscal 2018, as a result of the Tax Act, we recorded a non-recurring net tax benefit for the revaluation of our net deferred tax liabilities. This amount impacted diluted earnings per share by approximately $0.23 per diluted share for fiscal 2018. Additional discrete tax items recognized during each respective period are insignificant. Refer to Note L of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K for additional disclosures on income taxes.
Net income and diluted earnings per share: Net income increased 6% to $1.1 billion for fiscal 2020 and 4% to $1.0 billion for fiscal 2019. Diluted earnings per share increased 6% to $3.04 per diluted share for fiscal 2020 and 4% to $2.86 per diluted share for fiscal 2019. Adjusted net income increased 5% to $1.1 billion for fiscal 2020 and increased 11% to $1.0 billion for fiscal 2019. Adjusted diluted earnings per share was $3.00 per diluted share for fiscal 2020 and $2.84 per diluted share for fiscal 2019, reflecting increases of 6% and 11%, respectively. Refer to the "Non-GAAP Financial Measures" section that follows for a discussion of these non-GAAP measures.
Table of Contents
Non-GAAP Financial Measures: Adjusted operating income, adjusted net income, adjusted diluted earnings per share and EBITDA are summarized as follows:
. . .
Jul 17, 2020
Is there a problem with this press release? Contact the source provider Comtex at email@example.com. You can also contact MarketWatch Customer Service via our Customer Center.
(c) 1995-2020 Cybernet Data Systems, Inc. All Rights Reserved