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10-Q: PAYCHEX INC

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(EDGAR Online via COMTEX) -- Item 2. 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 the three months ended August 31, 2020 (the "first quarter"), the respective prior year period ended August 31, 2019, and our financial condition as of August 31, 2020. The focus of this review is on the underlying business reasons for material changes and trends affecting our revenue, expenses, net income, and financial condition. This review should be read in conjunction with the August 31, 2020 consolidated financial statements and the related Notes to Consolidated Financial Statements (Unaudited) contained in this Quarterly Report on Form 10-Q ("Form 10-Q"). This review should also be read in conjunction with our Annual Report on Form 10-K ("Form 10-K") for the year ended May 31, 2020 ("fiscal 2020"). Forward-looking statements in this review are qualified by the cautionary statement included under the next sub-heading, "Cautionary Note Regarding Forward-Looking Statements Pursuant to the United States Private Securities Litigation Reform Act of 1995."

Cautionary Note Regarding Forward-Looking Statements Pursuant to the United States Private Securities Litigation Reform Act of 1995

Certain written and oral statements made by us may constitute "forward-looking statements" within the meaning of the safe harbor provisions of the United States ("U.S.") Private Securities Litigation Reform Act of 1995. Forward-looking statements can be identified by such words and phrases as "we expect," "expected to," "estimates," "estimated," "intend," "overview," "outlook," "guidance," "we look forward to," "would equate to," "projects," "projections," "projected," "projected to be," "anticipates," "anticipated," "we believe," "believes," "could be," "targeting," and other similar words or phrases. Examples of forward-looking statements include, among others, statements we make regarding operating performance, events, or developments that we expect or anticipate will occur in the future, including statements relating to our outlook, revenue growth, earnings, earnings-per-share growth, or similar projections.

Forward-looking statements are neither historical facts nor assurances of future performance. Instead, they are based only on our current beliefs, expectations, and assumptions regarding the future of our business, future plans and strategies, projections, anticipated events and trends, the economy, and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks, and changes in circumstances that are difficult to predict, many of which are outside our control. Our actual results and financial conditions may differ materially from those indicated in the forward-looking statements. Therefore, you should not place undue reliance upon any of these forward-looking statements. Important factors that could cause our actual results and financial condition to differ materially from those indicated in the forward-looking statements include, among others, the following:

�the impact of the COVID-19 pandemic on the U.S. and global economy, and in particular on our small- and medium-sized business clients;

�changes in governmental regulations and policies;

�our ability to comply with U.S. and foreign laws and regulations;

�our ability to keep pace with changes in technology and to provide timely enhancements to our products and services;

�our compliance with data privacy laws and regulations;

�the possibility of cyberattacks, security vulnerabilities, and Internet disruptions, including breaches of data security and privacy leaks, data loss, and business interruptions;

�the possibility of failure of our operating facilities, computer systems, or communication systems during a catastrophic event, including the COVID-19 pandemic;

�the failure of third-party service providers to perform their functions;

�the possibility that we may be subject to additional risks related to our co-employment relationship with our professional employer organization ("PEO");

�changes in health insurance and workers' compensation insurance rates and underlying claim trends;

�our clients' failure to reimburse us for payments made by us on their behalf;

�the effect of changes in government regulations mandating the amount of tax withheld or the timing of remittances;

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�volatility in the political and economic environment;

�risks related to acquisitions and the integration of the businesses we acquire;

�our failure to comply with covenants in our debt agreements;

�changes in the availability of qualified people, including management, technical, compliance, and sales personnel;

�our failure to protect our intellectual property rights;

�the possible effects of negative publicity on our reputation and the value of our brand; and

�potential outcomes related to pending or future litigation matters.

Any of these factors, as well as such other factors as discussed in our Form 10-K for fiscal 2020 or in our other periodic filings with the Securities and Exchange Commission ("SEC"), could cause our actual results to differ materially from our anticipated results. The information provided in this Form 10-Q is based upon the facts and circumstances known as of the date of this report, and any forward-looking statements made by us in this Form 10-Q speak only as of the date on which they are made. Except as required by law, we undertake no obligation to update these forward-looking statements after the date of filing this Form 10-Q with the SEC to reflect events or circumstances after such date, or to reflect the occurrence of unanticipated events.

Our investor presentation regarding the financial results for the first quarter is available and accessible at Paychex's Investor Relations page at https://investor.paychex.com . Information available on our website is not a part of, and is not incorporated into, this Form 10-Q. We intend to make future investor presentations available exclusively through our Investor Relations page.

Overview

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. The workplace is evolving, and we lead the way by making complex HR, payroll, and benefits simple for our clients. Our purpose is to allow our clients the freedom to succeed. 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, and 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.

Within our HCM solutions we offer a comprehensive portfolio of services and products that cover the spectrum of the employee life cycle and allow our clients to meet their diverse HR and payroll needs. Clients can select services on an � la carte basis or as part of various product bundles. We can customize our offering to the client's business, whether it is small or large, simple or complex.

Our portfolio of HCM and employee benefit-related services is disaggregated into two categories, Management Solutions and PEO and Insurance Solutions, as discussed in Part 1, Item 1 of our Form 10-K for fiscal 2020. Our solutions bring together payroll and HCM software with flexible, personalized, technology-enabled service capabilities. Paychex Flex(R), our proprietary HCM software-as-a-service platform, unites HR, payroll, time and attendance, and benefits processes to manage the employee life cycle from recruiting and hiring to retirement. Clients can select the modules they need and easily add on additional services as they grow. Paychex Flex provides function-focused analytics throughout to assist HR leaders in making informed business decisions. Paychex Flex mobility and self-service capabilities allow clients and their employees access anywhere, at any time, on any device. We also provide comprehensive HR outsourcing solutions through our administrative services organization and PEO solutions. Our HCM and HR outsourcing solutions are supported with our HR and Compliance expertise and our technology-enabled service capabilities.

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 and go-to-market tools and resources. 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.

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Concentrated effort remains on the continued enhancements of our Paychex Flex platform. Our current and past investments in our platforms have prepared us well for the demands of this environment, allowing us to adapt while maintaining high levels of service delivery resulting in client satisfaction and retention. The Company's most recent round of product releases includes solutions designed to help organizations stay connected with remote workers and assist clients as workers return to the office, which are as follows:

?HR Connect, which enables employees to digitally submit questions, requests, and incidents directly to HR through an easy-to-use workflow;

?Occupational Safety and Health Administration ("OSHA") Dashboard, which prepares documentation and tracks open items for OSHA-reportable events and features links to relevant Paychex WORX Content, including up-to-date information on the compliance, HR, and business trends leaders need to know; and

?New Live Reports, such as Job Costing and Labor Distribution, Workers' Compensation, and Employee Change History reports, which provides improved report search capabilities and helps businesses lead with insights.

First Quarter Financial Highlights

Results of operations for the first quarter were adversely impacted as the COVID-19 pandemic has continued to affect our business, our clients' businesses, and the markets we serve. Refer to the "COVID-19 Update" section of this Item 2 for further discussion on the ongoing impact of COVID-19 along with our response to the pandemic.

Financial highlights for the first quarter compared to the prior year period are as follows:

?Total revenue decreased 6% to $932.2 million.

?Operating income decreased 19% to $284.0 million. Adjusted operating income(1) decreased 10% to $315.2 million.

?Net income decreased 20% to $211.6 million. Adjusted net income(1) decreased 11% to $228.0 million.

?Diluted earnings per share decreased 19% to $0.59 per share. Adjusted diluted earnings per share(1) decreased 11% to $0.63 per share.

(1) Adjusted operating income, adjusted net income, and adjusted diluted earnings per share are not U.S. generally accepted accounting principles ("GAAP") measures. Adjusted operating income, adjusted net income, and adjusted diluted earnings per share include adjustments for one-time costs of $31.2 million related to the acceleration of cost-saving initiatives, including the long-term strategy to reduce our geographic footprint and headcount optimization, and net tax windfall benefits related to employee stock-based compensation payments. Refer to the "Non-GAAP Financial Measures" section within the "Results of Operations" section of this Item 2 for a discussion of these non-GAAP measures and a reconciliation to the most comparable GAAP measures of operating income, net income, and diluted earnings per share.

For further analysis of our results of operations for the first quarter, and our financial position as of August 31, 2020, refer to the tables and analysis in the "Results of Operations" and "Liquidity and Capital Resources" sections of this Item 2.

COVID-19 Update

As the global COVID-19 pandemic has continued to evolve, our priority has been and continues to be, the health and safety of our employees. 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. While we are well-prepared to continue operating this way, we are in the planning stages of bringing back a small portion of our workforce to the office on a volunteer-only basis.

As our clients continue to manage through the COVID-19 pandemic, we remain committed to 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. In addition, we created a COVID-19 Help Center on our website to assist our clients and provide them with the support and resources they need as well as provide 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. We released several new innovative Paychex Flex features and functions during the first quarter to our clients to address the ongoing business challenges and shifting workplace dynamics as a result of the COVID-19 pandemic which are discussed in the "Overview" section of this Item 2. As the global economy continues to evolve for our clients, whether due to legislative changes, the pandemic, or other factors, we are committed to supporting our clients to help them navigate these challenges.

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Financial results for the first quarter showed marked improvement as most of our key business metrics recovered at a faster rate than anticipated. The effects of the COVID-19 pandemic continue to impact our results causing unfavorable year-over-year comparisons, however, client retention has remained strong and sales performance is accelerating with year-over-year growth in the number of clients sold. Our strong balance sheet and operational flexibility allowed us to successfully manage through the ongoing impacts of COVID-19 to date while protecting our cash flow and liquidity. In addition, we implemented cost-saving initiatives, including a long-term strategy to reduce our geographic footprint and headcount optimization. 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.

For further discussion on the risks posed to our business from the COVID-19 pandemic, refer to Item 1A of our Form 10-K for fiscal 2020.







        RESULTS OF OPERATIONS
        Summary of Results of Operations:
                                                     For the three months ended
                                                             August 31,
        In millions, except per share amounts        2020                      2019     Change(1)
        Revenue:
        Management Solutions                   $       687.4                 $ 724.5         (5) %
        PEO and Insurance Solutions                    229.9                   247.0         (7) %
        Total service revenue                          917.3                   971.5         (6) %
        Interest on funds held for clients              14.9                    20.5        (28) %
        Total revenue                                  932.2                   992.0         (6) %
        Total expenses                                 648.2                   642.9           1 %
        Operating income                               284.0                   349.1        (19) %
        Other expense, net                             (7.9)                   (4.8)         n/m
        Income before income taxes                     276.1                   344.3        (20) %
        Income taxes                                    64.5                    80.1        (19) %
        Effective income tax rate                       23.4 %                  23.3 %
        Net income                             $       211.6                 $ 264.2        (20) %
        Diluted earnings per share             $        0.59                 $  0.73        (19) %
        


(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 August 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:







                                                        For the three months ended
                                                                August 31,
        $ in millions                                      2020               2019         Change
        Average investment balances:
        Funds held for clients                      $      3,507.2       $  3,744.6         (6) %
        Corporate cash equivalents and
        investments                                        1,022.2            862.0          19 %
        Total                                       $      4,529.4       $  4,606.6         (2) %
        Average interest rates earned (exclusive of net realized gains/(losses)):
        Funds held for clients                                 1.7 %            2.1 %
        Corporate cash equivalents and
        investments                                            0.2 %            1.8 %
        Combined funds held for clients and
        corporate cash equivalents and
        investments                                            1.3 %            2.0 %
        Total net realized gains                    $          0.3       $      0.9
        


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                                                                      August 31,       May 31,
        $ in millions                                                    2020            2020
        Net unrealized gains on available-for-sale securities(1)     $    116.9      $   100.0
        Federal Funds rate(2)                                              0.25 %         0.25 %
        Total fair value of available-for-sale securities            $  2,980.1      $ 2,757.2
        Weighted-average duration of available-for-sale securities
        in years(3)                                                         3.3            2.9
        Weighted-average yield-to-maturity of available-for-sale
        securities(3)                                                       2.0 %          2.1 %
        


(1) The net unrealized gain on our investment portfolio was approximately $112.6 million as of October 2, 2020.

(2) The Federal Funds rate was in the range of 0.00% to 0.25% as of August 31, 2020 and May 31, 2020.

(3) These items exclude the impact of variable rate demand notes ("VRDNs") as they are tied to short-term interest rates.

Management Solutions revenue: Management Solutions revenue was $687.4 million for the first quarter reflecting a decrease of 5% compared to the prior year period. The decrease was primarily driven by a decline in check volumes, partially offset by increased penetration of retirement services. The decline in check volumes was due to a reduction in the number of clients processing payrolls as well as the number of clients' employees paid.

PEO and Insurance Solutions revenue: PEO and Insurance Solutions revenue was $229.9 million for the first quarter reflecting a decrease of 7% compared to the prior year period. The decrease was primarily driven by a decline in the number of our clients' worksite employees. Insurance Solutions revenue declined as a result of lower workers' compensation premiums driven by reduced wages due to fewer worksite employees for certain industries and related premium rates.

Interest on funds held for clients: Interest on funds held for clients was $14.9 million for the first quarter reflecting a decrease of 28% compared to the prior year period. The decrease resulted from lower average investment balances, average interest rates, and realized gains. Funds held for clients average investment balances were impacted by lower client fund collections and changes in client base mix, offset by wage inflation and timing of collections and remittances.

Total expenses: Total expenses were $648.2 million for the first quarter reflecting an increase of 1% compared to the prior year period. The following table summarizes total combined cost of service revenue and selling, general and administrative expenses:







                                             For the three months ended
                                                     August 31,
        In millions                         2020                       2019    Change(1)
        Compensation-related expenses  $         370.6                $ 363.4         2 %
        Depreciation and amortization             49.6                   52.9       (6) %
        PEO insurance costs                       84.5                   90.0       (6) %
        Cost-saving initiatives                   31.2                      -       n/m
        Other expenses                           112.3                  136.6      (18) %
        Total expenses                 $         648.2                $ 642.9         1 %
        


(1) Percentage changes are calculated based on unrounded numbers.

n/m - not meaningful

The increase in total expenses was primarily driven by one-time costs of $31.2 million related to the acceleration of cost-saving initiatives, including the long-term strategy to reduce our geographic footprint and headcount optimization. Total expenses, excluding these one-time costs, decreased approximately 4% for the first quarter compared to the prior year period. This decrease in total expenses, excluding one-time costs, was driven by lower discretionary spending and a decrease in PEO direct insurance costs, partially offset by an increase in compensation-related expenses.

Compensation-related expenses increased 2% for the first quarter compared to the prior year period. The increase in compensation-related expenses was driven by higher wages compared to the prior year period.

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 decrease in depreciation and amortization for the first quarter was driven by amortization of intangible assets acquired from Oasis Outsourcing Group Holdings, L.P., which are amortized using an accelerated method.

PEO insurance costs include workers' compensation, minimum premium medical insurance plan arrangements and self-insured dental and vision plans where we retain risk. The decrease in PEO insurance costs was primarily driven by a decline in the number of our clients' worksite employees.

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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. The decrease in other expenses was driven by lower spending in all areas, primarily travel and entertainment expenses.

Operating income: Operating income was $284.0 million for the first quarter, reflecting a decrease of 19% compared to the prior year period. Operating margin (operating income as a percentage of total revenue) was 30.5% for the first quarter, compared to 35.2% for the prior year period. Adjusted operating income(1), which excludes the impact of one-time costs, decreased 10% to $315.2 million for the first quarter compared to the prior year period. Adjusted operating margin(1) was 33.8% for the first quarter, compared to 35.2% for the prior year period.

(1) Adjusted operating income and adjusted operating margin are not U.S. GAAP measures. Adjusted operating margin is calculated as operating margin, adjusted for one-time non-recurring items, as a percentage of total revenue. Refer to the "Non-GAAP Financial Measures" section within the "Results of Operations" section of this Item 2 for a discussion of these non-GAAP measures and a reconciliation to the most comparable GAAP measure of operating income.

Other expense, net: Other expense, 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 $7.9 million and $4.8 million of other expense, net for the first quarter and respective prior year period, which was driven by interest expense related to our long-term borrowings. Other expense, net for both periods included $8.3 million of interest expense related to our long-term borrowings.

Income taxes: Our effective income tax rate was 23.4% for the first quarter compared to 23.3% for the prior year period. The effective income tax rates in both periods were impacted by the recognition of net discrete tax benefits related to employee stock-based compensation payments.

Net income and diluted earnings per share: Net income was $211.6 million for the first quarter, reflecting a decrease of 20% compared to the prior year period. Diluted earnings per share was $0.59 per share for the first quarter, reflecting a decrease of 19% compared to the prior year period. Adjusted net income and adjusted diluted earnings per share, both non-GAAP measures, each decreased 11% to $228.0 million and $0.63 per share, respectively, for the first quarter. Adjusted net income and adjusted diluted earnings per share include adjustments for one-time costs of $31.2 million related to the acceleration of cost-saving initiatives and net tax windfall benefits related to employee stock-based compensation payments. Refer to the "Non-GAAP Financial Measures" section that follows for a discussion of these non-GAAP measures.

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Non-GAAP Financial Measures: Adjusted operating income, adjusted net income, adjusted diluted earnings per share, earnings before interest, taxes, depreciation, and amortization ("EBITDA"), and adjusted EBITDA are summarized as follows:







                                                            For the three months ended
                                                                    August 31,
        . . .
        


Oct 09, 2020

COMTEX_372577471/2041/2020-10-09T16:49:32

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