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Dec. 23, 2020, 4:41 p.m. EST

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 November 30, 2020 (the "second quarter"), the six months ended November 30, 2020 (the "six months"), the respective prior year periods ended November 30, 2019, and our financial condition as of November 30, 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 November 30, 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;

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

�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 second quarter is available and accessible on our Paychex 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 on our Paychex 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 solutions 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 solutions 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 delivering superior 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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A key component of our service delivery strategy is to be a proactive partner with our clients and to develop and release integrated solutions within our Paychex Flex platform to meet their current and future needs. Our ongoing investments in our platforms have prepared us well for the demands of the current business and regulatory environments, allowing us to adapt while maintaining strong service delivery, resulting in high levels of client satisfaction and retention. We continue to make investments in leading-edge technology a priority as companies are looking to leverage technology solutions to maintain operations, stay connected to employees, and increase productivity. Our most recent round of product releases features tools to help clients manage risk, maintain compliance, better assess performance and adapt to mobile and artificial intelligence-driven trends, include:

?Apple Watch(R)/Google Assistant(TM) device integration, which enables workers to access their HR info easily without logging in from a phone or desktop personal computer;

?PEO Protection Plus Package, which helps business owners to protect their bottom line from unforeseen costs, including cyberattacks and employee lawsuits;

?Equal Employment Opportunity-1 ("EEO-1") Compliance reporting, which allows business owners to easily capture, track, and prepare a report to assist with completing the Employment Data section of the EEO-1 Report;

?Tax Lookup, a new tool allowing for quick and accurate application of employee tax information;

?Flex Time Employee User Experience, a mobile-first approach of enhanced tools allowing employees to easily track their hours, request time off, review their timecards, or exchange shifts with other workers from any device; and

?Peer Reviews, which includes manager and self-review workflows to offer another channel for communicating feedback on a continuous basis.

Second Quarter Financial Highlights

Results of operations for the second quarter improved but continued to be impacted by the COVID-19 pandemic. Total revenue, diluted earnings per share, and adjusted diluted earnings per share(1) grew 6%, 27%, and 16%, respectively, since the three months ended August 31, 2020 (the "first quarter") and year-over-year second quarter results showed marked improvement from the first quarter. 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 second quarter compared to the prior year period are as follows:

?Diluted earnings per share and adjusted diluted earnings per share(1) each increased 4% to $0.75 per share and $0.73 per share, respectively.

?Service revenue was consistent with the prior year period at $968.9 million, compared to a year-over-year decrease of 6% in the first quarter.

?Management Solutions revenue increased 1% to $732.8 million.

?Total revenue decreased 1% to $983.7 million.

(1) Adjusted diluted earnings per share is not a U.S. generally accepted accounting principles ("GAAP") measure. Refer to the "Non-GAAP Financial Measures" section within the "Results of Operations" section of this Item 2 for a discussion of this non-GAAP measure and a reconciliation to the most comparable GAAP measure of diluted earnings per share.

For further analysis of our results of operations for the second quarter and six months, and our financial position as of November 30, 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 have started to bring back a small portion of our workforce to the office on a volunteer-only basis. We will continue to evaluate our business continuity plan against observed results and will adjust the plan accordingly.

As our clients continue to manage through the COVID-19 pandemic, we remain committed to helping them adapt and thrive, not only through the uncertainties of the COVID-19 pandemic, but the transition to the future business environment. 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 HR suite of products positions us to service our clients

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and support them in managing a remote workforce. The COVID-19 Help Center on our website continues 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. To continue to support customers as they navigate the impacts of the COVID-19 pandemic and navigate the future of work, we have introduced several new products in the second quarter which are discussed in the "Overview" section of this Item 2. As the global economy continues to evolve, whether due to legislative changes, the pandemic, or other factors, we are committed to supporting our clients to help them navigate these challenges.

Second quarter results reflect sequential improvement in financial performance and key business metrics. The effects of the COVID-19 pandemic impacted our results and year-over-year comparisons, however, client retention remains strong and our sales performance has resulted in 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 the COVID-19 pandemic while protecting our cash flow and liquidity. In addition, during the first quarter, we substantially completed cost-saving initiatives, including an acceleration of our long-term strategy to reduce our geographic footprint and headcount optimization. We continue to evaluate the nature and extent of changes to the market and economic conditions related to the COVID-19 pandemic and will assess the potential impact on 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                        For the six months ended
                                          November 30,                                     November 30,
        In millions, except per
        share amounts                   2020            2019       Change(1)          2020                 2019        Change(1)
        Revenue:
        Management Solutions      $       732.8      $  726.7            1 %    $     1,420.2           $ 1,451.2          (2) %
        PEO and Insurance
        Solutions                         236.1         244.1          (3) %            466.0               491.1          (5) %
        Total service revenue             968.9         970.8            - %          1,886.2             1,942.3          (3) %
        Interest on funds held
        for clients                        14.8          19.9         (25) %             29.7                40.4         (27) %
        Total revenue                     983.7         990.7          (1) %          1,915.9             1,982.7          (3) %
        Total expenses                    629.4         649.0          (3) %          1,277.6             1,291.9          (1) %
        Operating income                  354.3         341.7            4 %            638.3               690.8          (8) %
        Other expense, net                (4.7)         (4.7)          n/m             (12.6)               (9.5)          n/m
        Income before income
        taxes                             349.6         337.0            4 %            625.7               681.3          (8) %
        Income taxes                       77.2          78.3          (1) %            141.7               158.4         (11) %
        Effective income tax
        rate                               22.1 %        23.2 %                          22.7 %              23.3 %
        Net income                $       272.4      $  258.7            5 %    $       484.0           $   522.9          (7) %
        Diluted earnings per
        share                     $        0.75      $   0.72            4 %    $        1.34           $    1.45          (8) %
        


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

n/m - not meaningful

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We invest in highly liquid, investment-grade fixed income securities and do not utilize derivative instruments to manage interest rate risk. As of November 30, 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                           For the six months ended
                                                November 30,                                        November 30,
        $ in millions                       2020              2019        Change(1)           2020                  2019        Change(1)
        Average investment
        balances:
        Funds held for clients        $      3,581.4      $ 3,726.3          (4) %      $     3,544.3           $ 3,735.5          (5) %
        Corporate cash equivalents
        and investments                        964.9          788.5           22 %              993.6               825.2           20 %
        Total                         $      4,546.3      $ 4,514.8            1 %      $     4,537.9           $ 4,560.7          (1) %
        Average interest rates earned (exclusive of net realized gains/(losses)):
        Funds held for clients                   1.6 %          2.0 %                             1.6 %               2.1 %
        Corporate cash equivalents
        and investments                          0.2 %          1.7 %                             0.2 %               1.9 %
        Combined funds held for
        clients and corporate cash
        equivalents and investments              1.3 %          2.0 %                             1.3 %               2.0 %
        Total net realized gains      $          0.4      $     0.9                     $         0.7           $     1.8
        


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







                                                                   November 30,      May 31,
        $ in millions                                                  2020           2020
        Net unrealized gains on AFS securities (1)                $       108.9    $   100.0
        Federal Funds rate (2)                                             0.25 %       0.25 %
        Total fair value of AFS securities                        $     3,186.8    $ 2,757.2
        Weighted-average duration of AFS securities in years (3)            3.4          2.9
        Weighted-average yield-to-maturity of AFS securities (3)            1.9 %        2.1 %
        


(1) The net unrealized gain on our investment portfolio was approximately $110.6 million as of December 21, 2020.

(2) The Federal Funds rate was in the range of 0.00% to 0.25% as of November 30, 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 $732.8 million for the second quarter and $1.4 billion for the six months, reflecting an increase of 1% and a decrease of 2%, respectively, compared to the prior year periods. Both periods were impacted by increases in our client base and increased penetration of our suite of solutions, particularly HR outsourcing, time and attendance, and retirement services, offset by a decline in check volumes, which had a larger impact during the first quarter.

PEO and Insurance Solutions revenue: PEO and Insurance Solutions revenue was $236.1 million for the second quarter and $466.0 million for the six months, reflecting decreases of 3% and 5%, respectively, compared to the prior year periods. The decreases in both periods were primarily driven by a decline in the number of our clients' worksite employees. Insurance Solutions revenue declined in both periods as a result of lower workers' compensation premiums driven by reduced wages due to fewer worksite employees in certain industries and related premium rates.

Interest on funds held for clients: Interest on funds held for clients was $14.8 million for the second quarter and $29.7 million for the six months, reflecting decreases of 25% and 27%, respectively, compared to the prior year periods. The decreases in both periods 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 timing of collections and remittances and wage inflation.

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Total expenses: Total expenses were $629.4 million for the second quarter and $1.3 billion for the six months, reflecting decreases of 3% and 1%, respectively, compared to the prior year periods. The following table summarizes total combined cost of service revenue and selling, general and administrative expenses:







                                         For the three months ended                   For the six months ended
                                                November 30,                                November 30,
        In millions                          2020            2019       Change(1)         2020           2019       Change(1)
        Compensation-related expenses   $         382.6   $    373.0          3 %    $        753.2   $    736.4          2 %
        Depreciation and amortization              48.6         55.0       (12) %              98.2        107.9        (9) %
        PEO insurance costs                        88.4         83.7          6 %             172.9        173.7          - %
        Cost-saving initiatives                     1.0            -        n/m                32.2            -        n/m
        Other expenses                            108.8        137.3       (21) %             221.1        273.9       (19) %
        Total expenses                  $         629.4   $    649.0        (3) %    $      1,277.6   $  1,291.9        (1) %
        


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

n/m - not meaningful

The decrease in total expenses during the second quarter and six months was primarily driven by lower discretionary spending, reduced facilities costs resulting from cost-saving initiatives, and amortization of intangible assets.

Compensation-related expenses increased 3% for the second quarter and 2% for the six months compared to the prior year periods. The increase in compensation-related expenses during the second quarter and six months was primarily driven by higher variable compensation expenses.

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 was driven by intangible assets amortized using an accelerated method.

PEO insurance costs include workers' compensation and health insurance arrangements where we retain risk. The expansion of our health insurance offerings to certain PEO clients and an increase in workers' compensation costs contributed to the growth in our PEO insurance costs in the second quarter. For the six months, PEO insurance costs were impacted by a decrease in worksite employees, which was more substantial during the first quarter.

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 discretionary spending in all areas, primarily travel and entertainment expenses, and reduced facilities costs.

Operating income: Operating income was $354.3 million for the second quarter and $638.3 million for the six months, reflecting an increase of 4% and a decrease of 8%, respectively, compared to the prior year periods. Operating margin (operating income as a percentage of total revenue) was 36.0% for the second quarter and 33.3% for the six months, compared to 34.5% and 34.8% for the respective prior year periods. Adjusted operating income(1), which excludes the impact of one-time costs, was $670.5 million for the six months, reflecting a decrease of 3% compared to the prior year period.

(1) Adjusted operating income is not a U.S. GAAP measure. Refer to the "Non-GAAP Financial Measures" section within the "Results of Operations" section of this Item 2 for a discussion of this non-GAAP measure 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 ("AFS") securities and other equity method investments. Other expense, net, was $4.7 million and $12.6 million for the second quarter and six months, as compared with $4.7 million and $9.5 million for the three and six months ended November 30, 2019, respectively.

Income taxes: Our effective income tax rate was 22.1% for the second quarter and 22.7% for the six months compared to 23.2% and 23.3%, respectively, for the prior year periods. The effective income tax rates in all periods were impacted . . .

Dec 23, 2020

COMTEX_376735340/2041/2020-12-23T16:41:19

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