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Oct. 1, 2021, 4:09 p.m. EDT

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, 2021 (the "first quarter"), the respective prior year period ended August 31, 2020 (the "prior year period"), and our financial condition as of August 31, 2021. 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, 2021 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, 2021 ("fiscal 2021"). Forward-looking statements in this review are qualified by the cautionary statement included under the next sub-heading, "Cautionary Note Regarding Forward-Looking Statements".

Cautionary Note Regarding Forward-Looking Statements

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 condition 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:

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

�software defects, undetected errors, or development delays for our products;

�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;

�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;

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

�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;

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

�changes in governmental regulations and policies;

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

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�our compliance with data privacy laws and regulations;

�our failure to protect our intellectual property rights;

�potential outcomes related to pending or future litigation matters;

�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;

�volatility in the political and economic environment;

�changes in the availability of qualified people; and

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

Any of these factors, as well as other factors discussed in our Form 10-K for fiscal 2021 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 on our Paychex Investor Relations portal 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 portal.

Overview

We are a leading human resource ("HR") software and services company, offering HR, payroll, benefits, and insurance solutions for small- to medium-sized businesses. Within our human capital management ("HCM") solutions, we offer a comprehensive portfolio of technology solutions and services that allow our clients to meet their diverse HR and payroll needs.

Our comprehensive solutions allow our clients to manage their workforces effectively from hire to retire. We provide leading-edge HCM technology solutions, coupled with human expertise, to make complex HR, payroll, and benefits issues simple for our clients. Paychex Flex is our proprietary HCM software-as-a-service "SaaS" platform that unites HR, payroll, time and attendance, and benefits processes to maximize efficiency and savings. Paychex Flex helps clients manage the employee life cycle from recruiting and hiring to retirement, providing an integrated suite of solutions including recruiting, onboarding, HR, time and attendance and employee benefits. It utilizes a single cloud-based platform, with single client and employee records. Clients can select the modules they need and easily add on services as they grow. In addition, we provide comprehensive HR Outsourcing solutions to help our clients plan, manage, and comply with all aspects of HR.

Our portfolio of HCM and employee benefit-related services is disaggregated into two categories, (1) Management Solutions and (2) PEO and Insurance Solutions, as discussed under the heading "Description of Services" in Part 1, Item 1 of our Form 10-K for fiscal 2021.

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 technology solutions and services 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 sales and marketing and innovative technology. We believe these investments are critical to our success. Looking to the future, we believe that investing in our products, people, and technology-enabled service capabilities will position us to capitalize on opportunities for long-term growth.

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A recent Company survey of 1,000 small businesses noted that the biggest challenge they currently face is recruiting and retaining employees as the evolution of the workplace resulting from the pandemic has increased the competition for talent. We continue to be a leader in innovative technology solutions. Our most recent round of product releases includes solutions designed to help employers hire and retain top talent in this challenging environment, including:

�Paychex Pre-Check, which notifies employees on the channel of their choice - including smart watches and smart speakers - that their gross-to-net paystub is ready to be securely reviewed. Employees may perform the review in Paychex Flex mobile app and are prompted to confirm the amount's accuracy or report an issue to the employer's administrator, who can address the potential issue before payday;

�Retention Insights, which uses predictive analytics to identify employees who may be more likely to consider leaving the organization;

�Pay Benchmarking, which allows employers to compare compensation details by position against national data provided by the Bureau of Labor Statistics;

�Talent Dashboard, which pulls together Retention Insights, time off balances, and performance management ratings into one place, allowing administrators to compare the performance rating and compensation of each job position;

�Amazon Alexa Integration, which makes it easy for users to interact with the Paychex Flex application from anywhere. With the addition of Amazon Alexa to existing integrations with Google Assistant(TM) and Siri(R) Shortcuts, Paychex Flex is the first HCM application to offer integration with three of the major voice assistant platforms;

�Time Off Management, which provides a full, end-to-end solution to ensure clients maintain compliance with ever changing time off regulations. Our solution includes an automated time off request and approval process (via our Flex mobile application) and manages accrual calculations and balance tracking; and

�Paychex Employee Retention Tax Credit Service, which helps businesses retroactively identify tax credits and file amended returns to claim these credits.







        First Quarter Business Highlights
        Highlights compared to the prior year period are as follows:
                                                       For the three months ended
                                                               August 31,
        In millions, except per share amounts            2021                2020         Change(2)
        Total service revenue                     $        1,068.4      $      917.3          16 %
        Total revenue                             $        1,082.9      $      932.2          16 %
        Operating income                          $          442.9      $      284.0          56 %
        Net income                                $          333.6      $      211.6          58 %
        Adjusted net income(1)                    $          323.2      $      228.0          42 %
        Diluted earnings per share                $           0.92      $       0.59          56 %
        Adjusted diluted earnings per share(1)    $           0.89      $       0.63          41 %
        Dividends paid to stockholders            $          238.1      $      223.2           7 %
        


(1)Adjusted net income and adjusted diluted earnings per share are not U.S. generally accepted accounting principle ("GAAP") measures. Adjusted net income and adjusted diluted earnings per share in both periods included an adjustment for net tax windfall benefits related to employee stock-based compensation payments. In the prior year period, adjusted net income and adjusted diluted earnings per share included an adjustment for one-time non-recurring cost-saving initiatives. Refer to the "Non-GAAP Financial Measures" section of this Item 2 for a discussion of these non-GAAP measures and a reconciliation to the U.S. GAAP measures of net income and diluted earnings per share.

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

For further analysis of our results of operations for the first quarter and prior year period, and our financial position as of August 31, 2021, refer to the tables and analysis in the "Results of Operations" and "Liquidity and Capital Resources" sections of this Item 2.

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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. A portion of our workforce that initially transitioned to work remotely has voluntarily returned to the office. As vaccination levels continue to increase and masking and social distancing guidelines further relax, we look forward to welcoming more of our employees back to their office locations. We currently anticipate a phased return to the office beginning in Fall 2021, with a greater level of flexibility in response to the feedback our employees have shared with us.

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 COVID-19 Help Center remains a source of near real-time information and tools to help businesses navigate this constantly evolving environment, including information surrounding the Biden administration's recent new vaccine requirements. We launched a new Paychex Employee Retention Tax Credit ("ERTC") service to help businesses retroactively identify tax credits, based on wages already paid, and file amended returns to claim the credit. Prior to and including this new service, we have helped clients secure $4.0 billion to date in combined ERTC and paid leave credits. 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. Our unique blend of technology solutions and expertise provides valuable tools and resources to assist our clients and their employees during this critical time and beyond.

Our strong balance sheet and operational flexibility have allowed us to successfully manage through the ongoing impacts of the COVID-19 pandemic to date while protecting our cash flow and liquidity. The fiscal year is off to a strong start as we achieved double-digit growth in both revenue and earnings over the prior year period. These results reflected gradual improvement in the economy, continued momentum in sales, and strong levels of client retention. We believe we are well-positioned with a broad portfolio of innovative technology and products along with our unparalleled expertise to meet the continuing needs of businesses and help them succeed and thrive as they begin to bring employees back to work and adjust to the changes of how, where, and when work gets done.

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. Despite improving macroeconomic conditions and the emergence of vaccines, surges in COVID-19 cases, including variants of the strain, such as those recently experienced in Europe and the U.S., may cause people to self-quarantine or governments to shut down nonessential businesses again. We expect that the pandemic will continue to have an effect on our results, although the magnitude, duration, and full effects of the pandemic on our future results of operations or cash flows are not possible to predict at this time.

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 2021.







        RESULTS OF OPERATIONS
        Summary of Results of Operations:
                                                      For the three months ended
                                                              August 31,
        In millions, except per share amounts           2021               2020          Change(1)
        Revenue:
        Management Solutions                     $         805.5      $      687.4           17 %
        PEO and Insurance Solutions                        262.9             229.9           14 %
        Total service revenue                            1,068.4             917.3           16 %
        Interest on funds held for clients                  14.5              14.9          (3) %
        Total revenue                                    1,082.9             932.2           16 %
        Total expenses                                     640.0             648.2          (1) %
        Operating income                                   442.9             284.0           56 %
        Other income/(expense), net                          1.0             (7.9)          n/m
        Income before income taxes                         443.9             276.1           61 %
        Income taxes                                       110.3              64.5           71 %
        Effective income tax rate                           24.9 %            23.4 %
        Net income                               $         333.6      $      211.6           58 %
        Diluted earnings per share               $          0.92      $       0.59           56 %
        


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

n/m - not meaningful

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The changes in revenue as compared to the prior year period were primarily driven by the following factors:

?Management Solutions revenue: $805.5 million for the first quarter, reflecting an increase of 17%:

oIncrease in our client base and penetration of our suite of solutions, primarily HR outsourcing and time and attendance,

oHigher checks per client as our clients' employees return to work, and

oHigher revenue per check reflecting better price realization.

?PEO and Insurance Solutions revenue: $262.9 million for the first quarter, reflecting an increase of 14%:

oIncrease in the number of worksite employees and the impact of an increase in average wages per worksite employee,

oHigher revenue on state unemployment insurance, and

oIncrease in PEO health insurance revenue.

?Interest on funds held for clients: $14.5 million for the first quarter, reflecting a decrease of 3%:

oLower average interest rates, partially offset by

oIncrease in average investment balances; impacted by growth in our overall client base and improving macroeconomic conditions.

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, 2021, 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 were as follows:







                                                               For the three months ended
                                                                       August 31,
        $ in millions                                             2021              2020       Change(1)
        Average investment balances:
        Funds held for clients                              $      3,897.5      $ 3,507.2          11 %
        Corporate cash equivalents and investments                 1,197.1        1,022.2          17 %
        Total                                               $      5,094.6      $ 4,529.4          12 %
        Average interest rates earned (exclusive of net realized gains/(losses)):
        Funds held for clients                                         1.5 %          1.7 %
        Corporate cash equivalents and investments                     0.1 %          0.2 %
        Combined funds held for clients and corporate
        cash equivalents and investments                               1.1 %          1.3 %
        Total net realized gains                            $          0.1      $     0.3
        


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







                                                                      August 31,       May 31,
        $ in millions                                                    2021            2021
        Net unrealized gains on available for sale ("AFS")
        securities (1)                                               $     78.7      $    79.3
        Federal Funds rate (2)                                             0.25 %         0.25 %
        Total fair value of AFS securities                           $  3,002.4      $ 3,020.2
        Weighted-average duration of AFS securities in years (3)            3.4            3.3
        Weighted-average yield-to-maturity of AFS securities (3)            1.8 %          1.9 %
        


(1) The net unrealized gain on our investment portfolio was approximately $58.2 million as of September 28, 2021.

(2) The Federal Funds rate was in the range of 0.00% to 0.25% as of August 31, 2021 and May 31, 2021.

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

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Total expenses: The following table summarizes the total combined cost of service revenue and selling, general and administrative expenses for the periods below:







                                             For the three months ended
                                                     August 31,
        In millions                         2021                       2020     Change(1)
        Compensation-related expenses  $         382.9                $ 370.6        3 %
        PEO insurance costs                       96.0                   84.5       14 %
        Depreciation and amortization             45.7                   49.6      (8) %
        Cost-saving initiatives                      -                   31.2      n/m
        Other expenses                           115.4                  112.3        3 %
        Total expenses                 $         640.0                $ 648.2      (1) %
        


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

n/m - not meaningful

Total expenses decreased 1% to $640.0 million for the first quarter compared to the prior year period. Excluding one-time costs of $31.2 million in the prior year period, total expenses increased 4%, impacted by the following:

?Compensation-related expenses: $382.9 million for the first quarter, reflecting a 3% increase, due to an increase in fringe benefits to our employees.

?PEO insurance costs: $96.0 million for the first quarter, reflecting a 14% increase, due to growth in client worksite employees and health insurance revenue across the PEO business.

?Depreciation and amortization: $45.7 million for the first quarter, reflecting an 8% decrease, due to lower amortization driven by intangible assets amortized using accelerated methodologies.

?Other expenses: $115.4 million for the first quarter, reflecting a 3% increase, due to continued investment in product development and information technology.

Operating income: Operating income increased 56% to $442.9 million for the first quarter compared to the prior year period as a result of double-digit revenue growth and slight expense reduction. Adjusted operating income(1), which excluded the impact of one-time costs related to the August 2020 geo-optimization plan in the prior year period, increased 41% to $442.9 million for the first quarter compared to the prior year period. Operating margin and adjusted operating margin (1) are as follows:







                                                                 For the three months ended
                                                                          August 31,
                                                                     2021           2020
        Operating margin (operating income as a percentage of
        total revenue)                                                40.9 %         30.5 %
        Adjusted operating margin (1) (operating income,
        adjusted for one-time costs, as a percentage of total
        revenue)                                                      40.9 %         33.8 %
        


Fluctuations in these metrics were attributable to the factors previously discussed.

(1) Adjusted operating income, adjusted operating margin, adjusted net income, and adjusted diluted earnings per share are not U.S. GAAP measures. Refer to the "Non-GAAP Financial Measures" 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.

Income taxes: Our effective income tax rate was 24.9% for the first quarter, compared to 23.4% for the prior year period. This increase was the result of an increase in state taxes. Both periods were impacted by the recognition of net discrete tax benefits related to employee stock-based compensation payments.

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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,
        $ in millions                                         2021              2020        Change(1)
        Operating income                               $         442.9      $   284.0           56 %
        Non-GAAP adjustments:
        Cost-saving initiatives(2)                                   -           31.2
        Total non-GAAP adjustments                                   -           31.2
        Adjusted operating income                      $         442.9      $   315.2           41 %
        Net income                                     $         333.6      $   211.6           58 %
        Non-GAAP adjustments:
        Excess tax benefit related to employee
        stock-based compensation payments(3)                    (10.4)          (7.0)
        Cost-saving initiatives(2)                                   -           23.4
        Total non-GAAP adjustments                              (10.4)           16.4
        Adjusted net income                            $         323.2      $   228.0           42 %
        . . .
        


Oct 01, 2021

COMTEX_394401181/2041/2021-10-01T16:09:28

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