filings.toolsItem 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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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, 2021 (the “second quarter”), the six months ended November 30, 2021 (the “six months”), the respective prior year periods ended November 30, 2020 (the “prior year periods”), and our financial condition as of November 30, 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 November 30, 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 Form 10-Q 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;
·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 second 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 integrated human capital management (“HCM”) solutions for HR, payroll, benefits, and insurance solutions for small- to medium-sized businesses. We offer a comprehensive portfolio of technology solutions and services, supported by our HR and compliance expertise, that help our clients address the evolving challenges of HR.
Paychex Flex® is our proprietary HCM software-as-a-service (“SaaS”) platform that helps clients manage the employee life cycle from recruiting and hiring to retirement. This integrated suite of solutions includes recruiting, onboarding, HR, payroll, 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 integrated digital technology solutions; increasing client satisfaction; expanding our leadership in HR; growing our client bases; and engaging in strategic acquisitions.
We focus on driving growth in the number of clients, revenue per client, total revenue, and profits, while providing HCM technology and HR outsourcing and benefits 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, investments in products, people, and technology have positioned us for long-term growth.
We continue to develop new and innovative solutions that help our customers balance the need to prioritize employee health and safety with the unique business challenges brought on by the COVID-19 pandemic. Most recently, we enhanced functionality within our Paychex Flex Document Management tool to help employers track vaccination status, restrict access, and maintain confidentiality of information.
Through a recent business acquisition completed in October 2021, we gained a state-of-the-art benefits administration software platform that is aligned with our commitment to driving innovation and delivering a suite of digital services. The combination of this technology with our full-service HR and benefits capabilities will position us for continued growth and expansion in the benefits marketplace.
Second Quarter and Year to Date Business Highlights
Highlights compared to the prior year periods are as follows:
| For the three months ended | For the six months ended | |||||||||||||||||||||
| November 30, | November 30, | |||||||||||||||||||||
| In millions, except per share amounts | 2021 | 2020 | Change**(2)** | 2021 | 2020 | Change**(2)** | ||||||||||||||||
| Total service revenue | $ | 1,094.4 | $ | 968.9 | 13 | % | $ | 2,162.8 | $ | 1,886.2 | 15 | % | ||||||||||
| Total revenue | $ | 1,108.5 | $ | 983.7 | 13 | % | $ | 2,191.4 | $ | 1,915.9 | 14 | % | ||||||||||
| Operating income | $ | 440.3 | $ | 354.3 | 24 | % | $ | 883.2 | $ | 638.3 | 38 | % | ||||||||||
| Net income | $ | 332.1 | $ | 272.4 | 22 | % | $ | 665.7 | $ | 484.0 | 38 | % | ||||||||||
| Adjusted net income(1) | $ | 329.8 | $ | 264.8 | 25 | % | $ | 653.0 | $ | 492.8 | 33 | % | ||||||||||
| Diluted earnings per share | $ | 0.91 | $ | 0.75 | 21 | % | $ | 1.83 | $ | 1.34 | 37 | % | ||||||||||
| Adjusted diluted earnings per share(1) | $ | 0.91 | $ | 0.73 | 25 | % | $ | 1.80 | $ | 1.36 | 32 | % | ||||||||||
| Dividends paid to stockholders | $ | 238.3 | $ | 223.5 | 7 | % | $ | 476.4 | $ | 446.7 | 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 all periods included an adjustment for net tax windfall benefits related to employee stock-based compensation payments. In the prior year periods, 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 second quarter and six months, the prior year periods, and our financial position as of November 30, 2021, 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 evolved, our priority has been, and continues to be, the health and safety of our employees. As vaccination levels increase and masking and social distancing guidelines help limit the impact of the pandemic, we implemented our phased return to office plan in October 2021. As part of our phased approach and in response to feedback received from our employees, we are providing greater levels of work flexibility as employees go back to their office locations.
We remain committed to proactively supporting our clients through the uncertainties of the COVID-19 pandemic and navigate the challenges of the future business environment. 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 COVID-19 Help Center provides near real-time information and tools to help businesses navigate the constantly evolving business environment, including information on the latest Biden administration vaccine requirements. Our Paychex Employee Retention Tax Credit (“ERTC”) service assists businesses in retroactively identifying tax credits and filing amended returns to claim these credits. To date, we have assisted businesses in securing $6.0 billion in ERTC and paid leave credits.
Our strong balance sheet and operational flexibility have allowed us to successfully manage through the ongoing impacts of the COVID-19 pandemic while protecting our cash flow and liquidity. The strong results we experienced to start our fiscal year carried through to the second quarter as we maintained double-digit growth in both revenue and earnings over the prior year period. These results reflected higher checks per payroll which benefited from economic recovery as well as strong sales and client retention results due to continued investment in people and technology. 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 continually evaluate the nature and extent of changes to the market and economic conditions related to the COVID-19 pandemic and assess the potential impact on our business and financial position. Despite improving macroeconomic conditions, the emergence of vaccines, and the recent approval of vaccine booster shots, surges in COVID-19 cases, including variants of the strain, 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 remain difficult to predict at this time.
For further discussion of 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 | For the six months ended | |||||||||||||||||||||
| November 30, | November 30, | |||||||||||||||||||||
| In millions, except per share amounts | 2021 | 2020 | Change**(1)** | 2021 | 2020 | Change**(1)** | ||||||||||||||||
| Revenue: | ||||||||||||||||||||||
| Management Solutions | $ | 832.0 | $ | 732.8 | 14 | % | $ | 1,637.5 | $ | 1,420.2 | 15 | % | ||||||||||
| PEO and Insurance Solutions | 262.4 | 236.1 | 11 | % | 525.3 | 466.0 | 13 | % | ||||||||||||||
| Total service revenue | 1,094.4 | 968.9 | 13 | % | 2,162.8 | 1,886.2 | 15 | % | ||||||||||||||
| Interest on funds held for clients | 14.1 | 14.8 | (5) | % | 28.6 | 29.7 | (4) | % | ||||||||||||||
| Total revenue | 1,108.5 | 983.7 | 13 | % | 2,191.4 | 1,915.9 | 14 | % | ||||||||||||||
| Total expenses | 668.2 | 629.4 | 6 | % | 1,308.2 | 1,277.6 | 2 | % | ||||||||||||||
| Operating income | 440.3 | 354.3 | 24 | % | 883.2 | 638.3 | 38 | % | ||||||||||||||
| Other expense, net | (2.7) | (4.7) | n/m | (1.7) | (12.6) | n/m | ||||||||||||||||
| Income before income taxes | 437.6 | 349.6 | 25 | % | 881.5 | 625.7 | 41 | % | ||||||||||||||
| Income taxes | 105.5 | 77.2 | 36 | % | 215.8 | 141.7 | 52 | % | ||||||||||||||
| Effective income tax rate | 24.1 | % | 22.1 | % | 24.5 | % | 22.7 | % | ||||||||||||||
| Net income | $ | 332.1 | $ | 272.4 | 22 | % | $ | 665.7 | $ | 484.0 | 38 | % | ||||||||||
| Diluted earnings per share | $ | 0.91 | $ | 0.75 | 21 | % | $ | 1.83 | $ | 1.34 | 37 | % |
(1) Percentage changes are calculated based on unrounded numbers.
n/m – not meaningful
The changes in revenue as compared to the prior year periods were primarily driven by the following factors:
Management Solutions revenue: $832.0 million for the second quarter and $1.6 billion for the six months, reflecting increases of 14% and 15%, respectively:
oHigher checks per payroll for HCM services and net gain in worksite employees for HR Solutions,
oHigher revenue per client resulting from improved price realization,
oGrowth in client bases across HCM and ancillary products resulting from strong sales performance and high levels of retention, with notably strong demand for our HR Solutions offering,
oImpact of improved market conditions on asset-based revenue for retirement services, and
oIncrease in funding for temporary staffing clients.
PEO and Insurance Solutions revenue: $262.4 million for the second quarter and $525.3 million for the six months, reflecting increases of 11% and 13%, respectively:
oIncrease in the number of average worksite employees and an increase in average wages per worksite employee,
oIncrease in PEO health insurance revenue, and
oHigher revenue related to state unemployment insurance.
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, 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 | For the six months ended | |||||||||||||||||||||
| November 30, | November 30, | |||||||||||||||||||||
| $ in millions | 2021 | 2020 | Change**(1)** | 2021 | 2020 | Change**(1)** | ||||||||||||||||
| Average investment balances: | ||||||||||||||||||||||
| Funds held for clients | $ | 3,917.5 | $ | 3,581.4 | 9 | % | $ | 3,907.5 | $ | 3,544.3 | 10 | % | ||||||||||
| Corporate cash equivalents and investments | 1,182.8 | 964.9 | 23 | % | 1,189.9 | 993.6 | 20 | % | ||||||||||||||
| Total | $ | 5,100.3 | $ | 4,546.3 | 12 | % | $ | 5,097.4 | $ | 4,537.9 | 12 | % | ||||||||||
| Average interest rates earned (exclusive of net realized gains/(losses)): | ||||||||||||||||||||||
| Funds held for clients | 1.4 | % | 1.6 | % | 1.5 | % | 1.6 | % | ||||||||||||||
| Corporate cash equivalents and investments | 0.1 | % | 0.2 | % | 0.1 | % | 0.2 | % | ||||||||||||||
| Combined funds held for clients and corporate cash equivalents and investments | 1.1 | % | 1.3 | % | 1.1 | % | 1.3 | % | ||||||||||||||
| Total net realized gains | $ | 0.0 | $ | 0.4 | $ | 0.1 | $ | 0.7 |
(1) Percentage changes are calculated based on unrounded numbers.
| November 30, | May 31, | |||||||
| $ in millions | 2021 | 2021 | ||||||
| Net unrealized gains on available for sale (“AFS”) securities (1) | $ | 35.9 | $ | 79.3 | ||||
| Federal Funds rate (2) | 0.25 | % | 0.25 | % | ||||
| Total fair value of AFS securities | $ | 3,317.1 | $ | 3,020.2 | ||||
| Weighted-average duration of AFS securities in years (3) | 3.3 | 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 $33.7 million as of December 20, 2021.
(2) The Federal Funds rate was in the range of 0.00% to 0.25% as of November 30, 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.
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 | For the six months ended | |||||||||||||||||
| November 30, | November 30, | |||||||||||||||||
| In millions | 2021 | 2020 | Change**(1)** | 2021 | 2020 | Change**(1)** | ||||||||||||
| Compensation-related expenses | $ | 394.2 | $ | 382.6 | 3 | % | $ | 777.1 | $ | 753.2 | 3 | % | ||||||
| PEO insurance costs | 100.2 | 88.4 | 13 | % | 196.2 | 172.9 | 13 | % | ||||||||||
| Depreciation and amortization | 48.6 | 48.6 | — | % | 94.3 | 98.2 | (4) | % | ||||||||||
| Cost-saving initiatives(2) | — | 1.0 | n/m | — | 32.2 | n/m | ||||||||||||
| Other expenses | 125.2 | 108.8 | 15 | % | 240.6 | 221.1 | 9 | % | ||||||||||
| Total expenses | $ | 668.2 | $ | 629.4 | 6 | % | $ | 1,308.2 | $ | 1,277.6 | 2 | % |
(1) Percentage changes are calculated based on unrounded numbers.
(2) One-time costs and corresponding tax benefit recognized during fiscal 2021 related to the acceleration of cost-saving initiatives, including the long-term strategy to reduce our geographic footprint and headcount optimization. These events are not expected to recur.
n/m – not meaningful
Total expenses increased 6% to $668.2 million for the second quarter and 2% to $1.3 billion for the six months compared to the prior year periods. Excluding one-time costs of $32.2 million incurred in the prior year period, total expenses increased 5% for the six months compared to the prior year period. Total expenses were impacted by the following:
Compensation-related expenses: $394.2 million for the second quarter and $777.1 million for the six months, both periods reflecting an increase of 3% due to an increase in wage rates and fringe benefits.
PEO insurance costs: $100.2 million for the second quarter and $196.2 million for the six months, both periods reflecting an increase of 13% as a result of growth in number of PEO worksite employees and health insurance revenue.
Other expenses: $125.2 million for the second quarter and $240.6 million for the six months, reflecting increases of 15% and 9%, respectively, due to investment in product development and information technology, an increase in the reserve for client fund losses due to growth in the business, and national advertising.
Operating income: Operating income increased 24% to $440.3 million for the second quarter and 38% to $883.2 million for the six months, as a result of double-digit revenue growth and a moderate expense increase.
Adjusted operating income(1), which excluded the impact of one-time costs related to the August 2020 geo-optimization plan in the prior year periods, increased 32% to $883.2 million for the six months. Operating margin (operating income as a percentage of total revenue) and adjusted operating margin(1) (operating income, adjusted for one-time costs, as a percentage of total revenue) were as follows:
| For the three months ended | For the six months ended | ||||||||||||||||||
| November 30, | November 30, | ||||||||||||||||||
| 2021 | 2020 | 2021 | 2020 | ||||||||||||||||
| Operating margin | 39.7 | % | 36.0 | % | 40.3 | % | 33.3 | % | |||||||||||
| Adjusted operating margin (1) | 39.7 | % | 36.1 | % | 40.3 | % | 35.0 | % |
Fluctuations in these metrics were attributable to the factors previously discussed.
(1) Adjusted operating income and adjusted operating margin 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.
Income taxes: Our effective income tax rate was 24.1% for the second quarter and 24.5% for the six months, compared to 22.1% 22.7%, respectively, for the prior year periods. All periods were impacted by the recognition of net discrete tax benefits related to employee stock-based compensation payments, with a higher benefit realized in the prior year periods. The increase for the six months ended November 30, 2021 was also impacted by an increase in state taxes.
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 | For the six months ended | |||||||||||||||||||||
| November 30, | November 30, | |||||||||||||||||||||
| $ in millions | 2021 | 2020 | Change | 2021 | 2020 | Change | ||||||||||||||||
| Operating income | $ | 440.3 | $ | 354.3 | 24 | % | $ | 883.2 | $ | 638.3 | 38 | % | ||||||||||
| Non-GAAP adjustments: | ||||||||||||||||||||||
| Cost-saving initiatives(1) | — | 1.0 | — | 32.2 | ||||||||||||||||||
| Total non-GAAP adjustments | — | 1.0 | — | 32.2 | ||||||||||||||||||
| Adjusted operating income | $ | 440.3 | $ | 355.3 | 24 | % | $ | 883.2 | $ | 670.5 | 32 | % | ||||||||||
| Net income | $ | 332.1 | $ | 272.4 | 22 | % | $ | 665.7 | $ | 484.0 | 38 | % | ||||||||||
| Non-GAAP adjustments: | ||||||||||||||||||||||
| Excess tax benefit related to employee stock-based compensation payments(2) | (2.3) | (8.5) | (12.7) | (15.5) | ||||||||||||||||||
| Cost-saving initiatives(1) | — | 0.9 | — | 24.3 | ||||||||||||||||||
| Total non-GAAP adjustments | (2.3) | (7.6) | (12.7) | 8.8 | ||||||||||||||||||
| Adjusted net income | $ | 329.8 | $ | 264.8 | 25 | % | $ | 653.0 | $ | 492.8 | 33 | % | ||||||||||
| Diluted earnings per share(3) | $ | 0.91 | $ | 0.75 | 21 | % | $ | 1.83 | $ | 1.34 | 37 | % | ||||||||||
| Non-GAAP adjustments: | ||||||||||||||||||||||
| Excess tax benefit related to employee stock-based compensation payments(2) | (0.01) | (0.02) | (0.03) | (0.04) | ||||||||||||||||||
| Cost-saving initiatives(1) | — | — | — | 0.07 | ||||||||||||||||||
| Total non-GAAP adjustments | (0.01) | (0.02) | (0.03) | 0.02 | ||||||||||||||||||
| Adjusted diluted earnings per share | $ | 0.91 | $ | 0.73 | 25 | % | $ | 1.80 | $ | 1.36 | 32 | % | ||||||||||
| Net income | $ | 332.1 | $ | 272.4 | 22 | % | $ | 665.7 | $ | 484.0 | 38 | % | ||||||||||
| Non-GAAP adjustments: | ||||||||||||||||||||||
| Interest expense, net | 8.9 | 8.5 | 17.9 | 16.9 | ||||||||||||||||||
| Income taxes | 105.5 | 77.2 | 215.8 | 141.7 | ||||||||||||||||||
| Depreciation and amortization expense | 48.6 | 48.6 | 94.3 | 98.2 | ||||||||||||||||||
| Total non-GAAP adjustments | 163.0 | 134.3 | 328.0 | 256.8 | ||||||||||||||||||
| EBITDA | 495.1 | 406.7 | 22 | % | 993.7 | 740.8 | 34 | % | ||||||||||||||
| Cost-saving initiatives(1) | — | 1.0 | — | 32.2 | ||||||||||||||||||
| Adjusted EBITDA | $ | 495.1 | $ | 407.7 | 21 | % | $ | 993.7 | $ | 773.0 | 29 | % | ||||||||||
(1) One-time costs and corresponding tax benefit recognized during fiscal 2021 related to the acceleration of cost-saving initiatives, including the long-term strategy to reduce our geographic footprint and headcount optimization. These events are not expected to recur.
(2) Net tax windfall benefits related to employee stock-based compensation payments recognized in income taxes. This item is subject to volatility and will vary based on employee decisions on exercising employee stock options and fluctuations in our stock price, neither of which is within the control of management.
(3) The calculation of the impact of non-GAAP adjustments on diluted earnings per share is performed on each line independently. The table may not add down by +/- $0.01 due to rounding.
In addition to reporting operating income, net income, and diluted earnings per share, which are U.S. GAAP measures, we present adjusted operating income, adjusted operating margin, adjusted net income, adjusted diluted earnings per share, EBITDA, and adjusted EBITDA, which are non-GAAP measures. We believe these additional measures are indicators of our core business operations’ performance period over period. Adjusted operating income, adjusted operating margin, adjusted net income, adjusted diluted earnings per share, EBITDA, and adjusted EBITDA, are not calculated through the application of U.S. GAAP and are not required forms of disclosure by the SEC. As such, they should not be considered a substitute for the U.S. GAAP measures of operating income, net income, and diluted earnings per share, and, therefore, they should not be used in isolation, but in conjunction with the U.S. GAAP measures. The use of any non-GAAP measure may produce results that vary from the U.S. GAAP measure and may not be comparable to a similarly defined non-GAAP measure used by other companies.
LIQUIDITY AND CAPITAL RESOURCES
As of November 30, 2021, our financial position remained strong with cash, restricted cash, and total corporate investments of $1.1 billion. Total short-term and long-term borrowings, net of debt issuance costs, were $806.4 million as of November 30, 2021. Our primary source of cash is generated by our ongoing operations. Cash flow from operations was $555.4 million for the six months. Our positive cash flows have allowed us to support our business and pay dividends. We currently anticipate that cash, restricted cash, and total corporate investments as of November 30, 2021, along with projected operating cash flows and available short-term financing, will support our business operations, capital purchases, share repurchases, and dividend payments for the foreseeable future.
We believe that our investments in an unrealized loss position as of November 30, 2021 were not impaired due to increased credit risk or other valuation concerns, nor has any event occurred subsequent to that date to indicate any change in our assessment.
Financing
Short-term financing: We maintain committed and unsecured credit facilities and irrevocable letters of credit as part of our normal and recurring business operations. The purpose of these credit facilities is to meet short-term funding requirements, finance working capital needs, and for general corporate purposes. We typically borrow on an overnight or short-term basis under our credit facilities. Refer to Note M of the Notes to Consolidated Financial Statements contained in Item 8 of our Form 10-K for fiscal 2021 for further discussion on our credit facilities.
Details of our credit facilities as of November 30, 2021 were as follows:
| Maximum | November 30, 2021 | ||||||||||
| Amount | Outstanding | Available | |||||||||
| $ in millions | Expiration Date | Available | Amount | Amount | |||||||
| Credit facilities: | |||||||||||
| JP Morgan Chase Bank, N.A. (“JPM”) | July 31, 2024 | $ | 1,000.0 | $ | — | $ | 1,000.0 | ||||
| JPM | September 17, 2026 | $ | 750.0 | — | 750.0 | ||||||
| PNC Bank, National Association (“PNC”) | February 6, 2023 | $ | 250.0 | 8.9 | 241.1 | ||||||
| Total Lines of Credit Outstanding and Available | $ | 8.9 | $ | 1,991.1 |
Amounts outstanding under the PNC credit facility as of November 30, 2021 remain outstanding as of the date of this report.
On September 17, 2021, we amended our $500.0 million credit facility with JPM. The amendment increased the credit facility’s maximum borrowing capacity to $750.0 million, extended the term through September 17, 2026, with the option to extend for two additional one-year periods, and amended interest rate provisions to phase out the use of the London Interbank Offered Rate (“LIBOR”). In addition, we also amended our $1.0 billion credit facility with JPM. The amendment phases out the use of LIBOR and adopts other administrative changes to maintain consistency with our other credit facilities.
Details of borrowings under each credit facility during the second quarter and the prior year period were as follows:
| For the three months ended November 30, 2021 | ||||||||||||
| Credit Facility | ||||||||||||
| $1 Billion | $750 Million | $250 Million | ||||||||||
| $ in millions | JPM | JPM | PNC | |||||||||
| Number of days borrowed | — | — | 91 | |||||||||
| Maximum amount borrowed | $ | — | $ | — | $ | 8.9 | ||||||
| Weighted-average amount borrowed | $ | — | $ | — | $ | 8.5 | ||||||
| Weighted-average interest rate | — | % | — | % | 1.21 | % |
| For the three months ended November 30, 2020 | ||||||||||||
| Credit Facility | ||||||||||||
| $1 Billion | $500 Million | $250 Million | ||||||||||
| $ in millions | JPM | JPM | PNC | |||||||||
| Number of days borrowed | 2 | — | 91 | |||||||||
| Maximum amount borrowed | $ | 217.5 | $ | — | $ | 246.9 | ||||||
| Weighted-average amount borrowed | $ | 204.5 | $ | — | $ | 14.4 | ||||||
| Weighted-average interest rate | 3.25 | % | — | % | 1.07 | % |
Short-term borrowings are primarily used for the settlement of client fund obligations, rather than liquidating previously collected client funds that have been invested in AFS securities allocated to our long-term investment portfolio.
Subsequent to November 30, 2021, there were no overnight borrowings under our PNC and JPM credit facilities.
We expect to have access to the amounts available under our current credit facilities to meet our ongoing financial needs. However, if we experience reductions in our operating cash flows due to any of the risk factors outlined in, but not limited to, Item 1A in our Form 10-K for fiscal 2021 and other SEC filings, we may need to adjust our capital, operating and other discretionary spending to realign our working capital requirements with the capital resources available to us. Furthermore, if we determine the need for additional short-term liquidity, there is no assurance that such financing, if pursued and obtained, would be adequate or on terms acceptable to us.
Letters of credit: As of November 30, 2021, we had irrevocable standby letters of credit available totaling $149.7 million, required to secure commitments for certain insurance policies. The letters of credit expire at various dates between approximately December 23, 2021 and December 5, 2022. No amounts were outstanding on these letters of credit during the second quarter or as of November 30, 2021.
Long-term financing: We have borrowed $800.0 million through the issuance of long-term private placement debt (“Senior Notes”). Certain information related to our Senior Notes are as follows:
| Senior Notes | Senior Notes | ||
| Series A | Series B | ||
| Stated interest rate | 4.07% | 4.25% | |
| Effective interest rate | 4.15% | 4.31% | |
| Interest rate type | Fixed | Fixed | |
| Interest payment dates | Semi-annual, in arrears | Semi-annual, in arrears | |
| Principal payment dates | March 13, 2026 | March 13, 2029 | |
| Note type | Unsecured | Unsecured |
Refer to Note N of the Notes to Consolidated Financial Statements contained in Item 8 of our Form 10-K for fiscal 2021 for further discussion on our long-term financing.
Other commitments: We had outstanding commitments under existing workers’ compensation insurance agreements and legally binding contractual arrangements, which included immaterial leases that have yet to commence. We also entered into various purchase commitments with vendors in the ordinary course of business and had outstanding commitments to purchase approximately $4.1 million of capital assets as of November 30, 2021. In addition, we are involved in three limited partnership agreements to contribute a maximum of $30.0 million to venture capital funds in the financial technology sector. As of November 30, 2021, we have contributed approximately $14.9 million of the total funding commitment.
In the normal course of business, we make representations and warranties that guarantee the performance of services under service arrangements with clients. Historically, there have been no material losses related to such guarantees. We have also entered into indemnification agreements with our officers and directors, which require us to defend and, if necessary, indemnify these individuals for certain pending or future claims as they relate to their services provided to us.
We currently self-insure the deductible portion of various insured exposures under certain corporate employee and PEO employee health and medical benefit plans. Our estimated loss exposure under these insurance arrangements is recorded in other current liabilities on our Consolidated Balance Sheets. Historically, the amounts accrued have not been material and were not material as of November 30, 2021. We also maintain insurance coverage in addition to our purchased primary insurance policies for gap coverage for employment practices liability, errors and omissions, warranty liability, theft and embezzlement, cyber threats, and acts of terrorism; and capacity for deductibles and self-insured retentions through our captive insurance company.
Operating, Investing, and Financing Cash Flow Activities
| For the six months ended | |||||||||
| November 30, | |||||||||
| In millions | 2021 | 2020 | Change | ||||||
| Net cash provided by operating activities | $ | 555.4 | $ | 430.7 | $ | 124.7 | |||
| Net cash used in investing activities | (451.4) | (490.4) | 39.0 | ||||||
| Net cash used in financing activities | (302.9) | (462.4) | 159.5 | ||||||
| Net change in cash, restricted cash, and equivalents | $ | (198.9) | $ | (522.1) | $ | 323.2 | |||
| Cash dividends per common share | $ | 1.32 | $ | 1.24 |
The changes in our cash flow for the six months compared to the prior year period were primarily the result of the following key drivers:
Operating Cash Flow Activities
Higher net income attributable to the reasons discussed in the “Results of Operations” section of this Item 2.
Decrease in income tax payments; offset by,
Increase in receivables due to an increase in funding for temporary staffing clients; and,
Higher incentive compensation payments.
Investing Cash Flow Activities
The decrease in cash used was primarily related to prior year period purchases of AFS securities from funds held for clients that were previously being held as cash or cash equivalents due to uncertainty in the economy. This is partially offset by,
Our recent completion of an immaterial business acquisition, discussed in the “Overview” section of this Item 2; and,
Greater investment in technology as we continued to introduce new product solutions and enhancements.
Fluctuations in the net purchases and sales/maturities of AFS securities are also due to timing within the client funds portfolio and market conditions. Amounts will vary based upon the timing of collection from clients, and the related remittance to applicable tax or regulatory agencies for payroll tax administration services and to employees of clients utilizing employee payment services.
Discussion of interest rates and related risks is included in the “Market Risk Factors” section of this Item 2.
Financing Cash Flow Activities
Increase in net cash inflows from changes in client fund obligations due to client base growth and improving economic conditions.
Decrease in the repurchase of common shares as we did not repurchase any shares in the six months versus 0.4 million shares repurchased in the prior year period. Refer to Part II, Item 2 of this Form 10-Q for further discussion on our common stock repurchase programs; partially offset by,
Decrease in equity-based plan activity as 1.0 million shares of our common stock were exercised or vested during the six months compared to 2.2 million shares exercised or vested in the prior year period; and,
Dividends paid increased $29.7 million compared to the prior year period due to an increase in our quarterly dividend from $0.62 per share to $0.66 per share. The payment of future dividends is dependent on our future earnings and cash flow and is subject to the discretion of our Board of Directors.
The client fund obligations liability will also vary based on the timing of collecting client funds and the related required remittance of funds to applicable tax or regulatory agencies for payroll tax administration services and to employees of clients utilizing employee payment services. Collections from clients are typically remitted from one to 30 days after receipt, with some items extending to 90 days.
MARKET RISK FACTORS
Changes in interest rates and interest rate risk: Funds held for clients are primarily comprised of short-term funds and AFS securities. Corporate investments are primarily comprised of AFS securities. As a result of our investing activities, we are exposed to changes in interest rates that may materially affect our results of operations and financial position. Changes in interest rates will impact the earnings potential of future investments and will cause fluctuations in the fair value of our longer-term AFS securities. We follow an investment strategy of protecting principal and optimizing liquidity. A substantial portion of our portfolios is invested in high credit quality securities with ratings of AA or higher, and A-1/P-1 ratings on short-term securities. We invest predominantly in municipal bonds; corporate bonds; and U.S. government agency securities. We limit the amounts that can be invested in any single issuer and invest primarily in short- to intermediate-term instruments whose fair value is less sensitive to interest rate changes. We manage the AFS securities to a benchmark duration of two and one-half to three and three-quarters years.
During the six months ended November 30, 2021, our primary short-term investment vehicle was bank demand deposit accounts. We have no exposure to high-risk or non-liquid investments. We have insignificant exposure to European investments. We have not and do not utilize derivative financial instruments to manage our interest rate risk.
During the six months ended November 30, 2021, the average interest rate earned on our combined funds held for clients and corporate cash equivalents and investment portfolios was 1.1% compared to 1.3% for the prior year period. When interest rates are falling, the full impact of lower interest rates will not immediately be reflected in net income due to the interaction of short- and long-term interest rate changes. During a falling interest rate environment, earnings decrease from our short-term investments, and over time, earnings will decrease from our longer-term AFS securities. Earnings from AFS securities, which as of November 30, 2021 had an average duration of 3.3 years, would not reflect decreases in interest rates until the investments are sold or mature and the proceeds are reinvested at lower rates.
The amortized cost and fair value of AFS securities that had stated maturities as of November 30, 2021 are shown below by expected maturity.
| November 30, 2021 | ||||||
| Amortized | Fair | |||||
| In millions | cost | value | ||||
| Maturity date: | ||||||
| Due in one year or less | $ | 349.5 | $ | 352.4 | ||
| Due after one year through three years | 670.5 | 690.1 | ||||
| Due after three years through five years | 1,122.5 | 1,142.7 | ||||
| Due after five years | 1,138.7 | 1,131.9 | ||||
| Total | $ | 3,281.2 | $ | 3,317.1 |
VRDNs are primarily categorized as due after five years in the table above as the contractual maturities on these securities are typically 20 to 30 years. Although these securities are issued as long-term securities, they are priced and traded as short-term instruments because of the liquidity provided through the tender feature.
As of November 30, 2021, the Federal Funds rate was in the range of 0.00% to 0.25%. There continues to be uncertainty in the changing market and economic conditions, including the possibility of additional measures that could be taken by the Federal Reserve and other government agencies, related to the COVID-19 pandemic. We will continue to monitor the market conditions.
Calculating the future effects of changing interest rates involves many factors. These factors include, but are not limited to:
governmental action resulting from the COVID-19 pandemic;
daily interest rate changes;
seasonal variations in investment balances;
actual duration of short-term and AFS securities;
the proportion of taxable and tax-exempt investments;
changes in tax-exempt municipal rates versus taxable investment rates, which are not synchronized or simultaneous; and
financial market volatility and the resulting effect on benchmark and other indexing interest rates.
Subject to these factors and under normal financial market conditions, a 25-basis-point change in taxable interest rates generally affects our tax-exempt interest rates by approximately 17 basis points. Under normal financial market conditions, the impact to earnings from a 25-basis-point change in short-term interest rates would be approximately $3.0 million to $3.5 million, after taxes, for a twelve-month period. Such a basis point change may or may not be tied to changes in the Federal Funds rate.
Our total investment portfolio (funds held for clients and corporate cash equivalents and investments) is expected to average approximately $5.5 billion for fiscal 2022. Our anticipated allocation is approximately 40% invested in short-term securities and VRDNs with an average duration of less than 30 days and 60% invested in AFS securities, with an average duration of two and one-half to three and three-quarters years.
The combined funds held for clients and corporate AFS securities reflected net unrealized gains of $35.9 million as of November 30, 2021 and $79.3 million as of May 31, 2021. During the six months, the net unrealized gain on our investment portfolios ranged from $23.4 million to $89.2 million. These fluctuations were driven by changes in market rates of interest. The net unrealized gain on our investment portfolio was approximately $33.7 million as of December 20, 2021.
As of November 30, 2021 and May 31, 2021, we had $3.3 billion and $3.0 billion, respectively, invested in AFS securities at fair value. The weighted-average yield-to-maturity was 1.8% as of November 30, 2021 and 1.9% as of May 31, 2021. The weighted-average yield-to-maturity excludes AFS securities tied to short-term interest rates, such as VRDNs. Assuming a hypothetical increase in longer-term interest rates of 25 basis points, the resulting potential decrease in fair value for our portfolio of AFS securities as of November 30, 2021, would be approximately $25.0 million. Conversely, a corresponding decrease in interest rates would result in a comparable increase in fair value. This hypothetical increase or decrease in the fair value of the portfolio would be recorded as an adjustment to the portfolio’s recorded value, with an offsetting amount recorded in stockholders’ equity. These fluctuations in fair value would have no related or immediate impact on our results of operations unless any declines in fair value are due to credit related concerns and an impairment loss is recognized.
Credit risk: We are exposed to credit risk in connection with these investments through the possible inability of the borrowers to meet the terms of their bonds. We regularly review our investment portfolios to determine if any investment is impaired due to increased credit risk or other valuation concerns and we believe that the investments we held as of November 30, 2021 were not impaired as a result of the previously discussed reasons. While $986.6 million of our AFS securities had fair values that were below amortized cost, we believe that it is probable that the principal and interest will be collected in accordance with the contractual terms, and that the gross unrealized losses of $14.6 million were due to changes in interest rates and were not due to increased credit risk or other valuation concerns. Most of the AFS securities in an unrealized loss position as of November 30, 2021 and May 31, 2021 had an AA rating or better. We do not intend to sell these investments until the recovery of their amortized cost basis or maturity, and further believe that it is not more-likely-than-not that we will be required to sell these investments prior to that time. Our assessment that an investment is not impaired due to increased credit risk or other valuation concerns could change in the future due to new developments, including changes in our strategies or assumptions related to any particular investment.
We have some credit risk exposure relating to the purchase of accounts receivable as a means of providing payroll funding to clients in the temporary staffing industry. There is also credit risk exposure relating to our trade accounts receivable. This credit risk exposure is diversified amongst multiple client arrangements and all such arrangements are regularly reviewed for potential write-off. No single client is material in respect to total accounts receivable, service revenue, or results of operations as of November 30, 2021.
CRITICAL ACCOUNTING POLICIES
Our critical accounting policies are described in Item 7 of our Form 10-K for fiscal 2021, filed with the SEC on July 16, 2021. On an ongoing basis, we evaluate the critical accounting policies used to prepare our consolidated financial statements, including, but not limited to, those related to:
revenue recognition;
assets recognized from the costs to obtain and fulfill contracts;
PEO insurance reserves;
goodwill and other intangible assets;
impairment of long-lived assets;
stock-based compensation costs; and
income taxes.
There have been no material changes in these aforementioned critical accounting policies.
NEW ACCOUNTING PRONOUNCEMENTS
Recently adopted accounting pronouncements: Refer to Note A of the Notes to Consolidated Financial Statements (Unaudited) contained in Item 1 of this Form 10-Q for a discussion of recently adopted accounting pronouncements.
Recently issued accounting pronouncements: Refer to Note A of the Notes to Consolidated Financial Statements (Unaudited) contained in Item 1 of this Form 10-Q for a discussion of recently issued accounting pronouncements.
Ite****m 3. Quantitative and Qualitative Disclosures of Market Risk
The information called for by this item is provided under the caption “Market Risk Factors” under Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations and is incorporated herein by reference.
Ite****m 4. Controls and Procedures
Disclosure Controls and Procedures: Disclosure controls and procedures are designed with the objective of ensuring that information required to be disclosed in the Company’s reports filed under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), such as this report, is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures are also designed with the objective of ensuring that such information is accumulated and communicated to the Company’s management, including the Company’s principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures: As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s principal executive officer and principal financial officer, of the effectiveness of disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act. Based on such evaluation, the Company’s principal executive officer and principal financial officer have concluded that as of November 30, 2021, the end of the period covered by this report, our disclosure controls and procedures were effective at a reasonable assurance level.
Changes in Internal Control over Financial Reporting: The Company also carried out an evaluation of the internal control over financial reporting to determine whether any changes occurred during the fiscal quarter ended November 30, 2021. Based on such evaluation, there have been no changes in the Company’s internal control over financial reporting that occurred during the Company’s most recently completed fiscal quarter ended November 30, 2021, that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
PAR****T II. OTHER INFORMATION
I****tem 2. Unregistered Sales of Equity Securities and Use of Proceeds
The Company maintains two programs to repurchase up to $400 million of the Company’s common stock under each program, with authorization expiring on May 31, 2022 and January 31, 2024, respectively. The purpose of these programs is to manage common stock dilution. There were no shares repurchased during the second quarter and $472.4 million remains available for share repurchases in total under both programs.
Ite****m 6. Exhibits
INDEX TO EXHIBITS
- Exhibit filed with this report
SIGNA****TURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
PAYCHEX, INC.
| Date: | December 22, 2021 | /s/ Martin Mucci | |
| Martin Mucci | |||
| Chairman of the Board of Directors and Chief Executive Officer | |||
| (Principal Executive Officer) | |||
| Date: | December 22, 2021 | /s/ Efrain Rivera | |
| Efrain Rivera | |||
| Senior Vice President, Chief Financial Officer and Treasurer | |||
| (Principal Financial Officer) | |||
| Date: | December 22, 2021 | /s/ Robert L. Schrader Robert L. Schrader Vice President and Controller (Principal Accounting Officer) | |
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