filings.toolsPaychex 10-Q 2022-08-31
Filed 2022-09-29. 3 sections, 125K characters. Original on sec.gov · Markdown · JSON
Cover and table of contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended August 31, 2022
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from __________to __________
Commission file number 0-11330
Paychex, Inc.
(Exact name of registrant as specified in its charter)
| Delaware (State or other jurisdiction of incorporation or organization) | 16-1124166 (I.R.S. Employer Identification No.) |
| 911 Panorama Trail South Rochester**,** NY (Address of principal executive offices) | 14625-2396 (Zip Code) |
Registrant's telephone number, including area code: (585) 385-6666
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered |
| Common Stock, $0.01 par value | PAYX | Nasdaq Global Select Market |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer | | Accelerated filer | |
| Non-accelerated filer | | Smaller reporting company | |
| Emerging growth company | |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No
As of August 31, 2022, 360,400,603 shares of the registrant’s common stock, $.01 par value, were outstanding.
PAYCHEX, INC.
Ta****ble of Contents
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
PAYCHEX, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (UNAUDITED)
In millions, except per share amounts
| For the three months ended | ||||||||||
| August 31, | ||||||||||
| 2022 | 2021 | |||||||||
| Revenue: | ||||||||||
| Management Solutions | $ | 905.5 | $ | 805.5 | ||||||
| PEO and Insurance Solutions | 282.8 | 262.9 | ||||||||
| Total service revenue | 1,188.3 | 1,068.4 | ||||||||
| Interest on funds held for clients | 17.9 | 14.5 | ||||||||
| Total revenue | 1,206.2 | 1,082.9 | ||||||||
| Expenses: | ||||||||||
| Cost of service revenue | 351.0 | 312.5 | ||||||||
| Selling, general and administrative expenses | 359.6 | 327.5 | ||||||||
| Total expenses | 710.6 | 640.0 | ||||||||
| Operating income | 495.6 | 442.9 | ||||||||
| Other (expense)/income, net | (3.6 | ) | 1.0 | |||||||
| Income before income taxes | 492.0 | 443.9 | ||||||||
| Income taxes | 112.8 | 110.3 | ||||||||
| Net income | $ | 379.2 | $ | 333.6 | ||||||
| Other comprehensive loss, net of tax | (37.5 | ) | (6.7 | ) | ||||||
| Comprehensive income | $ | 341.7 | $ | 326.9 | ||||||
| Basic earnings per share | $ | 1.05 | $ | 0.93 | ||||||
| Diluted earnings per share | $ | 1.05 | $ | 0.92 | ||||||
| Weighted-average common shares outstanding | 360.1 | 360.1 | ||||||||
| Weighted-average common shares outstanding, assuming dilution | 362.4 | 362.8 |
See Notes to Consolidated Financial Statements.
PA****YCHEX, INC.
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
In millions, except per share amounts
| August 31, | May 31, | |||||||||
| 2022 | 2022 | |||||||||
| Assets | ||||||||||
| Cash and cash equivalents | $ | 1,184.2 | $ | 370.0 | ||||||
| Restricted cash | 60.1 | 50.3 | ||||||||
| Corporate investments | 45.8 | 853.9 | ||||||||
| Interest receivable | 20.6 | 22.3 | ||||||||
| Accounts receivable, net of allowance for credit losses | 876.4 | 723.8 | ||||||||
| PEO unbilled receivables, net of advance collections | 476.3 | 572.1 | ||||||||
| Prepaid income taxes | — | 34.0 | ||||||||
| Prepaid expenses and other current assets | 286.2 | 272.3 | ||||||||
| Current assets before funds held for clients | 2,949.6 | 2,898.7 | ||||||||
| Funds held for clients | 3,135.8 | 3,682.9 | ||||||||
| Total current assets | 6,085.4 | 6,581.6 | ||||||||
| Long-term restricted cash | 32.6 | 25.5 | ||||||||
| Long-term corporate investments | 3.9 | 5.0 | ||||||||
| Property and equipment, net of accumulated depreciation | 398.1 | 401.3 | ||||||||
| Operating lease right-of-use assets, net of accumulated amortization | 74.7 | 78.7 | ||||||||
| Intangible assets, net of accumulated amortization | 212.5 | 224.6 | ||||||||
| Goodwill | 1,825.3 | 1,831.5 | ||||||||
| Long-term deferred costs | 441.1 | 433.3 | ||||||||
| Other long-term assets | 52.3 | 53.7 | ||||||||
| Total assets | $ | 9,125.9 | $ | 9,635.2 | ||||||
| Liabilities | ||||||||||
| Accounts payable | $ | 84.7 | $ | 105.7 | ||||||
| Accrued corporate compensation and related items | 138.7 | 225.4 | ||||||||
| Accrued worksite employee compensation and related items | 715.0 | 683.4 | ||||||||
| Short-term borrowings | 10.3 | 8.7 | ||||||||
| Accrued income taxes | 40.0 | — | ||||||||
| Deferred revenue | 40.8 | 38.4 | ||||||||
| Other current liabilities | 361.4 | 388.4 | ||||||||
| Current liabilities before client fund obligations | 1,390.9 | 1,450.0 | ||||||||
| Client fund obligations | 3,311.3 | 3,819.2 | ||||||||
| Total current liabilities | 4,702.2 | 5,269.2 | ||||||||
| Accrued income taxes | 61.7 | 58.1 | ||||||||
| Deferred income taxes | 157.1 | 165.5 | ||||||||
| Long-term borrowings, net of debt issuance costs | 797.8 | 797.7 | ||||||||
| Operating lease liabilities | 71.0 | 74.8 | ||||||||
| Other long-term liabilities | 198.7 | 184.7 | ||||||||
| Total liabilities | 5,988.5 | 6,550.0 | ||||||||
| Commitments and contingencies — Note H | ||||||||||
| Stockholders’ equity | ||||||||||
| Common stock, $0.01 par value; Authorized: 600.0 shares; Issued and outstanding: 360.4 shares as of August 31, 2022 and 359.9 shares as of May 31, 2022 | 3.6 | 3.6 | ||||||||
| Additional paid-in capital | 1,568.9 | 1,545.9 | ||||||||
| Retained earnings | 1,736.3 | 1,669.6 | ||||||||
| Accumulated other comprehensive loss | (171.4 | ) | (133.9 | ) | ||||||
| Total stockholders’ equity | 3,137.4 | 3,085.2 | ||||||||
| Total liabilities and stockholders’ equity | $ | 9,125.9 | $ | 9,635.2 |
See Notes to Consolidated Financial Statements.
P****AYCHEX, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (UNAUDITED)
In millions, except per share amounts
| For the three months ended August 31, 2022 | |||||||||||||||||||||||||||||
| Accumulated | |||||||||||||||||||||||||||||
| Additional | other | ||||||||||||||||||||||||||||
| Common stock | paid-in | Retained | comprehensive | ||||||||||||||||||||||||||
| Shares | Amount | capital | earnings | loss | Total | ||||||||||||||||||||||||
| Balance as of May 31, 2022 | 359.9 | $ | 3.6 | $ | 1,545.9 | $ | 1,669.6 | $ | **(**133.9 | ) | $ | 3,085.2 | |||||||||||||||||
| Net income | — | — | — | 379.2 | — | 379.2 | |||||||||||||||||||||||
| Unrealized losses on securities, net of $9.7 million in tax benefit | — | — | — | — | (29.5 | ) | (29.5 | ) | |||||||||||||||||||||
| Reclassification adjustment for realized gains on securities, net of $ - million in tax expense (1) | — | — | — | — | (0.1 | ) |
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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 August 31, 2022 (the “first quarter”), the prior year period ended August 31, 2021 (the “prior year period”), and our financial condition as of August 31, 2022. 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, 2022 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, 2022 (“fiscal 2022”). 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 “expect,” “estimate,” “intend,” “overview,” “outlook,” “guidance,” “we look forward to,” “will,” “would,” “project,” “projections,” “strategy,” “anticipate,” “believe,” “could,” “may,” “target,” “potential,” “strive,” “mission,” 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 or provide timely enhancements to our products and services;
software defects, undetected errors, and development delays for our products;
the possibility of cyberattacks, security vulnerabilities or Internet disruptions, including data security and privacy leaks and data loss and business interruptions;
the possibility of failure of our business continuity plan during a catastrophic event;
the failure of third-party service providers to perform their functions;
the possibility that we may be exposed to additional risks related to our co-employment relationship with our professional employer organization (“PEO”) business;
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 and other macroeconomic factors 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, including rising inflation;
changes in the availability and retention 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 2022 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 provider of integrated human capital management (“HCM”) software solutions for human resources (“HR”), payroll, benefits, and insurance services for small- to medium-sized businesses in the United States (“U.S.”). 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. Our purpose is to allow our customers the freedom to succeed. The workplace is evolving, and we lead the way by making complex HR, payroll, and benefits 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 through an integrated suite of solutions. 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 solutions to help our clients plan, manage, and comply with all aspects of HR.
Our portfolio of HCM and employee benefit-related solutions is disaggregated into two categories, (1) Management Solutions and (2) PEO and Insurance Solutions, as discussed under the heading “Description of Solutions” in Part I, Item 1 of our Form 10-K for fiscal 2022.
Our mission is to be the leading provider of HCM solutions for HR, payroll, benefits, and insurance 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 bases; and engaging in strategic acquisitions.
We continue to focus on driving growth in the number of clients, revenue per client, total revenue, and profit, 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 leading-edge technology. We believe these investments are critical to our success. Looking to the future, we believe that investing in our products, people, and service capabilities will position us to capitalize on opportunities for long-term growth.
We closely monitor the evolving challenges and needs of small- and mid-sized businesses. As a leader in innovative technology solutions, we provide employers with the digital tools and HR expertise to hire, engage, train, and retain top talent in this challenging workforce environment. We continue to find opportunities to innovate our HCM solutions to help our customers address these challenges. An example of our innovative technology is our recently introduced, industry first, Paychex Voice Assist. Paychex Voice Assist enables payroll administrators to run payroll through any Google Assistant-compatible device for a hands-free experience, simplifying and automating the payroll process with the sound of a verified user’s voice. Capabilities of the feature include starting a pay period or acting on one already in progress, applying standard pay, pay adjustments, reviewing totals, and submitting payroll for processing through a robust and resilient artificial intelligence (“AI”) assistant with built-in verifications for user authentication.
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 | 2022 | 2021 | Change**(2)** | ||||||||||||
| Total service revenue | $ | 1,188.3 | $ | 1,068.4 | 11 | % | |||||||||
| Total revenue | $ | 1,206.2 | $ | 1,082.9 | 11 | % | |||||||||
| Operating income | $ | 495.6 | $ | 442.9 | 12 | % | |||||||||
| Net income | $ | 379.2 | $ | 333.6 | 14 | % | |||||||||
| Adjusted net income(1) | $ | 371.9 | $ | 323.2 | 15 | % | |||||||||
| Diluted earnings per share | $ | 1.05 | $ | 0.92 | 14 | % | |||||||||
| Adjusted diluted earnings per share(1) | $ | 1.03 | $ | 0.89 | 16 | % | |||||||||
| Dividends paid to stockholders | $ | 284.6 | $ | 238.1 | 20 | % |
(1)
Adjusted net income and adjusted diluted earnings per share are not U.S. generally accepted accounting principle (“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 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, 2022, refer to the tables and analysis in the “Results of Operations” and “Liquidity and Capital Resources” sections of this Item 2.
RESULTS OF OPERATIONS
Summary of Results of Operations:
| For the three months ended | |||||||||||||||
| August 31, | |||||||||||||||
| In millions, except per share amounts | 2022 | 2021 | Change**(1)** | ||||||||||||
| Revenue: | |||||||||||||||
| Management Solutions | $ | 905.5 | $ | 805.5 | 12 | % | |||||||||
| PEO and Insurance Solutions | 282.8 | 262.9 | 8 | % | |||||||||||
| Total service revenue | 1,188.3 | 1,068.4 | 11 | % | |||||||||||
| Interest on funds held for clients | 17.9 | 14.5 | 24 | % | |||||||||||
| Total revenue | 1,206.2 | 1,082.9 | 11 | % | |||||||||||
| Total expenses | 710.6 | 640.0 | 11 | % | |||||||||||
| Operating income | 495.6 | 442.9 | 12 | % | |||||||||||
| Other (expense)/income, net | (3.6 | ) | 1.0 | n/m | % | ||||||||||
| Income before income taxes | 492.0 | 443.9 | 11 | % | |||||||||||
| Income taxes | 112.8 | 110.3 | (2 | ) | % | ||||||||||
| Effective income tax rate | 22.9 | % | 24.9 | % | |||||||||||
| Net income | $ | 379.2 | $ | 333.6 | 14 | % | |||||||||
| Diluted earnings per share | $ | 1.05 | $ | 0.92 | 14 | % |
(1) Percentage changes are calculated based on unrounded numbers.
The changes in revenue as compared to the prior year period were primarily driven by the following factors:
Management Solutions revenue: $905.5 million for the first quarter, reflecting an increase of 12%:
o
Growth in the number of client employees served for HCM and additional worksite employees for HR Solutions;
o
Improved revenue per client resulting from price realization and higher product penetration, including strong demand for HR Solutions, retirement, and time and attendance solutions; and
o
Expansion of HCM ancillary services.
PEO and Insurance Solutions revenue: $282.8 million for the first quarter, reflecting an increase of 8%:
o
Growth in the number of average worksite employees; and
o
Increase in PEO health insurance revenue.
Interest on funds held for clients and Corporate investment income: $17.9 million for the first quarter, reflecting an increase of 24% due to higher average invested balances and higher average interest rates earned.
We invest in highly liquid, investment-grade fixed income securities and do not utilize derivative instruments to manage interest rate risk.
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 | 2022 | 2021 | Change**(1)** | ||||||||||||||
| Average investment balances: | |||||||||||||||||
| Funds held for clients | $ | 4,118.0 | $ | 3,897.5 | 6 | % | |||||||||||
| Corporate cash equivalents and investments | 1,394.6 | 1,197.1 | 16 | % | |||||||||||||
| Total | $ | 5,512.6 | $ | 5,094.6 | 8 | % | |||||||||||
| Average interest rates earned (exclusive of net realized gains): | |||||||||||||||||
| Funds held for clients | 1.7 | % | 1.5 | % | |||||||||||||
| Corporate cash equivalents and investments | 1.5 | % | 0.1 | % | |||||||||||||
| Combined funds held for clients and corporate cash equivalents and investments | 1.7 | % | 1.1 | % | |||||||||||||
| Total net realized gains | $ | 0.1 | $ | 0.1 |
(1) Percentage changes are calculated based on unrounded numbers.
| August 31, | May 31, | |||||||||||
| $ in millions | 2022 | 2022 | ||||||||||
| Net unrealized losses on available for sale (“AFS”) securities (1) | $ | (175.6 | ) | $ | (136.3 | ) | ||||||
| Federal Funds rate (2) | 2.50 | % | 1.00 | % | ||||||||
| Total fair value of AFS securities | $ | 2,724.8 | $ | 4,029.2 | ||||||||
| Weighted-average duration of AFS securities in years (3) | 3.1 | 3.2 | ||||||||||
| Weighted-average yield-to-maturity of AFS securities (3) | 1.9 | % | 1.9 | % |
(1) The net unrealized loss on our investment portfolio was approximately $244.6 million as of September 27, 2022.
(2) The Federal Funds rate was in the range of 2.25% to 2.50% as of August 31, 2022 and in the range of 0.75% to 1.00% as of May 31, 2022. Effective September 22, 2022, the Federal Reserve increased the Federal Funds rate to a range of 3.00% to 3.25%.
(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 period below:
| For the three months ended | |||||||||||||||
| August 31, | |||||||||||||||
| In millions | 2022 | 2021 | Change**(1)** | ||||||||||||
| Compensation-related expenses | $ | 426.6 | $ | 382.9 | 11 | % | |||||||||
| PEO insurance costs | 104.5 | 96.0 | 9 | % | |||||||||||
| Depreciation and amortization | 44.0 | 45.7 | (4 | ) | % | ||||||||||
| Other expenses | 135.5 | 115.4 | 17 | % | |||||||||||
| Total expenses | $ | 710.6 | $ | 640.0 | 11 | % |
(1) Percentage changes are calculated based on unrounded numbers.
Total expenses increased 11% to $710.6 million for the first quarter compared to the prior year period. Total expenses increased as a result of the following:
Compensation-related expenses: $426.6 million for the first quarter, reflecting an increase of 11%, due to increases in headcount and wage rates.
PEO insurance costs: $104.5 million for the first quarter, reflecting an increase of 9%, as a result of higher health insurance enrollment.
Other expenses: $135.5 million for the first quarter, reflecting an increase and 17%, due to general cost increases to support business growth.
Operating income: Operating income increased 12% to $495.6 million for the first quarter, as a result of double-digit revenue growth which outpaced expense increases as previously discussed.
Operating margin (operating income as a percentage of total revenue) was as follows:
| For the three months ended | ||||||||||||
| August 31, | ||||||||||||
| 2022 | 2021 | |||||||||||
| Operating margin | 41.1 | % | 40.9 | % |
Fluctuations in this metric was attributable to the factors previously discussed.
Income taxes: Our effective income tax rate was 22.9% for the first quarter, compared to 24.9%, for the prior year period. Both periods were impacted by the recognition of excess tax benefits related to employee stock-based compensation payments. The prior year period was also impacted by an increase in state taxes.
Non-GAAP Financial Measures: Adjusted net income, adjusted diluted earnings per share, and earnings before interest, taxes, depreciation, and amortization (“EBITDA”) are summarized as follows:
| For the three months ended | |||||||||||||||
| August 31, | |||||||||||||||
| $ in millions | 2022 | 2021 | Change | ||||||||||||
| Net income | $ | 379.2 | $ | 333.6 | 14 | % | |||||||||
| Non-GAAP adjustments: | |||||||||||||||
| Excess tax benefits related to employee stock-based compensation payments(1) | (7.3 | ) | (10.4 | ) | |||||||||||
| Adjusted net income | $ | 371.9 | $ | 323.2 | 15 | % | |||||||||
| Diluted earnings per share(2) | $ | 1.05 | $ | 0.92 | 14 | % | |||||||||
| Non-GAAP adjustments: | |||||||||||||||
| Excess tax benefits related to employee stock-based compensation payments(1) | (0.02 | ) | (0.03 | ) | |||||||||||
| Adjusted diluted earnings per share | $ | 1.03 | $ | 0.89 | 16 | % | |||||||||
| Net income | $ | 379.2 | $ | 333.6 | 14 | % | |||||||||
| Non-GAAP adjustments: | |||||||||||||||
| Interest expense, net | 3.7 | 9.0 | |||||||||||||
| Income taxes | 112.8 | 110.3 | |||||||||||||
| Depreciation and amortization expense | 44.0 | 45.7 | |||||||||||||
| Total non-GAAP adjustments | 160.5 | 165.0 | |||||||||||||
| EBITDA | $ | 539.7 | $ | 498.6 | 8 | % |
(1) Excess tax 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.
(2) 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 net income and diluted earnings per share, which are U.S. GAAP measures, we present adjusted net income, adjusted diluted earnings per share, and EBITDA, which are non-GAAP measures. We believe these additional measures are indicators of our core business operations’ performance period over period. Adjusted net income, adjusted diluted earnings per share, and 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 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 August 31, 2022, our financial position remained strong with cash, restricted cash, and total corporate investments of $1.3 billion. Total short-term and long-term borrowings, net of debt issuance costs, were $808.1 million as of August 31, 2022. Our primary source of cash is our ongoing operations. Cash flow from operations was $364.3 billion for the first quarter. 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 August 31, 2022, 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 August 31, 2022 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 L of the Notes to Consolidated Financial Statements contained in Item 8 of our Form 10-K for fiscal 2022 for further discussion on our credit facilities.
Details of our credit facilities as of August 31, 2022 were as follows:
| Maximum | August 31, 2022 | ||||||||||||||||
| 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 | 10.3 | 239.7 | ||||||||||||
| Total Lines of Credit Outstanding and Available | $ | 10.3 | $ | 1,989.7 |
Amounts outstanding under the PNC credit facility as of August 31, 2022 remain outstanding as of the date of this report.
Details of borrowings under each credit facility during the first quarter and the prior year period were as follows:
| For the three months ended August 31, 2022 | ||||||||||||||||||
| Credit Facility | ||||||||||||||||||
| $1 Billion | $750 Million | $250 Million | ||||||||||||||||
| $ in millions | JPM | JPM | PNC | |||||||||||||||
| Number of days borrowed | — | — | 92 | |||||||||||||||
| Maximum amount borrowed | $ | — | $ | — | $ | 10.6 | ||||||||||||
| Weighted-average amount borrowed | $ | — | $ | — | $ | 10.2 | ||||||||||||
| Weighted-average interest rate | — | % | — | % | 3.15 | % |
| For the three months ended August 31, 2021 | ||||||||||||||||||
| Credit Facility | ||||||||||||||||||
| $1 Billion | $750 Million | $250 Million | ||||||||||||||||
| $ in millions | JPM | JPM | PNC | |||||||||||||||
| Number of days borrowed | — | — | 92 | |||||||||||||||
| Maximum amount borrowed | $ | — | $ | — | $ | 106.5 | ||||||||||||
| Weighted-average amount borrowed | $ | — | $ | — | $ | 8.3 | ||||||||||||
| Weighted-average interest rate | — | % | — | % | 1.15 | % |
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 August 31, 2022, there were no additional 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 2022 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 August 31, 2022, we had irrevocable standby letters of credit available totaling $140.2 million, required to secure commitments for certain insurance policies. The letters of credit expire at various dates between November 9, 2022 and August 24, 2023. No amounts were outstanding on these letters of credit during the first quarter or as of August 31, 2022.
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 M of the Notes to Consolidated Financial Statements contained in Item 8 of our Form 10-K for fiscal 2022 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 $7.6 million of capital assets as of August 31, 2022. 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 August 31, 2022, we have contributed approximately $19.0 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 August 31, 2022. 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 three months ended | |||||||||||||||
| August 31, | |||||||||||||||
| In millions | 2022 | 2021 | Change | ||||||||||||
| Net cash provided by operating activities | $ | 364.3 | $ | 385.6 | $ | (21.3 | ) | ||||||||
| Net cash provided by/(used in) investing activities | 1,223.1 | (22.3 | ) | 1,245.4 | |||||||||||
| Net cash used in financing activities | (809.7 | ) | (211.7 | ) | (598.0 | ) | |||||||||
| Net change in cash, restricted cash, and equivalents | $ | 777.7 | $ | 151.6 | $ | 626.1 | |||||||||
| Cash dividends per common share | $ | 0.79 | $ | 0.66 |
The changes in our cash flow for the first quarter 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; partially offsets
Cash outflow for changes in funding for temporary staffing clients; and
Cash outflow for various changes in other assets and liabilities.
Investing Cash Flow Activities
The increase in cash provided was primarily related to an increase in the net sales of VRDNs, that were reinvested into cash/money market accounts due to more favorable interest rates;
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 outflows from changes in client fund obligations due the timing of collections and remittances of client funds,
Dividends paid increased compared to the prior year period due to an increase in our quarterly dividend from $0.66 per share to $0.79 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, and
Decrease in cash inflows from equity-based plans primarily due to a decrease in the number of stock options exercised during the fiscal 2023 period when compared with the fiscal 2022 period.
The client fund obligations liability will 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; U.S. government agency securities; and VRDNs. 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 first quarter, our primary short-term investment vehicles were bank demand deposit accounts, VRDNs, and commercial paper. 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 first quarter, the average interest rate earned on our combined funds held for clients and corporate cash equivalents and investment portfolios was 1.7% compared to 1.1% for the prior year period. When interest rates are rising, the full impact of higher interest rates will not immediately be reflected in net income due to the interaction of short- and long-term interest rate changes. During a rising interest rate environment, earnings will increase from our short-term investments, and over time, increase from our longer-term AFS securities. Earnings from AFS securities, which as of August 31, 2022 had an average duration of 3.1 years, would not reflect increases in interest rates until the investments are sold or mature and the proceeds are reinvested at higher rates.
The amortized cost and fair value of AFS securities that had stated maturities as of August 31, 2022 are shown below by expected maturity.
| August 31, 2022 | ||||||||||
| Amortized | Fair | |||||||||
| In millions | cost | value | ||||||||
| Maturity date: | ||||||||||
| Due in one year or less | $ | 289.4 | $ | 288.4 | ||||||
| Due after one year through three years | 746.9 | 728.0 | ||||||||
| Due after three years through five years | 1,421.1 | 1,312.3 | ||||||||
| Due after five years | 443.0 | 396.1 | ||||||||
| Total | $ | 2,900.4 | $ | 2,724.8 |
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 August 31, 2022, the Federal Funds rate was in the range of 2.25% to 2.50%. Effective September 22, 2022, the Federal Reserve raised the Federal Funds rate 75 basis points placing it in the range of 3.00% to 3.25%. 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 concerns over inflation risk. We will continue to monitor the market and economic conditions.
Calculating the future effects of changing interest rates involves many factors. These factors include, but are not limited to:
governmental action to address inflation;
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 $4.5 million to $5.0 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 $6.0 billion for the year ended May 31, 2023. Our anticipated allocation is approximately 50% invested in short-term securities and VRDNs with an average duration of less than 30 days and 50% 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 losses of $175.6 million as of August 31, 2022 and $136.3 million as of May 31, 2022. During the first quarter, the net unrealized loss on our investment portfolios ranged from a loss of $126.5 million to a loss of $197.3 million. These fluctuations were driven by changes in market rates of interest. The net unrealized loss on our investment portfolio was approximately $244.6 million as of September 27, 2022.
As of August 31, 2022 and May 31, 2022, we had $2.7 billion and $4.0 billion, respectively, invested in AFS securities at fair value. The weighted-average yield-to-maturity was 1.9% as of August 31, 2022 and as of May 31, 2022, respectively. 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 August 31, 2022, would be in the range of $20.0 million to $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 August 31, 2022 were not impaired as a result of the previously discussed reasons. While $2.7 billion 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 $175.6 million were due to changes in interest rates and were not due to increased credit risk or other valuation concerns. A substantial portion of the AFS securities in an unrealized loss position as of August 31, 2022 and May 31, 2022 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 August 31, 2022.
CRITICAL ACCOUNTING POLICIES
Our critical accounting policies are described in Item 7 of our Form 10-K for fiscal 2022, filed with the SEC on July 15, 2022. 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 August 31, 2022, 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 August 31, 2022. 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 August 31, 2022, 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 a program to repurchase up to $400 million of the Company’s common stock with authorization expiring on January 31, 2024. The purpose of this program is to manage common stock dilution. There were no shares repurchased during the first quarter and $327.1 million remains available for share repurchases in total under the program.
Ite****m 6. Exhibits
INDEX TO EXHIBITS
- Exhibit filed with this report
Management contract or compensatory plan
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: | September 29, 2022 | /s/ Martin Mucci | |
| Martin Mucci | |||
| Chairman of the Board of Directors and Chief Executive Officer | |||
| (Principal Executive Officer) | |||
| Date: | September 29, 2022 | /s/ Efrain Rivera | |
| Efrain Rivera | |||
| Senior Vice President and Chief Financial Officer | |||
| (Principal Financial Officer) | |||
| Date: | September 29, 2022 | /s/ Robert L. Schrader Robert L. Schrader Vice President and Controller (Principal Accounting Officer) |