Paychex(PAYX) - 2023 Q4 - Annual Report

PART I Cautionary Note Regarding Forward-Looking Statements This section warns that forward-looking statements are subject to risks and uncertainties, including technological changes, cyberattacks, regulatory shifts, and macroeconomic conditions, which could cause actual results to differ materially - Forward-looking statements are based on current beliefs, expectations, and assumptions, not historical facts, and are subject to inherent uncertainties, risks, and changes in circumstances that are difficult to predict[17] - Important factors that could cause actual results to differ materially include the ability to keep pace with technology, software defects, cyberattacks, failure of third-party service providers, risks related to PEO co-employment, changes in health insurance and workers' compensation rates, acquisition risks, client payment failures, changes in government regulations, and macroeconomic factors[18] Item 1. Business Paychex provides comprehensive HCM solutions, including HR, payroll, benefits, and insurance, to approximately 740,000 small- to medium-sized businesses in the U.S. and Europe, leveraging its cloud-based Paychex Flex platform - Paychex is a leading provider of human capital management (HCM) solutions for human resources (HR), payroll, benefits, and insurance for small- to medium-sized businesses across the U.S. and parts of Europe[23] Paychex Client Base (as of May 31, 2023) | Client Type | Number | | :-------------------- | :--------- | | Payroll and PEO clients | ~740,000 | - Over 50% of Paychex's revenues are gained from services beyond payroll processing[27] Overview Paychex, incorporated in 1979, delivers comprehensive HCM solutions to approximately 740,000 small- to medium-sized businesses in the U.S. and Europe, assisting with complex regulatory and workplace challenges - Paychex was incorporated in Delaware in 1979 and serves approximately 740,000 payroll and PEO clients as of May 31, 2023[24] - The company offers a comprehensive portfolio of HCM technology and HR advisory solutions that help clients navigate complex and ever-changing federal, state, and local regulations[23][25] Company Strategy Paychex aims to be the leading HCM solutions provider for small- and medium-sized businesses, focusing on innovative technology, HR advisory, and a comprehensive cloud-based platform (Paychex Flex) for strong financial performance - Paychex's strategy is to be the leading provider of HCM solutions by being an essential partner to small- and medium-sized businesses, achieved through continued investments in innovative technology and HR advisory solutions[28] - Key strategic elements include a comprehensive cloud-based platform (Paychex Flex), streamlined workforce management, modern user experience, scalable and customizable platform, SaaS delivery model, and expertise from over 250 compliance experts and approximately 700 HR business professionals[29][30][36] - The company continues to invest in artificial intelligence (AI) and self-service capabilities to deliver superior client experiences[30] Our Solutions Paychex provides integrated payroll and HCM software with HR and compliance expertise via its proprietary Paychex Flex SaaS platform, leveraging embedded AI to manage the employee life cycle and address client challenges - Paychex Flex is a proprietary HCM SaaS platform that provides seamless workforce management throughout the employee life cycle, from recruiting and hiring to retirement, through an integrated suite of solutions[35] - The platform leverages embedded AI, including the Paychex Flex Intelligence Engine and Flex Assistant chatbot, which consistently handles nearly two-thirds of questions that would otherwise reach a payroll/HR functionary or customer service representative with high satisfaction scores[38] - Paychex supports its HCM software solutions with approximately 700 HR business professionals and over 250 compliance professionals to provide HR best practices, advice, and ensure timely adherence to regulations[36] Our Clients Paychex serves diverse small- to medium-sized businesses in the U.S. and Europe, offering flexible HR solutions from DIY payroll to comprehensive outsourcing, achieving 82% to 83% client retention in fiscal 2023 - Paychex targets small- to medium-sized businesses with HR solutions ranging from do-it-yourself payroll to comprehensive HR outsourcing, including ASO and PEO solutions, and benefits offerings like insurance and retirement services[40][43] - Client retention was in the range of 82% to 83% of the beginning client base for fiscal 2023, indicating client satisfaction with solutions and support[40] Description of Solutions Paychex's portfolio includes Management Solutions (payroll, HR, retirement, business services) and PEO and Insurance Solutions (co-employment, insurance agency), offering flexible, integrated services leveraging base payroll data - Paychex offers a comprehensive portfolio of HCM technology and HR advisory solutions, allowing clients to select services on an á la carte basis or as part of various solution bundles, often leveraging information from base payroll processing[44] Management Solutions Management Solutions cover payroll processing (flexible pay), tax administration, employee payments, regulatory compliance, HR solutions (ASO, cloud-based software, time/attendance), and business services (payroll funding, ERTC) - Payroll processing solutions include calculation, preparation, and delivery of employee payroll checks, tax returns, and collection/remittance of payroll obligations, with flexible pay options like same day ACH and pay-on-demand functionality[45][47] - HR administration solutions offer cloud-based software for employee benefits management, time and attendance (Paychex Flex Time, InVision™ IRIS Time Clock, wearable technology), recruiting, onboarding, performance management, and digital communication solutions like Paychex Flex HR Connect and HR Conversations[48][49][51] - Business services include payroll funding for the temporary staffing industry through Paychex Advance, LLC, and Employee Retention Tax Credit Service to help businesses identify and claim tax credits[51] PEO and Insurance Solutions PEO solutions provide comprehensive HR outsourcing, with Paychex as co-employer assuming workers' compensation and health insurance risks, while Insurance solutions offer diverse property & casualty and health & benefits coverages - PEO solutions involve Paychex serving as a co-employer of clients' employees, assuming the risks and rewards of certain workers' compensation and health insurance offerings, and are certified under the Small Business Efficiency Act[51] - Paychex Insurance Agency, Inc. provides insurance solutions, including property and casualty (workers' compensation, business-owner policies, cybersecurity, commercial auto) and health and benefits (health, dental, vision, life) through a variety of carriers[51] Sales and Marketing Paychex markets through direct/virtual sales and corporate marketing, with over 50% of new small-market payroll clients from indirect referrals, also leveraging its website for leads and educational resources - Paychex markets its solutions through direct and virtual sales forces, supported by marketing, advertising, public relations, trade shows, and telemarketing programs[51] - More than 50% of new small-market payroll clients (excluding business acquisitions) come from indirect sales channels, such as referrals from existing clients, certified public accountants ("CPAs"), and banks[52] - The company provides education and assistance through free webinars, podcasts, white papers, and other information on its website (Paychex WORX, Accountant Knowledge Center) to inform businesses and the CPA community about regulatory changes and best practices[55][56] Markets and Competition Paychex targets approximately 8 million small- to medium-sized U.S. employer firms in a highly competitive HCM market, differentiating with leading-edge technology, mobility, and personalized support against diverse competitors - Paychex focuses on servicing small- to medium-sized businesses, operating in a target market of approximately 8 million employer firms in the U.S.[57] - The market for HCM services is highly competitive and fragmented, with Paychex competing against national, international, regional, local, and online service providers, as well as in-house payroll and HR systems[58] - Paychex differentiates itself through its leading-edge technology, mobility applications, and personalized support provided by industry professionals and technology-enabled solution capabilities[59] Software Maintenance and Development Paychex continuously invests in proprietary software enhancements to meet evolving tax/regulatory mandates and client demands, focusing on integrated SaaS solutions and mobility applications for a unified user experience - Paychex regularly updates its proprietary software to meet the ever-changing mandates of federal, state, and local tax and regulatory agencies[60] - The company is continually engaged in developing enhancements to and maintaining its various software platforms to meet changing client requirements and market demands, focusing on integrated and unified SaaS solutions and mobility applications[60] Human Capital Paychex prioritizes attracting and retaining diverse talent, fostering DE&I, and ensuring employee well-being, employing approximately 16,600 people as of May 31, 2023, with compensation at 60% of total expenses - As of May 31, 2023, Paychex employed approximately 16,600 people, primarily in the U.S. and on a full-time basis, with no employees covered by collective bargaining agreements[63] - Compensation-related expenses accounted for approximately 60% of total expenses for fiscal 2023, reflecting the company's commitment to providing a fair wage and comprehensive total rewards package[67] - Paychex has been recognized 15 times as one of the World's Most Ethical Companies and as a Best Employer for Diversity for 2023, reflecting its commitment to DE&I, talent development, and employee well-being initiatives[64][66][68][70] Intellectual Property Paychex owns or licenses material intellectual property, including trademarks, copyrights, and software, protecting these rights through confidentiality and registrations, with the "Paychex" name and logo being critical - Paychex owns or licenses a number of trademarks, trade names, copyrights, service marks, trade secrets, computer programs and software, and other intellectual property rights, which are material to the conduct of its business[72] - The company takes measures to protect its intellectual property rights, including confidentiality/non-disclosure agreements and registration of certain trademarks, with the "Paychex" name, trademark, and logo being of material importance[72] Seasonality Paychex's business generally lacks significant seasonality, but its third fiscal quarter (ending February) sees higher new client numbers and increased transaction/client funds activity due to calendar year-end events - There is no significant seasonality to Paychex's business; however, the third fiscal quarter (ending February) tends to have higher numbers of new payroll, retirement services, and PEO clients[73] - Calendar year-end transaction processing and client funds activity are traditionally higher during the third fiscal quarter due to year-end bonus payments, additional services, and reporting requirements[73] Available Information Paychex is subject to SEC reporting requirements, with periodic reports, proxy statements, and other information available on sec.gov and the company's investor relations website - Paychex is subject to the informational and reporting requirements of the Securities Exchange Act of 1934 and files periodic reports, proxy statements, and other information with the SEC[74] - Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and other SEC filings are available free of charge on the SEC's website (www.sec.gov) and Paychex's corporate website (www.paychex.com)[74](index=74&type=chunk)[75] Item 1A. Risk Factors This section details significant risks, including operational (technology, cyberattacks, PEO liabilities), financial (client payments, interest rates, debt covenants), legal/regulatory (compliance, data privacy), and general macroeconomic factors, which could materially affect Paychex's future results - Paychex's future results are subject to risks and uncertainties that could cause actual results to differ materially from historical and current results, and from projections[76] - Important factors that could cause actual results to differ materially include the ability to keep pace with technology, software defects, cyberattacks, failure of third-party providers, PEO co-employment risks, changes in insurance rates, acquisition risks, client payment failures, government regulation changes, and macroeconomic factors[18] Business and Operational Risks Paychex faces operational risks from rapid technological changes, software defects, cyberattacks, third-party failures, PEO co-employment liabilities (health/workers' compensation), and acquisition integration challenges - The company's future success depends on its ability to keep pace with rapid technological advancements, provide timely enhancements to solutions, and adapt to changing customer requirements, including the successful utilization of artificial intelligence and machine learning solutions[77] - Cyberattacks, security vulnerabilities, and data privacy leaks pose a significant risk due to the large amounts of personal and business information collected, used, and retained, potentially leading to reduced revenues, increased costs, liability claims, or harm to its competitive position[79][80][81] - Risks related to the PEO co-employment relationship include potential liability for clients' employment law violations and adverse impacts from changes in health insurance and workers' compensation rates and underlying claim trends[85][86] Financial Risks Financial risks include potential losses from client payment failures, adverse impacts on interest income from client funds due to regulatory changes, and material effects on financial condition from non-compliance with debt covenants - Paychex could incur financial losses if clients have insufficient funds to reimburse payments made on their behalf for employee wages and taxes[88] - Interest income earned on client funds held for investment may be adversely impacted by changes in government regulations that decrease tax withholding amounts or shorten remittance periods[89] - Failure to comply with covenants in debt agreements, such as maximum leverage and minimum interest coverage ratios, could have a material adverse effect on the company's financial condition[90] Legal, Regulatory and Political Risks Paychex faces risks from changes in government regulations (payroll tax, benefits, PEO) and non-compliance with U.S./foreign laws (data privacy, anti-money laundering), potentially harming reputation and leading to penalties, alongside intellectual property infringement claims - Changes in government regulations and policies, particularly those affecting payroll tax administration, employee benefit plans, and PEO services, could reduce demand for Paychex's services or increase its cost of doing business[91] - Failure to comply with U.S. and foreign laws and regulations, including data privacy laws (e.g., GDPR, CCPA), anti-money laundering rules, economic sanctions, and anti-corruption laws, could adversely impact business reputation, lead to civil/criminal penalties, and affect operations[92][93][94] - Failure to protect intellectual property rights may harm the company's competitive position, and litigation to protect or defend against infringement claims can be costly[96] General Risk Factors General risks include adverse macroeconomic/political factors (inflation, banking instability) impacting transaction volumes and profitability, challenges in attracting/retaining personnel, and potential reputational harm from negative publicity - Macroeconomic and political factors, including inflationary pressure, banking instability, and volatility in the credit markets, can adversely impact Paychex's business, leading to lower transaction volumes, client attrition, and reduced revenue[98][99] - Funds held for clients and corporate investments are subject to general market, interest rate, credit, and liquidity risks, which may be exacerbated during periods of unusual financial market volatility and inflationary pressure, potentially decreasing interest income[100] - The inability to attract, retain, and motivate highly qualified and diverse personnel at all levels could impact the quality of services and customer satisfaction, harming future success[102] Item 1B. Unresolved Staff Comments This section states that there are no unresolved staff comments - There are no unresolved staff comments[105] Item 2. Properties As of May 31, 2023, Paychex owned 862,000 square feet and leased 1,191,000 square feet of facilities across the U.S. and internationally, with Rochester, NY, housing core functions and other sites supporting service, sales, and IT Paychex Properties as of May 31, 2023 | Type of Facility | Square Feet | | :-------------------- | :---------- | | Owned facilities: | | | Rochester, New York | 832,000 | | Other U.S. locations | 30,000 | | Total owned facilities | 862,000 | | Leased facilities: | | | Rochester, New York | 90,000 | | Other U.S. locations | 957,000 | | International locations | 144,000 | | Total leased facilities | 1,191,000 | - Facilities in Rochester, New York, house various distribution, processing, and technology functions, while other U.S. locations house service centers, fulfillment centers, and sales functions. International locations primarily house European operations and IT/service support in India[107] Item 3. Legal Proceedings Paychex is involved in various legal claims and matters arising in the normal course of business, with further details provided in Note P of the Consolidated Financial Statements - Paychex is subject to various claims and legal matters that arise in the normal course of its business[108] - Further discussion of legal proceedings, if any, is provided in Note P of the Notes to Consolidated Financial Statements[108] Item 4. Mine Safety Disclosures This item is not applicable to Paychex - This item is not applicable[109] PART II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Paychex common stock trades on NASDAQ ('PAYX'), paying quarterly dividends to 8,698 holders as of June 30, 2023. A $400.0 million share repurchase program, with $327.1 million remaining, was approved in July 2021, expiring January 31, 2024, with no repurchases in fiscal 2023 - Paychex common stock trades on the NASDAQ Global Select Market under the symbol "PAYX", with dividends historically paid quarterly[112] Share Repurchase Program (as of May 31, 2023) | Program Approval Date | Authorization Amount | Expiration Date | Amount Remaining | | :-------------------- | :------------------- | :-------------- | :--------------- | | July 2021 | $400.0 million | Jan 31, 2024 | $327.1 million | Five-Year Cumulative Total Returns (Investing $100 on May 31, 2018) | May 31, | 2018 | 2019 | 2020 | 2021 | 2022 | 2023 | | :--------- | :------ | :------ | :------ | :------ | :------ | :------ | | Paychex | $100.00 | $135.05 | $117.46 | $169.33 | $212.24 | $184.89 | | S&P 500 | $100.00 | $103.77 | $117.08 | $164.26 | $163.75 | $168.48 | | Peer Group | $100.00 | $117.55 | $131.60 | $169.26 | $158.04 | $160.00 | Item 6. [Reserved] This item is reserved and contains no information - This item is reserved[119] Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations This section reviews Paychex's fiscal 2023 operating results and financial condition, showing 9% total revenue growth to $5,007.1 million and 12% net income growth to $1,557.3 million, driven by client base, pricing, product attachment, and higher interest rates - Paychex is a leading provider of integrated human capital management (HCM) solutions for human resources (HR), payroll, benefits, and insurance for small- to medium-sized businesses across the United States and parts of Europe[122] - The company's strategy focuses on providing industry-leading, integrated technology; delivering superior customer experiences; expanding its leadership in HR; growing its client bases; and engaging in strategic acquisitions[125] - Paychex maintains industry-leading margins by managing personnel costs and expenses while continuing to invest in its business, particularly in sales and marketing and leading-edge technology[126] Overview Paychex provides integrated HCM solutions (HR, payroll, benefits, insurance) to small- to medium-sized businesses in the U.S. and Europe, offering flexible SaaS-based solutions and HR outsourcing, achieving high client satisfaction and retention - Paychex's portfolio of technology, HR advisory, and employee benefits-related solutions is disaggregated into two categories: Management Solutions and Professional Employer Organization (PEO) and Insurance Solutions[124] - Ongoing investments in platforms have prepared Paychex for current business and regulatory environments, allowing it to adapt while maintaining strong solutions and support delivery, resulting in high levels of client satisfaction and retention[127] Fiscal 2023 Business Highlights For fiscal 2023, Paychex reported 8% service revenue growth to $4,907.3 million, 9% total revenue growth to $5,007.1 million, 10% operating income growth to $2,033.1 million, 12% net income growth to $1,557.3 million, and 18% dividend growth to $1,175.0 million Fiscal Year 2023 Business Highlights (vs. Fiscal 2022) | In millions, except per share amounts | 2023 | 2022 | Change (%) | | :---------------------------------- | :------- | :------- | :--------- | | Total service revenue | $4,907.3 | $4,554.0 | 8 % | | Total revenue | $5,007.1 | $4,611.7 | 9 % | | Operating income | $2,033.1 | $1,840.0 | 10 % | | Net income | $1,557.3 | $1,392.8 | 12 % | | Diluted earnings per share | $4.30 | $3.84 | 12 % | | Dividends paid to stockholders | $1,175.0 | $999.6 | 18 % | - Dividends paid to stockholders represented approximately 75% of net income for fiscal 2023, compared to approximately 72% for fiscal 2022[129] Business Outlook As of May 31, 2023, Paychex's payroll and PEO client base was approximately 740,000, with 82% to 83% client retention. Technology investments remain a priority, with HR solutions seeing 10% growth in worksite employees and 8% in clients Selected HR Solution Offerings (as of May 31) | As of May 31, | 2023 | 2022 | Change (%) | | :------------------------------------------------ | :-------- | :-------- | :--------- | | Paychex HR Solutions and PEO client worksite employees | 2,168,000 | 1,977,000 | 10 % | | Paychex HR Solutions and PEO clients | 71,000 | 66,000 | 8 % | | Retirement services plans | 113,000 | 104,000 | 9 % | - Client retention remained high in the range of 82% to 83% of the beginning client base for fiscal 2023, compared to approximately 84% for fiscal 2022[130] - Paychex continues to make investments in technology a priority, with fiscal 2023 enhancements to the Paychex Flex platform designed to improve client and employee experiences from hiring and onboarding through employee retention[131] Results of Operations In fiscal 2023, total revenue grew 9% to $5,007.1 million, with Management Solutions up 8% and PEO/Insurance up 6%. Interest on client funds surged 73% to $99.8 million. Operating income rose 10% to $2,033.1 million, achieving a 40.6% operating margin, and net income increased 12% to $1,557.3 million Summary of Results of Operations for Fiscal Years (in millions, except per share amounts) | In millions, except per share amounts | 2023 | 2022 | Change (%) | | :---------------------------------- | :------- | :------- | :--------- | | Revenue: | | | | | Management Solutions | $3,730.5 | $3,442.7 | 8 % | | PEO and Insurance Solutions | $1,176.8 | $1,111.3 | 6 % | | Total service revenue | $4,907.3 | $4,554.0 | 8 % | | Interest on funds held for clients | $99.8 | $57.7 | 73 % | | Total revenue | $5,007.1 | $4,611.7 | 9 % | | Total expenses | $2,974.0 | $2,771.7 | 7 % | | Operating income | $2,033.1 | $1,840.0 | 10 % | | Net income | $1,557.3 | $1,392.8 | 12 % | | Diluted earnings per share | $4.30 | $3.84 | 12 % | - Management Solutions revenue increased by 8% due to growth in clients and employees, pricing realization, product attachment (including HR Solutions, retirement, and time and attendance solutions), and continued growth in HCM ancillary services[134] - Interest on funds held for clients increased by 73% primarily due to higher average interest rates and higher average investment balances, partially offset by realized losses on investment sales[134] Operating Margin | | Fiscal Year 2023 | Fiscal Year 2022 | | :-------------------- | :--------------- | :--------------- | | Operating Margin | 40.6 % | 39.9 % | Non-GAAP Financial Measures Paychex presents adjusted net income, adjusted diluted EPS, and EBITDA as non-GAAP measures. For fiscal 2023, adjusted net income grew 13% to $1,548.4 million, adjusted diluted EPS rose 13% to $4.27, and EBITDA increased 8% to $2,212.4 million Non-GAAP Financial Measures (in millions, except per share amounts) | $ in millions | 2023 | 2022 | Change (%) | | :-------------------------------- | :------- | :------- | :--------- | | Net income | $1,557.3 | $1,392.8 | 12 % | | Adjusted net income | $1,548.4 | $1,367.8 | 13 % | | Diluted earnings per share | $4.30 | $3.84 | 12 % | | Adjusted diluted earnings per share | $4.27 | $3.77 | 13 % | | EBITDA | $2,212.4 | $2,050.1 | 8 % | - Non-GAAP adjustments for adjusted net income and diluted EPS primarily include excess tax benefits related to employee stock-based compensation payments and a non-recurring tax benefit derived from prior years' research and development costs[142] Liquidity and Capital Resources Paychex maintained a strong financial position as of May 31, 2023, with $1.6 billion in cash/investments and $808.4 million in net borrowings. Operating cash flows of $1.7 billion in fiscal 2023 supported operations and $1.2 billion in dividends, with future needs expected to be met - As of May 31, 2023, Paychex's financial position remained strong with cash, restricted cash, and total corporate investments of $1.6 billion[143] - Cash flows from operations were $1.7 billion for fiscal 2023, which allowed the company to support its business and pay dividends of approximately $1.2 billion[143] - The company anticipates that current cash, projected operating cash flows, and available short-term financing will support business operations, capital purchases, share repurchases, and dividend payments for the foreseeable future[143] Financing Paychex uses committed credit facilities for short-term funding, with $10.2 million outstanding and $1,989.8 million available as of May 31, 2023. It also holds $800.0 million in long-term Senior Notes and $141.7 million in standby letters of credit Credit Facilities (as of May 31, 2023, in millions) | Credit Facility | Expiration Date | Maximum Amount Available | Outstanding Amount | Available Amount | | :----------------- | :-------------- | :----------------------- | :----------------- | :--------------- | | 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, 2026 | $250.0 | $10.2 | $239.8 | | Total | | | $10.2 | $1,989.8 | - The maturity date of the $250 million PNC credit facility was extended from February 6, 2023, to February 6, 2026[151] Long-term Private Placement Debt (Senior Notes) | Note Series | Stated interest rate | Effective interest rate | Principal payment dates | | :---------- | :------------------- | :---------------------- | :---------------------- | | Series A | 4.07% | 4.14% | March 13, 2026 | | Series B | 4.25% | 4.31% | March 13, 2029 | Other commitments Paychex has $424.7 million in long-term contractual obligations as of May 31, 2023, including leases, purchase obligations, workers' compensation, and Senior Notes debt. It also has a $30.0 million commitment to venture capital funds, with $22.2 million contributed Long-term Contractual Obligations (as of May 31, 2023, in millions) | Obligation Type | Amount | | :---------------------------------------- | :----------- | | Operating leases | $81.7 | | Purchase obligations | $228.9 | | Workers' compensation estimated obligations | $195.8 | | Long-term Senior Notes debt obligations | $800.0 | | Interest payments on Senior Notes | $150.8 | - Paychex has committed to contribute a maximum of $30.0 million to three venture capital fund arrangements, with $22.2 million contributed as of May 31, 2023[158] - The liability for uncertain tax positions, including interest and net of federal benefits, was approximately $69.4 million as of May 31, 2023[157] Operating, Investing, and Financing Cash Flow Activities For fiscal 2023, net cash from operating activities increased by $193.9 million to $1,699.4 million. Net cash from investing activities improved to $218.5 million (from a $1,420.9 million use). Net cash used in financing decreased by $267.9 million to $711.4 million Cash Flow Activities (in millions) | In millions | 2023 | 2022 | Change | | :---------------------------------------- | :--------- | :--------- | :--------- | | Net cash provided by operating activities | $1,699.4 | $1,505.5 | $193.9 | | Net cash provided by/(used in) investing activities | $218.5 | $(1,420.9) | $1,639.4 | | Net cash used in financing activities | $(711.4) | $(979.3) | $267.9 | | Net change in cash, restricted cash, and equivalents | $1,206.5 | $(894.7) | $2,101.2 | - Net cash provided by operating activities increased due to higher net income and changes in funding for temporary staffing clients[162] - Net cash provided by investing activities increased significantly due to higher net proceeds from sales of AFS securities and a decrease in cash payments for business acquisitions[162] - Net cash used in financing activities decreased due to increased cash inflows from changes in client fund obligations and no common share repurchases in fiscal 2023, partially offset by an increase in dividends paid ($3.26 per share in FY2023 vs. $2.77 in FY2022)[166][161] Other This section briefly mentions recently issued accounting pronouncements, directing readers to Note A of the financial statements for further discussion - Recently issued accounting pronouncements are discussed in Note A of the Notes to Consolidated Financial Statements[166] Critical Accounting Policies and Estimates This section outlines Paychex's critical accounting policies and estimates, requiring significant judgment in revenue recognition, contract costs, PEO insurance reserves, goodwill/intangible asset impairment, stock-based compensation, and income taxes - Revenue recognition policies detail how fees for services and investment income on funds held for clients are recognized, with PEO Solutions revenue reported net of certain pass-through costs[168][170][171] - Paychex capitalizes incremental costs to obtain and fulfill client contracts, such as sales commissions and implementation activities, amortizing them using an accelerated method over an eight-year life[172][173] - PEO insurance reserves for workers' compensation and health insurance are established based on independent actuarial estimates, which are complex and subject to change due to factors like historical loss experience, economic trends, and legal liability changes[174][175][176] - Goodwill and intangible assets with indefinite useful lives are tested annually for impairment using qualitative or quantitative assessments, with no impairment loss recognized in fiscal 2023 or 2022[177][178] - Stock-based compensation costs are recognized based on fair values measured at the grant date, using a Black-Scholes option pricing model for stock options and stock price for awards, requiring significant judgment for assumptions like expected volatility and option life[181][184] - Income taxes involve recognizing deferred tax assets and liabilities and maintaining a reserve for uncertain tax positions, which requires assumptions and judgment to determine if tax positions are more-likely-than-not to be sustained[186][187] Item 7A. Quantitative and Qualitative Disclosures About Market Risk Paychex faces market risks from interest rate changes affecting investments and credit risk. Rising rates in fiscal 2023 increased the average rate earned to 2.7% (from 1.1%) but led to $175.3 million in net unrealized losses on AFS securities, while credit risk and banking market volatility are actively monitored - Paychex is exposed to changes in interest rates that may materially affect its results of operations and financial position, primarily through its funds held for clients and corporate investment portfolios[189] - The average interest rate earned on combined funds held for clients and corporate cash equivalents and investment portfolios was 2.7% for fiscal 2023, compared to 1.1% for fiscal 2022[191] - The total investment portfolio averaged approximately $5.9 billion for fiscal 2023, with combined funds held for clients and corporate available-for-sale (AFS) securities reflecting net unrealized losses of $175.3 million as of May 31, 2023[197][198] Market Risk Factors Paychex's market risk factors include interest rate changes, credit risk, and market volatility. Client and corporate funds are invested in high-quality fixed income securities, with rising rates increasing short-term earnings but causing net unrealized losses on AFS securities, while credit risk is managed through monitoring - Paychex invests predominately in high credit quality securities (AA or higher) such as municipal bonds, corporate bonds, U.S. government agency securities, and Variable Rate Demand Notes (VRDNs), with an investment strategy focused on protecting principal and optimizing liquidity[189] - A hypothetical 25-basis-point change in short-term interest rates would generally affect after-tax earnings by approximately $4.0 million to $4.5 million for a twelve-month period[196] - As of May 31, 2023, AFS securities had net unrealized losses of $175.3 million, which the company believes were due to changes in interest rates and not increased credit risk, with no intent to sell these investments until recovery or maturity[198][202] Item 8. Financial Statements and Supplementary Data This section presents Paychex's audited consolidated financial statements for fiscal years ended May 31, 2023, 2022, and 2021, including statements of income, balance sheets, equity, and cash flows, with detailed notes, Schedule II, and internal control/auditor reports - This section includes the audited consolidated financial statements for the fiscal years ended May 31, 2023, 2022, and 2021, prepared in conformity with U.S. GAAP[215][216][228][231][232][234] - Management assessed the effectiveness of the company's internal control over financial reporting as of May 31, 2023, and determined it was effective[211] - PricewaterhouseCoopers LLP issued an unqualified opinion on the consolidated financial statements and the effectiveness of the company's internal control over financial reporting as of May 31, 2023[216] Report on Management's Assessment of Internal Control Over Financial Reporting Management of Paychex, Inc. is responsible for establishing and maintaining effective internal control over financial reporting, concluding it was effective as of May 31, 2023, based on the COSO framework (2013) - Management is responsible for establishing and maintaining adequate internal control over financial reporting and assessed its effectiveness as of May 31, 2023[209][211] - Based on the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in "Internal Control — Integrated Framework" (2013), management determined that Paychex maintained effective internal control over financial reporting as of May 31, 2023[211] Report of Independent Registered Public Accounting Firm PricewaterhouseCoopers LLP issued an unqualified opinion on Paychex's consolidated financial statements and internal control over financial reporting as of May 31, 2023, noting PEO insurance reserves for workers' compensation as a critical audit matter - PricewaterhouseCoopers LLP issued an unqualified opinion on Paychex's consolidated financial statements for the three years ended May 31, 2023, and on the effectiveness of its internal control over financial reporting as of May 31, 2023[216] - A critical audit matter identified was the significant judgment used by management in determining PEO insurance reserves for workers' compensation, which required a high degree of auditor judgment, subjectivity, and effort[223] Consolidated Statements of Income and Comprehensive Income For fiscal 2023, Paychex reported total revenue of $5,007.1 million (up from $4,611.7 million in 2022), net income of $1,557.3 million (up from $1,392.8 million), and diluted EPS of $4.30 (up from $3.84) Consolidated Statements of Income and Comprehensive Income (in millions, except per share amounts) | Year ended May 31, | 2023 | 2022 | 2021 | | :-------------------------------- | :------- | :------- | :------- | | Total service revenue | $4,907.3 | $4,554.0 | $3,997.5 | | Interest on funds held for clients | $99.8 | $57.7 | $59.3 | | Total revenue | $5,007.1 | $4,611.7 | $4,056.8 | | Total expenses | $2,974.0 | $2,771.7 | $2,596.1 | | Operating income | $2,033.1 | $1,840.0 | $1,460.7 | | Net income | $1,557.3 | $1,392.8 | $1,097.5 | | Diluted earnings per share | $4.30 | $3.84 | $3.03 | Consolidated Balance Sheets As of May 31, 2023, Paychex reported total assets of $10,546.4 million (up from $9,635.2 million in 2022), with cash/equivalents at $1,222.0 million. Total liabilities were $7,053.2 million, and stockholders' equity was $3,493.2 million Consolidated Balance Sheets (in millions) | As of May 31, | 2023 | 2022 | | :-------------------------------- | :--------- | :--------- | | Total assets | $10,546.4 | $9,635.2 | | Cash and cash equivalents | $1,222.0 | $370.0 | | Funds held for clients | $4,118.8 | $3,682.9 | | Total liabilities | $7,053.2 | $6,550.0 | | Total stockholders' equity | $3,493.2 | $3,085.2 | Consolidated Statements of Stockholders' Equity For fiscal 2023, Paychex's total stockholders' equity increased to $3,493.2 million (from $3,085.2 million in 2022), driven by $1,557.3 million net income, partially offset by $1,175.5 million in dividends declared Consolidated Statements of Stockholders' Equity (in millions) | Balance as of May 31, | 2023 | 2022 | 2021 | | :-------------------- | :------- | :------- | :------- | | Total Stockholders' Equity | $3,493.2 | $3,085.2 | $2,948.0 | | Net income | $1,557.3 | $1,392.8 | $1,097.5 | | Dividends declared | $(1,175.5) | $(1,000.1) | $(908.7) | | Repurchases of common shares | $— | $(145.2) | $(155.7) | - Dividends declared per share increased to $3.26 in fiscal 2023 from $2.77 in fiscal 2022[232] Consolidated Statements of Cash Flows For fiscal 2023, net cash from operating activities was $1,699.4 million (up from $1,505.5 million in 2022). Net cash from investing activities was $218.5 million (from a $1,420.9 million use). Net cash used in financing was $711.4 million (down from $979.3 million) Consolidated Statements of Cash Flows (in millions) | Year ended May 31, | 2023 | 2022 | 2021 | | :---------------------------------------- | :--------- | :--------- | :--------- | | Net cash provided by operating activities | $1,699.4 | $1,505.5 | $1,260.3 | | Net cash provided by/(used in) investing activities | $218.5 | $(1,420.9) | $(460.6) | | Net cash used in financing activities | $(711.4) | $(979.3) | $(636.4) | | Net change in cash, restricted cash, and equivalents | $1,206.5 | $(894.7) | $163.3 | | Cash, restricted cash, and equivalents, end of fiscal year | $2,134.9 | $928.4 | $1,823.1 | Notes to Consolidated Financial Statements This section provides detailed notes to the consolidated financial statements, covering significant accounting policies, revenue recognition, EPS, income/expense, stock-based compensation, investments, fair value, leases, assets, taxes, financing, cash flow, benefits, and contingencies - Paychex, Inc. and its wholly owned subsidiaries report as one segment, with substantially all of the company's revenue generated within the U.S.[236] - The notes detail significant accounting policies for revenue recognition, disaggregating service revenue into Management Solutions and PEO and Insurance Solutions, and explaining how fees and investment income are recognized[285][286][287][289] - Significant disclosures include the composition and fair value of funds held for clients and corporate investments, details of stock-based compensation plans, and information on short-term and long-term debt agreements[317][328][307][310][313][354][363] Note A — Description of Business, Basis of Presentation, and Significant Accounting Policies This note describes Paychex as a leading integrated HCM solutions provider, outlining the basis of consolidated financial statements and significant accounting policies for cash, receivables, investments, assets, revenue, expenses, PEO reserves, leases, stock-based compensation, and income taxes - Paychex is a leading provider of integrated human capital management (HCM) solutions for small- to medium-sized businesses in the U.S. and parts of Europe, reporting as one segment[235][236] - Significant accounting policies include the valuation of available-for-sale (AFS) securities at fair value, capitalization of software development costs, annual impairment testing for goodwill and indefinite-lived intangible assets, and recognition of PEO insurance reserves based on independent actuarial estimates[247][251][252][253][264] - Revenue recognition policies cover fees for services and investment income earned on funds held for clients, with PEO Solutions revenue reported net of certain pass-through costs like payroll wages and taxes[256][258][259] Note B — Service Revenue Service revenue is primarily from Management Solutions and PEO/Insurance Solutions, recognized over time, with PEO revenue reported net of pass-through costs. Deferred revenue for material rights is amortized over 3-4 years, and capitalized contract costs over eight years - Service revenue is disaggregated by Management Solutions and PEO and Insurance Solutions, reflecting how the nature, amount, timing, and uncertainty of revenue and cash flows are affected by economic factors[286] - PEO Solutions revenue is reported net of certain pass-through costs, which included $26,025.3 million for payroll wages and payroll taxes and $656.3 million for guaranteed cost benefit plans in fiscal 2023[289][290] Changes in Deferred Revenue related to Material Rights (in millions) | In millions | 2023 | 2022 | | :-------------------------- | :---- | :---- | | Balance, beginning of period | $48.9 | $40.2 | | Deferral of revenue | $42.1 | $35.0 | | Recognition of unearned revenue | $(29.0) | $(26.3) | | Balance, end of period | $62.0 | $48.9 | Changes in Deferred Costs to Obtain Contracts (in millions) | In millions | 2023 | 2022 | | :-------------------------- | :---- | :---- | | Balance, beginning of period | $550.2 | $488.2 | | Capitalization of costs | $240.5 | $239.1 | | Amortization | $(193.2) | $(177.1) | | Balance, end of period | $597.5 | $550.2 | Note C — Basic and Diluted Earnings Per Share This note details basic and diluted EPS calculations. For fiscal 2023, basic EPS was $4.32 (360.4 million shares) and diluted EPS was $4.30 (362.3 million shares, assuming dilution) Basic and Diluted Earnings Per Share (in millions, except per share amounts) | In millions, except per share amounts | 2023 | 2022 | 2021 | | :---------------------------------- | :------- | :------- | :------- | | Net income | $1,557.3 | $1,392.8 | $1,097.5 | | Weighted-average common shares outstanding | 360.4 | 360.6 | 359.9 | | Basic earnings per share | $4.32 | $3.86 | $3.05 | | Weighted-average common shares outstanding, assuming dilution | 362.3 | 363.1 | 362.1 | | Diluted earnings per share | $4.30 | $3.84 | $3.03 | Note D — Other Income/(Expense), Net Other income/(expense), net, for fiscal 2023 was $15.1 million, a significant increase from $(15.4) million in fiscal 2022, primarily due to higher interest income on corporate investments ($49.1 million vs. $2.9 million) Other Income/(Expense), Net (in millions) | In millions | 2023 | 2022 | 2021 | | :-------------------------------- | :---- | :----- | :----- | | Interest income on corporate investments | $49.1 | $2.9 | $2.3 | | Interest expense | $(36.7) | $(36.6) | $(35.8) | | Other | $2.7 | $18.3 | $7.0 | | Other income/(expense), net | $15.1 | $(15.4) | $(26.5) | Note E — Stock-Based Compensation Plans Paychex recognizes stock-based compensation for awards under its 2002 Stock Incentive Plan, with $62.6 million expense in fiscal 2023 and $97.5 million unrecognized costs, granting options and RSUs valued using Black-Scholes or market price - Stock-based compensation expense was $62.6 million for fiscal 2023, and the total unrecognized compensation cost related to all unvested stock-based awards was $97.5 million, expected to be recognized over a weighted-average period of 2.7 years[304] Stock Option Activity for Fiscal 2023 (in millions, except per share amounts) | | Shares subject to options | Weighted-average exercise price per share | | :------------------------------ | :------------------------ | :-------------------------------------- | | Outstanding as of May 31, 2022 | 3.3 | $70.68 | | Granted | 0.3 | $114.65 | | Exercised | (0.2) | $68.87 | | Forfeited | (0.1) | $115.00 | | Outstanding as of May 31, 2023 | 3.3 | $74.09 | RSU Activity for Fiscal 2023 (in millions, except per share amounts) | | Time-Based RSUs | Weighted-average grant-date fair value per share | Performance-based RSUs | Weighted-average grant-date fair value per share | | :------------------------------ | :-------------- | :----------------------------------------------- | :--------------------- | :----------------------------------------------- | | Nonvested as of May 31, 2022 | 1.3 | $80.60 | 0.1 | $92.33 | | Granted | 0.6 | $127.75 | 0.1 | $108.31 | | Vested | (0.4) | $73.88 | (0.1) | $80.59 | | Forfeited | (0.1) | $99.79 | (0.0) | $108.86 | | Nonvested as of May 31, 2023 | 1.4 | $102.13 | 0.1 | $107.88 | Note F — Funds Held for Clients and Corporate Investments This note details Paychex's client funds and corporate investments, primarily AFS securities. As of May 31, 2023, total investments were $4,496.0 million, with AFS securities at $3,604.6 million, showing $175.3 million net unrealized losses due to interest rate changes, not credit risk Funds Held for Clients and Corporate Investments (as of May 31, 2023, in millions) | Type of issue | Amortized cost | Gross unrealized gains | Gross unrealized losses | Fair value | | :---------------------------------------------- | :------------- | :--------------------- | :---------------------- | :--------- | | Funds held for clients' money market securities and other restricted cash equivalents | $863.1 | $— | $— | $863.1 | | AFS securities: | | | | | | Asset-backed securities | $88.1 | $— | $(1.4) | $86.7 | | Corporate bonds | $1,468.3 | $3.7 | $(31.1) | $1,440.9 | | Municipal bonds | $1,091.3 | $0.1 | $(105.3) | $986.1 | | U.S. government agency and treasury securities | $788.1 | $0.3 | $(41.6) | $746.8 | | Variable rate demand notes | $344.1 | $— | $— | $344.1 | | Total AFS securities | $3,779.9 | $4.1 | $(179.4) | $3,604.6 | | Other | $30.1 | $1.1 | $(2.9) | $28.3 | | Total funds held for clients and corporate investments | $4,673.1 | $5.2 | $(182.3) | $4,496.0 | - The company's AFS securities reflected net unrealized losses of $175.3 million as of May 31, 2023, with 967 securities in an unrealized loss position, representing approximately 88% of total securities held[322] - Paychex believes the unrealized losses on its AFS securities were due to changes in interest rates and not increased credit risk, and it does not intend to sell these investments until the recovery of their amortized cost basis or maturity[323] Note G — Fair Value Measurements This note defines fair value and its three-level hierarchy. Paychex's financial assets, primarily AFS securities and cash equivalents, are mostly Level 2 (independent pricing service), with some Level 1 (money market/mutual funds). Long-term borrowings are at historical cost, with Level 2 fair value estimates - Fair value measurements are categorized into a three-level hierarchy: Level 1 (quoted prices in active markets for identical instruments), Level 2 (observable inputs other than Level 1 quoted prices), and Level 3 (unobservable inputs)[326] Financial Assets Measured at Fair Value on a Recurring Basis (as of May 31, 2023, in millions) | In millions | Carrying value (Fair value) | Quoted prices in active markets (Level 1) | Significant other observable inputs (Level 2) | Significant unobservable inputs (Level 3) | | :---------------------------------------- | :-------------------------- | :---------------------------------------- | :-------------------------------------------- | :---------------------------------------- | | Restricted and unrestricted cash equivalents: | | | | | | Money market securities | $43.8 | $43.8 | $— | $— | | AFS securities: | | | | | | Asset-backed securities | $86.7 | $— | $86.7 | $— | | Corporate bonds | $1,440.9 | $— | $1,440.9 | $— | | Municipal bonds | $986.1 | $— | $986.1 | $— | | U.S. government agency and treasury securities | $746.8 | $— | $746.8 | $— | | VRDNs | $344.1 | $— | $344.1 | $— | | Other | $28.3 | $28.3 | $— | $— | - AFS securities are included in Level 2 and are valued utilizing inputs obtained from an independent pricing service, which uses a variety of observable inputs such as benchmark yields, reported trades, and broker/dealer quotes[330] Note H — Leases Paychex's lease portfolio consists primarily of operating leases for office space. As of May 31, 2023, operating lease ROU assets were $61.5 million, liabilities were $77.6 million, with a 4.7-year weighted-average remaining term and 2.21% discount rate. Fixed lease expense was $20.8 million in fiscal 2023 Supplemental Balance Sheet Information Related to Leases (as of May 31, in millions) | $ in millions | 2023 | 2022 | | :------------------------------------------------ | :---- | :---- | | Operating lease right-of-use assets, net of accumulated amortization | $61.5 | $78.7 | | Operating lease liabilities, current | $20.3 | $25.1 | | Operating lease liabilities, non-current | $57.3 | $74.8 | | Weighted average remaining lease term (in year