UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549 

_________________________________________



FORM 10Q

_________________________________________



QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934



For the quarterly period ended August 31, 2016 



Commission file number 0-11330

_________________________________________



PAYCHEX, INC.

_________________________________________



911 Panorama Trail South

Rochester, New York 14625-2396

(585) 385-6666

A Delaware Corporation



IRS Employer Identification Number: 16-1124166

_________________________________________



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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).    Yes      No  



Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):





 

 

 

Large accelerated filer

Accelerated filer

Non-accelerated filer

 (Do not check if a smaller reporting company)

Smaller reporting company



Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes      No  



The number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:





 

 

 

 

 



Common Stock, $0.01 Par Value

 

361,651,474 

  Shares

 



CLASS

 

OUTSTANDING AS OF 

August 31, 2016

 

 



 


 

PAYCHEX, INC.

Table of Contents





 

 



 

Page

PART I. FINANCIAL INFORMATION

 

Item 1.

Financial Statements



Consolidated Statements of Income and Comprehensive Income 



Consolidated Balance Sheets



Consolidated Statements of Cash Flows



Notes to Consolidated Financial Statements

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

14 

Item 3.

Quantitative and Qualitative Disclosures of Market Risk

28 

Item 4.

Controls and Procedures

28 

PART II. OTHER INFORMATION

29 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

29 

Item 6.

Exhibits

29 

Signatures

30 

Index to Exhibits

31 



 



 


 

Table 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,



 

2016

 

2015

Revenue:

 

 

 

 

 

 

Service revenue

 

$

773.5 

 

$

712.2 

Interest on funds held for clients

 

 

12.0 

 

 

10.8 

Total revenue

 

 

785.5 

 

 

723.0 

Expenses:

 

 

 

 

 

 

Operating expenses

 

 

225.1 

 

 

205.7 

Selling, general and administrative expenses

 

 

237.4 

 

 

221.2 

Total expenses

 

 

462.5 

 

 

426.9 

Operating income

 

 

323.0 

 

 

296.1 

Investment income, net

 

 

1.5 

 

 

1.4 

Income before income taxes

 

 

324.5 

 

 

297.5 

Income taxes

 

 

107.1 

 

 

88.4 

Net income

 

$

217.4 

 

$

209.1 



 

 

 

 

 

 

Other comprehensive income, net of tax:

 

 

 

 

 

 

Unrealized gains on securities, net of tax

 

 

10.0 

 

 

6.3 

Total other comprehensive income, net of tax

 

 

10.0 

 

 

6.3 

Comprehensive income

 

$

227.4 

 

$

215.4 



 

 

 

 

 

 

Basic earnings per share

 

$

0.60 

 

$

0.58 

Diluted earnings per share

 

$

0.60 

 

$

0.58 

Weighted-average common shares outstanding

 

 

361.0 

 

 

361.1 

Weighted-average common shares outstanding,
    assuming dilution

 

 

364.1 

 

 

362.8 

Cash dividends per common share

 

$

0.46 

 

$

0.42 



See Notes to Consolidated Financial Statements.

 

1

 


 

Table of Contents

 

PAYCHEX, INC.

CONSOLIDATED BALANCE SHEETS (UNAUDITED)

In millions, except per share amount







 

 

 

 

 

 



 

 

 

 

 

 



 

August 31,

 

May 31,



 

2016

 

2016

Assets

 

 

 

 

 

 

Cash and cash equivalents

 

$

130.0 

 

$

131.5 

Corporate investments

 

 

367.7 

 

 

220.6 

Interest receivable

 

 

31.7 

 

 

36.1 

Accounts receivable, net of allowance for doubtful accounts

 

 

485.6 

 

 

408.6 

Prepaid income taxes

 

 

 —

 

 

10.5 

Prepaid expenses and other current assets

 

 

62.7 

 

 

58.8 

Current assets before funds held for clients

 

 

1,077.7 

 

 

866.1 

Funds held for clients

 

 

3,443.3 

 

 

3,997.5 

Total current assets

 

 

4,521.0 

 

 

4,863.6 

Long-term corporate investments

 

 

446.3 

 

 

441.1 

Property and equipment, net of accumulated depreciation

 

 

348.4 

 

 

353.0 

Intangible assets, net of accumulated amortization

 

 

65.0 

 

 

69.5 

Goodwill

 

 

657.1 

 

 

657.1 

Prepaid income taxes

 

 

24.9 

 

 

24.9 

Other long-term assets

 

 

34.2 

 

 

31.6 

Total assets

 

$

6,096.9 

 

$

6,440.8 

Liabilities

 

 

 

 

 

 

Accounts payable

 

$

51.2 

 

$

56.7 

Accrued compensation and related items

 

 

245.8 

 

 

247.8 

Accrued income taxes

 

 

65.6 

 

 

 —

Short-term borrowings

 

 

51.3 

 

 

 —

Deferred revenue

 

 

26.8 

 

 

26.3 

Other current liabilities

 

 

84.9 

 

 

79.8 

Current liabilities before client fund obligations

 

 

525.6 

 

 

410.6 

Client fund obligations

 

 

3,387.6 

 

 

3,955.3 

Total current liabilities

 

 

3,913.2 

 

 

4,365.9 

Accrued income taxes

 

 

82.1 

 

 

72.8 

Deferred income taxes

 

 

41.2 

 

 

22.1 

Other long-term liabilities

 

 

72.3 

 

 

68.3 

Total liabilities

 

 

4,108.8 

 

 

4,529.1 

Commitments and contingencies — Note J

 

 

 

 

 

 

Stockholders’ equity

 

 

 

 

 

 

Common stock, $0.01 par value; Authorized: 600.0 shares;
  Issued and outstanding:  361.7 shares as of August 31, 2016
   and 360.4 shares as of May 31, 2016, respectively.

 

 

3.6 

 

 

3.6 

Additional paid-in capital

 

 

986.4 

 

 

952.7 

Retained earnings

 

 

958.9 

 

 

926.2 

Accumulated other comprehensive income

 

 

39.2 

 

 

29.2 

Total stockholders’ equity

 

 

1,988.1 

 

 

1,911.7 

Total liabilities and stockholders’ equity

 

$

6,096.9 

 

$

6,440.8 



See Notes to Consolidated Financial Statements.

 

2

 


 

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PAYCHEX, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

In millions







 

 

 

 

 

 



 

 

 

 

 

 



 

For the three months ended



 

August 31,



 

2016

 

2015

Operating activities

 

 

 

 

 

 

Net income

 

$

217.4 

 

$

209.1 

Adjustments to reconcile net income to net cash provided by
   operating activities:

 

 

 

 

 

 

Depreciation and amortization on property and equipment and
   intangible assets

 

 

29.7 

 

 

27.0 

Amortization of premiums and discounts on available-for-sale securities

 

 

18.6 

 

 

19.4 

Stock-based compensation costs

 

 

9.1 

 

 

8.8 

Provision for deferred income taxes

 

 

14.1 

 

 

14.4 

Provision for allowance for doubtful accounts

 

 

1.2 

 

 

0.1 

Net realized gains on sales of available-for-sale securities

 

 

(0.1)

 

 

 —

Changes in operating assets and liabilities:

 

 

 

 

 

 

Interest receivable

 

 

4.4 

 

 

5.8 

Accounts receivable

 

 

(78.1)

 

 

(30.1)

Prepaid expenses and other current assets

 

 

6.6 

 

 

0.2 

Accounts payable and other current liabilities

 

 

60.9 

 

 

6.8 

Net change in other long-term assets and liabilities

 

 

10.9 

 

 

16.8 

Net cash provided by operating activities

 

 

294.7 

 

 

278.3 

Investing activities

 

 

 

 

 

 

Purchases of available-for-sale securities

 

 

(14,777.0)

 

 

(2,362.9)

Proceeds from sales and maturities of available-for-sale securities

 

 

14,920.3 

 

 

3,046.8 

Net change in funds held for clients’ money market securities and other
   cash equivalents

 

 

257.3 

 

 

100.7 

Purchases of property and equipment

 

 

(20.3)

 

 

(21.2)

Purchases of other assets

 

 

 —

 

 

(3.5)

Net cash provided by investing activities

 

 

380.3 

 

 

759.9 

Financing activities

 

 

 

 

 

 

Net change in client fund obligations

 

 

(567.8)

 

 

(533.3)

Proceeds from short-term borrowings

 

 

51.3 

 

 

 —

Dividends paid

 

 

(166.3)

 

 

(151.9)

Repurchases of common shares

 

 

 —

 

 

(62.9)

Activity related to equity-based plans

 

 

6.3 

 

 

(4.2)

Net cash used in financing activities

 

 

(676.5)

 

 

(752.3)

(Decrease)/increase in cash and cash equivalents

 

 

(1.5)

 

 

285.9 

Cash and cash equivalents, beginning of fiscal year

 

 

131.5 

 

 

170.0 

Cash and cash equivalents, end of fiscal year

 

$

130.0 

 

$

455.9 



See Notes to Consolidated Financial Statements.

 



 

3

 


 

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PAYCHEX, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

August 31, 2016 

 

Note A: Description of Business, Basis of Presentation, and Significant Accounting Policies



Description of business: Paychex, Inc. and its wholly owned subsidiaries (collectively, the “Company” or “Paychex”) is a leading provider of integrated human capital management solutions for payroll, human resource, retirement, and insurance services for small- to medium-sized businesses in the United States (“U.S.”). The Company also has operations in Germany.



Paychex, a Delaware corporation formed in 1979, reports as one segment. Substantially all of the Company’s revenue is generated within the U.S. The Company also generates revenue within Germany, which represented less than one percent of the Company's total revenue for each of the three months ended August 31, 2016 and 2015. Long-lived assets in Germany are insignificant in relation to total long-lived assets of the Company as of August 31, 2016 and May 31, 2016. In addition, the Company has equity method investments for a joint-venture in Brazil and a minority investment in a Canadian entity, neither of which is significant.



Basis of presentation: The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to the Quarterly Report on Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statement presentation. The consolidated financial statements include the consolidated accounts of the Company with all intercompany transactions eliminated. In the opinion of management, the information furnished herein reflects all adjustments (consisting of items of a normal recurring nature), which are necessary for a fair statement of the results for the interim period. These financial statements should be read in conjunction with the Company’s consolidated financial statements and related Notes to Consolidated Financial Statements presented in the Company’s Annual Report on Form 10-K (“Form 10-K”) as of and for the year ended May 31, 2016 (“fiscal 2016”). Operating results and cash flows for the three months ended August 31, 2016 (the “first quarter”) are not necessarily indicative of the results that may be expected for other interim periods or the full fiscal year ending May 31, 2017 (“fiscal 2017”).



Accounts Receivable, net of allowance for doubtful accounts:  Accounts receivable balances are shown on the Consolidated Balance Sheets net of the allowance for doubtful accounts of $4.7 million as of August 31, 2016 and $4.2 million as of May 31, 2016.  Accounts receivable balances, net of allowance for doubtful accounts, include:  1) trade receivables for services provided to clients of $280.2 million as of August 31, 2016 and $221.6 million as of May 31, 2016; and 2) purchased receivables related to payroll funding arrangements with clients in the temporary staffing industry of $205.4 million as of August 31, 2016 and $187.0 million as of May 31, 2016.



PEO insurance reserves: As part of the professional employer organization (“PEO”), the Company offers workers' compensation insurance and health insurance to client companies for the benefit of client employees. For workers' compensation insurance, reserves are established to provide for the estimated costs of paying claims underwritten by the Company. The Company’s maximum individual claims liability is $1.3 million under both its fiscal 2017 and fiscal 2016 policies.



Under the minimum premium plan health insurance offering within the PEO, the Company's health benefits insurance reserves are established to provide for the payment of claims liability charges in accordance with its service contract with the carrier. The Company's maximum individual claims liability is $0.3 million under both its calendar 2016 and 2015 policies.



Estimating the ultimate cost of future claims is an uncertain and complex process based upon historical loss experience and actuarial loss projections, and is subject to change due to multiple factors, including economic trends, changes in legal liability law, and damage awards, all of which could materially impact the reserves as reported in the consolidated financial statements. Accordingly, final claim settlements may vary from the present estimates, particularly with workers' compensation insurance where those payments may not occur until well into the future. The Company regularly reviews the adequacy of its estimated insurance reserves. Adjustments to previously established reserves are reflected in the results of operations for the period in which such adjustments are identified. Such adjustments could be significant, reflecting any combination of new and adverse or favorable trends.



Stock-based compensation costs: The Company has issued stock-based awards to employees and directors consisting of stock options, restricted stock awards, restricted stock units, performance shares, and performance stock options. The Company accounts for all stock-based awards to employees and directors as compensation costs in the consolidated financial statements based on the fair value measured as of the date of grant. These costs are recognized over the requisite service period. Stock-based compensation costs recognized were $9.1 million for the three months ended August 31, 2016 as compared with $8.8 million for the three months ended August 31, 2015. The methods and assumptions used in the determination of the fair value of stock-based awards are consistent with those described in the Company’s fiscal 2016 Form 10-K.



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Recently adopted accounting pronouncements: In June 2016, the Company early-adopted Accounting Standards Update (“ASU”) No. 2016-09, “Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting,” issued by the Financial Accounting Standards Board (“FASB”).  ASU No. 2016-09 simplifies several aspects of the accounting for share-based payment award transactions, including income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. 



Amendments related to accounting for excess tax benefits have been adopted prospectively, resulting in the recognition of $13.2 million of excess tax benefits within income taxes rather than additional paid in capital during the three months ended August 31, 2016.  This increased diluted earnings per share by approximately three and one-half cents per share for the period. Excess tax benefits related to share-based payments are now included in operating cash flows rather than financing cash flows.  This change has been applied prospectively in accordance with the ASU and prior periods have not been adjusted.  We have previously classified cash paid for tax withholding purposes as a financing activity in the statement of cash flows, therefore there is no change related to this requirement.  The amendments allow for a one-time accounting policy election to either account for forfeitures as they occur or continue to estimate forfeitures as required by current guidance.  The Company has elected to continue estimating forfeitures under the current guidance.



In June 2016, the Company adopted the following ASUs, none of which had a material impact on its consolidated financial statements:



·

ASU No. 2015-09, “Financial Services - Insurance (Topic 944): Disclosures about Short-Duration Contracts.”



·

ASU No. 2015-05, “Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement.”



·

ASU No. 2015-03, “Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs.”



·

ASU No. 2015-02, “Consolidation (Topic 810): Amendments to the Consolidation Analysis.” 



·

ASU No. 2015-01, “Income Statement - Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items.” 



Recently issued accounting pronouncements: In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments.” ASU No. 2016-15 clarifies and provides specific guidance on eight cash flow classification issues that are not currently addressed by current GAAP and thereby reduce the current diversity in practice.  ASU No. 2016-15 is effective for public business entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2017, with early application permitted. This guidance is applicable to the Company's fiscal year beginning June 1, 2018. The Company does not anticipate that this guidance will have a material impact on its consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842).” ASU No. 2016-02 improves transparency and comparability among companies by recognizing lease assets and lease liabilities on the balance sheet and by disclosing key information about leasing arrangements. ASU No. 2016-02 is effective for public business entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2018, with early application permitted. This guidance is applicable to the Company's fiscal year beginning June 1, 2019. The Company is currently evaluating this guidance to determine the potential impact on its consolidated financial statements.

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606).”  This guidance, as amended by subsequent ASUs on the topic, supersedes current guidance on revenue recognition in Topic 605, “Revenue Recognition.”  This guidance will be effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods. Early application of the guidance is permitted for annual reporting periods beginning after December 31, 2016.  This guidance is applicable to the Company's fiscal year beginning June 1, 2018.  The Company has substantially completed its initial analysis identifying the areas that will be impacted by the new guidance and is currently analyzing the impact to its consolidated financial statements.



Other recent authoritative guidance issued by the FASB (including technical corrections to the Accounting Standards Codification), the American Institute of Certified Public Accountants, and the Securities and Exchange Commission (“SEC”) did not, or are not expected to, have a material effect on the Company’s consolidated financial statements.  

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Note B: Basic and Diluted Earnings Per Share



Basic and diluted earnings per share were calculated as follows:







 

 

 

 

 

 



 

 

 

 

 

 



 

For the three months ended



 

August 31,

In millions, except per share amounts

 

2016

 

2015

Basic earnings per share:

 

 

 

 

 

 

Net income

 

$

217.4 

 

$

209.1 

Weighted-average common shares outstanding

 

 

361.0 

 

 

361.1 

Basic earnings per share

 

$

0.60 

 

$

0.58 

Diluted earnings per share:

 

 

 

 

 

 

Net income

 

$

217.4 

 

$

209.1 

Weighted-average common shares outstanding

 

 

361.0 

 

 

361.1 

Dilutive effect of common share equivalents

 

 

3.1 

 

 

1.7 

Weighted-average common shares outstanding, assuming dilution

 

 

364.1 

 

 

362.8 

Diluted earnings per share

 

$

0.60 

 

$

0.58 

Weighted-average anti-dilutive common share equivalents

 

 

0.5 

 

 

0.5 



Weighted-average common share equivalents that have an anti-dilutive impact are excluded from the computation of diluted earnings per share.



For the three months ended August 31, 2016 and 2015, 1.3 million and 0.7 million shares, respectively, of the Company’s common stock were issued in connection with the exercise or vesting of stock-based awards.



The Company currently maintains two stock repurchase programs: the first authorized in May 2014 and expiring May 31, 2017, the second authorized in July 2016 and expiring May 31, 2019.  Under each program, the Board of Directors has approved the repurchase of up to $350.0 million of the Company's common stock. The purpose of both programs is to manage common stock dilution.  During the three months ended August 31, 2016, the Company did not repurchase any of its common stock under either program. During the three months ended August 31, 2015, the Company repurchased 1.3 million shares for $62.9 million under the May 2014 plan. Shares repurchased were retired.

 



Note C: Investment Income, Net



Investment income, net, consisted of the following items:







 

 

 

 

 

 



 

 

 

 

 

 



 

For the three months ended



 

August 31,

In millions

 

2016

 

2015

Interest income on corporate funds

 

$

2.4 

 

$

1.9 

Interest expense

 

 

(0.7)

 

 

(0.2)

Net loss from equity-method investments

 

 

(0.2)

 

 

(0.3)

Investment income, net

 

$

1.5 

 

$

1.4 

 







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Note D: Funds Held for Clients and Corporate Investments



Funds held for clients and corporate investments are as follows:







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 



 

August 31, 2016



 

 

 

 

Gross

 

Gross

 

 

 



 

Amortized

 

unrealized

 

unrealized

 

Fair

In millions

 

cost

 

gains

 

losses

 

value

Type of issue:

 

 

 

 

 

 

 

 

 

 

 

 

Funds held for clients money market securities and other
   cash equivalents

 

$

245.2 

 

$

 —

 

$

 —

 

$

245.2 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

 

 

142.9 

 

 

4.7 

 

 

 —

 

 

147.6 

General obligation municipal bonds

 

 

1,559.0 

 

 

35.6 

 

 

(0.1)

 

 

1,594.5 

Pre-refunded municipal bonds(1)

 

 

58.1 

 

 

1.5 

 

 

 —

 

 

59.6 

Revenue municipal bonds

 

 

981.1 

 

 

21.1 

 

 

(0.1)

 

 

1,002.1 

U.S. government agency securities

 

 

219.1 

 

 

0.6 

 

 

(0.3)

 

 

219.4 

Variable rate demand notes

 

 

972.3 

 

 

 —

 

 

 —

 

 

972.3 

Total available-for-sale securities

 

 

3,932.5 

 

 

63.5 

 

 

(0.5)

 

 

3,995.5 

Other

 

 

15.6 

 

 

1.0 

 

 

 —

 

 

16.6 

Total funds held for clients and corporate investments

 

$

4,193.3 

 

$

64.5 

 

$

(0.5)

 

$

4,257.3 

  





 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 



 

May 31, 2016



 

 

 

 

Gross

 

Gross

 

 

 



 

Amortized

 

unrealized

 

unrealized

 

Fair

In millions

 

cost

 

gains

 

losses

 

value

Type of issue:

 

 

 

 

 

 

 

 

 

 

 

 

Funds held for clients money market securities and other
   cash equivalents

 

$

502.4 

 

$

 —

 

$

 —

 

$

502.4 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

 

 

128.4 

 

 

2.9 

 

 

(0.1)

 

 

131.2 

General obligation municipal bonds

 

 

1,594.1 

 

 

27.6 

 

 

(0.1)

 

 

1,621.6 

Pre-refunded municipal bonds(1)

 

 

60.2 

 

 

1.4 

 

 

 —

 

 

61.6 

Revenue municipal bonds

 

 

916.2 

 

 

15.8 

 

 

(0.2)

 

 

931.8 

U.S. government agency securities

 

 

160.8 

 

 

0.6 

 

 

(0.3)

 

 

161.1 

Variable rate demand notes

 

 

1,234.6 

 

 

 —

 

 

 —

 

 

1,234.6 

Total available-for-sale securities

 

 

4,094.3 

 

 

48.3 

 

 

(0.7)

 

 

4,141.9 

Other

 

 

14.2 

 

 

0.8 

 

 

(0.1)

 

 

14.9 

Total funds held for clients and corporate investments

 

$

4,610.9 

 

$

49.1 

 

$

(0.8)

 

$

4,659.2 



(1)

Pre-refunded municipal bonds are secured by an escrow fund of U.S. government obligations.



Included in money market securities and other cash equivalents as of August 31, 2016 are bank demand deposit accounts, short-term municipal bonds, and money market funds. As of May 31, 2016, money market securities and other cash equivalents included bank demand deposit accounts and money market funds.



Classification of investments on the Consolidated Balance Sheets is as follows:







 

 

 

 

 

 



 

 

 

 

 

 



 

August 31,

 

May 31,

In millions

 

2016

 

2016

Funds held for clients

 

$

3,443.3 

 

$

3,997.5 

Corporate investments

 

 

367.7 

 

 

220.6 

Long-term corporate investments

 

 

446.3 

 

 

441.1 

Total funds held for clients and corporate investments

 

$

4,257.3 

 

$

4,659.2 



7

 


 

Table of Contents

 

The Company’s available-for-sale securities reflected a net unrealized gain of $63.0 million as of August 31, 2016 compared with a net unrealized gain of $47.6 million as of May 31, 2016. Included in the net unrealized gain as of August 31, 2016 and May 31, 2016 were 49 and 63 available-for-sale securities in an unrealized loss position, respectively. The available-for-sale securities in an unrealized loss position were as follows:







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

August 31, 2016



 

Securities in an unrealized 
loss position for less than 
twelve months

 

Securities in an unrealized 
loss position for more than 
twelve months

 

Total



 

Gross

 

 

 

 

Gross

 

 

 

 

Gross

 

 

 



 

unrealized

 

Fair

 

unrealized

 

Fair

 

unrealized

 

Fair

In millions

 

losses

 

value

 

losses

 

value

 

losses

 

value

Type of issue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

 

$

 —

 

$

8.5 

 

$

 —

 

$

 —

 

$

 —

 

$

8.5 

General obligation municipal bonds

 

 

(0.1)

 

 

39.9 

 

 

 —

 

 

2.8 

 

 

(0.1)

 

 

42.7 

Revenue municipal bonds

 

 

(0.1)

 

 

22.6 

 

 

 —

 

 

1.1 

 

 

(0.1)

 

 

23.7 

U.S. government agency securities

 

 

(0.3)

 

 

89.3 

 

 

 —

 

 

 —

 

 

(0.3)

 

 

89.3 

Total

 

$

(0.5)

 

$

160.3 

 

$

 —

 

$

3.9 

 

$

(0.5)

 

$

164.2 

  





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

May 31, 2016



 

Securities in an unrealized 
loss position for less than 
twelve months

 

Securities in an unrealized 
loss position for more than 
twelve months

 

Total



 

Gross

 

 

 

 

Gross

 

 

 

 

Gross

 

 

 



 

unrealized

 

Fair

 

unrealized

 

Fair

 

unrealized

 

Fair

In millions

 

losses

 

value

 

losses

 

value

 

losses

 

value

Type of issue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

 

$

(0.1)

 

$

14.7 

 

$

 —

 

$

 —

 

$

(0.1)

 

$

14.7 

General obligation municipal bonds

 

 

(0.1)

 

 

48.9 

 

 

 —

 

 

2.8 

 

 

(0.1)

 

 

51.7 

Pre-refunded municipal bonds

 

 

 —

 

 

5.7 

 

 

 —

 

 

 —

 

 

 —

 

 

5.7 

Revenue municipal bonds

 

 

 —

 

 

20.7 

 

 

(0.2)

 

 

11.7 

 

 

(0.2)

 

 

32.4 

U.S. government agency securities

 

 

(0.3)

 

 

51.1 

 

 

 —

 

 

 —

 

 

(0.3)

 

 

51.1 

Total

 

$

(0.5)

 

$

141.1 

 

$

(0.2)

 

$

14.5 

 

$

(0.7)

 

$

155.6 



The Company regularly reviews its investment portfolios to determine if any investment is other-than-temporarily impaired due to changes in credit risk or other potential valuation concerns. The Company believes that the investments held as of August 31, 2016 that had unrealized losses of $0.5 million were not other-than-temporarily impaired. The Company believes that it is probable that the principal and interest will be collected in accordance with contractual terms, and that the unrealized losses on these securities were due to changes in interest rates and were not due to increased credit risk or other valuation concerns. A significant portion of the securities in an unrealized loss position as of August 31, 2016 and May 31, 2016 held an AA rating or better. The Company does not intend to sell these investments until the recovery of their amortized cost basis or maturity and further believes that it is not more-likely-than-not that it will be required to sell these investments prior to that time. The Company’s assessment that an investment is not other-than-temporarily impaired could change in the future due to new developments or changes in the Company’s strategies or assumptions related to any particular investment.



Realized gains and losses on the sales of securities are determined by specific identification of the amortized cost basis of each security. On the Consolidated Statements of Income and Comprehensive Income, realized gains and losses from funds held for clients are included in interest on funds held for clients and realized gains and losses from corporate investments are included in investment income, net. Realized gains were insignificant for each of the three months ended August 31, 2016 and 2015. There were no realized losses recognized in any of the respective periods.



8

 


 

Table of Contents

 

The amortized cost and fair value of available-for-sale securities that had stated maturities as of August 31, 2016 are shown below by contractual maturity. Expected maturities can differ from contractual maturities because borrowers may have the right to prepay obligations without prepayment penalties.







 

 

 

 

 

 



 

 

 

 

 

 



 

August 31, 2016



 

Amortized

 

Fair

In millions

 

cost

 

value

Maturity date:

 

 

 

 

 

 

Due in one year or less

 

$

371.1 

 

$

372.3 

Due after one year through three years

 

 

743.4 

 

 

753.0 

Due after three years through five years

 

 

889.1 

 

 

915.3 

Due after five years

 

 

1,928.9 

 

 

1,954.9 

Total

 

$

3,932.5 

 

$

3,995.5 



Variable rate demand notes 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.

 

Note E: Fair Value Measurements



Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price), in an orderly transaction between market participants at the measurement date. The accounting standards related to fair value measurements include a hierarchy for information and valuations used in measuring fair value that is broken down into three levels based on reliability, as follows:



·

Level 1 valuations are based on quoted prices in active markets for identical instruments that the Company can access at the measurement date.



·

Level 2 valuations are based on inputs other than quoted prices included in Level 1 that are observable for the instrument, either directly or indirectly, for substantially the full term of the asset or liability including the following:



·

quoted prices for similar, but not identical, instruments in active markets;



·

quoted prices for identical or similar instruments in markets that are not active;



·

inputs other than quoted prices that are observable for the instrument; or



·

inputs that are derived principally from or corroborated by observable market data by correlation or other means.



·

Level 3 valuations are based on information that is unobservable and significant to the overall fair value measurement.



The carrying values of cash and cash equivalents, accounts receivable, net of allowance for doubtful accounts, accounts payable and short-term borrowings approximate fair value due to the short maturities of these instruments. Marketable securities included in funds held for clients and corporate investments consist primarily of securities classified as available-for-sale and are recorded at fair value on a recurring basis.



9

 


 

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The Company’s financial assets and liabilities measured at fair value on a recurring basis were as follows:







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 



 

August 31, 2016



 

 

 

 

Quoted

 

Significant

 

 

 



 

 

 

 

prices in

 

other

 

Significant



 

Carrying

 

active

 

observable

 

unobservable



 

value

 

markets

 

inputs

 

inputs

In millions

 

(Fair value)

 

(Level 1)

 

(Level 2)

 

(Level 3)

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

Cash equivalents:

 

 

 

 

 

 

 

 

 

 

 

 

Revenue municipal bonds

 

$

1.4 

 

$

 —

 

$

1.4 

 

$

 —

Money market securities

 

 

0.1 

 

 

0.1 

 

 

 —

 

 

 —

Total cash equivalents

 

$

1.5 

 

$

0.1 

 

$

1.4 

 

$

 —

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

 

$

147.6 

 

$

 —

 

$

147.6 

 

$

 —

General obligation municipal bonds

 

 

1,594.5 

 

 

 —

 

 

1,594.5 

 

 

 —

Pre-refunded municipal bonds

 

 

59.6 

 

 

 —

 

 

59.6 

 

 

 —

Revenue municipal bonds

 

 

1,002.1 

 

 

 —

 

 

1,002.1 

 

 

 —

U.S. government agency securities

 

 

219.4 

 

 

 —

 

 

219.4 

 

 

 —

Variable rate demand notes

 

 

972.3 

 

 

 —

 

 

972.3 

 

 

 —

Total available-for-sale securities

 

$

3,995.5 

 

$

 —

 

$

3,995.5 

 

$

 —

Other

 

$

16.6 

 

$

16.6 

 

$

 —

 

$

 —

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

Other long-term liabilities

 

$

16.6 

 

$

16.6 

 

$

 —

 

$

 —

  





 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 



 

May 31, 2016



 

 

 

 

Quoted

 

Significant

 

 

 



 

 

 

 

prices in

 

other

 

Significant



 

Carrying

 

active

 

observable

 

unobservable



 

value

 

markets

 

inputs

 

inputs

In millions

 

(Fair value)

 

(Level 1)

 

(Level 2)

 

(Level 3)

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

 

$

131.2 

 

$

 —

 

$

131.2 

 

$

 —

General obligation municipal bonds

 

 

1,621.6 

 

 

 —

 

 

1,621.6 

 

 

 —

Pre-refunded municipal bonds

 

 

61.6 

 

 

 —

 

 

61.6 

 

 

 —

Revenue municipal bonds

 

 

931.8 

 

 

 —

 

 

931.8 

 

 

 —

U.S. government agency securities

 

 

161.1 

 

 

 —

 

 

161.1 

 

 

 —

Variable rate demand notes

 

 

1,234.6 

 

 

 —

 

 

1,234.6 

 

 

 —

Total available-for-sale securities

 

$

4,141.9 

 

$

 —

 

$

4,141.9 

 

$

 —

Other

 

$

14.9 

 

$

14.9 

 

$

 —

 

$

 —

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

Other long-term liabilities

 

$

14.9 

 

$

14.9 

 

$

 —

 

$

 —



In determining the fair value of its assets and liabilities, the Company predominately uses the market approach. Money market securities, which are cash equivalents, are valued based on quoted market prices in active markets. Available-for-sale securities including municipal bonds, corporate bonds, U.S. government agency securities, and short-term municipal bonds with a maturity of less than 90 days included in Level 2 are valued utilizing inputs obtained from an independent pricing service. To determine the fair value of the Company’s Level 2 available-for-sale securities, a variety of inputs are utilized including benchmark yields, reported trades, non-binding broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, new issue data, and monthly payment information. The Company has not adjusted the prices obtained from the independent pricing service because it believes that they are appropriately valued.



Assets included as other are mutual fund investments, consisting of participants’ eligible deferral contributions under the Company’s non-qualified and unfunded deferred compensation plans. The related liability is reported as other long-term liabilities. The mutual funds are valued based on quoted market prices in active markets.



10

 


 

Table of Contents

 

The preceding methods described may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, although the Company believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement at the reporting date.

 

Note F: Property and Equipment, Net of Accumulated Depreciation



The components of property and equipment, at cost, consisted of the following:







 

 

 

 

 

 



 

 

 

 

 

 



 

August 31,

 

May 31,

In millions

 

2016

 

2016

Land and improvements

 

$

8.3 

 

$

8.3 

Buildings and improvements

 

 

103.1 

 

 

103.0 

Data processing equipment

 

 

197.4 

 

 

196.1 

Software

 

 

454.6 

 

 

447.5 

Furniture, fixtures, and equipment

 

 

120.2 

 

 

125.0 

Leasehold improvements

 

 

110.4 

 

 

108.2 

Construction in progress

 

 

24.1 

 

 

24.1 

Total property and equipment, gross

 

 

1,018.1 

 

 

1,012.2 

Less: Accumulated depreciation

 

 

669.7 

 

 

659.2 

Property and equipment, net of accumulated depreciation

 

$

348.4 

 

$

353.0 



Depreciation expense was $25.3 million for the three months ended August 31, 2016 compared to $24.0 million for the three months ended August 31, 2015.

 

Note G: Goodwill and Intangible Assets, Net of Accumulated Amortization



The Company had goodwill balances on its Consolidated Balance Sheets of $657.1 million as of both August 31, 2016 and May 31, 2016.



The Company has certain intangible assets with finite lives. The components of intangible assets, at cost, consisted of the following:







 

 

 

 

 

 



 

 

 

 

 

 



 

August 31,

 

May 31,

In millions

 

2016

 

2016

Client lists

 

$

288.7 

 

$

289.2 

Other intangible assets

 

 

5.4 

 

 

5.4 

Total intangible assets, gross

 

 

294.1 

 

 

294.6 

Less: Accumulated amortization

 

 

229.1 

 

 

225.1 

Intangible assets, net of accumulated amortization

 

$

65.0 

 

$

69.5 



Amortization expense relating to intangible assets was $4.4 million for the three months ended August 31, 2016, compared to $3.0 million for the three months ended August 31, 2015.



As of August 31, 2016, the estimated amortization expense relating to intangible asset balances for the full year fiscal 2017 and the following four fiscal years is as follows:







 

 

 

In millions

 

Estimated amortization

Year ending May 31,

 

expense

2017

 

$

17.6 

2018

 

 

14.1 

2019

 

 

11.1 

2020

 

 

8.5 

2021

 

 

6.5 

 

11

 


 

Table of Contents

 

Note H: Accumulated Other Comprehensive Income



The change in unrealized gains and losses, net of applicable taxes, related to available-for-sale securities is the primary component reported in accumulated other comprehensive income in the Consolidated Balance Sheets.  The changes in accumulated other comprehensive income are as follows:







 

 

 

 

 

 



 

 

 

 

 

 



 

For the three months ended



 

August 31,

In millions

 

2016

 

2015

Beginning balance

 

$

29.2 

 

$

7.5 

Other comprehensive income:

 

 

 

 

 

 

Unrealized gains on available-for-sale securities, net of tax

 

 

10.0 

 

 

6.3 

Total other comprehensive income, net of tax

 

 

10.0 

 

 

6.3 

Ending balance

 

$

39.2 

 

$

13.8 



 

 

 

 

 

 

Total tax expense included in other comprehensive income

 

$

5.7 

 

$

3.6 



Reclassification adjustments out of accumulated other comprehensive income for realized gains on the sale of available-for-sale securities were insignificant for both the three months ended August 31, 2016 and 2015.  Those reclassification adjustments are reflected in interest on funds held for clients on the Consolidated Statements of Income and Comprehensive Income.

 

Note I: Short-term Financing



The Company maintains lines of credit, letters of credit, and credit facilities as part of its normal and recurring business operations.  Details of the Company’s short-term financing arrangements as of August 31, 2016 are discussed below.



Lines of credit: As of August 31, 2016, the Company had unused borrowing capacity available under four uncommitted, secured, short-term lines of credit at market rates of interest with financial institutions as follows:







 

 

 

 



 

 

 

 

Financial institution

 

Amount available

 

Expiration date

JP Morgan Chase Bank, N.A.

 

$350 million

 

February 27, 2017

Bank of America, N.A.

 

$250 million

 

February 28, 2017

PNC Bank, National Association

 

$150 million

 

February 27, 2017

Wells Fargo Bank, National Association

 

$150 million

 

February 27, 2017



The primary uses of the lines of credit would be to meet short-term funding requirements related to deposit account overdrafts and client fund obligations arising from electronic payment transactions on behalf of clients in the ordinary course of business.  No amounts were outstanding under these lines of credit as of, or during the three months ended August 31, 2016. 



Certain of the financial institutions are also parties to the Company's credit facility and irrevocable standby letters of credit, which are discussed below.



Letters of credit: As of August 31, 2016 and May 31, 2016, the Company had irrevocable standby letters of credit outstanding totaling $46.8 million and $43.0 million, respectively, required to secure commitments for certain insurance policies. The letters of credit expire at various dates between December 2016 and July 2017, and are collateralized by securities held in the Company’s investment portfolios. No amounts were outstanding on these letters of credit as of, or during the three months ended August 31, 2016.



Credit facilities: The Company maintains a committed, unsecured, five-year syndicated credit facility, expiring on August 5, 2020. Under the credit facility, Paychex of New York LLC (the “Borrower”) may, subject to certain restrictions, borrow up to $1 billion to meet short-term funding requirements. The obligations under this facility have been guaranteed by the Company and certain of its subsidiaries. The outstanding obligations under this credit facility will bear interest at competitive rates to be elected by the Borrower. Upon expiration of the commitment in August 2020, any borrowings outstanding will mature and be payable on such date.



12

 


 

Table of Contents

 

There were no amounts outstanding under this credit facility as of August 31, 2016 and May 31, 2016.  During the three months ended August 31, 2016 and 2015, the Company borrowed against this facility, on an overnight basis, as follows:





 

 

 

 

 

 

 

 



 

For the three months ended



 

August 31,

$ in millions

 

2016

 

2015

Number of days borrowed

 

 

</