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, 2017 



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, a smaller reporting company, or an emerging growth company. See the definitions of  “large accelerated filer,” “accelerated filer,” “smaller reporting company, and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):



 

 

 

 

 

 

Large accelerated filer    

 

Accelerated filer    

 

Non-accelerated filer    

 

Smaller reporting company     



 

 

 

(Do not check if a smaller reporting company)

 

Emerging growth company   

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 



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



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

 

358,994,637 

 Shares

 



CLASS

 

OUTSTANDING AS OF 

September 29, 2017

 

 



 


 

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

15 

Item 3.

Quantitative and Qualitative Disclosures of Market Risk

28 

Item 4.

Controls and Procedures

29 

PART II. OTHER INFORMATION

29 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

29 

Item 6.

Exhibits

30 

Signatures

31 

Index to Exhibits

32 



 



 

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,



 

2017

 

2016

Revenue:

 

 

 

 

 

 

Service revenue

 

$

803.1 

 

$

773.5 

Interest on funds held for clients

 

 

13.7 

 

 

12.0 

Total revenue

 

 

816.8 

 

 

785.5 

Expenses:

 

 

 

 

 

 

Operating expenses

 

 

232.1 

 

 

225.1 

Selling, general and administrative expenses

 

 

239.7 

 

 

237.4 

Total expenses

 

 

471.8 

 

 

462.5 

Operating income

 

 

345.0 

 

 

323.0 

Investment income, net

 

 

2.1 

 

 

1.5 

Income before income taxes

 

 

347.1 

 

 

324.5 

Income taxes

 

 

119.3 

 

 

107.1 

Net income

 

$

227.8 

 

$

217.4 



 

 

 

 

 

 

Other comprehensive income, net of tax:

 

 

 

 

 

 

Unrealized gains on securities, net of tax

 

 

4.4 

 

 

10.0 

Total other comprehensive income, net of tax

 

 

4.4 

 

 

10.0 

Comprehensive income

 

$

232.2 

 

$

227.4 



 

 

 

 

 

 

Basic earnings per share

 

$

0.63 

 

$

0.60 

Diluted earnings per share

 

$

0.63 

 

$

0.60 

Weighted-average common shares outstanding

 

 

358.9 

 

 

361.0 

Weighted-average common shares outstanding,
    assuming dilution

 

 

361.3 

 

 

364.1 

Cash dividends per common share

 

$

0.50 

 

$

0.46 



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,



 

2017

 

2017

Assets

 

 

 

 

 

 

Cash and cash equivalents

 

$

234.4 

 

$

184.6 

Corporate investments

 

 

133.8 

 

 

138.8 

Interest receivable

 

 

32.0 

 

 

35.9 

Accounts receivable, net of allowance for doubtful accounts

 

 

538.6 

 

 

507.5 

Prepaid income taxes

 

 

 —

 

 

45.0 

Prepaid expenses and other current assets

 

 

81.6 

 

 

58.3 

Current assets before funds held for clients

 

 

1,020.4 

 

 

970.1 

Funds held for clients

 

 

4,953.1 

 

 

4,301.9 

Total current assets

 

 

5,973.5 

 

 

5,272.0 

Long-term corporate investments

 

 

483.2 

 

 

454.0 

Property and equipment, net of accumulated depreciation

 

 

328.6 

 

 

337.2 

Intangible assets, net of accumulated amortization

 

 

79.2 

 

 

57.6 

Goodwill

 

 

698.0 

 

 

657.1 

Prepaid income taxes

 

 

24.9 

 

 

24.9 

Other long-term assets

 

 

32.1 

 

 

30.9 

Total assets

 

$

7,619.5 

 

$

6,833.7 

Liabilities

 

 

 

 

 

 

Accounts payable

 

$

74.6 

 

$

57.2 

Accrued compensation and related items

 

 

277.0 

 

 

280.5 

Accrued income taxes

 

 

4.1 

 

 

 —

Short-term borrowings

 

 

57.2 

 

 

 —

Deferred revenue

 

 

24.7 

 

 

22.9 

Other current liabilities

 

 

100.0 

 

 

91.9 

Current liabilities before client fund obligations

 

 

537.6 

 

 

452.5 

Client fund obligations

 

 

4,918.1 

 

 

4,272.6 

Total current liabilities

 

 

5,455.7 

 

 

4,725.1 

Accrued income taxes

 

 

47.9 

 

 

45.6 

Deferred income taxes

 

 

95.4 

 

 

33.9 

Other long-term liabilities

 

 

76.7 

 

 

73.8 

Total liabilities

 

 

5,675.7 

 

 

4,878.4 

Commitments and contingencies — Note L

 

 

 

 

 

 

Stockholders’ equity

 

 

 

 

 

 

Common stock, $0.01 par value; Authorized: 600.0 shares;
  Issued and outstanding: 358.9 shares as of August 31, 2017
   and 359.4 shares as of May 31, 2017, respectively.

 

 

3.6 

 

 

3.6 

Additional paid-in capital

 

 

1,072.1 

 

 

1,030.0 

Retained earnings

 

 

843.7 

 

 

901.7 

Accumulated other comprehensive income

 

 

24.4 

 

 

20.0 

Total stockholders’ equity

 

 

1,943.8 

 

 

1,955.3 

Total liabilities and stockholders’ equity

 

$

7,619.5 

 

$

6,833.7 



See Notes to Consolidated Financial Statements.

 

2

 


 

Table of Contents

 

PAYCHEX, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

In millions







 

 

 

 

 

 



 

 

 

 

 

 



 

For the three months ended



 

August 31,



 

2017

 

2016

Operating activities

 

 

 

 

 

 

Net income

 

$

227.8 

 

$

217.4 

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

 

 

 

 

 

 

Depreciation and amortization on property and equipment and
   intangible assets

 

 

32.0 

 

 

29.7 

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

 

 

17.1 

 

 

18.6 

Stock-based compensation costs

 

 

8.7 

 

 

9.1 

Provision for deferred income taxes

 

 

59.2 

 

 

14.1 

Provision for allowance for doubtful accounts

 

 

0.7 

 

 

1.2 

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

 

 

 —

 

 

(0.1)

Changes in operating assets and liabilities:

 

 

 

 

 

 

Interest receivable

 

 

3.9 

 

 

4.4 

Accounts receivable

 

 

(15.4)

 

 

(78.1)

Prepaid expenses and other current assets

 

 

28.2 

 

 

6.6 

Accounts payable and other current liabilities

 

 

(19.2)

 

 

60.9 

Net change in other long-term assets and liabilities

 

 

0.6 

 

 

10.9 

Net cash provided by operating activities

 

 

343.6 

 

 

294.7 

Investing activities

 

 

 

 

 

 

Purchases of available-for-sale securities

 

 

(8,646.7)

 

 

(14,777.0)

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

 

 

8,892.0 

 

 

14,920.3 

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

 

 

(929.7)

 

 

257.3 

Purchases of property and equipment

 

 

(18.0)

 

 

(20.3)

Acquisition of businesses, net of cash acquired

 

 

(8.2)

 

 

 —

Purchases of other assets

 

 

(0.4)

 

 

 —

Net cash (used in)/provided by investing activities

 

 

(711.0)

 

 

380.3 

Financing activities

 

 

 

 

 

 

Net change in client fund obligations

 

 

645.5 

 

 

(567.8)

Net proceeds from short-term borrowings

 

 

57.2 

 

 

51.3 

Dividends paid

 

 

(179.1)

 

 

(166.3)

Repurchases of common shares

 

 

(94.1)

 

 

 —

Activity related to equity-based plans

 

 

(12.3)

 

 

6.3 

Net cash provided by/(used in) financing activities

 

 

417.2 

 

 

(676.5)

Increase/(decrease) in cash and cash equivalents

 

 

49.8 

 

 

(1.5)

Cash and cash equivalents, beginning of fiscal year

 

 

184.6 

 

 

131.5 

Cash and cash equivalents, end of period

 

$

234.4 

 

$

130.0 



See Notes to Consolidated Financial Statements.

 



 

PAYCHEX, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

August 31, 2017 

 

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 (“HR”), 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, 2017 and August 31, 2016. Long-lived assets in Germany are insignificant in relation to total long-lived assets of the Company as of August 31, 2017 and May 31, 2017.  The Company disposed of equity-method investments for a joint-venture in Brazil and a minority investment in a Canadian entity during the fiscal year ended May 31, 2017 (“fiscal 2017”), neither of which was 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 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”) for fiscal 2017. Operating results and cash flows for the three months ended August 31, 2017 are not necessarily indicative of the results that may be expected for other interim periods or for the full fiscal year ending May 31, 2018 (“fiscal 2018”).



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 up to per occurrence liability limits. The Company’s maximum individual claims liability is $1.3 million under both its fiscal 2018 and fiscal 2017 workers’ compensation insurance policies.



Under the minimum premium insurance plan 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 insurance carrier. The Company's maximum individual claims liability is $0.3 million under both its calendar 2017 and calendar 2016 minimum premium insurance plan 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 insurance reserves are reflected in the results of operations for the period in which such adjustments are identified. Such insurance reserve 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, performance-based restricted stock, 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 their fair values measured as of the date of grant. These costs are recognized over the requisite service period. Stock-based compensation costs recognized were $8.7 million for the three months ended August 31, 2017, as compared with $9.1 million for the three months ended August 31, 2016. 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 2017 Form 10-K.



Recently adopted accounting pronouncements: There were no recently adopted accounting pronouncements during the three months ended August 31, 2017.

 

Recently issued accounting pronouncements: In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“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, outlines a single comprehensive model for determining revenue recognition for contracts with customers, and supersedes current guidance on revenue recognition in Accounting Standards Codification (“ASC”) Topic 605, “Revenue Recognition.”  Entities have the option to apply the new guidance under a full retrospective approach to each prior reporting period presented or a modified retrospective approach with a cumulative effect of initially applying the new guidance recognized at the date of initial application within the consolidated financial statements.  This guidance will be effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods, with early adoption permitted for the annual reporting periods beginning after December 15, 2016.    

The Company did not elect to early-adopt the new standard, and will adopt the new standard in its fiscal year beginning June 1, 2018.  The analysis of the new standard and its impact to the Company is nearly complete as the Company is in the process of finalizing its conclusions.  Further, the Company currently anticipates applying the guidance under the full retrospective approach.    The Company’s ability to adopt using the full retrospective method is dependent on system readiness and the completion of the analysis of information necessary to restate prior period consolidated financial statements.  While the evaluation of the impact of the new revenue recognition standard on its consolidated financial statements has not yet been finalized, the Company anticipates the provisions to primarily impact the manner in which it treats certain costs to obtain contracts and costs to fulfill contracts.  Generally, in relation to these items, the new standard will result in the Company deferring additional costs on the Consolidated Balance Sheets and subsequently amortizing them to the Consolidated Statements of Income and Comprehensive Income over the estimated average life of the client.  The Company does not expect the provisions of the new standard will have a material impact on the timing or the amount of revenue it recognizes. 

The Company has also not yet fully determined the impacts of the disclosure requirements under the new standard, and is evaluating the way it will disaggregate revenue into categories that show how economic factors affect the nature, timing, and uncertainty of revenue and cash flows generated from contracts with customers.  Additionally, while the Company is in the process of assessing its accounting and forecasting considerations to ensure its ability to record, report, forecast, and analyze results under the new standard, it is not expecting significant changes in its business processes or systems.



Other recent authoritative guidance issued by the FASB (including technical corrections to the ASC), the American Institute of Certified Public Accountants, and the Securities and Exchange Commission during the three months ended August 31, 2017 did not, or are not expected to, have a material effect on the Company’s consolidated financial statements.  



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

 

2017

 

2016

Basic earnings per share:

 

 

 

 

 

 

Net income

 

$

227.8 

 

$

217.4 

Weighted-average common shares outstanding

 

 

358.9 

 

 

361.0 

Basic earnings per share

 

$

0.63 

 

$

0.60 

Diluted earnings per share:

 

 

 

 

 

 

Net income

 

$

227.8 

 

$

217.4 

Weighted-average common shares outstanding

 

 

358.9 

 

 

361.0 

Dilutive effect of common share equivalents

 

 

2.4 

 

 

3.1 

Weighted-average common shares outstanding, assuming dilution

 

 

361.3 

 

 

364.1 

Diluted earnings per share

 

$

0.63 

 

$

0.60 

Weighted-average anti-dilutive common share equivalents

 

 

1.1 

 

 

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, 2017 and August 31, 2016, 0.5 million and 1.3 million shares, respectively, of the Company’s common stock were issued in connection with the exercise or vesting of stock-based awards.  In addition, for the three months ended August 31, 2017, 0.6 million shares of the Company’s common stock were issued in relation to an immaterial business acquisition completed in August 2017.  Refer to Note C below for further details.



In July 2016, the Company announced that its Board of Directors approved a program to repurchase up to $350.0 million of the Company’s common stock, with authorization expiring in May 2019.  The purpose of the program is to manage common stock dilution. During the three months ended August 31, 2017, the Company repurchased 1.6 million shares for $94.1 million under this program.  The Company did not repurchase any of its common stock during the three months ended August 31, 2016.  All shares repurchased were retired.   



Note C: Business Combination



Effective August 18, 2017, the Company acquired HR Outsourcing Holdings, Inc. (“HROI”) and all of its operating subsidiaries.  HROI is a national PEO that provides HR solutions to small- and medium-sized businesses in more than 35 states.  The acquisition expands the Company’s presence in the PEO industry.  The purchase price was $75.4 million and was comprised of $42.2 million of cash plus $33.2 million issued in the form of Paychex common stock.  Goodwill in the amount of $40.9 million was recorded as a result of the acquisition, which is not tax-deductible.  The goodwill recorded is provisional and subject to change, pending completion of the valuation of the assets acquired and liabilities assumed.  However, further changes to goodwill as a result of the acquisition are not anticipated to be material to the Company’s Consolidated Balance Sheets.



The financial results of HROI are included in the Company’s consolidated financial statements from the date of acquisition.  The Company concluded that the acquisition was not material to its results of operations and financial position.  Therefore, pro-forma financial information has been excluded.



Note D: Investment Income, Net



Investment income, net, consisted of the following items:







 

 

 

 

 

 



 

 

 

 

 

 



 

For the three months ended



 

August 31,

In millions

 

2017

 

2016

Interest income on corporate funds

 

$

2.9 

 

$

2.4 

Interest expense

 

 

(0.8)

 

 

(0.7)

Net loss from equity-method investments

 

 

 —

 

 

(0.2)

Investment income, net

 

$

2.1 

 

$

1.5 

 

Note E: Funds Held for Clients and Corporate Investments



Funds held for clients and corporate investments are as follows:







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 



 

August 31, 2017



 

 

 

 

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

 

$

1,194.6 

 

$

 —

 

$

 —

 

$

1,194.6 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

 

 

263.9 

 

 

3.6 

 

 

(0.3)

 

 

267.2 

General obligation municipal bonds

 

 

1,407.4 

 

 

23.2 

 

 

(0.4)

 

 

1,430.2 

Pre-refunded municipal bonds(1)

 

 

60.9 

 

 

1.1 

 

 

 —

 

 

62.0 

Revenue municipal bonds

 

 

921.3 

 

 

13.5 

 

 

(0.2)

 

 

934.6 

U.S. government agency securities

 

 

368.6 

 

 

0.8 

 

 

(2.7)

 

 

366.7 

Variable rate demand notes

 

 

1,296.8 

 

 

 —

 

 

 —

 

 

1,296.8 

Total available-for-sale securities

 

 

4,318.9 

 

 

42.2 

 

 

(3.6)

 

 

4,357.5 

Other

 

 

15.8 

 

 

2.2 

 

 

 —

 

 

18.0 

Total funds held for clients and corporate investments

 

$

5,529.3 

 

$

44.4 

 

$

(3.6)

 

$

5,570.1 

  





 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 



 

May 31, 2017



 

 

 

 

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

 

$

264.8 

 

$

 —

 

$

 —

 

$

264.8 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

 

 

208.6 

 

 

2.7 

 

 

(0.5)

 

 

210.8 

General obligation municipal bonds

 

 

1,422.0 

 

 

21.2 

 

 

(0.9)

 

 

1,442.3 

Pre-refunded municipal bonds(1)

 

 

54.6 

 

 

0.9 

 

 

 —

 

 

55.5 

Revenue municipal bonds

 

 

929.2 

 

 

12.5 

 

 

(0.8)

 

 

940.9 

U.S. government agency securities

 

 

328.9 

 

 

0.5 

 

 

(3.6)

 

 

325.8 

Variable rate demand notes

 

 

1,637.9 

 

 

 —

 

 

 —

 

 

1,637.9 

Total available-for-sale securities

 

 

4,581.2 

 

 

37.8 

 

 

(5.8)

 

 

4,613.2 

Other

 

 

14.8 

 

 

1.9 

 

 

 —

 

 

16.7 

Total funds held for clients and corporate investments

 

$

4,860.8 

 

$

39.7 

 

$

(5.8)

 

$

4,894.7 



(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, 2017 were bank demand deposit accounts, time deposits, and money market funds.  Included in money market securities and other cash equivalents as of May 31, 2017 were 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

 

2017

 

2017

Funds held for clients

 

$

4,953.1 

 

$

4,301.9 

Corporate investments

 

 

133.8 

 

 

138.8 

Long-term corporate investments

 

 

483.2 

 

 

454.0 

Total funds held for clients and corporate investments

 

$

5,570.1 

 

$

4,894.7 



The Company’s available-for-sale securities reflected net unrealized gains of $38.6 million and $32.0 million as of August 31, 2017 and May 31, 2017, respectively.  Included in the net unrealized gain totals as of August 31, 2017 and May 31, 2017, there were 149 and 216 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, 2017



 

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

 

$

(0.2)

 

$

34.1 

 

$

(0.1)

 

$

6.6 

 

$

(0.3)

 

$

40.7 

General obligation municipal bonds

 

 

(0.3)

 

 

78.2 

 

 

(0.1)

 

 

12.1 

 

 

(0.4)

 

 

90.3 

Pre-refunded municipal bonds

 

 

 —

 

 

9.1 

 

 

 —

 

 

 —

 

 

 —

 

 

9.1 

Revenue municipal bonds

 

 

(0.1)

 

 

70.6 

 

 

(0.1)

 

 

12.3 

 

 

(0.2)

 

 

82.9 

U.S. government agency securities

 

 

(1.8)

 

 

144.3 

 

 

(0.9)

 

 

39.1 

 

 

(2.7)

 

 

183.4 

Total

 

$

(2.4)

 

$

336.3 

 

$

(1.2)

 

$

70.1 

 

$

(3.6)

 

$

406.4 

  





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

May 31, 2017



 

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

 

$

(0.5)

 

$

43.6 

 

$

 —

 

$

 —

 

$

(0.5)

 

$

43.6 

General obligation municipal bonds

 

 

(0.9)

 

 

188.8 

 

 

 —

 

 

 —

 

 

(0.9)

 

 

188.8 

Pre-refunded municipal bonds

 

 

 —

 

 

9.2 

 

 

 —

 

 

 —

 

 

 —

 

 

9.2 

Revenue municipal bonds

 

 

(0.8)

 

 

154.8 

 

 

 —

 

 

1.0 

 

 

(0.8)

 

 

155.8 

U.S. government agency securities

 

 

(3.6)

 

 

210.0 

 

 

 —

 

 

 —

 

 

(3.6)

 

 

210.0 

Total

 

$

(5.8)

 

$

606.4 

 

$

 —

 

$

1.0 

 

$

(5.8)

 

$

607.4 



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, 2017 that had unrealized losses of $3.6 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 majority of the securities in an unrealized loss position as of August 31, 2017 and May 31, 2017 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 the three months ended August 31, 2017 and August 31, 2016. There were no realized losses for the three months ended August 31, 2017 and August 31, 2016.



The amortized cost and fair value of available-for-sale securities that had stated maturities as of August 31, 2017 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, 2017



 

Amortized

 

Fair

In millions

 

cost

 

value

Maturity date:

 

 

 

 

 

 

Due in one year or less

 

$

286.3 

 

$

287.0 

Due after one year through three years

 

 

803.0 

 

 

812.0 

Due after three years through five years

 

 

1,026.3 

 

 

1,048.5 

Due after five years

 

 

2,203.3 

 

 

2,210.0 

Total

 

$

4,318.9 

 

$

4,357.5 



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 F: 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:



o

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



o

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



o

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



o

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, when used by the Company, 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.



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







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 



 

August 31, 2017



 

 

 

 

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:

 

 

 

 

 

 

 

 

 

 

 

 

Time deposits

 

$

50.0 

 

$

50.0 

 

$

 —

 

$

 —

Money market securities

 

 

30.4 

 

 

30.4 

 

 

 —

 

 

 —

Total cash equivalents

 

$

80.4 

 

$

80.4 

 

$

 —

 

$

 —

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

 

$

267.2 

 

$

 —

 

$

267.2 

 

$

 —

General obligation municipal bonds

 

 

1,430.2 

 

 

 —

 

 

1,430.2 

 

 

 —

Pre-refunded municipal bonds

 

 

62.0 

 

 

 —

 

 

62.0 

 

 

 —

Revenue municipal bonds

 

 

934.6 

 

 

 —

 

 

934.6 

 

 

 —

U.S. government agency securities

 

 

366.7 

 

 

 —

 

 

366.7 

 

 

 —

Variable rate demand notes

 

 

1,296.8 

 

 

 —

 

 

1,296.8 

 

 

 —

Total available-for-sale securities

 

$

4,357.5 

 

$

 —

 

$

4,357.5 

 

$

 —

Other

 

$

18.0 

 

$

18.0 

 

$

 —

 

$

 —

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

Other long-term liabilities

 

$

18.0 

 

$

18.0 

 

$

 —

 

$

 —

  





 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 



 

May 31, 2017



 

 

 

 

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

 

$

210.8 

 

$

 —

 

$

210.8 

 

$

 —

General obligation municipal bonds

 

 

1,442.3 

 

 

 —

 

 

1,442.3 

 

 

 —

Pre-refunded municipal bonds

 

 

55.5 

 

 

 —

 

 

55.5 

 

 

 —

Revenue municipal bonds

 

 

940.9 

 

 

 —

 

 

940.9 

 

 

 —

U.S. government agency securities

 

 

325.8 

 

 

 —

 

 

325.8 

 

 

 —

Variable rate demand notes

 

 

1,637.9 

 

 

 —

 

 

1,637.9 

 

 

 —

Total available-for-sale securities

 

$

4,613.2 

 

$

 —

 

$

4,613.2 

 

$

 —

Other

 

$

16.7 

 

$

16.7 

 

$

 —

 

$

 —

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

Other long-term liabilities

 

$

16.7 

 

$

16.7 

 

$

 —

 

$

 —



In determining the fair value of its assets and liabilities, the Company predominately uses the market approach. Time deposits and 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, and U.S. government agency securities, are included in Level 2 and 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, the independent pricing service uses a variety of inputs, 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.



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 G: Accounts Receivable, Net of Allowance for Doubtful Accounts



The components of accounts receivable, net of allowance for doubtful accounts, consisted of the following:







 

 

 

 

 

 



 

 

 

 

 

 



 

August 31,

 

May 31,

In millions

 

2017

 

2017

PEO receivables(1)

 

$

115.4 

 

$

137.8 

Purchased receivables(2)

 

 

284.4 

 

 

257.3 

Other trade receivables(3)

 

 

144.5 

 

 

118.4 

Total accounts receivable, gross

 

 

544.3 

 

 

513.5 

Less:  Allowance for doubtful accounts

 

 

5.7 

 

 

6.0 

Accounts receivable, net of allowance for doubtful accounts

 

$

538.6 

 

$

507.5 

(1)

PEO receivables are primarily client wages and related tax withholdings since the last payroll processed.  Balances will vary based on timing of the last payroll processed and the end of the reporting period.  In addition, balances as of August 31, 2017 include receivables balances acquired from HROI.  Refer to Note C for further details of this immaterial business acquisition.

(2)

Purchased receivables relate to payroll funding arrangements with clients in the temporary staffing industry.

(3)

Other trade receivables primarily relate to other ongoing services provided to our clients and can vary based on the timing of these services and the end of the reporting period.



No single client had a material impact on total accounts receivable, service revenue, or results of operations.



Note H: 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

 

2017

 

2017

Land and improvements

 

$

8.3 

 

$

8.3 

Buildings and improvements

 

 

103.6 

 

 

103.5 

Data processing equipment

 

 

207.8 

 

 

199.7 

Software (1)

 

 

503.9 

 

 

496.1 

Furniture, fixtures, and equipment

 

 

115.3 

 

 

115.2 

Leasehold improvements

 

 

111.5 

 

 

109.5 

Construction in progress (1)

 

 

17.7 

 

 

18.7 

Total property and equipment, gross

 

 

1,068.1 

 

 

1,051.0 

Less: Accumulated depreciation

 

 

739.5 

 

 

713.8 

Property and equipment, net of accumulated depreciation

 

$

328.6 

 

$

337.2 

(1)

Software includes both purchased software and costs capitalized related to internally developed software placed in service.  Capitalized costs related to internally developed software that has not yet been placed in service is included in construction in progress. 



Depreciation expense was $28.1 million for the three months ended August 31, 2017 compared to $25.3 million for the three months ended August 31, 2016.



In August 2017, the Company announced its plan for a new multi-building Paychex campus based in Rochester, NY.  This involves the purchase of five buildings and the renovation of over 300,000 square feet of existing space in Rochester for an estimated cost of $60 million.  Subsequent to August 31, 2017, and as of the date of this report, the Company has completed the purchase of two of these buildings for a combined cost of $19.5 million.  Renovations on the buildings purchased have not yet commenced.  In addition, in September 2017, the Company entered into a transaction with the County of Monroe Industrial Development Agency (“COMIDA”) for purposes of obtaining public benefits and inducements, expiring on December 31, 2039.  The public inducements include exemption from sales and use taxes for goods and services directly related to the renovations of the new multi-building campus.



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



The Company had goodwill balances on its Consolidated Balance Sheets of $698.0 million as of August 31, 2017 and $657.1 million as of May 31, 2017.  The increase of $40.9 million in goodwill since May 31, 2017 was the result of the acquisition of HROI in August 2017.  Refer to Note C for further information.



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

 

2017

 

2017

Client lists

 

$

318.7 

 

$

293.5 

Other intangible assets

 

 

5.4 

 

 

5.4 

Total intangible assets, gross

 

 

324.1 

 

 

298.9 

Less: Accumulated amortization

 

 

244.9 

 

 

241.3 

Intangible assets, net of accumulated amortization

 

$

79.2 

 

$

57.6 



Amortization expense relating to intangible assets was $3.9 million for the three months ended August 31, 2017 compared to $4.4 million for the three months ended August 31, 2016.



As of August 31, 2017, the estimated amortization expense relating to intangible asset balances for the full year fiscal 2018 and the following four fiscal years is as follows:







 

 

 

In millions

 

Estimated amortization

Year ending May 31,

 

Expense

2018

 

$

20.1 

2019

 

 

17.3 

2020

 

 

13.9 

2021

 

 

10.9 

2022

 

 

8.2 



Note J: Accumulated Other Comprehensive Income



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







 

 

 

 

 

 



 

 

 

 

 

 



 

For the three months ended



 

August 31,

In millions

 

2017

 

2016

Beginning balance

 

$

20.0 

 

$

29.2 

Other comprehensive income:

 

 

 

 

 

 

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

 

 

4.4 

 

 

10.0 

Total other comprehensive income, net of tax

 

 

4.4 

 

 

10.0 

Ending balance

 

$

24.4 

 

$

39.2