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 February 28, 2018 



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.



 

 

 

 

 

 

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

 

359,275,368 

 Shares

 



CLASS

 

OUTSTANDING AS OF 

February 28, 2018

 

 



 


 

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

32 

Item 4.

Controls and Procedures

32 

PART II. OTHER INFORMATION

33 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

33 

Item 6.

Exhibits

33 

Signatures

34 



 



 


 

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

 

For the nine months ended



 

February 28,

 

February 28,



 

2018

 

2017

 

2018

 

2017

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

Service revenue

 

$

848.4 

 

$

782.6 

 

$

2,464.0 

 

$

2,316.1 

Interest on funds held for clients

 

 

18.1 

 

 

13.2 

 

 

45.8 

 

 

36.6 

Total revenue

 

 

866.5 

 

 

795.8 

 

 

2,509.8 

 

 

2,352.7 

Expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses

 

 

270.7 

 

 

236.8 

 

 

751.5 

 

 

688.2 

Selling, general and administrative expenses

 

 

303.3 

 

 

252.4 

 

 

788.6 

 

 

723.8 

Total expenses

 

 

574.0 

 

 

489.2 

 

 

1,540.1 

 

 

1,412.0 

Operating income

 

 

292.5 

 

 

306.6 

 

 

969.7 

 

 

940.7 

Investment income, net

 

 

2.3 

 

 

1.2 

 

 

6.1 

 

 

3.6 

Income before income taxes

 

 

294.8 

 

 

307.8 

 

 

975.8 

 

 

944.3 

Income taxes

 

 

34.4 

 

 

105.3 

 

 

270.6 

 

 

322.3 

Net income

 

$

260.4 

 

$

202.5 

 

$

705.2 

 

$

622.0 



 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive (loss)/income, net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized (losses)/gains on securities, net of tax

 

 

(17.5)

 

 

21.4 

 

 

(46.7)

 

 

(24.6)

Total other comprehensive (loss)/income, net of tax

 

 

(17.5)

 

 

21.4 

 

 

(46.7)

 

 

(24.6)

Comprehensive income

 

$

242.9 

 

$

223.9 

 

$

658.5 

 

$

597.4 



 

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

$

0.72 

 

$

0.56 

 

$

1.96 

 

$

1.73 

Diluted earnings per share

 

$

0.72 

 

$

0.56 

 

$

1.95 

 

$

1.71 

Weighted-average common shares outstanding

 

 

359.2 

 

 

359.0 

 

 

359.1 

 

 

360.0 

Weighted-average common shares outstanding,
    assuming dilution

 

 

362.0 

 

 

361.8 

 

 

361.6 

 

 

362.8 

Cash dividends per common share

 

$

0.50 

 

$

0.46 

 

$

1.50 

 

$

1.38 



See Notes to Consolidated Financial Statements.

 

1

 


 

Table of Contents

 

PAYCHEX, INC.

CONSOLIDATED BALANCE SHEETS (UNAUDITED)

In millions, except per share amount







 

 

 

 

 

 



 

 

 

 

 

 



 

February 28,

 

May 31,



 

2018

 

2017

Assets

 

 

 

 

 

 

Cash and cash equivalents

 

$

323.9 

 

$

184.6 

Corporate investments

 

 

97.3 

 

 

138.8 

Interest receivable

 

 

31.5 

 

 

35.9 

Accounts receivable, net of allowance for doubtful accounts

 

 

550.5 

 

 

507.5 

Prepaid income taxes

 

 

22.9 

 

 

45.0 

Prepaid expenses and other current assets

 

 

77.9 

 

 

58.3 

Current assets before funds held for clients

 

 

1,104.0 

 

 

970.1 

Funds held for clients

 

 

3,944.7 

 

 

4,301.9 

Total current assets

 

 

5,048.7 

 

 

5,272.0 

Long-term corporate investments

 

 

405.4 

 

 

454.0 

Property and equipment, net of accumulated depreciation

 

 

397.2 

 

 

337.2 

Intangible assets, net of accumulated amortization

 

 

105.1 

 

 

57.6 

Goodwill

 

 

827.4 

 

 

657.1 

Prepaid income taxes

 

 

24.9 

 

 

24.9 

Other long-term assets

 

 

34.1 

 

 

30.9 

Total assets

 

$

6,842.8 

 

$

6,833.7 

Liabilities

 

 

 

 

 

 

Accounts payable

 

$

71.9 

 

$

57.2 

Accrued compensation and related items

 

 

356.3 

 

 

280.5 

Short-term borrowings

 

 

57.7 

 

 

 —

Deferred revenue

 

 

23.7 

 

 

22.9 

Other current liabilities

 

 

142.2 

 

 

91.9 

Current liabilities before client fund obligations

 

 

651.8 

 

 

452.5 

Client fund obligations

 

 

3,971.9 

 

 

4,272.6 

Total current liabilities

 

 

4,623.7 

 

 

4,725.1 

Accrued income taxes

 

 

51.8 

 

 

45.6 

Deferred income taxes

 

 

41.9 

 

 

33.9 

Other long-term liabilities

 

 

79.9 

 

 

73.8 

Total liabilities

 

 

4,797.3 

 

 

4,878.4 

Commitments and contingencies — Note L

 

 

 

 

 

 

Stockholders’ equity

 

 

 

 

 

 

Common stock, $0.01 par value; Authorized: 600.0 shares;
   Issued and outstanding: 359.3 shares as of February 28, 2018
   and 359.4 shares as of May 31, 2017

 

 

3.6 

 

 

3.6 

Additional paid-in capital

 

 

1,107.2 

 

 

1,030.0 

Retained earnings

 

 

961.4 

 

 

901.7 

Accumulated other comprehensive (loss)/income

 

 

(26.7)

 

 

20.0 

Total stockholders’ equity

 

 

2,045.5 

 

 

1,955.3 

Total liabilities and stockholders’ equity

 

$

6,842.8 

 

$

6,833.7 



See Notes to Consolidated Financial Statements.

 

2

 


 

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PAYCHEX, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

In millions







 

 

 

 

 

 



 

 

 

 

 

 



 

For the nine months ended



 

February 28,



 

2018

 

2017

Operating activities

 

 

 

 

 

 

Net income

 

$

705.2 

 

$

622.0 

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

 

 

 

 

 

 

Depreciation and amortization on property and equipment and
   intangible assets

 

 

102.3 

 

 

90.7 

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

 

 

50.1 

 

 

55.0 

Stock-based compensation costs

 

 

29.4 

 

 

26.5 

Provision for deferred income taxes

 

 

6.5 

 

 

 —

Provision for allowance for doubtful accounts

 

 

3.3 

 

 

3.4 

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

 

 

(0.1)

 

 

(0.1)

Changes in operating assets and liabilities:

 

 

 

 

 

 

Interest receivable

 

 

4.4 

 

 

4.1 

Accounts receivable

 

 

(6.2)

 

 

(24.6)

Prepaid expenses and other current assets

 

 

9.7 

 

 

(32.1)

Accounts payable and other current liabilities

 

 

80.9 

 

 

37.5 

Net change in other long-term assets and liabilities

 

 

3.4 

 

 

(13.1)

Net cash provided by operating activities

 

 

988.9 

 

 

769.3 

Investing activities

 

 

 

 

 

 

Purchases of available-for-sale securities

 

 

(36,422.2)

 

 

(36,029.5)

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

 

 

37,162.9 

 

 

35,617.4 

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

 

 

(409.1)

 

 

(459.8)

Purchases of property and equipment

 

 

(122.0)

 

 

(66.8)

Acquisition of businesses, net of cash acquired

 

 

(178.5)

 

 

 —

Purchases of other assets

 

 

(6.7)

 

 

(8.4)

Net cash provided by/(used in) investing activities

 

 

24.4 

 

 

(947.1)

Financing activities

 

 

 

 

 

 

Net change in client fund obligations

 

 

(300.7)

 

 

819.8 

Net proceeds from short-term borrowings

 

 

57.7 

 

 

55.4 

Dividends paid

 

 

(538.7)

 

 

(496.9)

Repurchases of common shares

 

 

(94.1)

 

 

(166.2)

Activity related to equity-based plans

 

 

1.8 

 

 

24.1 

Net cash (used in)/provided by financing activities

 

 

(874.0)

 

 

236.2 

Increase in cash and cash equivalents

 

 

139.3 

 

 

58.4 

Cash and cash equivalents, beginning of fiscal year

 

 

184.6 

 

 

131.5 

Cash and cash equivalents, end of period

 

$

323.9 

 

$

189.9 



See Notes to Consolidated Financial Statements.

 



 

3

 


 

Table of Contents

 

PAYCHEX, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

February 28, 2018 

 

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 (“HCM”) 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 Europe. Effective February 28, 2018, the Company acquired Lessor Group (“Lessor”), headquartered in Denmark and serving clients in Northern Europe.  Refer to Note C for further details. 

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 Europe, which represented less than one percent of the Company's total revenue for each of the three and nine months ended February 28, 2018 and February 28, 2017.  Long-lived assets in Europe were approximately 13% of total long-lived assets of the Company as of February 28, 2018 and were insignificant as of May 31, 2017



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”) for the fiscal year ended May 31, 2017 (“fiscal 2017”).  Operating results and cash flows for the period ended February 28, 2018 are not necessarily indicative of the results that may be expected for other interim periods or for the fiscal year ending May 31, 2018 (“fiscal 2018”).



Subsequent event: During the three months ended February 28, 2018, the Company began negotiations to terminate certain license agreements and acquire rights to certain client lists in order to resolve a contractual dispute with certain licensees.  The negotiations were completed in March 2018.  The Company recorded $32.6 million on its Consolidated Balance Sheets within other current liabilities as of February 28, 2018, and $24.7 million, net of tax, in its Consolidated Statements of Income and Comprehensive Income for the three months ended February 28, 2018 related to the termination of these license agreements. In addition, the Company acquired rights to certain client lists as it relates to this agreement in March 2018 for a cost of approximately $30.0 million.



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 2018 and calendar 2017 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.



4

 


 

Table of Contents

 

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 $10.3 million and $29.4 million for the three and nine months ended February 28, 2018, respectively, as compared with $8.9 million and $26.5 million for the three and nine months ended February 28, 2017, respectively. 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: In January 2018, the Company early adopted Accounting Standards Update (“ASU”) No. 2017-01, “Business Combinations (Topic 805): Clarifying the Definition of a Business.”  ASU No. 2017-01 clarifies the definition of a business in order to allow for the evaluation of whether transactions should be accounted for as acquisitions or disposals of assets or businesses.  The adoption of ASU 2017-01 did not have a material impact on the Company’s consolidated financial statements.

 

Recently issued accounting pronouncements: In February 2018, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2018-02, “Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.” ASU No. 2018-02 allows entities to reclassify certain stranded income tax effects from accumulated other comprehensive income to retained earnings resulting from the Tax Cuts and Jobs Act (the “Tax Act”), enacted on December 22, 2017.  The guidance also requires additional financial statement disclosures to clarify the effects of adoption.  ASU No. 2018-02 should be applied either in the period of adoption or retrospectively to each period or periods in which the effect of the change in the U.S. Federal corporate income tax rate in the Tax Act is recognized.  This guidance is effective for fiscal years beginning after December 15, 2018, and for interim periods within those fiscal years, with early adoption permitted. This guidance is applicable to the Company’s fiscal year beginning June 1, 2019.   The Company is currently evaluating the potential effects of this guidance 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 adoption permitted. This guidance is applicable to the Company's fiscal year beginning June 1, 2019. The Company is in the preliminary stages of gathering data and assessing the impact of the new lease accounting standard and the Company anticipates that the adoption of the new lease accounting standard will result in additional assets and liabilities being recorded on its Consolidated Balance Sheets.

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. 

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 considerations to ensure its ability to record, report, and analyze results under the new standard, it is not expecting significant changes in its business processes or systems.



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Other recent authoritative guidance issued by the FASB (including technical corrections to the ASC), the American Institute of Certified Public Accountants, and the Securities Exchange Commission (“SEC”) during the nine months ended February 28, 2018 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

 

For the nine months ended



 

February 28,

 

February 28,

In millions, except per share amounts

 

2018

 

2017

 

2018

 

2017

Basic earnings per share:

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

260.4 

 

$

202.5 

 

$

705.2 

 

$

622.0 

Weighted-average common shares outstanding

 

 

359.2 

 

 

359.0 

 

 

359.1 

 

 

360.0 

Basic earnings per share

 

$

0.72 

 

$

0.56 

 

$

1.96 

 

$

1.73 

Diluted earnings per share:

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

260.4 

 

$

202.5 

 

$

705.2 

 

$

622.0 

Weighted-average common shares outstanding

 

 

359.2 

 

 

359.0 

 

 

359.1 

 

 

360.0 

Dilutive effect of common share equivalents

 

 

2.8 

 

 

2.8 

 

 

2.5 

 

 

2.8 

Weighted-average common shares outstanding, assuming dilution

 

 

362.0 

 

 

361.8 

 

 

361.6 

 

 

362.8 

Diluted earnings per share

 

$

0.72 

 

$

0.56 

 

$

1.95 

 

$

1.71 

Weighted-average anti-dilutive common share equivalents

 

 

 —

 

 

0.7 

 

 

0.8 

 

 

0.7 



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 February 28, 2018 and February 28, 2017,  0.1 million and 0.4 million shares, respectively, of the Company’s common stock were issued in connection with the exercise or vesting of stock-based awards.  For the nine months ended February 28, 2018 and February 28, 2017,  0.9 million and 1.8 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 nine months ended February 28, 2018, 0.6 million shares of the Company’s common stock were issued in relation to a business acquisition completed in August 2017.  Refer to Note C 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. No shares were repurchased during the three months ended February 28, 2018 and February 28, 2017.   During the nine months ended February 28, 2018 and February 28, 2017, the Company repurchased 1.6 million shares for $94.1 million and 2.9 million shares for $166.2 million, respectively.  Of the shares repurchased during the nine months ended February 28, 2017, $59.7 million were repurchased under a previously authorized common stock repurchase program.  All shares repurchased were retired.   



Note C: Business Combinations



Effective February 28, 2018, the Company completed its acquisition of Lessor. Upon closing, Lessor became a wholly owned subsidiary of the Company.  Lessor is a market-leading provider of payroll and HCM software solutions headquartered in Denmark and serving clients in Northern Europe.  The Company believes that the acquisition will provide additional opportunities for growth in Europe.  The purchase price was $160.6 million, net of cash acquired.  Goodwill in the amount of $119.2 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 a final valuation of Lessor.  However, further changes to goodwill resulting from the acquisition are not anticipated to be material to the Company’s Consolidated Balance Sheets. 



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 $51.1 million was recorded as a result of the acquisition, which is not tax-deductible.



The financial results of both Lessor and HROI are included in the Company’s consolidated financial statements from the respective dates of acquisition.  The Company concluded that these acquisitions were not material to its results of operations and financial position.  Therefore, pro-forma financial information has been excluded.

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Note D: Investment Income, Net



Investment income, net, consisted of the following items:







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 



 

For the three months ended

 

For the nine months ended



 

February 28,

 

February 28,

In millions

 

2018

 

2017

 

2018

 

2017

Interest income on corporate funds

 

$

3.1 

 

$

2.4 

 

$

8.7 

 

$

7.2 

Interest expense

 

 

(1.1)

 

 

(0.6)

 

 

(3.2)

 

 

(1.9)

Net gain/(loss) from equity-method investments

 

 

0.3 

 

 

(0.6)

 

 

0.6 

 

 

(1.7)

Investment income, net

 

$

2.3 

 

$

1.2 

 

$

6.1 

 

$

3.6 

 

Note E: Funds Held for Clients and Corporate Investments



Funds held for clients and corporate investments are as follows:







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 



 

February 28, 2018



 

 

 

 

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

 

$

673.9 

 

$

 —

 

$

 —

 

$

673.9 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

 

 

305.8 

 

 

0.1 

 

 

(6.5)

 

 

299.4 

General obligation municipal bonds

 

 

1,303.8 

 

 

2.6 

 

 

(10.6)

 

 

1,295.8 

Pre-refunded municipal bonds(1)

 

 

64.7 

 

 

0.6 

 

 

(0.1)

 

 

65.2 

Revenue municipal bonds

 

 

851.3 

 

 

1.7 

 

 

(7.9)

 

 

845.1 

U.S. government agency securities

 

 

410.2 

 

 

 —

 

 

(14.8)

 

 

395.4 

Variable rate demand notes

 

 

854.7 

 

 

 —

 

 

 —

 

 

854.7 

Total available-for-sale securities

 

 

3,790.5 

 

 

5.0 

 

 

(39.9)

 

 

3,755.6 

Other

 

 

15.8 

 

 

2.1 

 

 

 —

 

 

17.9 

Total funds held for clients and corporate investments

 

$

4,480.2 

 

$

7.1 

 

$

(39.9)

 

$

4,447.4 

  





 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 



 

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.



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Included in money market securities and other cash equivalents as of February 28, 2018 were bank demand deposit accounts, time deposits, commercial paper, 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:







 

 

 

 

 

 



 

 

 

 

 

 



 

February 28,

 

May 31,

In millions

 

2018

 

2017

Funds held for clients

 

$

3,944.7 

 

$

4,301.9 

Corporate investments

 

 

97.3 

 

 

138.8 

Long-term corporate investments

 

 

405.4 

 

 

454.0 

Total funds held for clients and corporate investments

 

$

4,447.4 

 

$

4,894.7 



The Company’s available-for-sale securities reflected a net unrealized loss of $34.9 million as of February 28, 2018 compared with a net unrealized gain of  $32.0 million as of May 31, 2017.  Included in the net unrealized loss as of February 28, 2018 were 859 available-for-sale securities in an unrealized loss position.  Included in the net unrealized gain as of May 31, 2017 were 216 available-for-sale securities in an unrealized loss position. The available-for-sale securities in an unrealized loss position were as follows:







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

February 28, 2018



 

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

 

$

(5.2)

 

$

252.1 

 

$

(1.3)

 

$

34.7 

 

$

(6.5)

 

$

286.8 

General obligation municipal bonds

 

 

(8.0)

 

 

735.5 

 

 

(2.6)

 

 

71.4 

 

 

(10.6)

 

 

806.9 

Pre-refunded municipal bonds

 

 

(0.1)

 

 

7.2 

 

 

 —

 

 

0.5 

 

 

(0.1)

 

 

7.7 

Revenue municipal bonds

 

 

(6.1)

 

 

435.7 

 

 

(1.8)

 

 

51.6 

 

 

(7.9)

 

 

487.3 

U.S. government agency securities

 

 

(6.8)

 

 

219.3 

 

 

(8.0)

 

 

176.1 

 

 

(14.8)

 

 

395.4 

Total

 

$

(26.2)

 

$

1,649.8 

 

$

(13.7)

 

$

334.3 

 

$

(39.9)

 

$

1,984.1 

  





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

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 February 28, 2018 that had gross unrealized losses of $39.9 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 February 28, 2018 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

8

 


 

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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 and losses were insignificant for the three and nine months ended February 28, 2018 and February 28, 2017.



The amortized cost and fair value of available-for-sale securities that had stated maturities as of February 28, 2018 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.







 

 

 

 

 

 



 

 

 

 

 

 



 

February 28, 2018



 

 

 

 

 

 



 

Amortized

 

Fair

In millions

 

cost

 

value

Maturity date:

 

 

 

 

 

 

Due in one year or less

 

$

317.9 

 

$

317.9 

Due after one year through three years

 

 

820.5 

 

 

819.9 

Due after three years through five years

 

 

998.1 

 

 

990.7 

Due after five years

 

 

1,654.0 

 

 

1,627.1 

Total

 

$

3,790.5 

 

$

3,755.6 



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.



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







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 



 

February 28, 2018



 

 

 

 

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:

 

 

 

 

 

 

 

 

 

 

 

 

Commercial paper

 

$

225.0 

 

$

 —

 

$

225.0 

 

$

 —

Time deposits

 

 

150.0 

 

 

150.0 

 

 

 —

 

 

 —

Money market securities

 

 

30.0 

 

 

30.0 

 

 

 —

 

 

 —

Total cash equivalents

 

$

405.0 

 

$

180.0 

 

$

225.0 

 

$

 —

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

 

$

299.4 

 

$

 —

 

$

299.4 

 

$

 —

General obligation municipal bonds

 

 

1,295.8 

 

 

 —

 

 

1,295.8 

 

 

 —

Pre-refunded municipal bonds

 

 

65.2 

 

 

 —

 

 

65.2 

 

 

 —

Revenue municipal bonds

 

 

845.1 

 

 

 —

 

 

845.1 

 

 

 —

U.S. government agency securities

 

 

395.4 

 

 

 —

 

 

395.4 

 

 

 —

Variable rate demand notes

 

 

854.7 

 

 

 —

 

 

854.7 

 

 

 —

Total available-for-sale securities

 

$

3,755.6 

 

$

 —

 

$

3,755.6 

 

$

 —

Other

 

$

17.9 

 

$

17.9 

 

$

 —

 

$

 —

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

Other long-term liabilities

 

$

17.9 

 

$

17.9 

 

$

 —

 

$

 —

  





 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 



 

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.  Money market securities, which are cash equivalents, are valued based on quoted market prices in active markets. Time deposits are considered Level 1 investments as they are highly liquid and have a short-term maturity period, usually no longer than overnight.  Commercial paper is included in Level 2 because it may not trade on a daily basis.  Available-for-sale securities, including municipal bonds, variable rate demand notes, 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.



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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:







 

 

 

 

 

 



 

 

 

 

 

 



 

February 28,

 

May 31,

In millions

 

2018

 

2017

PEO receivables(1)

 

$

172.8 

 

$

137.8 

Purchased receivables(2)

 

 

281.4 

 

 

257.3 

Other trade receivables(3)

 

 

103.6